Marijuana ETFs have been among the best-performing sectors of 2021 and it's easy to see why. At the fundamental level, growth and demand are improving significantly, but legal victories (cannabis legislation passed in four states in the November elections) are quickly paving the way to legalize and de-stigmatize the use of cannabis-related products.
Year-to-date, many of the big marijuana ETFs are up more than 25%. Over the past three months, several have gained more than 75%. Over the past couple of years, pot stocks have traded on speculation more than anything, but the Aphria-Tilray merger signaled that a narrative may finally be building making them a more viable investment option.
Two of the biggest funds in the cannabis space are the ETFMG Alternative Harvest ETF (MJ) and the AdvisorShares Pure Cannabis ETF (YOLO). MJ got the first mover advantage and, thus, is the largest in the group with assets of about $1.5 billion, but there are now 7 different marijuana ETFs available. That means more choice for investors, more competitive fees and different styles to approach investing in the sector in different ways.
MJ and YOLO are notably different and choosing which you might prefer requires a deeper dive into the styles of both.
Passive vs. Active
The biggest difference between the two is that MJ passively follows the Prime Alternative Harvest Index, while YOLO is actively managed.
According to the MJ prospectus, the fund's index will target companies that
- are engaged in the legal cultivation of cannabis, including industrial hemp, or the legal production, marketing or distribution of cannabis, including industrial hemp, products for medical or non-medical purposes
- engage in the lawful creation, marketing or distribution of prescription drugs that utilize cannabinoids as an active ingredient
- trade tobacco or produce tobacco products, such as cigarettes, cigars or electronic cigarettes
- produce cigarette and cigar components, such as cigarette paper and filters
- engage in the creation, production and distribution of fertilizers, plant foods, pesticides or growing equipment to be used in the cultivation of cannabis or tobacco
You can see that MJ casts a pretty wide net when it comes to defining what it means to be involved in the cannabis industry. Owning companies that cultivate cannabis directly or manufacture products that use cannabinoids makes intuitive sense. Companies that produce tobacco products, such as cigarettes? Perhaps. Produce cigarette paper and filters? Not so much. Produce fertilizers and plant foods? That's a bit of a stretch.
YOLO offers more direct exposure to the sector. It targets the securities of companies that derive at least 50% of their net revenue from the marijuana and hemp business. That's an important distinction because it eliminates companies like Scotts Miracle-Gro from consideration (or any other company that has only ancillary exposure to cannabis).
The active nature of YOLO also makes it a preferred choice. In an industry, such as cannabis which is evolving rapidly, it's important to have a portfolio that can quickly pivot to changing conditions. MJ's index rebalances quarterly and may not be able to keep up with immediate changes to the industry.
Both of these factors make YOLO more preferable in this scenario.
Both MJ and YOLO are mostly invested in companies categorized as healthcare or consumer defensive. That part isn't surprising, but what is is what the funds are invested in outside of the top sectors.
MJ has modest exposure to both consumer cyclicals and materials. I attribute this to the wide net the fund casts. When you're willing to include consumer businesses outside of the industry's core and things, such as fertilizer companies, you're bound to get some non-traditional exposures.
YOLO is interesting because it has a relatively large exposure to REITs, although it comes largely from just one name. Innovative Industrial Properties (IIPR) is a REIT that invests in medical-use cannabis facilities, so its inclusion makes sense. The real estate sector has been beaten up over the past year, but IIPR has been the exception due to riding the cannabis wave.
Again, I prefer the greater allocation of YOLO to direct industry cannabis exposure. The addition of one of the biggest REIT's in the space is an added bonus.
YOLO would be considered the more globally diverse of the two funds. It has about 62% of assets dedicated to U.S. companies compared to 87% for MJ. The remainder of MJ's portfolio is split fairly evenly between Canada and the United Kingdom. YOLO's 35% allocation to overseas companies belongs mainly to the U.K.
Which allocation is better depends on where you think the industry's growth is going to come from. The more recent changes are in the United States and I think that's where the greater overall growth is going to come from in the near-term. In that case, MJ's exposure would be preferable, in my opinion.
In general, I'm a fan of more global portfolios, but MJ might have the better short-term potential here.
You wouldn't think of the cannabis sector as a place to find yield, but that's actually not the case. YOLO has a modest 1.4% yield, which is around what you'd expect (actually, many of these companies don't pay a dividend at all, so 1.4% might be a little high).
MJ actually pays a total yield of more than 8% right now. How in the world does it generate such a high yield? Securities lending. Demand for shares to short is high and MJ satisfies that demand by lending out its shares. It pockets a fairly hefty price for this lending and distributes the income received to shareholders.
Since it's not a traditional yield, I'd hesitate to say it's sustainable, but it's certainly an aspect of investing in cannabis stocks that MJ is taking full advantage of.
If forced to choose between the two cannabis ETFs, I'd go with YOLO. The actively-managed nature of the fund (which comes at no expense ratio premium to MJ, something that is usually the case when it comes to active vs. passive) along with the more focused exposure to the cannabis space are the tiebreakers for me.
I mentioned earlier the greater growth potential I believe there is in the U.S. market. Investors wishing to take advantage of that might prefer the AdvisorShares Pure U.S. Cannabis ETF (MSOS) and its focus entirely on domestic companies.