How you can profit from the fast-growing cannabis industry

The problem with many traditional funds, be they actively-managed unit trusts or investment trusts, is that they tend to be rather staid and mainstream. That does not mean that they ignore unusual ideas – quite the opposite, in fact. Niches such as infrastructure or music royalties have become respectable over the past few years.

But once we move out of these relatively safe areas, active managers tend to run a mile, especially if they think they might be investing in something remotely legally dubious. That brings us to cannabis, the great investment taboo.

It’s a growing sector rapidly becoming legitimate in some major jurisdictions, such as Canada and a number of US states. But most fund managers in the UK are acutely aware that under our law they might be falling foul of the UK’s Proceeds of Crime Act if they invest in a company whose main activity is deemed illegal here.

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So if you invest in businesses in the US or Canada that trade in recreational cannabis, you might be breaking the law in Britain. That even theoretically applies to British investors buying US cannabis stocks available on big online platforms. The law hasn’t been tested and no individual investor is likely to be had up for investing in a US supplier, but you can understand why many fund managers tend to avoid the subject entirely.

Where others fear to tread

Nonetheless, that has not stopped specialist exchange-traded fund (ETF) managers in the UK from offering ETFs that give you diversified exposure to the global cannabis business.

But there is a clever twist: they focus on businesses selling medicinal products that are not illegal in the UK. In practical terms that might mean investing in everything from a well known name such as GW Pharmaceuticals (UK-based but listed in the US), which patents therapies using cannabis-derived ingredients, to businesses that supply the “picks and shovels” of the cannabis sector: the basic infrastructure it needs, such as greenhouses. I would also argue that despite the ups and downs of the cannabis merry-go-round, now is not a bad time to look afresh at this space.

A positive political backdrop

GW has just been on the receiving end of a huge takeover bid and momentum is building in the American market, in particular, where the political backdrop is changing. Matt Bottomley is an analyst who works for Canadian investment bank Canaccord Genuity and has been tracking the listed North American funds for years. Following Joe Biden’s US presidential election win, sentiment – and legislative action – is picking up speed as various states are deciding to decriminalise.

Bottomley points out that 2021 has seen the Democrats effectively gaining control of the US Senate and pushing legislative reform; Arizona commencing recreational sales; the official signing of adult-use cannabis into law in New Jersey and Virginia; a joint statement from Democratic Senators (including Senate majority leader Chuck Schumer) pledging the party’s intention to move comprehensive cannabis reform through the necessary political and legal channels; and more than $1bn of capital raised “as US operators look to take advantage of what appears to be an industry that is growing at an accelerated pace”.

Expect strong earnings

Crucially, Bottomley says that many of the leading US multi-state operators (MSOs) are soon to report earnings for the fourth quarter of 2020, “which we believe will cap off what was largely a banner year for many US operators”. Canadian cannabis stocks, by contrast, have tended to promise a huge amount but have disappointed on earnings growth. The US pot sector now looks ideally positioned. Canaccord Genuity’s own US Cannabis Index (CGUSCI) is up by nearly 40% so far this year and the positive momentum should flow through into the wider cannabis sector, including the businesses focused more on medicinal products.

Where to look in London

This brings us to the two main UK-listed ETFs that focus on the sector. They are the Medical Cannabis and Wellness UCITS ETF (LSE: CBDX), operated by HANetf, and the Rize Medical Cannabis and Life Sciences UCITS ETF (LSE: FLWR). Both issuers go to great lengths to say that their approach is differentiated and superior. The former skews more towards small companies and the agricultural technology sector, for instance, while the latter has more of an emphasis on large caps and biotech groups. It is also a tad cheaper, with a total expense ratio (TER) of 0.65%; the HANetf product costs 0.8%.

Many stocks in common

Nevertheless, the two ETFs share many of the same stocks. These include names such as GrowGeneration Corp, Scotts Miracle-Gro, Amyris, Arena Pharma and Cara Therapeutics.The Rize ETF makes more of its global focus, pointing out that more than 50 countries now allow cannabis for medicinal use.

It also concentrates on the underlying liquidity of the stocks in its fund. The managers consider liquidity crucial, and they build the index with a keen eye on the volume weighting of each stock. By contrast, the HanETF tracker fund is market cap-weighted and more North America-focused, especially in the US. It also has less exposure to large well-known names such as Teva and Novartis.

It also helps that the HANetf operates a 15% maximum exposure to one stock and is a more concentrated portfolio. Last but by no means least, I noticed that the HANetf fund recently rebalanced its portfolio and has some new US names in there such as HydroFarm (NASDAQ: HYFM), a large wholesaler of hydroponics equipment, which is helping to extend cannabis cultivation in the US.

There is also Agrify (NASDAQ: AGFY), an engineering and planning company that helps the largest cannabis operators in the US grow pot indoors, as well as Silver Spike (Nasdaq: SSPK), which is a special purpose acquisition company (SPAC) that has just completed its qualifying transaction to take public a cannabis marketing company called WeedMaps.

I make no comment on the overall relative appeal of either ETF. Both will help you gain some exposure to cannabis, which I maintain will be one of the key investment themes of 2021.