Why the First Marijuana ETF May Pose Serious Problems for US Investors

With the explosive growth in medical and recreational marijuana in America, a slew of emerging companies have come public and brought new interest by investors in recent years. With there being an exchange traded fund (ETF) for just about every single investment strategy, it might have just been a matter of time before a true marijuana ETF came to market.

Back in 2014, 24/7 Wall St. pondered what a marijuana ETF might actually look like. Now the markets are getting their first real look at an ETF tacking the medical marijuana sector. The Horizons Medical Marijuana Life Sciences ETF began trading on the Toronto Stock Exchange on April 5, 2017. This was said to be the first ETF that will have exposure to North American companies that operate in the medical marijuana bioengineering and production fields.

There is absolutely no denial that a marijuana ETF will generate some investor interest. While this may be a first for true ETF investors, unfortunately many U.S. investors might have a very hard time investing in this ETF. There are some serious barriers and risks that investors need at least consider before jumping blindly into the strategy of investing in marijuana.

For starters, the Trump administration’s initial communication to the public indicated to expect greater enforcement of marijuana laws. Then there is the issue that very few such companies are large enough and have other characteristics that would qualify for a true Nasdaq or New York Stock Exchange listing, and that may mean companies with managers who are not business people or with too few employees or directors. Also, many U.S. investors do not have easy access to buy stocks in OTC Bulletin Board and Pink Sheets listings without filling out additional approval forms in their brokerage accounts.

Perhaps the largest barrier of them all for U.S. investors to buy into the Horizons Medical Marijuana Life Sciences ETF is that it trades in Canada. Having an ETF structure is meant to solve the hurdle of not being real baskets to buy in the marijuana sector, but having it not listed in the United States will keep many U.S. investors who are interested from jumping in.

There are some additional real issues surrounding the Horizons Medical Marijuana Life Sciences ETF. The management fee is listed as 0.75%, plus applicable sales taxes (and exit taxes) in Canada, which is higher than many ETF investors might want to pay. With this ETF effort targeting only medical marijuana, it might be missing out on many of the immediate growth opportunities. Then again, this nonrecreational targeting might insulate it from many federal risks if enforcement actions actually get more strict.

Another serious risk here is that the medical marijuana ETF, while it had only $26 million (Canadian dollars) in the fund as of April 6, could theoretically become larger (perhaps much larger) than some of the underlying stock holdings. The North American Medical Marijuana Index provided by Solactive, which is cited in the prospectus, is supposed to have companies with a minimum market cap over C$75 million and have an average trading volume of 75,000 shares per day (and a trading value of C$250,000 per day).

Even if the ETF doesn’t get larger than the holdings due to a maximum of 10% weighting at each rebalance date, it could easily become the largest shareholder in many of the underlying companies listed in the holdings (see below). If it owns too high a stake, it could be forced into additional SEC registrations or could become either locked into a position or unable to easily move in and out of a position as market caps change.

Another issue is that some of the holdings are small enough that the underlying trading volume could make these too volatile for comfort, and it could allow some otherwise small cap stocks to have close to the same weighting as the larger constituents.

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