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How to Choose the Right Cannabis ETF

A cannabis ETF is a logical choice for investors given the sector’s volatility, but picking the right ETF requires some legwork.

As the number of companies making cannabis and cannabis-based products grows exponentially across the country, discussions around the best opportunities dominate among both seasoned investors and those looking to enter the market for the first time. Are edibles stocks going to soar? Should one set one’s long-term sights on medical marijuana? What is popular now, and what will be popular and profitable in the long run?

Exchange-traded funds (ETFs) are a natural choice for those who believe in cannabis’ potential to explode in value in the coming years -- some predict it could become an almost $43 billion market by 2024 -- but do not necessarily want to pick individual stocks. In addition, the cannabis market is inherently high-risk and volatile as states change their laws and new products enter the market, so ETFs can be a great and more stable entry point into the sector.

Picking the right ETF comes with its own nuances and things worth knowing before taking the plunge, however -- not counting inverse and leveraged ETFs, there are currently six cannabis ETFs that trade in the United States and around 15 that do so globally. One of the biggest points to consider is precisely what holdings each one has -- some focus on medical marijuana or a specific type of product, while others invest in everything from pharmaceuticals to hemp, agriculture and the cultivation necessary to grow it. Some will focus exclusively on cannabis while others have it among other products such as tobacco and alcohol.

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“Even if one is trying to invest in an ETF rather than trying to pick individual stocks, they should look under the hood of the ETF,” Dan Ahrens, the chief operating officer of investment managing firm AdvisorShares and portfolio manager for the Pure U.S. Cannabis ETF MSOS, which focuses exclusively on U.S.-based cannabis companies, told The Street. “One of the beauties of an ETF is that it has daily transparency. You can see the prior day's holdings of the fund.”

What to Look For

Ahrens advises anyone who is trying to invest in an ETF to consider each of the holdings point by point. The holdings should be diversified not only across product type but also the market cap, liquidity and how much it trades daily. High trading activity can indicate that the assets are more likely to be liquid.

“Most of the multi-state operators in the United States, just like their name implies, are moving into additional states,” Ahrens said. “Many states already have medical marijuana but are going to approve the bigger market of adult-use marijuana. The main point is to get invested and accumulate but [also] have a very long-term focus for the future.”

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Problems can also arise from misunderstanding companies’ ability to enter a specific market. Ever since Canada moved to legalize marijuana in 2018, many Americans who believed in its potential for growth turned to companies north of the border for investment opportunities not available at home at the time.

But even when Canadian companies like Canopy Growth  (CGC) - Get Canopy Growth Corporation Report and OrganiGram Holdings  (OGI) - Get Organigram Holdings Inc. Report began trading on the New York Stock Exchange and Nasdaq, cannabis’ classification as a Schedule I controlled substance at the federal level means that most are unable to sell their product cross-border -- inexperienced investors drawn in by the current hype surrounding cannabis may not always realize that legalization in New York will not affect companies that are unable to ship there.

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They key is doing one’s research and understanding what one is investing in -- choosing Canadian ETFs could be a good option for those who see the potential for growth within the country, or companies that are based in Canada but specialize in the American market. Companies based in the United States, meanwhile, have the potential for enormous growth as more states move toward legalization and decriminalization.

MSOS vs. MJ: Which Is the Better Cannabis ETF?

Toronto-based Horizons ETFs launched the first cannabis ETF, the Horizons Marijuana Life Sciences Index ETF HMMJ, in 2017; it invests in a range of companies working on cannabis manufacturing, distribution and biopharmaceuticals. The company’s CEO, Steve Hawkins, told the Street that a rush of U.S. investors asking how they could invest in HMMJ cross-border led to the launch of the Horizons U.S. Marijuana Index ETF HMUS, whose holdings are exclusively American companies that operate at the state level.

“There are roughly 15 marijuana ETFs worldwide,” Hawkins said. “That number is soon going to start breaking down into more specified pieces or sectors of the marijuana [sector] such as oils and gummies and vaping. Your subset of companies gets pretty small pretty quickly...and you have to be very careful when you see new ETFs and how specified they are because there can be a lot of illiquidity in that marketplace.”

While analysts disagree about whether federal legalization in the U.S. is on the horizon, many see New York as a domino state that will lead to more states legalizing cannabis and in turn an explosion of new American companies that are both growing and producing cannabis directly and creating derivative products. Those products could be anything from equipment to leasing space to medical producers.

ETFs to Consider

Matthew Carr, the chief trends strategist at financial research firm the Oxford Club, advised those who are tracking the current movement of increasing legalization across different states to consider MSOS, since it focuses exclusively on U.S.-based cannabis operators. For those who want more international exposure, Carr recommends either the ETFMG Alternative Harvest ETF MJ or Global X Cannabis ETF POTX, which both hold some of the world’s largest global cannabis operators.

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“When you're looking at ETFs you really need to understand what it is you are actually buying,” Carr told The Street. “A lot of times, people rush out and buy ETFs because it's part of a sector but don't really dig further into what that actually holds.”

Due to rapid changes in laws governing cannabis, it is often difficult to predict which individual companies that are doing well will continue to dominate and which will flame out.

“Lessons learned from either California’s legalization or Canada’s legalization show that there’s going to be this volatility,” Carr said. “There are going to be these run-ups and then there'll be these short pullbacks. If you’re looking to trade very short term over the next several months you can do that but this is a market that over the next five to 10 years is going to evolve in a very rapid way.”