Cannabis ETFs: A “President Sanders” Hedge

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Cannabis ETFs: A “President Sanders” Hedge

Back in August, we answered a common question we receive about investing in the legal marijuana industry: “why aren’t there more US-listed exchange traded funds to choose from?” Our good friend and Managing Director at Innovation Shares, Matt Markiewicz (also a DataTrek client), gave us first hand insight having just launched The Cannabis ETF (THCX) a month prior.

Here’s a brief recap of why it is so difficult to get a cannabis ETF off the ground, which took his firm several months longer than usual to do so:

  • It’s very hard to find a custodian for a marijuana-based fund because most banks or broker dealers do not want to risk violating US banking laws since cannabis is Federally illegal.
  • Many investment platforms, such as the major wirehouse firms, ban marijuana ETFs because of the drug’s national illegality.
  • Since the marijuana industry is so new, cannabis stocks and the entire industry are under-covered by most research analysts and investment banks. Consequently, there is a shortage of education among investors.

Now that THCX has been out for +6 months (since July), Matt was kind enough to meet back up with us to share the 3 biggest surprises he’s encountered while trying to market his cannabis ETF:

#1: Binary reactions from the advisor community: Despite that two-thirds of Americans favor legalizing marijuana according to the latest Gallup poll, it remains a deeply polarizing topic in investment circles. Either advisors do not want to invest in a marijuana ETF because it is still Federally illegal, or because they have had a negative experience with marijuana which has impacted their investment views.

On the flip side, some advisors feel obligated to look into a marijuana ETF due to client demand, or they have a positive personal perspective on the drug (particularly on the medicinal side). Bottom line: there is not much grey area here, it’s either a yes or no at the top of a conversation before even getting into the details of the fund.

#2: Low level of education: A lack of understanding about the industry persists. Advisors are more aware of big, liquid names, such as Canopy Growth or Tilray. But there are additional kinds of public cannabis stocks than just the better-known Canadian growers. Some investors therefore don’t fully appreciate the variety of marijuana-related stocks within a fund, such as midstream companies that serve the marijuana market or those with exposure to CBD.

The upshot: there is still little financial research coverage on the cannabis industry at bulge bracket firms, leaving a dearth of information from which advisors can learn about this relatively new market.

#3: Misunderstanding about a marijuana ETFs’ role in a portfolio and lack of transparency from investment platforms: Most advisors focus on returns, which we recognize is important. That said, a cannabis fund like THCX also offers diversification benefits with low correlation to other broader market-based ETFs like those that track the S&P 500. Matt views a marijuana ETF’s role as a sliver of a growth equity position, and should only make up about 3-5% of a total portfolio.

Moreover, many advisors are unsure if they can even buy marijuana-based investments. Some platforms have also unexpectedly stopped allowing investors to trade cannabis stocks or ETFs. Additionally, cannabis ETFs cannot advertise or be on many large platforms, which is a big headwind to asset gathering for these funds. In the end, marijuana’s illegality on a Federal level leaves advisors living in the grey.

One point of interest we did not fully appreciate: an ETF loaded with heavily shorted names can pay a dividend with the proceeds from lending stock. Payouts will vary with lending rates, of course, but in January THCX paid a $0.418/share even though its portfolio holdings generally have no payout.

We’ll close with how Nick and I ended our conversation with Matt relative to the investment merits of cannabis just now. If you are worried about Bernie Sanders becoming the Democratic presidential nominee and therefore a potential US President, marijuana stocks or a cannabis-based ETF are a sensible equity portfolio hedge for that scenario. At a rally before this week’s Iowa caucus, Sanders pledged: “On my first day in office through executive order we will legalize marijuana in every state in this country.”

Whether or not that is feasible, public marijuana stocks’ best chance of working is with national legalization. A President Sanders would be a huge step forward in making that happen.