By Morgan Paxhia, co-founder of Poseidon Investment Management
The regulated cannabis market has warmed up over the past two years. During the pandemic, cannabis sales have increased by 46%, and that certainly isn’t slowing down anytime soon. The US legal market is expected to reach $45 billion in 3 years according to industry data company, Headphones.
Although the cannabis sector is on the rise with more states legalizing the plant and sales are increasing year over year, the fall in stock prices of individual companies has given potential investors pause. . At the start of 2022, individual US stocks posted three consecutive weekly declines to kick off the year.
Instead of individual stocks, exchange-traded funds (ETFs) provide access to an organized portfolio of stocks, minimizing risk through diversification. Managers can weight the different positions according to the conviction of each company. When investors buy ETF shares, they are owning a stake in multiple cannabis companies with a single purchase. Therefore, if the price of one of the stocks in the portfolio falls, it may be offset by other holdings.
In addition to offsetting risk, ETFs are generally easier to trade than individual cannabis stocks. Due to the federal cannabis ban, US exchanges like NASDAQ and NYSE do not allow herbal companies like Multistate Operators (MSOs) to trade on their platforms. US investors interested in buying these shares must go through services that provide access to US over-the-counter (OTC) markets or via Canadian Securities Exchange (CSE) markets – which is not atypical for US brokerage platforms. But because ETFs are structured as investment vehicles, they can be listed on US exchanges. In turn, investors can access these products on familiar platforms such as Robinhood, Equity.com, Schwabb, TDAmeritrade, etc.
Factors to consider before investing in ETFs
Like any investment, it is prudent to research different ETFs before making an allocation. Like mutual funds, most ETFs can provide investors with a prospectus, a document that provides information about the fund’s investment objectives, risks, past performance, and expenses.
When reviewing an ETF and its prospectus, here are some key factors to keep in mind:
When choosing a cannabis (or any other) ETF, you want to know what’s included in the portfolio. Although there are several cannabis ETFs, none are the same.
Some ETFs focus solely on cannabis companies, while others trade hemp and CBD-based pharmaceuticals. Other ETFs will invest in non-factory related companies such as real estate investment trusts (REITs) or technology or software solutions. Yet others invest strictly in
US-based companies that will form the backbone of the retail supply chain in the US when cannabis is legalized.
Be sure to choose an ETF that you believe will maximize returns as more states open legal cannabis markets.
There is inherent complexity and volatility in the cannabis industry. Being federally illegal poses challenges for even the most established cannabis businesses.
This is a good reason to invest in an ETF where someone should have a watchful eye on your investment. When analyzing the management team, many factors should be considered – years of experience and focus, track record, and the type of investments they specialize in. For example, hedge fund managers are known to be comfortable with high risk management strategies that maximize return. On the other hand, investment bankers generally have a strong background in underwriting and trading rather than portfolio and risk management.
Consider the expertise of the management team behind an ETF and choose a team that aligns with your risk appetite and return schedule.
Another reason to buy ETFs is the various strategies experienced management teams can use. Unlike ordinary day traders who simply buy and sell stocks, fund managers can boast the ability to tout an array of sophisticated investment strategies.
For example, at Poseidon we use dynamic leverage capability, which means we can be 80% exposed to the market or go up to 150% (1.5X). Then we can manage both the portfolio and its leverage at our discretion based on various internal inputs. Early cannabis investors have already seen greater than expected returns based on the early stages of acceleration within the industry.
Other common ETF strategies that management teams can use include:
● Long/Short Equity — A fund may sometimes hold both short and long positions in different asset classes.
● Merger Arbitrage – The buying and selling of the shares of two merging companies at the same time to create “risk-free” profits
● Global Macro — Investment decisions based on global economic trends
● Event-Driven: strategy that takes advantage of a specific event such as liquidation or bankruptcy
● Distressed Debt – Repurchase of debt from distressed companies at a reduced price
Generally, an ETF’s strategy will be described in the prospectus. Find, research and invest in a strategy you are comfortable with.
The trend towards cannabis legalization is clear
Although federal legalization has been put on the back burner politically, the trend to expand access to cannabis is clear. Today, there are 18 states with legalized adult use and 38 states with legalized medical use. Cannabis ETFs are an easy way for investors to gain exposure to this industry today for the future wave of earnings from this growing industry.