Marijuana ETFs: The Pros and Cons

The United States is taking incremental steps in the legalization of marijuana, as individual states are adopting different approaches for either medical or recreational purposes—or both. While advocates continue to push for nationwide legalization, even the existing piecemeal road to legal cannabis is generating a sizable new industry.

For many investors, the idea of a regulated, legal marijuana industry suggests ample new opportunities for investment and growth. Still, after news broke that Canada legalized cannabis across the country in 2018, the United States has yet to take a similar path. Political and regulatory changes and confusion abound, investors have not been able to capitalize on the potential of this space as they would like.

Exchange-traded funds (ETFs) have seen massive growth spurts when it comes to assets and overall popularity in recent years. For this reason, it was perhaps only a matter of time before the ETF space and the budding legal cannabis industry crossed paths. Investors may be wondering whether marijuana ETFs are a worthwhile use of their time and money at this point, or if it's maybe better to wait until the market is fully developed. This article explores some of the pros and cons of marijuana-focused ETFs.

Marijuana ETF Basics

Marijuana ETFs function in essentially the same way as traditional ETFs. That is to say, a marijuana ETF is a fund that tracks a basket of different names related to the legal cannabis industry, just as a video game ETF tracks video game companies or an energy ETF tracks a portfolio of energy outfits. 

New Jersey-based ETF Managers Group filed plans in February 2017 for the Emerging AgroSphere ETF. Then, in late March, Horizons ETFs announced that its Horizons Medical Marijuana Life Sciences ETF (HMMJ.TO) was conditionally approved to be listed on the Toronto Stock Exchange (TSX). It began trading on April 5, 2017, tracking the performance of the North American Medical Marijuana Index. Both ETFs were developed to specifically eye the medical marijuana industry—a subset of the broader cannabis space.

But marijuana ETFs have generally faced setbacks in getting started. Regulation is a major concern, as many banks are hesitant to back ETFs tracking companies in a business that isn't federally legal. Some of the concern has to do with the ETF structure—custodied assets must be held in a U.S. bank that holds the underlying securities. But many banks are not willing to take this risk, given the regulatory uncertainties.

Another cannabis ETF called the ETFMG Alternative Harvest ETF (MJ) launched in December 2015, but it ran into difficulties when custodian U.S. Bancorp (USB) declined to hold its assets. Alternative Harvest was able to circumvent its custodian issues by swapping in a cannabis index for an existing fund's benchmark and then relaunching. Another successful ETF, the AdvisorShares Vice ETF (ACT), got its start as a fund offering non-pure-play cannabis exposure.

How to Invest in Marijuana ETFs

Investors who are interested in taking part in marijuana ETFs face somewhat limited options. The Horizons Medical Marijuana Life Sciences ETF, one of the most established and popular marijuana ETFs, remains listed only on the Toronto exchange, although it routinely includes some American companies in its basket of holdings. U.S. investors interested in buying into this ETF would have to work with services that allow access to Canadian markets to do so.

For the AdvisorShares Vice ETF and the ETFMG Alternative Harvest ETF, the process is a bit more straightforward. U.S. investors can access these ETFs through the same means that they would like any other U.S. ETFs. 

Do Marijuana ETFs Deserve a Place in Your Portfolio?

For most investors, the biggest question about marijuana ETFs remains whether or not they are worth the time and trouble. At this stage, it is difficult to say. Despite a strong performance in some cases, marijuana ETFs face a troubled and uncertain future. With banks continuing to refuse to take on the potential legal and reputation-related risks that come with backing an ETF that deals in an industry that is not legal at the national level, there are likely going to be many marijuana ETFs that fail to get off the ground at all. Even those that succeed in going through the launch process—like ACT and MJ—are likely to experience a tough time, with highly tense negotiations with regulators and custodian institutions for the simple reason that they have had to go about achieving their goals through unconventional means.

Trading is a concern for marijuana ETFs. MJ is seeing healthy trading volumes and had about $677.59 million in assets, making it a breakout success story in the U.S. marijuana ETF market. ACT, on the other hand, had just $10.1 million in assets, making its future much less stable, even solely from the position of trading viability. Both funds have seen declines overall since the start of the year as well, which makes them even less of a sure thing for many investors already spooked by regulatory concerns. This drop in performance has mirrored an overall decline among stocks focused on marijuana as well.

The Bottom Line

Investors, banks, regulators, and others are all concerned about the future of marijuana stocks. For the time being, it remains difficult to say what that future will look like. Although many believe that there is reason to be optimistic about the eventual success of the space, for many investors today, it is simply too much of a headache to keep tabs on marijuana ETFs in a shifting landscape. That being said, if and when the legal marijuana industry in the U.S. does take off as some enthusiasts predict, those investors who got in early may be the ones who are happiest with their decisions.