With support for cannabis legalization at an all-time high and cannabis stock prices hovering around 52-week lows, many investors have been considering whether to dip their toes in the cannabis industry. Investing in marijuana stocks can be challenging and even confusing to investors, with the current legal regulatory regime adding another layer of complexity.
Cannabis Industry: Broad and Diverse
One of the challenges investors face with regard to investing in the cannabis industry is deciding how to approach it. Investors must consider what segment of the industry they may want to focus on. The cannabis industry is incredibly broad and diversified; thus there are many ways to benefit from the overall growth of the industry. Consequently, the variety of investment opportunities may create confusion amongst investors. For example, should one invest in companies that grow, cultivate and sell cannabis? If so, should one invest in global companies that operate in legal global markets, or in domestic companies that must manage around the restrictions and hurdles relating to the current regulatory regime? Is it better to consider companies that sell products containing cannabis, such as health and wellness products, or pharmaceuticals? Another approach could be to invest in companies that support the cannabis industry, such as companies that provide financial services specifically to cannabis companies, companies that provide equipment and products to grow and cultivate cannabis, and companies that provide software and other related services specifically for cannabis producers. As with companies that grow, cultivate and sell cannabis directly, these types of companies that are ancillary to the cannabis industry are in a position to benefit from the overall growth of the cannabis industry, but without the legal issues involving companies that “touch the plant.” Additionally, ancillary businesses can benefit from industry growth with less sensitivity to cannabis pricing and taxes, two items that can have a material effect on the profitability of traditional cannabis producers.
Once these threshold decisions are made, investors must then consider how they will gain exposure. Most investors will look to buy individual stocks. However, conducting research on individual companies can be difficult for even the most experienced investors. Also, since many cannabis stocks (including stocks of cannabis companies that operate in the U.S.) trade on foreign exchanges in foreign currencies, or only trade over the counter, they can be difficult to invest in. When an investor has limited funds available to invest, the challenge of investing in single stocks becomes even greater as it is hard to gain adequate diversification in the industry and doing so can be very expensive as an investor may incur fees or indirect costs associated with purchasing a basket of companies.
Cannabis ETFs vs. Cannabis Stocks
For many investors, the obvious choice is to invest in a cannabis-focused exchange-traded fund (an ETF). Effectively, ETFs are bundles of securities that provide a cost-effective way to make diversified investments in a range of asset classes. ETFs can be easily traded, are available on virtually all investment platforms and to most types of investment accounts, and, as federally regulated entities, ETFs have strong governance—including transparency on fees and portfolio holdings. Currently, there are a handful of ETFs that provide exposure to the cannabis industry. The longest-standing cannabis-focused ETF, the ETFMG Alternative Harvest Fund, has both a global and industry-wide focus and trades on the New York Stock Exchange under the ticker MJ. MJ does not offer exposure to companies that grow, cultivate and sell cannabis in the U.S.; however, investors that would like more direct exposure to the U.S. market could consider the ETFMG U.S. Alternative Harvest Fund, which invests directly in MSOs and other cannabis-related companies that operate in the U.S. The ETFMG U.S. Alternative Harvest Fund trades on the New York Stock Exchange under the ticker MJUS.
Fractional shares are becoming increasingly popular with investors that wish to increase their portfolio diversification with limited investment capital. However, whether an investor can buy fractional shares of cannabis stocks or ETFs depends on the broker an investor maintains an account with. Some brokers offer fractional shares for most stocks or ETFs listed on a major exchange, while some brokers offer only a limited list of stocks and ETFs from which to choose. While many global cannabis operators and ETFs, such as MJ and MJUS, trade on major exchanges, U.S.-based cannabis operators trade on secondary exchanges, so investors can expect to experience more hurdles and difficulties in buying fractional shares of U.S.-based operators over global cannabis operators.
Even where investors wish to purchase whole shares instead of fractional shares, not all brokers offer exposure to stocks that trade on tertiary foreign exchanges. For brokers that provide access to stocks that trade on foreign exchanges, they will all have different procedures and costs. In some cases, the fees associated with purchasing a small number of stocks on a foreign exchange may be prohibitive, or at least might not make sense relative to purchasing an ETF that provides diversified exposure to the same types of stocks but trades on a primary exchange. Investors also need to understand the costs and procedures associated with buying stocks that trade in a foreign currency.
Regardless of whether an investor is buying the stock of a foreign or domestic cannabis operator, in whole shares or fractional shares, directly or through an ETF, most financial advisors will recommend investing for the long term. In this regard, it is important to consider many aspects relating to the company an investor is buying, including the financial strength and condition of the company, the experience and effectiveness of its management team, whether the company has a competitive advantage relative to its peers, and what the outlook of the company’s specific market is.
The Challenges
Investors are often unsure whether they should focus on companies that operate in the U.S. (the world’s largest cannabis market, even though it is federally illegal to grow and sell cannabis), or whether they should focus on cannabis companies that operate in legal global markets (such as Canada, Europe and South America) where the path forward is more certain but arguably more fractured.
There are pros and cons to both. At the moment, given the size of the U.S. market and the number of states that have legalized cannabis, cannabis companies that operate in multiple states (referred to as MSOs) have experienced stronger revenue growth than many of their global competitors. However, the federal illegality of cannabis has presented many challenges. As a result, MSOs have incurred higher operating costs as they face operational and funding hurdles, including not having access to traditional banking and capital markets services, and the inability to deduct many expenses relating to the sale of cannabis. Additionally, even though the U.S. represents the world’s largest cannabis market, until cannabis reform legislation is enacted, and the related regulatory framework is put in place, there will continue to be uncertainty as to what business model will be the most effective.
Although the U.S. market has significant potential, the current regulatory regime has left many U.S. operators feeling like they are in a knife fight with one hand tied behind their back, and they are not sure what is around the next corner. All of this has resulted in U.S. operators trading at a discount to their global peers. Looking forward, it is expected that this discount will disappear upon federal legalization—which based on public opinion appears to be a matter of if, not when; however, when legalization will happen and how it will affect different types of operators remains uncertain.
Industry Outlook
The outlook for the cannabis industry remains strong, especially with public support of legalizing cannabis at an all-time high. Additionally, many cannabis companies are trading at relatively low valuations for growth companies that are operating in an emerging industry. At a macro level, this makes investing in the cannabis industry an interesting proposition for many investors. However, it is important for an investor to remember and understand that most cannabis companies have limited financial track records, often have lesser experienced management and executive teams at helm, operate in new or uncertain markets where a change in regulations could result in significant disruption (including the potential upon legalization for increased competition from companies in more experienced industries), and in many instances have limited (and expensive) options to finance their growth plans. For these reasons, many investors choose to invest in a cannabis ETF that provides diversified exposure to the cannabis market of their choice versus buying individual domestic and foreign stocks on multiple exchanges.
To learn more about ETFMG’s collection of cannabis ETFs, visit: etfmg.com/cannabis.
Carefully consider the Fund’s investment objectives, risks, and charges and expenses before investing. This and other information can be found in the Fund’s summary or statutory prospectuses, available on www.etfmg.com. Please read the prospectus carefully before investing.
Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Narrowly focused investments typically exhibit higher volatility. The possession and use of marijuana, even for medical purposes, is illegal under federal and certain states’ laws, which may negatively impact the value of the Fund’s investments. Use of marijuana is regulated by both the federal government and state governments, and state and federal laws regarding marijuana often conflict. Even in those states in which the use of marijuana has been legalized, its possession and use remains a violation of federal law. Federal law criminalizing the use of marijuana pre-empts state laws that legalizes its use for medicinal and recreational purposes. Cannabis companies and pharmaceutical companies may never be able to legally produce and sell products in the United States or other national or local jurisdictions.
The Fund’s investments will be concentrated in an industry or group of industries to the extent that the Index is so concentrated. In such event, the value of the Fund’s shares may rise and fall more than the value of shares of a fund that invests in securities of companies in a broader range of industries. The consumer staples sector may be affected by the permissibility of using various product components and production methods, marketing campaigns and other factors affecting consumer demand. Tobacco companies, in particular, may be adversely affected by new laws, regulations and litigation.
The consumer staples sector may also be adversely affected by changes or trends in commodity prices, which may be influenced or characterized by unpredictable factors.
The Fund is distributed by ETFMG Financial LLC. ETF Managers Group LLC and ETFMG Financial LLC are wholly owned subsidiaries of Exchange Traded Managers Group LLC (collectively, “ETFMG”). ETFMG Financial is not affiliated with Prime Indexes.
