Cannabis ETFs: Safe Harbor for Investors of all Types?

Although the cannabis industry is growing steadily, with legal sales of nearly $15 billion globally in 2019, stocks in the space have proven to be much more volatile than expected, especially in the past year.

In this context, cannabis ETFs emerge as a practical possibility to easily diversify an investment and reduce the natural risk of the stock market. To understand how the major cannabis ETFs work, we spoke with the managers of the four major funds listed on the New York Stock Exchange (NYSE).

Cannabis ETFs

“Pure-play” ETFs (that is, ETFs that focus the majority of their portfolio on cannabis companies) are relatively new. The first of them debuted on the New York Stock Exchange in late 2017.

Tim Seymour, who heads the Amplify Seymour Cannabis ETF, explains that the inevitability of overall growth in the sector, coupled with the volatility of its company stocks, makes cannabis the ideal industry for this type of investment.

Investing in cannabis companies' stocks requires full-time dedication. This is the only way to understand and keep abreast of developments in the industry and laws, adds the investor, who is also a panelist on CNBC's "Fast Money".

But it's not just individual investors looking to diversify their portfolios that flock to these ETFs, says Dan S. Ahrens, director of the AdvisorShares Pure Cannabis ETF. The largest holders of ETF shares are in fact institutional investors.

Understanding the Cannabis Industry

According to Matt Markiewicz, manager of The Cannabis ETF, a large portion of cannabis investors choose to seek out the most liquid and sought-after stocks, those of vertically integrated cultivation companies. But they don't always make for the best opportunity.

"We believe that investors should be exposed to some of the subgroups of the sector, which include growing, retail, testing, medicine, CBD, extraction and adjacent businesses." Investors, says Markiewicz, can benefit from the diversification, liquidity, and dividends that ETFs deliver.

4 Options in Cannabis ETFs

There are numerous cannabis-focused ETFs on Canadian Stock Exchanges. In this article we focus on the four main ETFs traded on the New York Stock Exchange, the most familiar to investors in Latin America.

1. ETFMG Alternative Harvest ETF (NYSE: MJ)

The ETFMG Alternative Harvest ETF (NYSE: MJ) was the first cannabis ETF to be listed on a US Stock Exchange, launched in December 2017. It is a passive fund that tracks the Prime Alternative Harvest Index.

This helps keep administration costs low, but in turn limits profit potential. According to its director, Jason Wilson, MJ is the most liquid ETF on the market.

Its assets total more than $ 567 million, making it larger than all other cannabis ETFs combined.

Strategy:

MJ was designed to measure the performance of cannabis companies whose growth is associated with the progress of global legalization.

"This differentiated approach recognizes the fact that the cannabis industry is intertwined with many industries, and that many companies outside the cannabis industry ecosystem are likely to benefit from the continued move to legalization world-wide," says Wilson.

As a main criterion, MJ invests in companies that generate most of their income from the cultivation of cannabis, or its derived products.

Second, the fund invests in cannabis companies that offer services adjacent to cultivation and are expected to benefit from the global growth of the industry. Finally, and to a lesser extent, companies not directly related to cannabis are included, which can benefit from its growth.

2. Amplify Seymour Cannabis ETF (NYSE: CNBS)

The Amplify Seymour Cannabis ETF (NYSE: CNBS) debuted on the New York Stock Exchange in July 2019. It is an actively managed ETF led by Tim Seymour, who also runs the Seymour Asset Management fund.

Strategy:

CNBS is an actively managed ETF that, by internal mandate, must have at least 80% of its portfolio invested in cannabis companies. Those companies that derive more than 50% of their income from the plant fit this criterion.

“Being an actively managed ETF means that we are not tied to an index, we are free to buy and sell every day. That doesn't mean we do it. But if there are catalysts to invest, we can execute them quickly,” says Seymour. In his opinion, the nature of the cannabis industry today, with startups debuting on the stock market and many other companies entering mergers and acquisitions, requires the ability to adapt and act speedily in order to evolve in lockstep with the sector.

"The top 5 or 6 privately held cannabis companies in 2017 and 2018 are not the top ones today," he adds.

CNBS invests in Canadian, Australian THC companies, or companies that produce CBD, the non-psychotropic component of cannabis that is legal in the US.

The ETF avoids investing in US THC companies that, despite operating legally in the states they are based in, remain in violation of US federal law.

3. The Cannabis ETF (NYSE: THCX)

The Cannabis ETF (NYSE: THCX) was launched in July 2019.

This passive fund follows the Innovation Labs Cannabis Index, a global portfolio of stocks from companies focused on legal marijuana, hemp, and CBD products.

Matt Markiewicz, manager of the fund, was a director of iShares, the ETF arm of the BlackRock fund, for six years.

Strategy:

For a stock to be listed on the Innovation Labs Cannabis Index, it must be listed on the NYSE, NASDAQ, Toronto Stock Exchange (TSX) or Australian Stock Exchange (ASX); operate legally in the jurisdiction in which it is based; and have a market capitalization of at least $ 100 million. Furthermore, none of the positions can be worth more than 8% of the total value of the index.

For Markiewicz, THCX is a pure-play cannabis fund that boasts even more purity than its counterparts, as it does not feature any stocks from alcohol or tobacco companies.

“On a recreational basis, T&A are losing market share to cannabis. T&A stocks are defensive while cannabis is a growth theme. Defensive stocks should not be part of a growth portfolio,” he explains.

Seeking to reduce its exposure to the industry’s inherent volatility, THCX reviews and adapts its portfolio on a monthly basis, in contrast to the other passive cannabis ETFs that do so on a quarterly basis.

4. AdvisorShares Pure Cannabis ETF (NYSE: YOLO)

The AdvisorShares Pure Cannabis ETF (NYSE: YOLO) was launched in April 2019 and was the first active cannabis ETF in the United States. In turn, it is the only ETF that includes significant investments in multi-state cannabis operators in that country.

Strategy:

The AdvisorShares Pure Cannabis ETF is not based on an index, but rather selects stocks individually.

“We hand-select cannabis-related companies that we believe offer the best opportunities for price appreciation,” says Dan S. Ahrens, manager of the fund. AdvisorShares only looks for companies with sources of income coming from cannabis at least 50%, avoiding companies whose main income comes from tobacco, alcohol, fertilizer or lighting for cultivation.

What are ETFs?

Exchange Traded Funds are publicly traded mutual investment funds. They differ from traditional mutual funds in that their shares can be bought and sold just like the shares of publicly held companies.

An ETF portfolio can include stocks, bonds, and assets. By participating in an ETF, investment risk is reduced because the fund's assets are much more diversified than those of a typical company.

Actively vs. Passively Mananged

There are two basic types of ETFs: actively managed and passively managed.

Passively managed ETFs are dedicated to tracking an index. This helps keep administration costs low, but in turn limits profit potential.

Actively managed ETFs are dedicated to selling and buying shares based on their own criteria, with the aim of increasing the profits produced by the fund. This activity means a higher cost of administration, but can provide a greater return for the investor.

Administration costs are deducted from the net value of the fund, and are not charged separately.

Natan Ponieman co-authored this article.

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