Canopy Growth Corp (NYSE:CGC), the second Canadian pure-play marijuana stock, hit U.S. markets May 24. American investors now have direct access to two of the biggest players in the global cannabis market. There are a number of different ways investors can put their hard-earned dollars to work in what is arguably one of the fastest growing industries in the world, but the easiest is to buy one of the several marijuana ETFs available.
Even though mainline banks in both the U.S. and Canada are getting on board the marijuana gravy train, it’s still an industry very much in its infancy.
Dilution Hell
Here in Canada where I live, publicly-traded marijuana stocks whose valuations are not worth the paper they’re written on are issuing shares to pay for acquisitions at an alarming rate. This is leaving pre-acquisition investors terribly diluted.
It’s one thing to issue shares to buy companies that are making money but almost none of them are, making the dilutive effect that much more troublesome.
Alberta-based Aurora Cannabis Inc (OTCMKTS:ACBFF) recently announced it would pay C$3.2 billion in company stock to buy Ontario-based MedReleaf Corp (OTCMKTS:MEDFF). Aurora’s issuing approximately 388 million shares increasing the number outstanding by about 68% making the combined entity the largest cannabis company in the world.
That’s a nice title to hold. Of course, if you’re one of the pre-acquisition investors, you’re probably wondering what happened to the value of your stock?
There’s no guarantee that any of these pie-in-the-sky deals will amount to more than a hill of beans.
In effect, companies like Aurora, are robbing Peter to pay Paul. That always comes at a cost.
Probabilities, Possibilities and Marijuana ETFs
The trick about investing is knowing the difference between possible and probable.
It’s possible that Aurora will become the most valuable public company in the world surpassing Amazon.com, Inc. (NASDAQ:AMZN) and the rest of the big hitters, but it’s not probable.
By investing in marijuana ETFs you’ve decided to diversify your bet understanding the difference between possible and probable. There wouldn’t be marijuana ETFs if a large portion of investors didn’t think this way.
By playing it a little safer, you’re doing the right thing.
Which of the Marijuana ETFs to Buy?
There are so many ETFs today with tiny assets that the ETF Deathwatch sits around 427. ETFs that make this list have assets under management (AUM) of less than $25 million. These are to be avoided.
Currently, there are five marijuana ETFs available on U.S. and Canadian stock exchanges with varying AUM.
The Biggest
The biggest is Horizons’ Marijuana Life Sciences Index ETF (OTCMKTS:HMLSF) with C$779.4 million.
It tracks the performance of the North American Medical Marijuana Index. It’s got all the big producers including Aurora and Canopy Growth at 14.2% and 10.3% weightings respective. Naturally, they’re the ETFs two largest positions.
About 80% of the ETFs assets are investing in Canadian equities with the remainder split between the U.S. (12%) and UK (8%).
I have two issues with this ETF.
It’s top-heavy with the ten largest holdings accounting for 72% of the assets. It leaves no potential to benefit from the success of lesser-known companies farther down the list.
In addition, given the unknown factor of the cannabis industry, I would prefer an equal-weighted ETF that actually provides real diversification.
The second is its management fee. At 0.75%, it’s a bit high for a passive index. The ETF provider will argue that many of the stocks held are tiny companies making the tracking of the index more expensive but it’s something to keep in mind.
At the end of the day, with so few options, if you want to make a play on marijuana, you’ll have to pay the piper. In the future, expect fees to come down as more players enter the market.
Two Other Options
American investors would rather own ETFs that are traded on U.S. exchanges. Buying over the counter is still foreign to most retail investors so the natural choice for most is the ETFMG Alternative Harvest ETF (NYSE:MJ), which tracks the Prime Alternative Harvest Index, has $379.4 million in AUM.
In addition to cannabis investments, the index can invest in tobacco-related stocks. As a result, MJ ETF allocates about 10% of the total weighting in companies like Altria Group Inc (NYSE:MO). In my opinion, that’s a good thing, because Big Tobacco will get into this business once the Feds legalize pot.
The second option is possibly an even better way to gain access to the cannabis industry without overplaying your hand.
InvestorPlace feature writer James Brumley recently discussed the AdvisorShares Vice ETF (NASDAQ:ACT) which invests in a number of so-called vices including alcohol with a 54% weighting, tobacco at 26% and cannabis-related stocks at 19%.
Right there in the top ten holdings is Constellation Brands, Inc. (NYSE:STZ). It owns 10% of Canopy Growth. Also, in the top ten are two cigarette companies. One or both will be in the cannabis business within five years.
The big downside is it will only invest in cannabis-related companies doing federally legal business as defined by the U.S. government.
It does have a small weighting in Alliance One International, Inc. (NYSE:AOI), a North Carolina tobacco processor that acquired 75% of Island Garden in February, a Prince Edward Island licensed medical marijuana producer.
But that’s about it. I’m sure the index will be adjusted to accommodate more marijuana producers.
The Bottom Line on Marijuana ETFs
After seeing the success of the Spirited Funds/ETFMG Whiskey & Spirits ETF (NYSEARCA:WSKY), I’m inclined to recommend that you put 50% of whatever amount you were intending to invest in marijuana ETFs in ACT and the other 50% in MJ.
If you don’t invest in cigarette companies, I’d put the whole thing in HMLSF.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
