What are ETFs?
An ETF, or exchange-traded fund, is a group of stocks or securities designed to track a particular index. ETFs trade on an exchange, and the price fluctuates as people buy or sell stocks during trading hours.
The ETFMG Alternative Harvest ETF
The ETFMG Alternative Harvest ETF was the first US ETF to focus on cannabis stocks. Founded on December 3, 2015, the fund tracks companies engaged in cannabis, tobacco, fertilizer, and pharmaceutical businesses across the world. It had approximately $836.8 million worth of assets under its management as of September 26. The ETF invests its holdings in approximately 40 companies across the world. It reconstitutes and rebalances its portfolio every quarter. It charges a 0.75%, or $7.5, management fee for every $1,000 invested.
MJ’s top ten investments constitute approximately 60% of its holdings. The fund invests 8.26% of its holdings in Aurora Cannabis (ACB) and 8.0% of its holdings in GW Pharmaceuticals (GWPH). It also invests in Canopy Growth (CGC) (WEED), Cronos Group (CRON), and Tilray (TLRY).
The Horizons ETFs currently include the Horizons Marijuana Life Sciences Index ETF (HMMJ), the Horizons US Marijuana Index ETF (HMUS), and the Horizons Emerging Marijuana Growers Index ETF (HMJR), which have exposure to cannabis stocks.
Founded on April 4, 2017, the Horizons Marijuana Life Sciences Index ETF tracks the North American Marijuana Index. It provides exposure to publicly traded cannabis companies in North America. HMMJ has net assets worth 614.9 million Canadian dollars as of September 25, and it charges a 0.75% management fee.
HMMJ invests 10.6% of its holdings in Aurora and 10.1% in Canopy Growth. The fund also invests in Cronos Group, Tilray, and GW Pharmaceuticals.
Founded on April 17, 2019, the Horizons US Marijuana Index ETF seeks to track the US Marijuana Companies Index. It provides exposure to North American public companies involved in the cannabis and hemp businesses in the US. It had net assets worth 14.1 million Canadian dollars on September 25, and it charges a 0.85% management fee.
Founded on February 13, 2018, HMJR tracks the Emerging Marijuana Growers Index. It provides exposure to small-cap public cannabis companies in North America. The fund had net assets worth 5.6 million Canadian dollars on September 25, 2019. It charges a 0.85% management fee.
The Cambria Cannabis ETF
Founded on July 25, 2019, the Cambria Cannabis ETF focuses on investing in 20–50 micro-, small-cap, and mid-cap cannabis companies. On September 26, the fund’s net assets stood at $8.87 million. It charges a 0.59% management fee, and it maintains approximately 10% of its holdings in cash. It also invests 6.4% of its holdings in Aurora, 6.0% in Aphria, 5.3% in MediPharm Labs (MEDIF), and 4.9% in Constellation Brands (STZ).
Comparing the performances of cannabis ETFs
Since its inception, MJ’s CAGR, or compound annual growth rate, is -3.9% as of September 26. The Horizon ETFs HMMJ, HMUS, and HMJR have CAGRs of 9.6%, -74.1%, and -43.5%, respectively, since their inceptions. Since its inception, TOKE’s CAGR is -71.5%.
Now let’s look at the ETFs in the consumer and healthcare sectors. The Consumer Staples Select Sector SPDR ETF (XLP), which provides exposure to large-cap consumer staples stocks, was founded on December 22, 1998. Since its inception, XLP’s CAGR is 4.1%.
The Invesco Dynamic Pharmaceuticals ETF (PJP), which invests in companies involved in the pharmaceuticals and drug businesses, was founded on June 23, 2005. The ETF’s CAGR is 9.8% since its inception.
Since the beginning of 2018, MJ and HMMJ are down 32.5% and 30.9%, respectively. During the same period, XLP has risen 7.6%, while PJP has fallen 11.9%. So since the beginning of 2018, cannabis ETFs have underperformed their peers. Cannabis companies’ higher-than-expected operating losses and regulatory scandals appear to have dented investor confidence.
What could drive these ETFs higher?
On September 26, only 11 states in the US had legalized recreational cannabis, and 33 had legalized medical marijuana. In December 2018, the US government legalized hemp, a type of cannabis. Hemp contains less THC (tetrahydrocannabinol), which provides the “high” that’s associated with cannabis, and more CBD (cannabidiol). CBD extracted from hemp is used for medical purposes. However, the FDA hasn’t authorized any CBD products except Epidiolex, which is used to cure seizures.
On September 25, the US House of Representatives passed the SAFE (Secure and Fair Enforcement) Banking Act of 2019. The bill allows financial institutions to conduct business with cannabis players. If it’s enacted, it will provide cannabis companies with access to capital, which could support their expansion plans. The bill will move to the Senate next for clearance.
Canada legalized recreational cannabis in October 2018. Currently, it allows for the sale of marijuana only in the form of dry leaves, oil, and gel. In the second phase of legalization, which is scheduled for October, Canada is set to legalize derived cannabis products such as vapes, edibles, and infused beverages.
These developments may be positive for the cannabis stocks held by the ETFs mentioned above. There’s a chance that these ETFs will reverse their losses if the cannabis sector starts seeing more regulatory easing in the US and around the world.
On the flip side
The cannabis industry is still in its growth phase, so opportunity abounds. However, the sector faces uncertainty on the legalization and regulatory fronts. For example, on September 17, CNBC reported the seventh vaping-related death, which occurred in California. These health concerns could affect vape legalization in terms of Canada’s Cannabis 2.0 rollout next month. Cannabis industry players rely heavily upon the vaping market, so as more stories about the dangers of vaping emerge, their hopes could dampen.
Recently, Health Canada suspended CannTrust Holdings’ (CTST) license under the Cannabis Act over regulatory issues. The FDA also warned Curaleaf Holdings about promoting unapproved CBD-based products.
These risks could negatively affect cannabis companies, which could, in turn, affect cannabis ETFs.
Why are ETFs less risky?
Those who invest in cannabis stocks expose themselves to the kinds of risks mentioned above. However, by investing in cannabis ETFs, you can minimize stock-specific risks by accessing a diversified portfolio of stocks.
Although cannabis ETFs have underperformed ETFs in other sectors since the beginning of 2018, we expect the following factors to potentially boost cannabis ETFs’ performances:
- an increase in the number of US states that legalize marijuana for both medical and recreational purposes
- cannabis legalization at the federal level in the US
- the second phase of legalization in Canada
- growth in the US hemp business
- more countries legalizing cannabis
The cannabis sector is still in its nascency, so it’s sensitive to bad news. The banning of vapes due to growing concerns over recent vaping-related deaths, the delay in the legalization of cannabis at the federal level, and regulatory scandals could severely affect the sector.