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How To Navigate The Cannabis ETF 'Craze'

Benzinga Cannabis

By Kip Meadows, Founder and CEO of Nottingham.

The launch of four new cannabis ETFs in 2019, paired with the recent filing for yet another one, has many investors wondering how to navigate amongst the options as they seek exposure to the growing cannabis industry. There are significant differences among the current options, or at least enough differentiation to provide some decision points.

The oldest and still largest cannabis ETF on the market is the ETFMG Alternative Harvest ETF (NYSE: MJ). MJ got a jump-start by amending a South American real estate ETF into a cannabis ETF. This unorthodox change caught both the SEC and the ETF’s custodian by surprise, with the custodian resigning during the first few months of operations.

The MJ investment objective is quite broad, and an examination of the portfolio indicates more than 17% is allocated to tobacco stocks, with other sizable positions including fertilizer companies, breweries and real estate investment trusts (REITs). It is difficult to envision how the cannabis industry will move the stock price needle on any tobacco company, fertilizer company or international brewing holding company for the next decade at least. Perhaps there will occur a time when cigarette rolling equipment and distribution networks will be useful to the cannabis industry, but not any time soon. The same goes for agricultural fertilizer companies, which likely derive much less than 1% of their revenues from providing fertilizer to cannabis growers.

The trading spread on MJ has recently averaged 0.24%, while the ETF has an expense ratio of 0.75%.

The other four cannabis ETFs can be differentiated first by those that are actively managed and those that are index ETFs. Like MJ, the Cambria Cannabis ETF (BATS: TOKE) and the Cannabis ETF (NYSE: THCX) are index ETFs, while the AdvisorShares Pure Cannabis ETF (NYSE: YOLO) and the Amplify Seymour Cannabis ETF (NYSE: CNBS) are actively managed.

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YOLO was the second cannabis ETF to become available in April 2019. YOLO’s portfolio is more closely aligned with true cannabis issuers, although 17% of that exposure is achieved through the use of swaps and derivatives. A well-constructed swap does provide high correlation to the underlying tracked asset but can prove difficult for market makers to price into the bid/ask spread for the ETF. This can be seen in the recent spread on YOLO averaging 0.47%. The expense ratio is well within range at 0.74%. YOLO is actively managed by portfolio manager Dan Ahrens.

THCX is an index that limits its composition to mostly North American cannabis, hemp and CBD issuers, primarily those based in Canada and the U.S. While THCX is an index, the index is updated monthly to react to a rapidly changing industry still in its infancy. The recent spread on THCX has averaged 0.25%, and the fund has an expense ratio of 0.70%.

CNBS is another actively managed cannabis ETF. CNBS limits its portfolio to companies that derive 50% or more of their revenue from cannabis-related activities. This effectively makes large cap tobacco stocks and fertilizer companies ineligible for investment, a correlation plus. CNBS has the most favorable trading spread of the ETFs, averaging a tight 0.19%, although on lower volume of trading thus far. The expense ratio is in line at 0.75%. CNBS is actively managed by well-known investment advisor and financial broadcast analyst Tim Seymour.

The most recent offering is the easy-to-remember stock symbol TOKE. TOKE is an index ETF touting the lowest expense ratio of 0.45%, although it has the highest trading spread of 0.60%. TOKE has primarily cannabis-focused securities in its portfolio but also includes a high percentage of tobacco stocks, Scotts Miracle-Gro and major international beer brewer and distributor Constellation Brands.

So how does one navigate the current offerings and the projected offerings that large ETF and mutual fund firms may bring to market in the future? One recent article quoted an expert from a financial data firm claiming that cannabis-focused ETFs will grow from the current $1.2 billion in AUM to between $5 to $10 billion, but that “only two ETFs will survive.” This conclusion is overly simplistic. For one thing, industry experts recognize that any fund that surpasses $75 to $100 million in AUM will likely survive quite well. Second, the focus seems to be almost solely on expense ratio as the differentiator rather than looking at the underlying portfolio composition. If this rationale were in fact true, then the most successful mutual funds of the last half century would be money market funds, the open-end funds with the lowest expense ratios. This is, of course, an argument no industry expert would make. It is curious why this seems to be the primary criteria for ETFs. Market maturity should prove this approach to be worthy of discard.

The five ETFs currently on the market have several differences, and their approaches will likely appeal to different audiences. Some investors may even elect to have exposure in more than one of these offerings.

Given the opening-to-closing ratio of the ETF industry, which last year was approximately 1.5 to 1, it is likely that one or more of these ETFs will not see their five- or 10-year anniversary, but it is equally likely that more than two will find traction and be a longer-term player and survivor.

Photo by Javier Hasse.

Kip Meadows is the Founder and CEO of Nottingham, a fund administration firm and white-label ETF issuer headquartered in Rocky Mount, NC. The firm has been offering fund organization consulting, net asset value calculations and transfer agency services since 1989 and seeks to be the nation’s primary destination for small and emerging fund issuers in need of back-office and administrative support.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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