Cannabis ETF Diversifies Risk for Investors

Why are potential investors so nervous about the legal cannabis industry?
Cannabis ETF Diversifies Risk for Investors

With the legal cannabis market expected to hit more than $66 billion by the end of 2025, many investors are ready to try to take advantage of the new sector. But with that explosive growth comes a lot of volatility and the risk of an unproven industry, two factors that can scare away many potential investors. To help manage and mitigate some of that risk, several exchange-traded funds (ETFs) have been launched to help diversify investment in the industry.

Matt Markiewicz, the managing director of investment company Innovation Shares, told High Times that his firm’s new Cannabis ETF (THCX) can serve as an entryway into the marijuana industry to investors at any level.

“The beauty of an ETF is that it’s the most democratized investment vehicle on the planet,” Markiewicz said in a telephone interview. “My grandmother can buy five shares or you can have a pension fund buy $15-20 million in one trade. So it really spans the gamut of who can buy. We’re looking to appeal to any investor that wants to get exposure to cannabis.”

Managing Volatility and Risk

However, he adds, many potential investors are leery of the new opportunity because they don’t understand just how varied an industry cannabis has become.

“One of the challenges in explaining the cannabis investment case to investors, especially financial advisors, is to convey that cannabis is more than just growing and selling pot,” says Markiewicz. “There are a lot of other businesses that are involved in the industry that don’t necessarily involve the retail aspect of it.”

Cultivation and retail are just the ends of the cannabis supply chain. In between are other firms who add value to the product such as extraction operations and testing labs. Ancillary companies including packaging businesses and fertilizer manufacturers are increasing sales for the industry without touching the plant. Even some pharmaceutical makers are part of the sector as they seek to produce FDA-approved medications that harness the therapeutic value of cannabinoids.

Companies like these with a market capitalization of at least $100 million are candidates for inclusion in the Innovation Labs Cannabis Index, which is the basis for the passively-managed Cannabis ETF. Investments in the various subthemes within cannabis help the fund realize the growth capable in all aspects of the industry while diversifying the portfolio.

“Exposure to a broad range of companies involved in the cannabis ecosystem is what we’re trying to achieve with THCX,” explains Markiewicz, adding that “the idea is that you’re building a portfolio that investors can feel good about from the diversity as well as a size and liquidity perspective.”

Passive vs. Active Management

Innovation Shares’ decision to passively manage the Cannabis ETF by following the index with a monthly rebalancing eliminates the temptation for an active manager to overreact to the volatility inherent in the cannabis industry.

“By removing a lot of the human emotional bias out of the decision-making process,” says Markiewicz, “we feel it’s a more efficient way to get access to what is a very volatile sector.”

With “this systematic rules-based approach to rebalancing, we […] will better serve investors who are looking to eliminate the volatility often associated with cannabis investing,” he explains.

Historically, he adds, actively-managed funds haven’t proven to be a better investment than those that follow an index.

“Active management over the long-run has not proven to generate any outperformance, and most times, the active management strategy charges a higher fee,” says Markiewicz. “So, not only is it underperforming, but you’re paying more.”

Markiewicz notes that even investors who don’t believe the hype and think that stock prices in the marijuana sector are headed lower have an opportunity to make money with the Cannabis ETF by taking a short position in the fund.

“Whether you have a view on cannabis and you want to be long in the stocks because you think there’s good value at that point in time in the sector or if you think the sector is overvalued, you can also short our ETF, too. So from the long or short perspective, it’s a very efficient capital markets tool to express a view on cannabis.”

Shares of the Cannabis ETF, which trades on the NYSE Arca Exchange, were trading at $22.32 per share on Wednesday morning, down more than 5% from Tuesday’s close.

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