Cannabis Investment: Mutual Funds And The Green Rush

Marijuana ETFs (exchange-traded funds) provide investors with a way to invest in a range of cannabis-related companies. These include companies that grow, distribute, or sell marijuana, as well as those that research its medical uses. Marijuana ETFs can also include companies with significant exposure to marijuana stocks, such as those in the alcohol and tobacco industries. While investing in cannabis comes with considerable risk due to regulatory uncertainty and the illegal status of marijuana at the federal level in the US, the potential reclassification of cannabis as a less dangerous drug may breathe new life into cannabis stocks.

Marijuana ETFs vs. stocks

There are hundreds of cannabis stocks to choose from, many of them risky penny stocks or stocks of companies with extremely small market capitalizations. Given the industry's youth, there's ample room for shakeouts that could significantly affect a stock's price. There will likely be many losers, and it's hard to predict the number of potential winners. The current state of the industry makes an already risky strategy—picking individual stocks—even riskier.

Marijuana ETFs still come with considerable risk, but you'll at least broaden your exposure to dozens of companies. If one company in the fund fails, those losses will ideally be offset by another company's success. You could miss out on the sky-high returns of an individual breakout stock, but investing in ETFs could help you avoid significant losses in such an unproven industry.

Marijuana ETFs let you invest in companies that operate in every vertical of the marijuana industry, from product conception to consumption. For example, the AdvisorShares Pure US Cannabis ETF (the largest cannabis ETF in terms of assets under management) invests in companies from across the entire marijuana industry, including GW Pharmaceuticals, Cronos Group, Canopy Growth Corporation, and Aurora Cannabis.

Investing in marijuana ETFs spreads your risk across multiple companies and segments of the industry, rather than concentrating it in any single stock. This strategy, known as diversification, is a proven method in any kind of investing but is especially important in a sector as new and volatile as the cannabis industry.

However, one potential downside of investing in marijuana ETFs is that they generally have very few companies in their portfolios worth investing in, and the rest can drag them down. Because they only have a select few worth investing in, you would probably outperform the ETF by investing directly in those few companies.

The risks of marijuana ETFs

Marijuana ETFs come with considerable risk. Here are some of the risks to consider:

Regulatory Uncertainty

Although recreational marijuana consumption and possession is now legal in several states, and medical marijuana is legal in even more, marijuana is still considered an illegal substance by the federal government. The recent proposal to shift it from Schedule I to Schedule III could open up more opportunities for medical research and commercialisation, but it stops short of full recreational legalization. This regulatory uncertainty can impact the value of marijuana stocks and ETFs.

Financing and Banking

While access to traditional financing and banking services has improved for marijuana businesses, there are still challenges and uncertainties in this area. The Secure and Fair Enforcement Banking Act, which would protect depository institutions that provide financial services to marijuana companies, was reintroduced in the House in 2023 but has not yet become law. The number of depository institutions providing banking services to marijuana companies has increased, but the landscape is still evolving, creating continued uncertainty in the short term.

Business Model and Operational Risks

The marijuana industry is subject to unpredictable business models and operations, which could significantly and quickly alter the future landscape. This includes issues such as oversupply, competition from the illicit market, and poor management. These factors can impact the performance of marijuana stocks and ETFs.

Volatility and Limited Growth

Marijuana ETFs have faced challenges due to the changing legal landscape, and their price fluctuations and limited growth have made them less attractive to investors. The regulatory uncertainties and the unpredictable nature of the industry can contribute to the volatility of marijuana ETFs.

Competition and Market Dynamics

The marijuana industry faces competition from the illicit market, where weed can be obtained at lower prices. Additionally, the industry is dealing with issues such as oversupply and lack of access to mainstream institutional investors and lending. These factors can impact the financial performance and competitiveness of marijuana companies, affecting the value of marijuana ETFs.

AdvisorShares Pure US Cannabis ETF

MSOS is managed by Dan Ahrens, a Managing Director and Chief Operating Officer of AdvisorShares, who has over two decades of experience in the financial services industry. The fund has delivered strong performance, outperforming the S&P 500 with a year-to-date gain of 27.8% as of May 8, 2024. As of March 1, 2024, it had total net assets of $892.50 million, making it the largest cannabis ETF in terms of assets under management.

The ETF provides easy access to U.S. cannabis exposure by trading on the NYSE Arca exchange, allowing investors to buy multiple cannabis securities in a single trade. It offers investors a convenient way to gain exposure to a variety of cannabis-related businesses, including agriculture, biotechnology, pharmaceuticals, real estate, and finance. The active management approach allows the portfolio manager to adjust the portfolio quickly in response to market changes.

MSOS can be used as a thematic investment, providing specific exposure to the U.S. cannabis market, or as a high-growth complement to a broad-based equity allocation. It is suitable for investors who are willing to take on substantial risks and hold their investments for the long term.

Amplify Alternative Harvest ETF

The Amplify Alternative Harvest ETF (or MJ) is a passively managed fund that tracks the Prime Alternative Harvest Index, which focuses on companies within the cannabis ecosystem that benefit from medicinal and recreational cannabis legalization initiatives. It was the first US ETF to target the global cannabis industry.

The fund's objective is to seek investment results that generally correlate (before fees and expenses) to the total return performance of the Prime Alternative Harvest Index. The fund's net assets recently stood at $324.2 million, and its shares have gained 27% year-to-date as of May 8, 2024. It has an expense ratio of 0.78%.

The global cannabis market is expected to show an annual growth rate (CAGR 2024-2028) of 14.06%, resulting in a market volume of USD $102.9 billion by 2028. The US market is expected to reach $67 billion by 2028.

The Amplify Alternative Harvest ETF is not without risk. The possession and use of marijuana are illegal under federal and certain states' laws, which may negatively impact the value of the fund's investments. Federal law criminalizing marijuana use pre-empts state laws that legalize its use for medicinal and recreational purposes. Cannabis companies may never be able to legally produce and sell products in the United States or other jurisdictions.

Cambria Cannabis ETF

The Cambria Cannabis ETF (TOKE) is an actively managed fund that aims for capital appreciation by investing in 20 to 50 of the top cannabis companies worldwide. It is a global, all-cap portfolio that provides exposure to the broad cannabis industry, including related industries such as real estate, food, medicine, and tourism. With a low expense ratio of 0.42%, it is one of the cheapest options among non-leveraged cannabis ETFs.

The fund's net assets were valued at $9.2 million in July 2023 and $11.1 million in May 2024. TOKE has shown positive performance, with a year-to-date increase of 9.9% as of May 8, 2024, rebounding from a period in the red during the first quarter. The fund's median bid-ask spread is calculated over 30 calendar days, taking into account the national best bid and offer every 10 seconds during trading days.

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