Managing Risk in Pot Stock Investing
Since you are reading this article, you are likely interested in the huge upsides offered by marijuana stocks. Indeed, over the past two years, the cannabis industry has provided some serious returns to stock market investors.
But more recently, sentiment seems to have changed. The marijuana stocks that used to deliver double-digit gains every other day have experienced downturns of similar magnitudes.
Of course, the pullback in the overall U.S. stock market certainly had something to do with the latest crash in pot stocks. But at the very least, the recent share price performance of many cannabis companies serves as a reminder that investing in the industry still involves quite a bit of risk.
I don’t like risk. And even if you are not as risk-averse as I am, you probably don’t want to see double-digit drops in your portfolio.
That’s why today I want to talk to you about a relatively safe way to invest in the marijuana industry: exchange-traded funds (ETFs).
A Marijuana ETF?
As the name suggests, exchange-traded funds are funds that trade on stock exchanges.
You can buy and sell them throughout the trading day, just as you would do with regular stocks. The difference is that an ETF is not just one company; it can have tens—sometimes hundreds—of companies in its holdings.
In other words, an ETF is like a diversified portfolio of stocks.
Of course, you can also construct your own portfolio, but keep in mind that, when you are buying tens of stocks, transaction costs could be substantial.
Even if you use a discount broker that charges, say, $7.00 per transaction, the amount can quickly add up when you purchase shares of dozens of companies.
With an ETF, you get to own a diversified portfolio with just one transaction.
Obviously, there’s no free lunch. By providing investors with a convenient way to have exposure to a large portfolio, ETFs charge a management fee. It’s important for investors keep this fee in mind before making investment decisions.
There are many types of ETFs. Some track an index and others are structured to provide income. There are even triple-leveraged ETFs designed to triple an investor’s exposure to a certain index or asset class.
To marijuana stock investors, though, the ETF choices are very limited at the moment. One of the best marijuana ETFs right now is Horizons Marijuana Life Sciences Index ETF (OTCMKTS:HMLSF, TSE:HMMJ).
Horizons Marijuana Life Sciences Index ETF
Horizons Marijuana Life Sciences Index ETF aims to replicate the performance of the North American Marijuana Index after expenses. The index tracks the leading cannabis stocks in the U.S. and Canada.
The components include biopharmaceuticals, medical manufacturing, distribution, bioproducts, and other businesses. Companies on the index are required to have a business strategy focused on the marijuana or hemp industry.
To become a constituent, a company has to meet the index’s trading criteria.
Generally speaking, a component will need to have a market capitalization of greater than CA$75.0 million. Furthermore, the average monthly daily trading volume will need to be greater than 75,000 shares a day, with a trading value generally greater than CA$250,000.
The index is equal weighted and is rebalanced on a quarterly basis. Also, no single marijuana stock can represent more than 10% of the index on each rebalance date.
With an inception date of April 4, 2017, Horizons Marijuana Life Sciences Index ETF was the very first ETF to focus specifically on the cannabis industry. The fund currently holds 48 stocks, including some of the biggest names in the business.
As of November 27, 2018, HMMJ ETF’s top five holdings were Tilray Inc (NASDAQ:TLRY), Scotts Miracle-Gro Co (NYSE:SMG), Canopy Growth Corp (NYSE:CGC), Aurora Cannabis Inc (NYSE:ACB), and GW Pharmaceuticals PLC (NASDAQ:GWPH). (Source: “Horizons Marijuana Life Sciences Index ETF,” Horizons Exchange Traded Funds, last accessed November 28, 2018.)
As I mentioned before, ETFs charge a fee for offering investors the convenience of owning a diversified portfolio with one transaction. In the case of HMMJ ETF, the management expense ratio is 0.75% annually.
At the end of the day, I believe that tracking the North American Marijuana Index is a relatively safer way to get some exposure to the industry, and HMMJ ETF provides a convenient way to do so.
However, it is by no means risk-free. While the fund is diversified across more than four dozen stocks, these companies are mostly still within the cannabis industry.
In other words, if marijuana stocks take a tumble, like what happened in the past two months, the fund could see its value drop. And that’s exactly what happened.
However, I should point out, that since its inception last year, HMMJ stock is still up more than 66%.
Like most ETFs, Horizons Marijuana Life Sciences Index ETF takes the burden of stock-picking away from the investor.
If you are great at picking individual pot stocks, you may be able to beat the performance of the fund. But for investors who don’t want to check a lot of companies’ earnings reports, or for novice investors who just want to have some exposure to the marijuana industry, HMMJ ETF deserves a serious look.