Cannabis and psychoactive substances like psilocybin are government illegal drugs. But while many American investors are banned from buying marijuana or psychedelics, they can try to make money from it.
This investment exposure to the cannabis market – at least in the case of two active ETFs operated by AdvisorShares – does not take place through direct equity investments, but through total return swaps. The structure is necessary because major exchanges do not list US companies that are directly involved in the cultivation, processing, or sale of cannabis.
AdvisorShares, a Bethesda, Maryland-based active ETF manager of approximately $ 2.3 billion, has launched two cannabis ETFs that get exposure to companies that cannot trade like legal stocks. And the company is preparing a third ETF that would use hallucinogenic drugs.
All three ETFs are overseen by Dan Ahrens, COO of AdvisorShares, who has developed and managed strategy stocks for more than a decade. He wrote a book on the subject in 2004, Investing in Vice: The Recession-Proof Portfolio of Booze, Bets, Bombs & Butts.
Psilocybin, the focus of AdvisorShare’s upcoming Plant Medicine ETF, remains more controversial than cannabis. The active mind-altering chemical in magic mushrooms, psilocybin, generally remains illegal. A handful of U.S. cities have decriminalized the substance, however, and Oregon legalized psilocybin use in certain health applications in February.
Recent studies have indicated its potential in treating mental illnesses such as depression. According to an article published in Nature in January, psilocybin (along with ecstasy) is upsetting psychiatry.
“We’re not talking about recreational drug use here,” Ahrens said in a recent interview. “We’re talking about real therapeutics.”
How it works
The Plant Medicine ETF will operate in a similar manner to the two previously launched AdvisorShares cannabis ETFs, the AdvisorShares Pure Cannabis ETF (YOLO) and the AdvisorShares Pure US Cannabis ETF (MSOS), which together have assets of over $ 1 billion exhibit.
Cannabis and psilocybin are among the substances classified as List 1 drugs by the federal government, which means that they have “currently no recognized medical use and high potential for abuse”.
While the future of federal cannabis legalization is unclear, 36 U.S. states have legalized medical marijuana and 19 more have legalized recreational use of cannabis by adults. That created a market of around $ 17.5 billion in legal annual sales in 2020, according to cannabis market research firm BDSA.
But, as Ahrens puts it, American companies with cannabis interests that “touch the plant” are not listed on major exchanges, but instead trade on over-the-counter (OTC) markets. The companies listed include companies based in Canada – which fully legalized cannabis in 2018 – or American companies whose businesses are in addition to the actual cultivation, harvest, processing, distribution and sale of cannabis.
So how do you set up a publicly traded fund to track these over-the-counter stocks?
Ahrens worked with the Securities and Exchange Commission, BNY Mellon (which acts as the custodian of the AdvisorShares ETFs) and law firms specializing in cannabis to find a legally unproblematic way to develop an investment vehicle with direct exposure to American cannabis companies.
The solution was to use total return swaps instead of holding the stocks of companies that Ahrens wanted to track.
Neither the ETF nor AdvisorShares’ counterparty, Cowen, ever invest directly in the companies. Instead, AdvisorShares pays Cowen a fee in exchange for the risk and reward of an increase or decrease in the value of the cannabis stocks.
“The funds receive nothing and are not obliged to do anything other than make and receive cash payments,” says a legal opinion for AdvisorShares.
“A lot of funds that rely on leverage use swap agreements, but it’s very rare – we were perhaps the first – to swap individual stocks just for a reason like this,” Ahrens said.
The AdvisorShares Pure Cannabis ETF (YOLO) with 297 million – and Canadian companies listed on the Nasdaq – launched last September.
Almost half of MOS holdings are swaps related to four companies: Green Thumb Industries, Curaleaf Holdings, Trulieve Cannabis, and Cresco Labs.
The unique structure can encourage different perspectives. Ahrens noted that some third-party providers occasionally report his ETF’s holdings as being too cash-heavy. Morningstar, for example, has around 50% cash in MSOS, which is how the rating company interprets the fund’s collateral for its swaps.
ups and downs
AdvisorShares, a pioneer in the field, is facing increasing competition from other cannabis funds.
The ETFMG Alternative Harvest ETF (MJ) is a formidable competitor at $ 1.4 billion, but differs from AdvisorShares in that it takes a passive approach and has no direct exposure to American cannabis companies.
Another competitor is the Amplify Seymour Cannabis ETF (CNBS), an active strategy that has amassed $ 136 million in net worth. And the Canadian company Horizons has a US-focused cannabis strategy, the Horizons Marijuana Life Sciences ETF (HMMJ), valued at $ 453 million. Meanwhile, Horizons also operates the Psychedelic Stock Index ETF (PSYK), which launched AdvisorShares’ Plant Medicine ETF.
In terms of performance, MSOS and YOLO are up 45% and 59% respectively over the past year.
The young, highly regulated cannabis sector is volatile, and peaks and troughs go hand in hand with the territory of investing in the plant. Ahrens also blamed “misinformation” and emotional investor sentiments for the price distortion. As an example, he said it wouldn’t be surprising if an announcement of American cannabis reform triggered price increases at Canadian cannabis companies. Even if the companies were not directly affected, unlike their American counterparts, they can trade on the NYSE and Nasdaq.
“There are too many investors who don’t understand that these companies are based in Canada,” said Ahrens.
Ahrens is based in the United States and he laughed when asked if investors had ever brought him up on the subject of personal drug use.
“I’m in Texas where it’s not legal,” said Ahrens, “so I have no comment.”