The Marijuana Stock on the Rise
Investing in cannabis stocks always comes with an inherent risk.
While the moneymaking opportunities are potentially massive, the uncertain legislative status of marijuana in many jurisdictions worldwide has made the market prone to investor volatility.
Many pot stocks are also being hamstrung by poorly conceived government regulations, which are limiting their ability to adequately service the market. Too much investment in the sector may even result in an oversupply of product, causing a drop in the price of cannabis per pound that could have serious repercussions for cultivators.
However, while it's impossible to completely insulate yourself from risk when investing in the cannabis market, buying into a marijuana exchange traded fund (ETF) could protect you from the financial fallout of any one investment failing.
Similarly to a mutual fund, an ETF operates by using investor's money to make investments based on the strategy laid out in its' prospectus. The prospectus is a legal document outlining the fund's key information including the management team, finances, expenses, and overall investment strategy.
Although there are ETFs that invest in bonds and commodities, most funds typically invest in stocks by passively tracking the shares listed in an underlying index. These indexes are typically compiled by the ETF's issuer, or a third-party creator such as Standard & Poor's (S&P). Despite operating in a comparable fashion, one key difference between ETFs and mutual funds is that they can be bought or sold at any time during the trading day, which gives flexibility-oriented investors greater manoeuvrability in the market.
One of the largest marijuana funds in the world is the Horizons Marijuana Life Sciences Index ETF (TSX:HMMJ), which trades on the Toronto Stock Exchange. The fund tracks the North American Marijuana Index, which was compiled by the German firm Solactive, and is primarily composed of U.S. and Canada-based cannabis or hemp companies.
To become eligible for listing in the index companies must have a market cap higher than $75 million (CAD), and meet certain liquidity requirements, including a monthly daily trading volume that exceeds 75,000 shares, as well as an average daily trading value of $250,000 or higher.
Rather than purchasing an equal stake in each stock listed on the index, the HHMJ fund uses each company's quarterly market cap to adjust its' weighting. Each time the ETF commences quarterly rebalancing it limits the maximum weight for any one stock to 10 percent, although the weightings can become much larger in between these periods due to market volatility.
The most recent quarterly rebalancing took place earlier this month, and saw a number of new companies added to the ETF's portfolio, including Flowr Corp (CVE:FLWR), Heritage Cannabis Holdings Corp (CSE:CANN), ICC International Cannabis Corp (CSE:WRLD.U), and Zenabis Global Ltd (CVE:ZENA).
The president and CEO of Horizons, Steve Hawkins, called HMMJ the "best-performing equity ETF in Canada, with a year-to-date return of 58.95 percent, as at last Friday's close".
"As the number of listings and the market-capitalisation of cannabis stocks continues to grow so dramatically, so too have the number of eligible issuers to be included in HMMJ."
"This is why the ETF has added ten new names to its portfolio, bringing the total number of investee companies in HMMJ to 59," Hawkins said.
Another important piece of HMMJ news is Horizons' recent decision to pursue the increasingly lucrative CBD market. As part of this strategy it has added the Colorado-based company Charlotte's Web Holdings (CSE:CWEB) to the HMMJ investment portfolio, which now takes up 1.39 percent of the fund's overall holdings.
The senior vice-president of ETF strategy for Horizons, Mark Noble, described the investment as "a big one, a fairly substantial size".
"We've seen significant growth in that stock [this year], because people recognize there's going to be a direct revenue stream for that business," he said.
Despite the annual management fee of 0.75 percent on assets—which is almost three times the cost of an average ETF investment—the fund has become an attractive prospect for investors who are looking to buy in to the marijuana market. One reason for this may be that the fund is already paying a distribution to investors, even though a significant number of the companies it has invested in have yet to yield a dividend.
Horizons have been able to achieve this thanks to the fund's reliance on securities lending, which has allowed it to generate revenue despite the embryonic nature of most cannabis markets. While the notoriously high volatility of cannabis stocks may discourage long haul investors, they have proven particularly attractive to traders who are willing to take on a short position. The fund has been able to generate a considerable return by lending shares to short sellers looking to unload them on the market before buying them back later at a reduced price.
According to senior vice-president, Mark Noble, numerous cannabis stocks in the HMMJ portfolio can be lent out for a robust rate.
"Due to a number of factors that include … volatility and the amount of free-market float and available lenders, many of the stocks in HMMJ can be lent out at higher-than-average lending rates compared to what is available for traditional large-cap equities," Noble said.
However, the company has also cautioned investors that payment of an HMMJ dividend is not guaranteed, saying that they will be declared "at the discretion of Horizons ETFs and may not be announced with a set frequency".
"With a limited operating history, Horizons ETF believes that the disclosure of an annualized yield for the ETF at this time would be misleading to unitholders," a company spokesperson said.
To Be Blunt
Although HMMJ had a highly successful 2017—generating a return of nearly 85 percent—2018 was a different story. Unfortunately, while the ETF started the year up by a double-digit percentage, by the end of 2018 it had plunged by almost 31 percent.
While it seems likely HMMJ will perform better in 2019 than it did the previous year—having already netted a year-to-date return of 58.95 percent as of March—investors should also remain wary that investing in ETFs comes with several drawbacks, such as high expenses.
The HMMJ has an expense ratio of 0.94 percent—which is considerably higher than most ETFs—despite roughly three quarters of the fund's net assets being held in just ten stocks. In contrast, several of the most popular index ETFs on the market have an expense ratio of less than 0.10 percent.
Another massive issue with the fund is that its' net assets are heavily loaded with stocks that have excessively large market caps. The three biggest HMMJ holdings are currently Aurora Cannabis, Canopy Growth, and the Cronos Group, which all had staggeringly high valuations that may have left their stock overpriced.
This means that investors who bought into the fund as a means of volatility reduction may find themselves unable to weather a sudden shift in the market due to a lack of adequate stock diversification.
However, even though the fund suffered some losses in value over the course of 2018, it still managed to reach $1 billion in assets by September. While the HMMJ stock price did eventually plunge to 14.04 in December—the lowest it's been since November 2017—it has also already begun to rebound, and as of March this year it was trading at 23.65.
Despite being a passively managed index, the HMMJ has still managed to outperform other cannabis-centric ETFs that offer more active investment management. The CEO of Horizons, Steve Hawkins, says that the fund's goal of providing investors with exposure to a basket of North American cannabis companies has been a key component of its' success.
"While there are clearly leaders in the Marijuana equity sector, nobody knows for sure which companies will truly be successful over the long term or even be swallowed-up," Hawkins said.
"HMMJ's one-ticket, diversified investment solution has become very popular with investors looking to get broader exposure to the sector while mitigating single-stock risk without being subject to any active management bias."
The only thing left for investors to do now is sit back and see just how far HMMJ's ticket is going to take them.