Avoid Most Cannabis Investment Funds For Now

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Photo Credit: Chris Roussakis

I have been following the publicly-traded cannabis stocks for over five years now, and one of the most interesting developments has been the recent introduction of mutual funds and exchange-traded funds (ETFs) focusing on the sector. Many investors prefer buying a fund over picking individual stocks, as a fund offers diversification and allows the investor to save the time and effort required to select individual securities. These benefits come with the cost of the management fee, which is not inconsequential and can eat into the returns over time.

While I like the concept of an investment fund targeting cannabis stocks, the ones that have been created thus far are not well constructed for the most part. Only two funds have achieved critical mass, and both of them are heavily exposed to Canadian licensed producers with limited exposure to the U.S. cannabis industry. Only one fund is traded on a U.S. exchange.

While many credit Horizons for being the first to market with its ETF listed on the Toronto Stock Exchange, it was actually preceded by a small mutual fund in the United States. I will now review each of the mutual funds, ETFs and other investment vehicles in the order of their coming to market.

American Growth Fund Series II

Distributed by World Capital Brokerage in Denver, the American Growth Fund Series II was the first cannabis-focused mutual fund. The fund, which has the symbol ‘AMREX’ and a long record of poor investment performance,  changed its focus in late 2016 to the cannabis industry. This is one that should be immediately dismissed as an investment option in my view. The fund, as of October 31, 2017, had just $502,903 in assets under management. The management doesn’t appear to have any sort of expertise in stock selection within or beyond the cannabis sector, and fund is very expensive, with a 6.1% up-front sales charge for investment of less than $50,000.

Horizons Marijuana Life Sciences Index ETF

Last April, Horizons Marijuana Life Sciences Index ETF went public via an IPO on the Toronto Stock Exchange with the symbol ‘HMMJ’ and initial assets of C$10 million. Today, it has over C$755 million under management and is the premier publicly-traded cannabis focused investment fund. The management fee is 0.75%, and its liquidity is quite excellent. U.S. investors can purchase the security on the OTC using the symbol ‘HMLSF’, though there is no quoted market in the U.S.

When it first debuted, I was concerned with the structure, noting the inclusion of some biotech stocks that are engaged in the development of synthetic cannabinoids, including Insys and Zynerba, as well as ScottsMiracle-Gro, which has a very small amount of exposure to the cannabis industry relative to its overall business. Since inception, SMG (as well as these biotechs) has impacted performance negatively. The total return of HMMJ, which includes its dividends, has greatly lagged the three largest Canadian LPs that were trading at that time.

As it has evolved, HMMJ now is much more a bet on Canadian licensed producers, which represent 74% of the fund. Additionally, the fund has become less concentrated in its top holdings and has more than doubled the number of securities it holds. Still, investors should understand that it has very limited exposure to the state-legal U.S. cannabis industry, holding only Innovative Industrial Properties, which I recently detailed, and SMG.

While I continue to believe that most investors can likely do better than HMMJ by picking a few large Canadian LPs, thus avoiding the 0.75% management fee as well as exposure to a few names that don’t really make sense, I can see the appeal to those investing smaller amounts of money but who want diversification.

ETFMG Alternative Harvest ETF

Like AMREX, ETFMG Alternative Harvest ETF, which trades on the NYSE Arca under the symbol ‘MJ’ (formerly ‘MJX’), didn’t begin its life with a cannabis-focus. Previously named the Tierra XP Latin American Real Estate Fund, MJ changed its focus and began trading in late December with just $6 million in assets. It now has almost $400 million under management and has excellent liquidity. Contributing to its success is the fact that it is the only ETF trading on a U.S. exchange. The management fee is 0.75%.

The ETF holds 41 securities and is highly diversified, with the top 10 names representing about 48% of the holdings. The largest names include several Canadian licensed producers, which is quite similar to HMMJ, but the fund has substantial exposure to companies that appear to have little or no connection to the cannabis industry, like tobacco companies and biotech companies developing synthetic cannabinoids or with even looser connections. The irony is that while it is available to U.S. investors, it has no exposure to the state-legal cannabis industry in the U.S. Another issue is that the ETF may face a big challenge, as its Trustee, U.S. Bank, could discontinue serving in that role. In my view, investors should opt for HMMJ over this ETF.

Cannabis Growth Opportunity Corp.

Cannabis Growth Opportunity Corporation, which trades on the Canadian Securities Exchange with the symbol ‘CGOC’, is not a mutual fund or ETF. Instead, it is an investment corporation that is managed by StoneCastle Investment Management. It began trading in late January after pricing an IPO, selling units at C$2.50 that included shares along with C$2.50 warrants, raising C$38.7 million. Unlike its ETF and fund peers, CGOC is able to invest up to 40% of its assets in private companies. One potential drawback is that there is no mechanism to get the trading price in line with the net asset value, which isn’t reported in any event except periodically. U.S. investors have no option to invest in CGOC except by having an account that can invest in Canadian securities. Finally, investors should be aware of the management fee of 1% plus 20% of profits above 5% return, a potentially steep price to pay, though the structure does provide strong incentive to the managers to perform well.

Marijuana Opportunities Fund

Redwood Asset Management oversees the Marijuana Opportunities Fund, which began trading in early February on the NEO Eexchange with the symbol ‘MJJ’. Unlike the other ETFs, it has the ability to sell short. The top 10 holdings are dominated by Canadian LPs, accounting for over 66% of the fund. As of March 16th, the fund held cash amounting to 22.5% of the portfolio. The management fee is 0.75%, and the only way to invest is directly into the Canadian ticker. The assets are just C$8.2 million, and the past week saw trading volume of only 7967 shares, perhaps a function of the exchange on which it trades.

Evolve Marijuana ETF

Evolve Marijuana ETF, which trades on the Toronto Stock Exchange with the symbol ‘SEED’, began trading in February. The fund is tiny, with only C$2.5 million in assets under management, of which 91% is invested in Canada, with the balance in Australia.  The holdings are dominated by the large licensed producers in Canada, with the top 8 names all from that group and representing over 62% of the ETF. The lack of trading volume is a major issue here, as the stock trade only 12,742 shares last week. Additionally, there is no way for a U.S. investor to buy the ETF unless he or she has an account that permits direct investment into Canadian securities. Finally, the management fee is 1%.

Horizons Emerging Marijuana Growers Index ETF

The most recent debut was the Horizons Emerging Marijuana Growers Index ETF, which began trading on the NEO Exchangewith the symbol ‘HMJR’ on February 14th. The ETF limits its holdings to companies with market capitalization below C$500 million. Thus far, it has been a dud compared to HMMJ, with assets under management of just C$14.6 million. Trading appears to be impacted by the exchange on which it trades, with only 35,575 shares traded last week. Note that U.S. investors are able to buy it on the OTC under the ticker ‘HZEMF’ without having to have a Canadian brokerage account. The management fee is 0.85%. What I like about this ETF is that the assets it holds are different from the other options, with the no exposure to easy-to-buy large Canadian LPs and some exposure to other geographies, like Australia and the United States.

Bottom-line: Cannabis mutual funds and ETFs are a great concept, but the existing funds have substantial flaws, with perhaps the exception of the larger Horizons fund, HMMJ, which is very focused on Canada and quite easy to replicate. For those who want to invest in companies focused on the U.S. cannabis market, there are no viable options at this time.

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