One of the most interesting developments in small-cap stocks over recent years has been the growth in companies trying to exploit the medicinal benefits of cannabis and its derivatives.
Whilst growth in the sector within in the UK has been constrained by an inconsistent approach to the use of cannabis by both customs and the medical profession, in other jurisdictions the use of such products is commonplace and an ecosystem of legitimate businesses have sprung to support it.
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According to research from Investment bankers Canaccord, in Germany alone, there were 185,000 prescriptions written for medical cannabis in 2018 and the bank estimates that Europe wide the number of prescriptions written for such products grew by +123% YoY in 2018 and by a further 45% YoY in 2019 to date.
It’s very timely then that the US Securities and Exchange Commission has recently announced the approval for cannabis orientated ETFs, the US regulator ruled that if an ETF manager could produce an independent legal opinion that their holdings do not contravene any federal laws then they were free to list in the United States.
In truth, the legal picture for cannabis-based companies in the US is still patchy and can vary widely from state to state, as indeed it does in Europe. However, the US Federal Drug Administration or FDA has approved several cannabis-derived products for use as medicines in areas such as the relief of nausea in chemotherapy patients and in the prevention of specific types of childhood epilepsy.
The current state of Cannabis ETFs
Existing marijuana-focused ETFs are now applying to list on US exchanges in the hopes of attracting a much wider client base and a greater flow of funds from both retail and institutional investors.
Some of these funds focus purely on the growing market for the medicinal use of cannabis whilst others invest along the whole supply chain with particular emphasis on Canadian listed stocks. Canada has a much more relaxed set of drug laws than say the United States, and as such many businesses have chosen to base and list themselves in the country.
Interestingly though the US has the most assets under management in marijuana-related ETFs, with AUM estimated to be around US$ 1.0 billion compared to just US$ 530 million under management in Canada. Some experts believe that as much as US$10 billion could ultimately flow into these type of ETFs.
It has hardly been plain sailing for investors in the sector though, indeed the index that tracks the performance of quoted marijuana businesses has fallen by almost -50% since March according to the FT. That sort of volatility might be expected to continue until we see a widespread consensus about the legal status and use of the underlying cannabis products.
That said Cannacord believe that the European CBD and wellness markets will generate as much as €1.0 billion in revenues in 2018/2019 with further opportunities for growth beyond that as and when regulatory and legal barriers come down.
What do the professionals think of marijuana ETFs?
Managers of ETFs in the sector also believe that there are significant growth opportunities to be had, they predict that cannabis-related medicinal products will ultimately find a place in most households.
This is clearly an exciting market with lots of potential opportunities, however, it is also at a very early stage in its development and as such it has something of the frontier feel about it.
Prices and returns are likely to be driven by sentiment rather than fundamentals and as we noted above the lack of a common legal framework around cannabis in developed nations is a substantial barrier to progress.
That said the SEC ruling suggests that the cannabis ETF sector can move into the mainstream and that means that investors can put their money into a spread of businesses and diversify their risk rather than concentrating it in one or two names and that has to be a good thing.
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Richard founded the Good Money Guide (previously Good Broker Guide) in 2015 and has been a broker for 20 years most recently at Investors Intelligence and previously a multi-asset derivatives broker at MF Global (Man Financial). Richard started his career working as a private client stockbroker at Walker Crips and Phillip Securities (now King and Shaxson) after interning on the NYMEX oil trading floor in New York and London IPE in 2001 & 2000.