Promise & Peril Of Marijuana ETFs

January 08, 2018

A cloud looms over the newly traded marijuana ETFs, and it's something—or someone—that most investors don't know anything about.

Custodians are the independent third parties, usually banks, whose sole task is to hold securities for an exchange-traded fund. Though they often go unseen and unnoticed, custodians play a critical role in the launch and operation of any fund. Without custodians, there can be no ETFs.

But when it comes to marijuana ETFs, custodians remain wary, at best.

Until recently, most big banks refused to shoulder the reputational and possible legal risk of having their brands associated with a cannabis fund. Nevermind Attorney General Jeff Sessions' anti-marijuana crusade. Holding stocks involved with a drug still outlawed by the U.S government could potentially run a bank afoul of federal banking laws, maybe even cost them their FDIC insurance or banking license. It was perceived as simply too wide a river to cross.

Yet now there are two marijuana ETFs trading in the U.S., the AdvisorShares Vice ETF (ACT) and the ETFMG Alternative Harvest ETF (MJX). MJX, in particular, has caught investors' attention: Though the ETF only began trading in its current form on Dec. 26, 2017, the ETF now stands at $273 million in assets.

So, what changed?

Nothing. Despite MJX's overnight success, custodian fears haven't been laid to rest—not even close, according to sources. The possibility a custodian might yank support of MJX, or any marijuana ETF, is being discussed throughout the ETF industry.

This article results from conversations with more than a dozen knowledgeable industry sources, many of whom spoke to ETF.com only on condition of anonymity, given the sensitivity of the issue.

Right Time For A Pot ETF

After decades of demonization, the tide is finally turning for marijuana. Legal pot sales in North America, which are projected to hit $10 billion for 2017, will likely quadruple over the next decade. Medical marijuana has already been legalized in 29 states, while recreational marijuana is now legal in eight, including California as of the start of this year.

Yet marijuana remains illegal at the federal level. The U.S. government still classifies cannabis as a Schedule I substance under the 1970 Controlled Substance Act (CSA), which places it alongside heroin, MMDA and ecstasy as drugs with a high potential for abuse and no approved medical usage. "There are some big dominoes falling," said Eric Balchunas, senior ETF analyst for Bloomberg. "A major wave could sweep the nation soon, because there's a lot of money here."

Already, the world's first pot fund, the Canadian Horizons Marijuana Life Sciences Index ETF (HMMJ), has gathered $713 million in assets in just over nine months of trading, though MJX’s rapid asset gathering could soon eclipse that figure.

What's remarkable about HMMJ, says Balchunas, is how sticky its assets are. Shortly after the ETF launched, HMMJ's price plummeted over several months. But the $150 million in assets the fund had already gathered stayed put:

HMMJ Assets Since Inception vs. Price Performance

Source: Eric Balchunas, Bloomberg. Data as of Dec. 21, 2017. Reprinted with permission.

 

For a larger view, please click on the image above.

 

"That's really rare," said Balchunas. "Usually flows are correlated to performance; most products won't get assets if they don't perform. That indicates real pent-up demand."

 

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