One such fund is the
Horizons Marijuana Life Sciences Index ETF (TSX: HMMJ), launched last April. It was the first to invest in cannabis-related
companies and remains one of the few ways to access a diversified portfolio
of “pot stocks.” It carries an MER of 0.75% (plus applicable sales tax) and
boasts assets of $1 billion as of Aug. 31.
The fund tracks the performance of the North American Medical Marijuana
Index, a cap-weighted index. To be considered for inclusion, a company must
be involved in the production of cannabis, the research and development of
cannabinoids, equipment providers, and companies involved in leasing
property to growers. The maximum weight of any one name is capped at 10%,
and the index is rebalanced quarterly.
There is little doubt that the potential for growth is very high in the
space, as the industry is in its infancy and governments in Canada and some
U.S. states continue to legalize the drug. Some estimates expect that
annual, regulated pot sales in North American will top more than $20
billion by 2021. But strong growth potential doesn’t necessarily make a
Today, there are many small players in the industry, with more joining in
every day. Some are well-managed, with well-thought-out business plans, but
most are undercapitalized and have inexperienced management with poor
Furthermore, valuation levels are off the charts, based on any normalized
fundamental metric. For example, the largest holdings in the Horizons fund,
Aurora Cannabis (17.6% of assets at Aug. 31), with market capitalization of
$11.4 billion, just reported its fiscal fourth quarter profit of $79.9
million, up from a loss of $19.2 million in the year-ago quarter. The stock
is trading at a forward price/earnings ratio of 322, and a price/sales
ratio of 124. That level of valuation increases the risks substantially in
an evolving industry.
There is no doubt that money is to be made in the sector, but one is
cautioned to proceed with caution.
In such an evolving industry, I don’t believe an ETF that selects and
weights stocks based on market capitalization is necessarily the best way
to access the sector. One of the flaws of a market-cap index is that it
tends to overweight the most overvalued names, which in this sector
significantly increases the risks.
Instead, investors who want diversified exposure to the sector may be wise
to hold off until other, more actively-managed funds become available and
establish a trading history of at least a year or more.
Dave Paterson, CFA, is the Director of Research, Investment Funds for
D.A. Paterson & Associates Inc., a consulting firm specializing in providing research and due
diligence on a variety of investment products. He is also the publisher
Dave Paterson’s Top Funds Report,
offering regular commentary and in-depth analysis of Canada’s top
investment funds. He uses a unique analytical approach to identify
funds with strong, risk-adjusted returns, and regularly publishes his
insights and analyses in Fund Library.
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