The rise of legal cannabis and the shift from the black market to the legitimate industry has led to the creation of many new cannabis exchange-traded funds (ETFs). An ETF is an investment fund traded stock, which trades on equity markets like any other stock, but holds assets made up of stocks, commodities, or bonds related to a certain area, such as cannabis.
Cannabis ETFs have actually been performing quite poorly as of late, mirroring tumbling pot stocks as the Canadian market continues to struggle, and the US market remains shrouded in regulatory and legal uncertainty. This, however, could represent a massive opportunity for savvy investors. It's worth remembering that cannabis is moving closer to, and not further from, the mainstream, and while individual firms may be buckling under the pressure, the composite nature of ETFs ensure they are best placed to reap the benefits of the cannabis market once it reaches maturity.
For investors looking to protect themselves from the worst of the market's underperformance, cannabis ETFs represent a good opportunity to spread the risk across a variety of assets.
How are ETFs Doing Right Now?
Much like the broader market, many ETFs appear in a spot of bother at the minute, dragged down by the disappointing performance of some big hitters like Canopy Growth (TSX:WEED) (NYSE:CGC) and Aurora Cannabis (TSX:ACB) (NYSE:ACB), and likely further hampered by the outbreak of the coronavirus. In fact, some cannabis ETFs are down over 50% in the last 12 months, and others have fared even worse and been forced to pack it in.
For example, the Evolve Marijuana Fund on the Toronto Stock Exchange was delisted in January after just two years, and a related US-focused cannabis ETF on the Toronto-based NEO exchange was also shut down.
Tim Seymour launched the Amplify Seymour Cannabis ETF on the New York Stock Exchange in July 2019, which now controls around US$7.5 million in assets. Speaking on the difficulties facing cannabis ETFs, he said, “raising money has been challenging for the past nine months. I would have preferred it if I had started the ETF fund in July of the previous year.”
It's hardly surprising to see ETFs specific to cannabis struggle in what is still a very nascent market.
Jason Wilson, a research and banking expert for the New Jersey-based ETFMG Alternative Harvest (NYSE:MJ), the largest cannabis ETF in the space, said, "There is always this question in an emerging industry as to what is the landscape going to look like. Companies are going through this process. There has been a lot of jostling to build up production capacity. There is a maturing going on, and it’s going to take some time.”
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Portfolio Diversification
One major benefit of cannabis ETFs is that they provide investors with an opportunity to diversify their portfolio without having to make multiple investments, and therefore spreads out the risk and makes an investment less prone to volatility. The cannabis market is very broad, with plenty of vertically integrated companies and just as many specified firms. For example, Canopy focuses on every part of the supply chain from seed to store, while The Valens Company (TSXV:VLNS) (OTCQX:VLNCF) is specifically focused on providing extraction services to major operators.
When you take all these differences into account, it's easy to see why it's important for investors to identify and invest in each of these segments in order to diversify their risk. But that kind of diversification can be costly, and many investors may worry about placing all their eggs in one basket. Too much concentration in one stock can be dangerous, exposing your portfolio to a high level of volatility and risk.
Cannabis ETFs are for the Long-Term
The struggles of the Canadian market have been well documented, and many investors have been burned in the months following legalization. However, south of the border, the legislation remains murky and varies from state to state, making it even more difficult to invest in individual firms. According to ETFMG's Jason Wilson, “It’s very hard to pick individual winners when you have an industry where there is so little (federal) regulation, and, if you look at the Farm Bill passing in 2018 and legalizing hemp, we see that legalization is not enough in itself.”
Almost all cannabis ETF managers will agree on the need to invest in the industry long-term because of increasing global attraction and acceptability of the product, meaning the big picture view is much brighter than current market conditions. Tim Seymour believes that “while there is unlikely to be any federal descheduling anytime soon, things are going better than could be expected on the state's side. We actually have a better story than we did a year ago.”
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