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Canadian cannabis ETFs emerge

Volatile sector expands with additional investment opportunities

Canada’s budding cannabis industry has experienced some volatility since legalization in October 2018. With asset managers introducing a range of new cannabis exchange-traded funds (ETFs), investors now have further options to gain exposure to the sector.

The unpredictability of cannabis

Key insights

  • While the Canadian cannabis sector continues to experience volatility, largely the result of ongoing restructuring, new ETF options continue to emerge
  • Cannabis ETFs have experienced significant trading volumes and recorded impressive returns
  • Retail investors value the flexibility of ETFs in this volatile sector

Volatility in this sector is due to a range of factors, including supply chain bottlenecks and a slow roll-out of brick and mortar retail locations. The primary source, however, remains the sector’s ongoing restructuring activities, particularly among the largest players.

After Canada became the first industrialized nation to make the sale of recreational marijuana legal in October 2018, speculation regarding its potential value sent stock prices soaring, before gradually bringing them back down. As significant brands compete for territory, and as related industries like alcohol, tobacco, agriculture, and pharmaceuticals try to gain their own foothold in the space, there are few signs to suggest stability is coming anytime soon. The expected emergence of edibles and beverages will also contribute to unpredictable market dynamics.

Mergers and acquisitions continue

Since cannabis companies began trading on major exchanges, there has been a regular stream of restructuring and consolidation activities, with each move sending stock values in a new direction. Not only are licensed producers (LPs) competing for territory and capacity in Canada, the United States, and abroad, but a range of other peripheral industries are making deals that are adding to the ongoing restructuring of the industry.

The first such merger among publicly traded LPs was completed by Canopy Growth in late 2015, followed by further acquisitions in 2017 and 2018.1 Then, as a result of capacity-expanding projects, the company lost almost CAD 215 million on an operating basis in 2018. In the first quarter of 2019, however, Canopy Growth’s stock gained nearly 61 percent, in large part due to a USD 4 billion investment from alcoholic beverage maker Constellation Brands.2

Since cannabis companies began trading on major exchanges, there has been a regular stream of restructuring and consolidation activities

Despite the company’s growth, its stock still lagged behind competitor Aurora Cannabis, which ended the first quarter of 2019 up 83 percent.3 Even with an impressive start to the year, Aurora was down 44 percent through 2018 after its own year of restructuring, which included a partnership with Denmark-based Alfred Pedersen & Son, and a new organic project in Medicine Hat, Alberta.4 The company recently saw its net revenue surge 617 percent year-over-year to CAD 73.6 million in its fiscal third quarter, yet still posted a loss of about 20 cents per share, excluding charges.5

The stock performance of Tilray, another major industry player, is experiencing similar volatility, with a first quarter decline of seven percent.6 Unlike its competitors, however, Tilray has not yet received an equity investment, though it has a partnership with alcoholic beverage producer, Anheuser-Busch InBev.7 The company also signed major partnership deals with pharmaceutical giant Novartis and global lifestyle and entertainment brand portfolio holder Authentic Brands Group. Tilray recently announced the acquisition of leading hemp food company Manitoba Harvest and another privately held LP in Ontario.

Since legalization, such deals have become regular events. With the number of LPs in Canada now exceeding 140, and more than 50 publicly traded companies in the sector, the consolidation may have only just begun.8 2019 started off strong for Canadian marijuana companies, and the pattern of restructuring and resulting volatility shows no signs of easing.

Cannabis added to S&P/TSX 60 Index

On April 12, 2019, it was announced that Canopy Growth would join the S&P/TSX 60 Index, achieving another public market ‘first’ for the cannabis industry. The S&P/TSX 60 index includes 60 large Canadian companies that trade on the Toronto Stock Exchange (TSX). Canopy Growth was the first cannabis company to list on the exchange, and celebrated its fifth anniversary as a publicly traded company being added to the TSX’s large-cap index.

Diversifying with ETFs

Did you know? 

In 2018, securities lending
in the cannabis sector
delivered USD 230 million
in lending revenue, compared
with USD 106 million the prior
year, equivalent to 7.5 percent
of all North American equity
lending revenue.9

Selecting individual stocks in this sector is tying outcomes to the fortunes of companies whose structures and stock values are in constant flux. Instead, retail investors are turning to ETFs to help mitigate the industry’s unpredictability.

Today, there are a range of ETFs focused on the cannabis sector, each with its own unique strategy and approach. Their popularity can largely be traced back to the success of the world’s first fund in the space, the Horizons Marijuana Life Sciences Index ETF (HMMJ).10

“It wasn’t until the early part of 2017 where we felt there were enough names, about 15 stocks, to allow us to launch an ETF that would give everyone a one-ticket diversified solution to buying marijuana stocks,” Mark Noble, senior vice president of ETF strategy with Horizons ETFs, told Investing News.11

HMMJ now has more than CAD 800 million in assets under management and 124 percent total return since its inception.12 The fund’s growth, as well as the success of other actively managed ETFs, has helped solidify their position as a strong-performing, yet less-volatile investing strategy for the sector. Most recently, Horizons ETFs expanded their ETF line-up with the addition of the “world’s first leveraged and inverse marijuana ETFs, HMJU, and HMJI, respectively.”13

With the impressive performance of HMMJ, a range of competing ETFs have since emerged. Horizons ETFs itself has also since introduced additional cannabis ETFs, one with a focus on smaller players in the cannabis space, as well as the world’s first US-specific marijuana index, HMUS.14

With the impressive performance of HMMJ, a range of competing ETFs have since emerged

From launching the first marijuana ETF in April 2017 to its introduction of leveraged and inverse marijuana ETFs in May 2019, Horizons ETFs has quickly positioned itself as the provider of the world’s largest suite of funds focused on the cannabis sector.

Though options were once limited for investors in the cannabis sector, the number, and diversity of ETF opportunities is only expected to increase. “The sector continues to evolve and the emergence of cannabis ETFs provide yet another avenue for investors to diversify. Our ETF solutions provide valuable support to managers as they look to further expand their ETF line-ups,” notes Paul Stillabower, Global Head of Product Management at RBC Investor & Treasury Services.

Cannabis ETFs draw retail investors while institutional money buys direct

Though cannabis ETFs are gaining in popularity and number, institutional investors, Canadian pension plans in particular, are investing directly.15 The Public Sector Pension Investment Board, for example, invested in four individual names during Q4 2018.16 The Ontario Teachers’ Pension Plan Board also ended 2018 with a position in Aurora Cannabis valued at approximately CAD 1 million.17 While the positions are not substantial, relative to their portfolios overall, it may signal that the market is beginning to mature, making it more palatable for conservative institutional investors.

Against this backdrop, firms capable of demonstrating compliance will become increasingly attractive as privacy takes on greater importance

Within the sector, ETFs continue to drive forward. In fact, the world’s first cannabis ETF is also poised to become one of Canada’s most profitable, after returning more than 50 percent at the start of 2019. “HMMJ’s growth has far exceeded our expectations, as investors have strongly supported the sector in anticipation of Canada’s upcoming recreational marijuana legalization,” Steve Hawkins, President and CEO of Horizons ETFs, said in a press release in early 2018.18 The fund is now the country’s 18th largest ETF, according to data provider ETFGI. Despite the recent activity, the bulk of ETF capital remains with retail investors. The HMMJ ETF, for example, has less than one percent of its holdings tied up with institutions, according to Bloomberg figures.

A hazy future?

The cannabis sector, while still subject to volatility, is performing strongly as a whole. Investors now have greater choice in gaining exposure to the sector with the emergence of a growing range of cannabis ETFs. Moreover, as institutional funds begin to enter the sector, it could signal confidence in the sector’s growth potential.

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Sources

  1. Profit Confidential (April 16, 2019) Canopy Growth's S&P/TSX 60 Win a Major Milestone for CGC Stock & Marijuana Stocks Everywhere
  2. Motley Fool (April 3, 2019) Why Aurora Cannabis Outperformed Canopy Growth and Tilray in Q1
  3. Ibid.
  4. The Globe and Mail (February 25, 2019) Canadian pension funds buy cannabis stocks
  5. Ibid. Motley Fool (April 3, 2019)
  6. Ibid.
  7. Ibid. The Globe and Mail (February 25, 2019)
  8. Forbes (April 7, 2019) Mergers and Acquisitions Light up the Cannabis Sector
  9. IHS Markit (January 23, 2019) Securities Finance 2018 Year in Review
  10. Midas Letter (April 24, 2019) Horizons ETFs Management Inc (TSE:HMMJ) Launches US-Focused Horizons US Marijuana Index (NEO:HMUS)
  11. Investing News (March 7, 2019) Cannabis ETFs to Track in 2019
  12. Ibid. Midas Letter (April 24, 2019)
  13. Horizons (May 21, 2019) Horizons ETFs Launches Worlds' First Leveraged and Inverse Marijuana ETFs
  14. The Globe and Mail (February 17, 2019) Active management in cannabis? These ETFs make a compelling case
  15. Ibid. Globe and Mail (February 25, 2019)
  16. The Cannabis Investor (February 24, 2019) Canadian Pension Fund Loads up on These 4 Marijuana Stocks
  17. Ibid. Globe and Mail (February 25, 2019)
  18. Cision NewsWire (September 7, 2018) World's First Marijuana ETF Reaches $1 Billion in Assets