New Marijuana ETF On The Way

April 16, 2019

A year and a half after the first marijuana ETF came to market, investors are finally getting a second option. The actively managed AdvisorShares Pure Cannabis ETF, filed back in January, is set to launch on Thursday.

The fund, which will trade on the NYSE Arca under the memorable ticker "YOLO," will track a portfolio of cannabis companies domiciled in the U.S. and Canada, spanning a range of industries from consumer products to health care.

Another existing AdvisorShares ETF also invests in cannabis-related stocks, the $13.8 million AdvisorShares Vice ETF (ACT), but not as a pure-play.

Troubles Plaguing Marijuana ETFs

Since December 2017, there has been only one pure-play marijuana ETF on the U.S. market: the $1.21 billion ETFMG Alternative Harvest ETF (MJ). (However, Horizons operates several marijuana ETFs in Canada, including the $872 million Horizons Marijuana Life Sciences Index ETF (HMMJ).)

ETF.com has extensively reported on the troubles dogging MJ, from the unorthodox way in which the fund came into existence to its continuing struggles with its fund service providers and persistent trading anomalies.

At the root of all these problems is marijuana's continued prohibition in the U.S. With the substance still illegal at the federal level, few large custodian banks are willing to custody the stocks of marijuana companies for a marijuana-specific fund, as that action could potentially risk their federal license, charter and/or FDIC insurance.

Indeed, the custodial issue came to a head earlier this year for MJ, when the fund suddenly parted ways with its previous custodian, U.S. Bank. ETFMG has since signed Wedbush Securities, a regional broker/dealer, as custodian instead (read: "Marijuana ETF Shifts Custody").

New ETF Addresses Custodial Risk Head-On

However, it appears unlikely that the same problems will dog YOLO, which has contracted the Bank of NY Mellon ("BNY Mellon") as fund custodian, as well as administrator and transfer agent. (BNY Mellon serves these functions for all AdvisorShares ETFs.)

"We've been working with BNY Mellon for more than 10 years,”  said Dan Ahrens, COO and portfolio manager for AdvisorShares. “We have a very honest and open relationship, and there's a great deal of communication and trust between us."

AdvisorShares worked closely with BNY Mellon to prepare a fund that the bank would feel comfortable custodying, says Ahrens.

Furthermore, Ahrens stresses that over 20 authorized participants have agreements in place for the new ETF, which will help smooth creation/redemption activity and provide additional liquidity for trading.

"I can't stress enough the importance of having a regular federal custody bank be in place for this fund," said Ahrens.

Investing In 'Pure Cannabis'

YOLO will invest 80% or more of its assets into companies that derive 50% or more of their revenue from the marijuana and hemp industry, so-called cannabis companies. These securities could hail from a variety of sectors, including agriculture, biotech, pharmaceuticals, real estate, retail and finance.

At least 25% of the fund will be invested in pharmaceutical, biotech and life sciences companies using cannabis and cannabinoid-related substances.

The ETF will also invest in federally legal U.S. companies that "don't touch the plant," said Ahrens. One such example is Innovative Industrial Properties (IIRP), a U.S.-listed REIT that focuses on medical marijuana facilities (read: "Proposed Marijuana ETFs Rooted Differently").

However, in the interest of keeping the fund focused on "pure cannabis" plays, says Ahrens, YOLO will not invest in stocks of large alcohol or tobacco companies. That's a significant distinction from MJ, which invests in a range of forward-looking cannabis plays, including Turning Point Brands (TPB), Philip Morris International (PM) and Scotts Miracle-Gro (SMG).

What YOLO Can & Cannot Hold

YOLO will primarily invest in the stocks of mid- and small-cap cannabis companies, but the portfolio managers have sweeping discretion to invest in a range of other securities, including derivatives, swaps, futures, other ETFs and even IPO opportunities, according to the fund's prospectus. (The starting portfolio is 100% equity, however.)

"Especially in the rapidly growing, rapidly evolving cannabis space, there are going to be many new companies coming to market, and a lot of merger and acquisition activity," said Ahrens. "As active managers, we want to be able to move quickly."

However, YOLO's prospectus invokes several restrictions placed on what constitutes a cannabis-related business. The fund can't invest in companies with operations inside the U.S. unless that company is also legal at a federal level, nor will it invest in companies whose businesses are legal at state or local levels, but not federally.

Furthermore, the fund is currently limited to stocks trading on the NYSE, Nasdaq, Toronto Stock Exchange and TSX Venture exchanges.

Restrictions To Smooth Approval Process

These restrictions are the result of a year's worth of conversations between AdvisorShares and BNY Mellon, as well as back-and-forth with the Securities and Exchange Commission (SEC).

Ahrens says AdvisorShares also worked with its custodian to devise a list of preapproved securities in which the portfolio managers could invest for YOLO. The company did something similar for the cannabis stocks in ACT.

That list was also provided to the SEC, as well as a full legal opinion (by request) and due diligence on each of the securities in the investable universe from an outside law firm.

"We took a lot of aggressive steps to do our due diligence and get this fund approved legally and properly," said Ahrens.

Undercutting Competition

YOLO will have total annual expenses of 0.74%, breaking down to a 0.60% management fee and 0.14% for "other expenses," including costs for fund administration, accounting, custody fees, exchange listing fees and so on.

That puts YOLO's expense ratio at 0.01% less than that of MJ.

Contact Lara Crigger at [email protected]

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