The two largest pot ETFs in North America, the Horizons Marijuana Life Sciences Index ETF (HMMJ.XTSE) and the ETFMG Alternative Harvest ETF (MJ), returned over 45% to investors in the first quarter. The stellar performance of these funds, which beat almost all non-leveraged ETFs in North America, was boosted by the help of short sellers. The top cannabis funds have made millions of dollars lending out their holdings to traders betting against this year’s 60% surge in the high-flying market for cannabis stocks, per a recent Bloomberg story.

Canadian Cannabis ETFs Shine

  • HMMJ, MJ both gained over 45% in Q1, versus S&P 500’s 13.1% increase
  • Borrow rate for cannabis securities at average of 15% versus traditional 1% rate
  • Horizon made $38 million in securities lending to short sellers in 2018
  • Alternative Harvest generated $9 million in income from short sellers last year, translating into a 2% gain for shareholders
  • Cannabis securities lending added 1.1% points HMMJ performance in the first two months of 2019, added 0.58% to MJ’s performance in Q1

Source: Bloomberg Intelligence

Pot ETFs Charge Short Sellers a Premium

“There’s a lot of people that don’t believe in this sector from a long-term growth perspective and are trading on that volatility,” said Steve Hawkins, president and chief executive of Horizons ETFs Management Canada, in an interview on Bloomberg TV last week. “They’re coming to us because we are the largest institutional holder of a lot of these companies.”

Cannabis ETFs have had significant success in the securities lending space, where they generate additional income by charging traders a fee to borrow their cannabis shares. Their stellar performance compared to other ETFs that engage in securities lending is driven by the fact that many pot stocks have a small public float and are not readily available to borrow.

The cost of borrowing cannabis securities is significantly higher than the traditional rate, at about 15% versus 1%, per Bloomberg Intelligence. For companies in high demand by short sellers, such as Tilray Inc. (TLRY), the charge can rise as high as 110%. This can translate into hefty revenue streams for cannabis ETFs, considering Canadian funds can lend out as much as half of their holdings, and U.S. funds can lend one-third of their holdings.

Big Winners

One of the sector’s main beneficiaries of short seller interest has been the Horizon Fund, the first cannabis ETF to exist. It gained a whopping 53% in Q1, compared to the S&P 500’s 13.1% increase over the same period. It generated about $38 million in securities lending to short sellers in 2018, with nearly half attributable to the final quarter. The business added 1.1% points to the fund’s performance in the first two months of 2019, a 7% yield on an annualized basis, per the ETF.

The ETFMG Alternative Harvest was up 46% in Q1. Securities lending generated over $9 million for shareholders last year, translating into about 2% growth. The securities lending business added 0.58% to MJ’s overall performance in Q1, per the fund’s manager.

Looking Ahead

Uncertainty regarding the future of U.S. cannabis companies has kept both Horizon Fund and the Alternative Harvest away from those investments. The prospects for legalization of cannabis on a federal level in the U.S. could spell good news for the North American Marijuana Index, which covers both Canadian and U.S. companies and has lagged the other two.

“These funds have the double positive whammy of securities lending and U.S. pot stocks trailing Canadian ones,” said Bloomberg analyst Eric Balchunas in reference to HMMJ and MJ. “If U.S. pot stocks rally, it’s possible some of this boost goes away, because the securities lending benefits may be overwhelmed by the funds not holding the U.S. stocks.”