A Reassessment Of The Cannabis ETFs

Introduction

When I first began writing about cannabis ETFs in 2019, the sector was in a primitive and volatile state. Canadian legalization was a year old, and legalization in the US was at an early stage. Stock prices had risen and declined by 100%, 200% or more. Given the state of the sector, I suggested that ETFs had a place in most cannabis portfolios. Among the reasons why were:

• It was very uncertain which companies would be successful (or even survive) and which would not.
• ETFs were a way to smooth out volatility.
• ETFs were a way to guarantee participation in the inevitable growth of the sector.
• Professional management could be helpful in navigating Byzantine capital structures, murky management and unproven strategies.

Two and a half years later, the sector has matured appreciably, and it’s time to reevaluate the usefulness of ETFs. This article will look at the performance of ETFs vs. individual stocks, and then discuss the role of ETFs today.

Performance Of Cannabis ETFs Vs. Individual Stocks

The chart below shows the 12-month performance of four prominent ETFs:

• AdvisorShares Pure US Cannabis ETF (MSOS)
• AdvisorShares Pure Cannabis ETF (YOLO)
• Amplify Seymour Cannabis ETF (CNBS)
• ETFMG Alternative Harvest ETF (MJ)

Although the ETFs have different investment strategies, the homogeneity of performance is remarkable. Even MSOS, whose US-only strategy is distinctly different than the others, couldn’t break out of the pack. There are a couple of reasonable explanations for the bunched performance. First, every name has been equally beaten down as investor sentiment has deserted. Second, it’s a small industry. Even with different strategies, ETFs will have significant holdings in common. A small handful of names contain a large portion of total market cap (only 9 have a market cap of over $1 billion) and will necessarily attract the lion’s share of investor money.

The next chart shows the 12-month performance of four widely held individual names:

• Trulieve Cannabis (OTCQX:TCNNF)
• Curaleaf Holdings (OTCPK:CURLF)
• Green Thumb Industries (OTCQX:GTBIF)
• Cresco Labs (OTCQX:CRLBF)

Although there is more variability than in the ETF chart, all four have ended up in roughly the same position.

The specific 12-month returns of all eight entities are in the table below.

	Current price ($)	12-month loss (%)
** ETFS **
MSOS	14.36	-63.2
CNBS	8.59	-64.3
YOLO	6.94	-64.4
MJ	7.46	-62.9
ETF avg.		-63.7
** COMPANIES **
GTBIF	12.70	-53.8
TCNNF	14.97	-61.1
CURLF	6.10	-57.6
CRLBF	4.14	-62.7
Company avg.		-58.8

There has been no place to hide in cannabis. Even Innovative Industrial Properties (IIPR), an outstanding investment since its inception, is down 27.3% for the year and 55% since its high in November 2021. IIPR illustrates how the investor community has painted all of cannabis with the same brush, ignoring differences between companies. IIPR has been profitable every quarter since inception, is backed largely by real estate, and pays a well-covered dividend, yet its decline is equivalent to clearly more speculative companies. The entire sector is in a major slump.

Did The ETFs Work As Designed?

The ETFs did smooth out volatility. They enabled investors to own parts of the best companies and prevent excessive allocation to the worst ones. They accurately represented the sector as a whole. However, professional management did not appear to be an advantage, and the drag of fees and expenses, minimal as they are, hurt. Considering their overall bottom line performance, a reassessment of their role is warranted.

A Change In Strategy

The bull case for cannabis is still intact. Growth estimates for the sector are high and unchanged, even if a difficult first quarter led some companies to dial back revenue projections for the year. It’s an important time for investors to guard against the recency phenomenon, in which people assume what has occurred in the recent past will continue in the future. In fact, the one thing we know about the future is that it will be different. It’s not time to get out of cannabis, but perhaps it’s time to reallocate.

As I have written recently, the sector has changed greatly in just a few years. Many of the reasons for investing in ETFs no longer apply. The eventual cannabis winners are becoming evident. As they become stronger and more successful, they will reap the biggest portion of revenue and profits in a much larger industry. Their slightly superior performance in the data above is perhaps a sign that this has already started. In the early days, cannabis investors needed ETFs to spread their bets across many companies, but the advantages of such a strategy today are diminished. It’s possible to focus on the strongest companies, and avoid the weaker and/or more speculative ones. Alternatively, investors with a more adventurous mindset can focus on their speculative favorites.

Recommendations

ETFs remain a valid choice for some investors. They are still the best vehicle for getting broad-based sector coverage that requires minimal ongoing attention. But we have reached a point where many investors with new money can skip the ETFs and concentrate on emerging leaders like Trulieve, Green Thumb, Curaleaf, Cresco and Verano (OTCQX:VRNOF). Those who already own ETF shares may wish to sell and reallocate to companies like these. (Note that this strategy allows a tax loss benefit while maintaining the same sector exposure.) Other investors may have their eye on smaller companies they find attractive. I have written positively about Schwazze (OTCQX:SHWZ) and Ayr Wellness (OTCQX:AYRWF).

Summing Up

The development of the cannabis sector over the past two or three years has made the use of ETFs unnecessary. The sector was truly the Wild West just a few years ago, and no one knew which names would thrive and which would not. This is no longer the case. Investors can now reallocate money to the strongest companies, which will be receiving the lion’s share of industry growth and profits.

Some investors may be disheartened by the decline across the entire sector, but such experiences are to be expected in any high growth emerging industry. Cannabis names did not warrant the high prices they had in early 2021, and now we can get back to fundamentals, where we should have been all along. A number of companies have solid fundamentals, looking like value stocks with a high growth profile. The cannabis correction is ahead of some other high growth sectors, where sky-high PE ratios or negative earnings are still a burden. By focusing on the future rather than the past, we can be assured of being there as cannabis fulfills its exciting potential.