Don't Get Burned: An Excerpt From Dan Ahrens' New Cannabis Investing Book

(The following excerpt is from the Chapter 16 of the book, “Don’t Get Burned”)

The choice of investing in individual stocks or using managed portfolios and exchange traded funds (ETFs) is up to each investor, or investment team, or advisor. I am biased, but I believe in the use of ETFs as the most efficient trading vehicle. As a portfolio manager, I can do things at an institutional level that individual investors simply cannot, such as the lending of portfolio securities to create quarterly fund income payments or ETF basket trades to minimize capital gains taxes. If an investor does want to choose their own stocks, I would invite them to follow what I do as a cannabis fund portfolio manager. There is nothing to hide. An exchange-traded fund’s website lists complete portfolio holdings on a daily basis. 

I am also biased toward investing in public, exchange-listed stocks – with the regulatory oversight and reporting that goes along with public stocks. It seems that almost everyone has heard about a friend of a relative, or neighbor, or co-worker who is involved in some type of cannabis opportunity. I would stay away from private deals and local investments. Like any entrepreneurial start-up business, most will not make it. Only a few will lead to great success stories. Many entrepreneurs are great idea people, but lousy businesspeople. Cannabis investing already has plenty of upside and plenty of risk. Stick to larger publicly traded stocks and ETFs.

For legal and compliance reasons, I am not going to describe individual cannabis related ETFs by name, but I will tell you what I like and do not like.

Actively Managed

I believe in active portfolio management. A fund’s portfolio manager should use information available to make decisions on the stocks to own, which to avoid, and when to trade. On the other hand, cannabis-focused exchange-traded funds that are based on an index seem rather stupid to me. In a very rapidly changing and volatile area such as cannabis, I would never want to invest by blindly following an index. An index fund is often weighted just by the size (market cap) of the companies they invest in. There is no portfolio manager making the investment decisions within the fund. With a large, diversified US index like the S&P 500, index investing makes perfect sense. The best performing companies often become the index’s largest companies and largest portfolio weightings. Widely diversified, large company index funds with low fees can often outperform. You get stocks like Apple and Amazon in the largest percentage. With a relatively new industry like cannabis? The largest market cap companies could very well be among the worst investments.

Exchange-traded funds are transparent. That means they are required to post their portfolio holdings for public view before each trading day. In considering an ETF, look at the fund’s top holdings. With an index-based fund in the cannabis space, you will almost always see top holdings in what I call “the usual suspects” of large Canadian LPs – Canopy, Cronos, Aurora, Tilray. I think you can do better.

Don’t follow an index. Active portfolio management and active cannabis stock selection, while still diversified, is the way to go.

Whether an investor is choosing their own stocks or using exchange-traded funds, cannabis investments should only make up a predetermined percentage of an overall portfolio. I can’t tell you what that percentage should be. It depends on an investor’s individual situation and risk tolerance. Cannabis investments are very volatile. Cannabis investments are high risk or speculative in nature. Any investment portfolio, whether individual or institutional, should be soundly diversified with investments that are less volatile than cannabis stocks.

I think a fund described as a cannabis fund should be just that – a cannabis fund. If an investor is properly diversified elsewhere, there should be no need for non-cannabis stocks within their cannabis fund. Companies like Altria, Constellation Brands, Scotts Miracle-Gro, Abbvie, and others could be good investments in general, but don’t kid yourself thinking that they are cannabis companies. They are not. Their primary focus is elsewhere. If an investment portfolio already holds an S&P 500 index fund or other diversified large company fund, the portfolio already holds stocks like Altria, Constellation Brands, Scotts Miracle-Gro, and Abbvie. I am a big believer in having investors know and understand what they invest in. I manage two funds for pure cannabis investments. I manage another fund for indirect, cannabis-related investments combined with alcohol and tobacco “vice” investments.

While the funds that I manage are of good size and trade very efficiently in my opinion, there are other very small cannabis-related ETFs in existence. Don’t be confused and think that because a fund is small or lightly traded that it is illiquid. Any exchange-traded fund’s liquidity is based on the fund’s underlying holdings. That means that most ETFs that hold exchange-listed stocks are perfectly liquid. But to be blunt, a tiny fund might trade like crap. A tiny fund could trade with big spreads between its bid and ask price (sell and buy price). A fund could go through portions of the day without trading at all, causing its price to look much different than its real value. A lightly traded fund could close the day without a recent trade, creating a significant premium or discount compared to its end-of-day real value (its NAV or net asset value price). Some people might call it inefficient trading. A nicer term to use may be to say that some ETFs do not always trade smoothly.

Use Limit Orders

In making a trade for an ETF, use limit orders. Do not place a market order. With a market order, you are subject to the ETF’s (or stock’s) prevailing bid / ask price at any point in time and may simply pay too much or receive too little. Investors don’t have to accept that. By simply placing a limit order between the posted bid / ask price, an investor should be able to get a good execution price on a trade. Better yet, before anyone places a trade at a brokerage firm they should call the fund company and discuss how to best place the order. A fund company representative should be able to easily quote the fund’s value at any time of the trading day and help with where to set a limit price. If placing a relatively large buy or sell order for a fund, always call first. A fund company like mine can communicate with institutional trade desks and market making firms to help assure a smooth trade and an accurate price.

See Also:

• Book List: 10 Cannabis Books To Help You Grow Like A Pro
• 10 Cannabis Books To Enjoy During Social Distancing

Photo Via Unsplash