Let's Unroll Two Cannabis-Related ETFs

It wasn't too long ago that accessing the swaps market was the stuff of institutional, family office and other ultra-rich investors. It also wasn't that long ago that cannabis was thought of as something for ... potheads. Now, however, swaps are within reach of average investors, and marijuana is as close as the local dispensary, and both can be rolled up as options for exchange-traded fund investors. Swimming in the Swap Entering into a swap often requires eight or nine-figure pools of principle, an International Swaps and Derivatives Association (ISDA) Master Agreement and a willing counterparty. Anyone not bringing that kind of capital to a potential deal ends up having ... well ... this kind of this kind of experience. That changed in the U.S. exchange-traded fund market during the 2008 housing crash, when the Securities and Exchange Commission issued an effectiveness letter to a then-new firm called Direxion and on Nov. 4 2008, regular U.S. investors were, for the first time, able to trade a three-times levered position in a single ticket, margin-free position. Anyone with a brokerage account (assuming the platform approved the ETFs) could go long or short with 3-times leverage in financial, large-cap, small-cap or energy stocks. Now, technically, investors could and still can invest in exchange traded notes (ETNs) that provided swap-based exposures. ETNs, however, are pieces of unsecured debt and investors are at the mercy of the issuers' balance sheet, not to mention at least third in line behind bank and secured debt holders of the issuer in the event of a bankruptcy filing, which we saw both in 2008 (looking at you, Lehman) and again in the volatility of last year from a number of issuers, primarily UBS. Up until recently, swaps were used primarily as a vehicle to provide leveraged exposures to investors at the fund level, meaning an entire fund would essentially be one big swap that would get marked to market daily (some on a monthly basis) and investors and traders alike could express their opinion on any particular sector as the industry likes to say. Did I mention that only Direxion and ProShares have approval to issue leveraged products? That's a whole other story. What changed was when the folks at Advisor Shares convinced the SEC to allow them to use a swap structure to provide U.S. based shareholders easy exposure to a group of securities that they otherwise would not be able to invest in. The group of securities of course are the Multi-State Operators that are the primary producers and sellers of cannabis products. Barely Legal: Multi-State Operators (MSO) As the debate over legalizing marijuana burns on, only six states still have laws punishing users and two more deem marijuana illegal, but have decriminalized the drug. Despite the steps states have taken to legalize marijuana, either for medicinal or recreational use, the federal government has it as Schedule 1 drug, right up there with heroin. Because of this federal designation, any commerce that occurs in a state where marijuana is legal must remain in that state. What I mean by this is that any activity that involves product or proceeds from the sale of any product crossing state lines is illegal at the federal level. What this also means is that while a company can do business in more than one state, each state must be registered as its own separate entity. Any nationally chartered bank is essentially blocked from doing business with an MSO and listing an MSO on the New York Stock Exchange, Nasdaq or the Chicago Board Options Exchange? Forget it. Having said that, there are cannabis companies listed on Nasdaq, but from what I can tell they are either serving markets outside of the U.S. or acting as a product provider to existing MSOs, but not acting as an MSO in their own right. What does that mean? It's complicated. No explicit rules bar listings, but honestly, that's a lot of potential lawyer fees for fighting a battle that one day will likely be resolved through legislation. Many MSOs trade over the counter, but due to exchange listing rules, OTC securities are not allowed to be directly held in ETFs. This has to do primarily with company reporting rules for listed companies. The year 2019 saw the launch of the first actively managed cannabis focused ETFs in the U.S. market. Advisor Shares beat Amplify to the bell, launching the aptly tickered YOLO on April 18, followed fairly closely by CNBS on July 23. Let's look at each. You Only Live Once: YOLO The 75 basis point Advisor Shares Pure Cannabis ETF as stated is an actively managed fund so there is no index to track here. The portfolio is managed by Dan Ahrens who, among other achievements authored both Investing In Vice (Wiley, 2004) and Investing In Cannabis (Wiley, 2020). In reviewing security selection, YOLO not only provides solid exposure to the space but also includes a roughly 16% allocation to the AdvisorsShares Pure US Cannabis ETF (MSOS) and as such provides exposure to the sought after multi-state operators talked about earlier. In reviewing quarter-to-date returns to Tuesday, YOLO is down 12.71% with the allocation to MSOS (down 16%) contributing to approximately 20% of those returns. MSOS itself wasn't the biggest drawdown in the portfolio, but its hefty weight didn't do it any favors. If you include the holdings of MSOS, YOLO has a total of 55 positions, 20 of which are shared (36% overlap) with the next fund I'll talk about, CNBS. Can-Do CNBS The 75-basis point Amplify Seymour Cannabis ETF is also actively managed, so no index as well. The portfolio is managed by Tim Seymour, who holds board or advisory roles to several private cannabis companies and also has the distinction of regularly appearing on CNBC's Fast Money show to provide cannabis industry commentary. The fund fact sheet does specify that Amplify is setting a 50% revenue exposure threshold to the cannabis and hemp segments, which is lower than I care for, but from what I can see in the holdings, nothing aside from Perkin Elmer, raises any eyebrows for me. The $7-plus billion acquisition of GW Pharmaceuticals earlier this year by Jazz Pharmaceuticals (also held in YOLO) not only provided that huge early 2021 valuation spike in the space, but looking at its development pipeline shows it's done a good job integrating that purchase into the overall mix. In reviewing quarter to date returns to Tuesday, CNBS is down 18.88% with the allocation to WM Technology contributing to approximately 23% of those returns essentially getting cut in half over the period. If we look at overlap between the two funds from the CNBS side of things we see an overlap of 20 of 34 names (59%) with YOLO. A Tough One As you can see by the chart, 2021 has not been kind to the cannabis sector post the acquisition I mentioned earlier. This is interesting, considering the growth in the space (46% growth from 2019 - 2020 per cannabis industry analyst BDSA) as well as advancements in legislation that continue to crack open markets to medicinal use or open them further to what the industry refers to as Adult Use. As to which fund I prefer, it's a tough call, because both provide great targeted exposure, have experienced managers running the portfolio and charge the same fees. If I were to get down to the most basic of analysis points, the since inception chart above (since inception of CNBS) shows more periods of persistent outperformance coming from YOLO than CNBS. I'm sure there are some rolling periods where CNBS has outperformed, but so far it looks like Dan and the team at Advisor Shares are winning this particular day.

Let's Unroll Two Cannabis-Related ETFs

Let's review Advisor Shares Pure Cannabis and Amplify Seymour Cannabis ETFs -- and what do swaps have to do with the 'sticky icky.'

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