A 7% Dividend Yield From.... Marijuana Stocks?

Investors often think of REITs, junk bonds and utilities for high yields, but pot stocks offer an interesting option too.
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Stocks still yield less than 2%. The 10-year Treasury yield is well below 1%. The hunt for higher yields is on!

If you're someone seeking regular income from your portfolio, you probably don't like your options. The S&P 500 yields around 1.8%, but you can do modestly better without taking on too much risk. ETFs, such as the Schwab U.S. Dividend Equity ETF (SCHD), get you north of 3% and focus on high quality, long-term dividend growers.

Beyond that, however, you're looking at pushing yourself out on the risk spectrum. Not that this is necessarily a bad idea, but you do want to limit your exposure.

Utilities are a decent option for higher yield, but don't typically offer much growth. There's REITs, MLPs, junk bonds and other riskier stuff that can net you 5-6% yields or higher.

Looking for a bit of an off-the-grid high yield option for your portfolio? How about pot stocks?

Yes, companies that operate in the marijuana space are offering unusually high yields right now.

Where Is This Yield Coming From?

This might be the million dollar question. If you look at companies, such as Tilray, Aurora Cannabis, Canopy Growth or Cronos, none of them is paying any kind of dividend. Many of the top 10 holdings don't pay a dividend. So how in the world is the ETFMG Alternative Harvest ETF (MJ), otherwise known as the Marijuana ETF, paying out a 7% annualized distribution yield?

The answer: securities lending income.

Many of the most popular stocks and industries are also among the most shorted. Tesla may be the most talked about stock in the world, but it's also one of the most heavily shorted. In order to short sell, traders need to find the shares from somewhere in order to sell on the open market.

That's where securities lending comes in. Owners of marijuana stocks, or the MJ ETF, can lend out these securities to short sellers and pocket part of the commission for doing so. And in the cannabis world, there is no lack of short sellers.

Sustainability Of Securities Lending

One of the upsides of securities lending is that it can be a fairly sustainable process. As long as there's a market for short selling, pot stock owners can continue lending their shares for income. When securities are in greater demand, the yields for loaning those securities go up.

And that's what we're seeing with MJ. It's been enough to push the yield on this ETF to more than 7% over the past 12 months.

MJ_^MSWNTR_chart

While 7% is on the high side historically, it's been able to steadily maintain a yield above 5% for several quarters. The trailing 12-month yield shown above took some time to ramp up as it completed its transition from its original structure as a Latin American real estate fund. Since then, it's been generating a surprisingly sustainable yield.

The Downside Of MJ & Securities Lending

Of course, these yields aren't risk-free.

The marijuana industry is in its infancy, making it a highly volatile sector. If short interest starts drying up, the potential yield could go down.

And from a tax treatment standpoint, the income generated by this strategy may not qualify for a more tax-advantaged rate, since it's not technically a dividend in the traditional sense. Also consider that securities being lent are just like any other loan. The recipient of the shares loaned could be a credit risk exposing you to additional risk.

Conclusion

If you're willing to roll with a bit of an unorthodox strategy, adding MJ to your portfolio for a yield boost makes some sense. It also has the benefit of being a high growth potential sector, which could put you in line for outsized capital gains as well.

I wouldn't load up your income portfolio with MJ trying to make a huge yield grab. But using it to augment a broader dividend strategy isn't a bad idea.

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