To help deepen investor knowledge in all aspects of ETFs, we periodically feature interviews with key individuals from across the industry. The goal is to highlight new ETF ideas and delve into more nuanced topics currently impacting the space. One area that has grown more popular over the last several years is cannabis-related ETFs. This industry seems primed for growth given the slew of individual states legalizing cannabis. However, cannabis is still illegal at the Federal level, making investing in the space more complicated. The ETF Institute’s VP of Operations, Devin Bos, recently sat down with AdvisorShares’ Dan Ahrens to discuss investing in this sector.
AdvisorShares currently offers 25 ETFs, including three cannabis ETFs. Dan Ahrens is Managing Director and an experienced portfolio manager currently overseeing multiple ETFs in the AdvisorShares suite, including Pure Cannabis ETF (YOLO), Pure US Cannabis ETF (MSOS), Psychedelics ETF (PSIL), and Vice ETF (VICE).
Bos: You currently manage two of AdvisorShares cannabis ETFs – YOLO and MSOS. I believe that YOLO is global-focused, while MSOS is US domestic. Can you briefly compare and contrast the funds?
Ahrens: Yes. YOLO was our first cannabis ETF launched and is a global strategy. It has US exposure along with Canadian, and even holds Israeli and UK companies. It was the first actively managed cannabis ETF launched in the US. Soon after it was launched, we filed for the US-only ETF MSOS. We are very selective in the stocks we hold and how we weight them in both funds since we are actively managed. I think our track record has quickly proven that active management is best in a rapidly changing area like cannabis.
Bos: Let’s briefly focus on just YOLO for a minute. This fund came to market in the spring of 2019. Even though it wasn’t the first cannabis fund to trade in the US, it was the first to utilize swaps, correct?
Ahrens: Correct. We did a lot of work behind the scenes and before launch in communication with the stock exchange, our custody bank, and others to get everyone’s approval. We utilize total return swaps to get exposure to US multi-state operators, that aren’t yet allowed to list on major exchanges, and that many banks aren’t willing to custody.
Bos: Just to make sure all readers understand what we’re talking about, can you briefly go over the swap process?
Ahrens: A total return swap is a derivative contract with a counterparty. We are simply getting a swap on individual equities, so that we are not actually owning the stock or having custody of the stock, but rather getting its total return. We have some education and explanation on our website. The only reason we do this is to get the returns or exposure to stocks that we’re currently not allowed to own directly, but all parties agreed that it was ok via total return swaps. Investors should notice that our holdings show a very large amount in cash or money market, as well as a very large negative cash balance that’s pledged to the swaps. The Fund itself isn’t leveraged. People should focus on the total exposure we have to underlying stocks.
Bos: What difficulties did you encounter before bringing YOLO to market? Was there any legal pushback, specifically with the use of swaps correlated to cannabis?
Ahrens: Not push back, but a great deal of work and communication. Written legal opinions and official filings with comment periods were quite time-consuming. We had great partners through the process at our Fund Administrator and Custody Bank, at the Exchange, at our Distributor, and with our outside legal counsel.
Bos: Since this is a global fund, are there any cannabis legalization opportunities that you’re watching currently? What type of diligence would you put into allocating to another international market?
Ahrens: It’s a great question, and there are ever-increasing opportunities in Europe, South America, and even places like Israel. But those opportunities are usually available through US and Canadian-traded stocks. While other continents have plenty of population, the international cannabis markets are actually quite tiny compared to the North American cannabis market.
Bos: Let’s switch our focus to MSOS for a second. You gave us a general overview of MSOS initially, but can you go a little deeper? Since the legalization landscape is different in almost every state, what’s the investment case for allocating to a US domestic cannabis fund right now?
Ahrens: Each state does vary, but we’ve seen a rather constant wave of states either approving medical marijuana or adult-use cannabis sales. Significant states like New York and New Jersey have recently approved and are prepared to start adult-use sales. Even without counting these new states, revenue growth has been fantastic, yet doesn’t seem to be reflected in stock price. An amazing amount of revenue is expected in the coming years. We look closely at companies existing footprint of state licensees and dispensaries, and future markets that they’ll have come online soon.
Bos: I noticed that a large portion of the market cap for MSOS is within the mid-cap range. This was surprising to me since I assumed many of these companies would still be in the micro or small-cap range. Can you give us a few names that are in your current allocation?
Ahrens: Successful US operators continue to grow revenue state by state and have grown into the largest cannabis companies in the world. Just a couple of years ago, the largest were Canadian due to their 2019 legalization. Among favorites are Trulieve Cannabis (TCNNF), Green Thumb Industries (GTBIF), Verano Holdings Corp (VRNOF), and Curaleaf Holdings (CURLF).
Bos: What about the current sector allocations? How likely is this allocation to change over the next 5 or 10 years? Are there any specific sectors that will be more prone to growth?
Ahrens: We own a few ancillary companies such as suppliers and even cannabis-focused REITS, but the focus is really on plant-touching US multi-state operators, and they generally operate as vertically integrated companies – meaning they grow it, package it, and sell it in their own dispensaries. Things will change with multiple steps in the reform of Federal laws, and the cannabis market will steadily turn to a more consumer-packaged goods focused business. We view the current operators with their licenses, experience, operations, and infrastructure as set up to dominate or at least as extremely attractive acquisition targets.
Bos: Assuming that most investors would invest in this fund as a satellite holding to potentially enhance their alpha, do you have any specific thoughts or advice that an investor should consider before allocating to this theme?
Ahrens: Investors need to keep a long-term focus and realize that volatility or long-term drawdowns could be severe. While the opportunity seems huge because the cannabis industry is still in its infancy, it is heavily dependent on continued political developments.
Bos: How about some advice for advisors when framing the investment case to clients?
Ahrens: The US cannabis opportunity is massive, but it’s extremely important to understand the difference between Canadian cannabis companies and US cannabis companies. It’s hard to think of another industry where a similar situation could exist. Under current laws, Canadian companies can list on major US exchanges, but cannot do any actual marijuana business in the US. Companies operating in the US can’t list on those same exchanges but are thriving in the US with generally very strong balance sheets and terrific revenue growth. In many cases, the Canadian cannabis operators have been suffering fundamentally.