CTA Investing in Commodities and Carbon Markets

EMS:
Absolutely. So to kick off the conversation, tell us a little about your firm and how you got to where you are today.

CAB:
Absolutely. So Sigma Advanced Capital Management is a commodity trading advisor hedge fund based in Chicago. We specialize in niche absolute return strategies with a focus on commodities and carbon markets. And as a firm, we are actively seeking investment solution that is generating attractive performance, while also having a positive climate and social impact by supporting different projects and initiatives aligned with the global sustainability development. Our firm established in 2016, and in 2020, we launched one of the first investment programs in the US focusing exclusively on carbon emission markets.

EMS:
Carlos, given your focus on CTA investing in commodities, especially carbon markets, love to hear your overall outlook for the space.

CAB:
Yes. So the energy transition, I believe is presenting several opportunities. And let me go in further details in the specific of the carbon markets that is where we focus on. In the first place, Europe recently approved a significant policy called the Fit for 55 package, and this initiative is set to be more aggressive in reduction emissions by 2030, meaning that there will be less supply of carbon allowances in the market. It decreases supply may create a scarcity of carbon allowances and support a bullish case of the European compliance carbon markets. As you see, European allowances or carbon allowances have increased tremendously from 2020, we're trading around €20 to around €90 today, and big part of that is related with this Fit for 55 package.

However, the European reference gas, the TTF has seen a notable decrease in price compared to last year when the energy crisis was a main thing, and this price drop has made a gas to coal switch, especially in the utilities to take a role again. In the short term, saying that coupled with another macro variables and the decrease in industrial demand, we see a potentially impact in this bullish case that we believe exist. But in the coming months, we see that that bullish case could be impacted. Not only Europe but also the UK have been in a similar way.

The UK initiated a consultation back in March 2022 and published their recommendation this year on their own emission trading system. And we anticipate that several reforms such as an important reduction on the current cap trajectory, again meaning less supplies of allowances extending this system from 2030 to 2050, including more sectors. All of that is very, very positive in the carbon space in the United Kingdom, creating a bullish scenario for UK allowances. And not to mention that the potential impact of weather and renewable generation can play a role in this market as well. And even though the UK government has been delaying the announcements and have an impact in prices, I believe that this announcement and policy package will occur in the UK sooner rather than later and will align with the overall UK net-zero strategy.

That again, if it's adopted as the recommendations suggest, it will be very, very attractive in 2024 and going forward. And lately, not to mention is the United States. The United States is also stepping up with cities like Washington and New York developing their own emission trading system. Also, the cap and trade, it's known as the cap and trade. California, that is the most consolidated market in the US, is looking and discussing a more aggressive emission reduction similar path as the Europe and the UK, and the carbon compliance market has been growing in the US. And more than that, if you put the Inflation Reduction Act, that includes tax benefit and other financial incentive aimed at making clear energy and more accessible and incentivize the energy transition, I think all of that and all these developments represent a very promising business case in a new niche asset class that historically has shown very low correlation with other asset classes.

EMS:
Carlos, as a follow-up, where do you see some of the greatest opportunities looking ahead and why?

CAB:
For that question, let me talk a little bit more about the macroeconomic environment. I believe that the emergence of a new macroeconomic regime characterized by higher borrowing cost, increased volatility as sustained inflation has prompt achieved in client preferences. I believe the traditional 60/40 portfolio are being adapted by ones that incorporate more non-correlated alternative investments such as hedge funds, commodity, real assets, and assets that I think should be in a portfolio of times of low, high volatility, and between.

With this current macroeconomic environment, I anticipate that a more tactical and active portfolio strategy will yield the best opportunities across diverse asset classes. As I mentioned before, I firmly believe one of the greatest investment opportunities in the coming years will arise from the energy transition, not only in carbon markets as a commodity but in the equity space, in debt, in VC, but coming back to the carbon markets seen as a asset class and as a potential diversification characteristics, I think this market is one of the most attractive opportunities.

Just to give you an idea, back in 2020, the total market was around 200 billion, the compliance market. Last year was around 900 billions, and they showed and new development that I mentioned before I think will create really interesting strategies, opportunities, new instrument to invest. Additionally to that, I'm personally drawn to technology removal solutions such as direct carbon capture and carbon capture utilization and storage alongside with green hydrogen and sustainable fuels. I believe the energy transition is not only one mechanism, it's not only one market, but I think it's a portfolio of different actions and investment in different sectors that will help and convince this market process a substantial growth potential and offer significant, again, opportunities. And investors can access these markets to different channels, private equity, venture capital, exchange market, public equity derivatives, and there why providing diverse franchise option. So that's my view could be a little bit biased due to my focus, but again, I believe in the energy transition as a whole is a whole opportunity.

EMS:
Carlos on the other hand, what are some of the greatest challenges you face and why?

CAB:
That's a great question, and I think I foresee that risk that we have seen in the past like persistent inflation, the energy security, the quantitative tiny thing by central banks will continue at least in the coming months or even years. And even with the recent normalization of the supply chains, I don't see a notable deflationary impact, and I believe the long-term inflation expectation still persist. And if inflation does not decrease, countries will be forced to maintain high interest rates and therefore, meaning impacting different asset clauses including mortgages, private debt, loans and more. I also see that both the Fed and the European Central Bank are raising interest rates, even though yesterday the Fed announced a pause, but they're still shrinking their balance sheets through the QT programs, and this could create a potential risk in default and liquidity that we have seen in the last months widening the spreads and increase the chances of our recessions.

For instance, I see an important risk in commercial loans, for example, and how the inflation decelerate will depend in a big part on the performance of commodities and especially on the labor market. Geopolitical issues, I think will continue to influence the markets as well, and it's a risk that is persistent in this environment. The ongoing conflict of Ukraine and Russia, tensions between Taiwan and China I think will remain significant discussion points. In addition, something that I want to point out is this technological dominance conflict between China and the United States that introduce an additional layer of risk and challenges to the markets. So in summary, I see geopolitical, I see macroeconomical, I still see the inflation as a risk and that's what I will oversee.

EMS:
Carlos, to shift gears a little bit with ESG and DEI top of mind for the industry, I wanted you to address how your firm is integrating those?

CAB:
Absolutely. And again, thanks for the question. So Sigma Advanced Capital Management, we are a purpose driven organization and we have this shift from a mission to a purpose back in 2018 where we define a well sustainability strategy to have a positive economic impact and that mean risk adjusted return for our investors, but also social and environmental impact. We are committed to developing and identifying investment solutions that as I mentioned before, have these attractive returns but also have an impact on the SDGs and help to facilitate investment into this transition or energy transition economy. In 2018, as I mentioned, we developed this strategy not to be too long and to extend too much, we focus on two main parts. One was our business operation in an effort to reduce our emission and increase our energy efficiency. And the second part was our investment.

So in the business operation part, what we did was to reduce our carbon footprint, adapt our technology. As a service company, our emission were not too high, but even though a small action can help us to create or to reduce our carbon footprint, especially troubling was one of that, plus other action that we took, recycling, virtual working, et cetera. And in the investment side, we developed this carbon investment program and we took one simple idea, but we think that is powerful, that we dedicate a percentage of our management and performance fees to support different projects with social and environmental and in the market. And that aligned with our core principle, we are a hedge fund. We are here to produce risk adjusted returns to our investor. So the more money we manage, the better performance we can have to our investor, the more money we can dedicate actually to support projects like biochar, direct carbon capture that today is very expensive or not sustainable if you talk about economics, but we are doing that.

Additionally, for that we have been part of... We are signatory of the principle of responsible investment and in compliance of the CFA Asset Manager Code. So to summarize all of that is as a company we really are aligned. We really believe in a sustainability, purpose, actions, not only as a firm but also in our investment. And we currently took actions to be a leaders in this industry, having first type reports on this and having actions or innovating in solutions that can have some impact in that.

EMS:
Carlos, we've covered a lot of ground today and wanted to see what your future plans are for the firm.

CAB:
Yeah, absolutely. So as I mentioned, we are committed to develop and find investment solutions with these attractive absolute returns while also directing this capital to different sustainability development goals. And the Carbon Neutral Alpha Program is our first solution in this regard. However, as our firm continues to grow, we are actively engaged in the development of new investment strategies. We strive to attract and work with the best talents, using the best technology to offer an investor innovative and profitable solutions, and they will come very slowly.

And this solution actually will help our investors not only to capitalize and to flow capital into these opportunities and new market transformation, but also is going to help our investors to have something non-correlated in their portfolio. Again, our core principle is simple, is to deliver these absolute returns, create diversification, and direct this capital into sustainability goals, and that will be the core as we expand. So innovation, growth, and expansion with our core principles.

EMS:
Carlos, I want to thank you so much for sharing your perspective with our listeners.

CAB:
Thank you so much for having me, Elana, and it has been my pleasure.

EMS:
And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a list of other topics. And join us for our next EisnerAmper podcast when we get down to business.

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