Riding a Pot ETF to New Highs

Mary Jane.


Whatever you want to call it--it's the craze that's sweeping the nation.


Now, if you were born in the decades surrounding the 1960's, you might be thinking "darn kid, we've been doing pot since way back," and you're totally right--but it's never been as widely used, or widely accepted, as it is today. In 1969, Gallup first asked individuals about marijuana, they found that only 4% of American adults had tried it, and 34% said that they hand no idea what the effects of marijuana were. By contrast 42% of Americans 12 or older said that they had used marijuana at one point in their lives, with a 4.4 million increase in users since 2007.


What's driven this change? At a high level, there has been a rapid change in general sentiment regarding the drug, which has lead to a change in the laws that govern it. As of November 8, 2016, 7 states and Washington, D.C. had approved referendums to allow recreational marijuana use, meaning that three-fifths of the U.S. population now lives in states where some type of use (medical or recreational) is legal. And, while that is the population of people who have some kind of legal access to marijuana, the 32 million people who use it regularly are not necessarily all found in those states (obviously).


Even further, those 32 million users are putting their money where their mouths are. In 2015, legal marijuana sales across the country totaled approximately $6 billion--a number that's expected to more than triple by 2020, to approximately $20.6 billion; not bad, huh? Sounds like an industry that you wanna just throw your money at, right? Well, you may want to consider a big issue that will be looming for the next four years (or more): Trump.


Before we start drawing lines in the sand, I'm not talking big picture politics of President Trump, only his administration's views on marijuana. Since marijuana is still illegal on a federal level, there are two main issues for businesses in the industry: 1) intrastate commerce is forbidden, and 2) a business can't deduct marijuana related expenses from it's tax filing. What does that mean for businesses? It's actually an issue that limits their top-line (revenues missed from markets in other states) and limits their bottom line (they have a higher tax burden, since they can't write-off their expenses).


In spite of this, there are several options for businesses to make the most of the industry, while also playing by the rules:


1) Third-party licensing: Companies, like Privateer Holdings, have taken a page out of the books of Coca-Cola and other major brands by licensing out their brand to other operators in other states. They collect a fee from the use of their brand, and are able to legally tap into those markets.


2) Edible Products: Edible marijuana products have seen a huge rise in popularity over the past few years, seeing it's market share go from 32% in 2014, to 43% in the first half of 2016. For example, Auntie Dolores, a private, San Fransisco-based company that specializes in edibles, saw a growth of 28% year-over-year.


3) (Legal) Pharmaceutical Applications: There's a lot of talk about marijuana being good for one's health, helping to ease all kinds of symptoms and solve all types of ailments, but there are several pharmaceutical companies that are testing those limits. GW Pharmaceutical (GWPH) is a British company whose drug received the first market approval for a natural cannabis-derived treatment.


4) Cannabis Accessories: I use the term "accessories" very loosely to also cover the tools that are used to grow and cultivate the crop, especially hydroponic tools, which allow one to grow plants without the use of soil. Good ol' Scott's Miracle Grow (SMG) has decided to get into the drug-game the safe and easy way by buying up hydroponic companies to bolster their exposure to the marijuana market. Two of these buy-outs cost them $260 million, but brought in more than $300 million in revenue (2015).


However, since the marijuana market is so sensitive to regulation and the whim of federal la enforcement agencies (they could technically "bust" any distributor and user for breaking federal law), it is a very risky industry to invest in--at least when looking at individual companies. Just like the Law of Large Numbers protects insurance companies from a disproportionate amount of houses burning down, an ETF protects investors from a single company failing. However, there is not an ETF for pot stocks...yet.


Though there have been many non-trade-able indicies that follow the value of the marijuana industry for many years now, the volume in those companies is not large enough to safely create an ETF based on them. By the end of this year, however, there will likely be two companies who pull it off: Viridian Capital Advisors and ETF Managers Trust. While the former manages the Viridian Cannabis Stock Index and has been working toward an ETF for many months, the latter will be launching the Emerging Agrosphere ETF at some point over the next few months--and have already filed their preliminary prospectus with the Securities and Exchange Commission (SEC). The reason for the name, by the way, is likely because lawyers and regulators 'suggested' that they not explicitly put "marijuana" or "pot" in the name. Furthermore, these companies would only follow companies who's major business line is medical marijuana, not necessarily recreational distribution. Before you fret too much, the Bloomberg index that tracks medical marijuana is up more than 200% on its trailing-twelve-month.


No matter who sets up their ETF first, one thing that is for sure is we will see lots of people cashing-in on the pot trade.

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