New SEC Filings Reveal Risks In Cannabis ETFs Following Recent Volatility — But There's Still Room For Optimism (CORRECTED) - 4Front Ventures (OTC:FFNTF), Green Thumb Industries (OTC:GTBIF)

Editor’s note: This article has been updated to reflect the correct exposure of Green Thumb Industries (GTI) in the MSOS ETF and to clarify the structure and risk factors associated with MSOX and MSOS. Additionally, we’ve provided more accurate information on the liquidity of the ETFs and their underlying assets.

Cannabis investors have been navigating a complex and volatile market, with two major ETFs, the AdvisorShares Pure US Cannabis ETF MSOS and its leveraged counterpart, the AdvisorShares MSOS 2x Daily ETF MSOX, at the center of the storm.

Both ETFs have faced considerable headwinds in the form of regulatory uncertainty and underperforming stocks in the cannabis space, new SEC filings show. Yet the potential for regulatory reform — particularly the rescheduling of cannabis under federal law — along with emerging pro-cannabis political momentum, offers a glimpse of hope that could reinvigorate these funds and the broader market.

Closer Look At MSOS, MSOX: Performance And Market Pressures

In recent regulatory filings for MSOS and MSOX, we see a mixed picture of the ETFs’ positions and struggles. MSOS, which tracks a diverse range of U.S.-based cannabis companies, is facing significant pressure due to the prolonged regulatory gridlock in the U.S. and the economic downturn that has weighed heavily on growth-oriented sectors like cannabis.

The filings reveal the ETF’s holdings in prominent cannabis companies such as Green Thumb Industries GTBIF, Verano Holdings Corp VRNOF and Trulieve Cannabis Corp TCNNF. These stocks have shown both potential and volatility, yet have been unable to escape the broader downturn in the cannabis market. MSOS reported a 25.48% exposure to Green Thumb Industries, one of the most stable multi-state operators (MSOs), as of August 21, 2024, but the sector's struggles have prevented these assets from delivering consistent gains. This exposure includes a Total Return Swap (TRS) position on Green Thumb Industries with a notional amount of $18.39 million and an unrealized appreciation of $9.53 million as of the latest filing.

MSOX, the leveraged counterpart of MSOS, is built for more aggressive investors seeking amplified returns by leveraging the performance of MSOS itself. This strategy also means amplified risk, particularly in a volatile sector like cannabis. Unlike MSOS, which directly holds positions in cannabis stocks and Total Return Swaps (TRS), MSOX delivers its returns by applying leverage to the entire MSOS portfolio, rather than individual stock positions. While MSOS does have some exposure to 4Front Ventures Corp FFNTF, its weighting is relatively small at 0.24% as of yesterday's close, which further underscores the diversified yet leveraged risk of MSOX.

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Structural And Liquidity Challenges In Cannabis ETFs

The filings also shed light on some of the structural challenges these ETFs face. Both MSOS and MSOX hold complex financial instruments, including total return swaps on major cannabis companies like Green Thumb Industries, Verano Holdings, and 4Front Ventures. While these swaps can provide potential gains, current market conditions have pushed many of these positions into significant losses since May of 2024.

MSOX, which leverages the performance of the entire MSOS portfolio, has experienced depreciation in value due to the broader market downturn. While MSOS holds TRS positions, such as a $462,000 loss on 4Front Ventures and a $1.22-million depreciation on swaps tied to Vapen MJ Ventures Corp, MSOX does not hold individual stock positions or swaps but amplifies the overall returns and risks of MSOS.

These derivative positions are often tied to companies that are under pressure, not just from declining stock prices but also from liquidity constraints and challenges in raising capital due to the regulatory environment and restricted access to traditional financing options. While the ETFs themselves, particularly MSOS, are highly liquid, with an average of 9 million shares trading daily over the past 10 days, the underlying assets, such as cannabis stocks, can be less liquid. Many of these stocks fall into the microcap category, where liquidity is often more limited compared to larger-cap stocks. This lower liquidity in the underlying assets can still contribute to volatility, especially in leveraged products like MSOX, where market movements are amplified.

Additionally, regulatory uncertainty, especially around U.S. federal cannabis reform, has kept institutional investors cautious, limiting the inflows into cannabis stocks and ETFs. These structural factors have contributed to the subdued performance of MSOS and MSOX.

Potential Cannabis Rescheduling: Beacon Of Hope

Despite these challenges, potential catalysts could significantly alter the landscape for cannabis stocks and ETFs. One of the most prominent developments on the horizon is the potential rescheduling of cannabis from a Schedule I to a Schedule III controlled substance. This shift would be a monumental step for the industry, easing many of the financial and operational burdens that cannabis companies face under federal prohibition.

Rescheduling cannabis would alleviate major obstacles related to taxation (particularly the burdensome Section 280E of the tax code), banking access and investment restrictions. This move could unlock broader institutional investment, which has been largely absent from the cannabis sector due to its federal illegality.

It would also allow cannabis companies to deduct ordinary business expenses, vastly improving their profitability. The market is already speculating that rescheduling could prompt a wave of new investments into the sector, lifting ETFs like MSOS and MSOX.

Legislative Momentum: Harris, Walz's Pro-Cannabis Formula

On the legislative front, pro-cannabis political figures such as Democratic presidential nominee Vice President Kamala Harris and her running mate Minnesota Gov. Tim Walz are helping drive momentum for cannabis reform. The Harris-Walz formula seeks to advance legalization and cannabis-friendly policies that focus on progressive reform and social equity initiatives. Harris has been a vocal advocate for cannabis legalization and her influence, along with growing bipartisan support, could accelerate progress in federal reform efforts.

Walz, meanwhile, has been instrumental in advancing state-level cannabis reforms and advocating for broader change at the federal level. His focus on legalization and progressive cannabis policies in Minnesota could serve as a blueprint for federal policy, should he be elected. These initiatives, coupled with broader political momentum, create a more favorable environment for cannabis legislation, which could ultimately benefit ETFs like MSOS and MSOX.

Key Catalysts: Banking Reform, International Expansion And SAFE Banking

Beyond rescheduling, other legislative and regulatory changes could offer significant tailwinds for the cannabis sector. The SAFE Banking Act, which aims to provide cannabis businesses with access to traditional banking services, is another key area of focus. Cannabis companies have limited access to banking, forcing many to operate in cash — a risky and inefficient model that stifles growth. Passage of the SAFE Banking Act would provide cannabis companies with much-needed financial services, lowering operational risks and making the sector more attractive to institutional investors.

International markets also present growth opportunities for cannabis companies. Germany, for example, has emerged as one of the most significant markets for medical cannabis in Europe and recent regulatory developments suggest that the country could become a global leader in cannabis. U.S.-based cannabis companies, many of which are part of MSOS and MSOX's portfolios, have already begun expanding internationally and success in international markets could help offset some of the domestic challenges.

The Road Ahead For Cannabis ETFs

While the environment remains challenging, the future holds several potential catalysts for the cannabis sector. Cannabis rescheduling, legislative reform and international expansion offer promising opportunities for growth. As these developments unfold, they could provide much-needed relief for ETFs like MSOS and MSOX, which are poised to benefit from a more favorable regulatory landscape and the subsequent influx of institutional capital.

For investors, the key lies in navigating the current volatility while staying attuned to the potential for a turnaround driven by regulatory and legislative progress. ETFs like MSOS and MSOX, though battered by recent market conditions, remain well-positioned to capture the upside if these catalysts come to fruition. The road ahead for cannabis ETFs may be rocky, but with the right mix of policy changes and market momentum, the sector could see a significant rebound in the not-too-distant future.

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