What Are Marijuana ETFs?

Marijuana may still be in legal limbo, but that hasn't stopped the market from booming. With legalization creeping across various states and the whole of Canada, recreational spending in the U.S. alone is expected to grow to over $47 billion a year over the next decade.

As with any successful market, the more money that cannabis brings in, the more investors it will attract. The industry has moved from a handful of hobbyists to professional firms with industry and retail locations. They have created formal investment opportunities and stock offerings.

For some investors that's where they story ends, with sinking some money into a single company. Investors who'd like a bit more diversity, however, can explore marijuana ETFs.

What Is a Marijuana ETF?

As we discuss in our ETF article, an Exchange Traded Fund (ETF) is a form of bundled investment. Like a mutual fund, an ETF is not a single investment. Instead it is a group of assets, such as stocks, bonds, commodities or currencies, bundled into a product which produces its return based on their aggregate movement.

Typically an ETF is organized around a central theme. It might track a market or it might be simply industry- or asset-organized. A fund designed to track the overall market capitalization of cryptocurrency is an example of the former, while a fund which collects a series of strong cryptocurrency assets is an example of the latter.

Unlike a mutual fund, an ETF is available for purchase like common stock. You can buy it from a stock exchange and sell it at will.

A marijuana ETF is an industry-organized ETF, in this case organized around the cannabis industry. This can include a wide variety of businesses, but most funds will invest chiefly in recreational growers, pharmaceuticals and research. Some may invest in retail, although this remains a relatively small section of the cannabis industry by value.

Why Invest in a Marijuana-Focused ETF?

There are a number of different reasons to invest in a cannabis ETF.

The main reason is risk mitigation. Marijuana has become a booming industry. In just a few short years since the legalization movement truly began cannabis companies have gained billions of dollars in value. The potential for future gains is even larger. Recreational marijuana is only legal in nine states and is already worth $10 billion. How much more can it grow if (or when) the other 41 markets open up?

Yet as we will discuss below, the cannabis industry has a few specific features that make it an unusually risky investment. This makes the risk mitigation of an ETF even more valuable when it comes to investing in marijuana. By diversifying your investment you protect yourself from an individual grower getting shut down, a state changing its laws or a particular lab's research turning out to be a pipe dream.

Most ETFs in this market focus on cannabis-specific investments. However a cross section of companies and investors see marijuana as a diverse recreational substance investment, typically paired with alcohol and tobacco. For investors, an industry-specific fund will capture more of the gains from the cannabis market. However a diverse substance-oriented fund will do more to mitigate the risks inherent to any single-industry investment, as well as those particular to marijuana.

Marijuana Risk Profile

The cannabis industry has two particular risk profiles that investors should consider before jumping in.

1. Volatility Issues

Like cryptocurrency, cannabis is a high-risk, high-reward investment.

This market has been inflated by a combination of actual value, anticipated profits and sheer enthusiasm. The high degree of emotional investing, in this case with some investors who have gotten into the market to get rich quick and others simply enthusiastic about legalization, makes the market less predictable. Investors will move as much on whims as on metrics.

Some individual stocks have swung by as much as 26% in a single day's trading.

A lot of capital has poured into the cannabis market in a very short amount of time. That's a recipe for significant short-term market corrections and reinvestment… in other words, volatility.

2. Legal Issues

Investors in marijuana need to be very clear on one fact: Marijuana is not legal in the U.S.

Many states have decriminalized marijuana, some for recreational purposes and more for medicinal purposes. However the federal government still bans its use and possession. The Department of Justice has decided not to prosecute, but this is a matter of pure discretion. At any time the attorney general or the president could change their minds and shut down every single U.S.-based cannabis business.

Investors should take particular note of this risk in light of the trend many Republican politicians have shown toward campaigning on social issues and appealing to their conservative base.

There's more. Because recreational marijuana growers and retailers are breaking federal law, handling their money may qualify as money laundering depending on the circumstances. While an increasing number of banks do work with cannabis companies, at the same time Congress has explicitly rejected protecting them from future enforcement. This means that both funds and banks take an active risk by participating in this market, and may choose to withdraw at any time.

Only legislation can change this. Without a change in the laws, at any time the Department of Justice, the Treasury and Securities and Exchange Commission can crack down. That could mean anything from a disruption in the market to shutting down every single marijuana-related fund overnight.

Major Marijuana ETF Examples

While these are not the only funds in the market, or even the ones you should pay most attention to, these three funds are good examples of the kind of ETFs you can consider while getting into marijuana investments.

North American Marijuana Index

This is an industry and grower centered fund. The North American Marijuana Index is a classic cannabis ETF focused on growers and the overall industry value.

Teucrium Emerging Medical Agriculture Index Fund

As opposed to a grower-focused fund, this brand new ETF intends (by all reports) to focus on the emerging medical market for cannabis.

ETFMG Alternative Harvest

This is an example of a diversified fund. While Alternative Harvest (MJ) puts most of its assets into marijuana, it also holds several tobacco companies. Firms do this for a wide variety of reasons, two of which can include counter-cyclical stability and future forecasting. If Phillip Morris (PM) decides to expand its smokeable products, Alternative Harvest will be ready.

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