Magnifying glass with green cannabis leaf

With the legalization of cannabis set for Oct. 17, financial advisors have work to do before they discuss this new and volatile industry with curious clients.

This is especially the case because cannabis stocks are flying high and several investment funds now are available to take advantage of this emerging business.

“This is a new industry, so there’s not a lot of expertise and knowledge that’s available to investors [and] investment advisors,” says Louis Bérard, vice president, private wealth management, and head portfolio manager with Montreal-based National Bank Financial Ltd. (NBF). “So, advisors must perform additional research to gain knowledge on the industry and on the companies that are being contemplated.”

NBF has received a modest amount of interest from advisors and their clients about investing in cannabis over the past couple of years – and particularly this year, because of the legalization of the product, Bérard says.

However, Bérard adds, the interest is strictly coming from clients, as NBF itself remains on the sidelines regarding investment banking and research on the cannabis market.

Meanwhile, stock markets have seen plenty of interest in the cannabis industry, which has led to volatile stock prices in recent weeks.

For example, Nanaimo, B.C.-based cannabis producer Tilray Inc.’s stock closed at $214.06 on Sept. 19 after hitting an intraday high of $300 – only to see its price drop to $99.50 by Sept. 24. Tilray closed at $156.83 on Oct. 3, just before Investment Executive went to press.

Of course, this is not the only time recently that there has been a flurry of interest surrounding a new investing theme. During the past year, much has been made of the potential of cryptocurrencies and new technologies such as blockchain.

Yet, some people argue that although there’s hype and speculation surrounding cannabis-related investing, there are significant differences between blockchain and cannabis – namely, that marijuana already has an established market, while blockchain and its related market still are being developed.

“The ‘black’ market for marijuana in [Canada] is significant,” says Charles Taerk, president and CEO of Toronto-based Faircourt Asset Management Inc., “and so, there are big opportunities, both at the federal government level to collect tax revenue and regulate supply, but then also to have these companies exploit this demand.”

A recent report from the Toronto-based Canadian unit of Deloitte LLP estimates that total sales of cannabis products could reach about $7.2 billion in 2019. Recreational marijuana would account for up to $4.3 billion in sales and medical marijuana sales would account for up to $1.8 billion, with the remainder going to the illegal market.

Also looking to take advantage of that demand and the new business opportunities in this space are asset-management companies that have launched investment funds in the past year.

In the mutual funds space, Kelowna, B.C.-based StoneCastle Investment Management Inc. introduced StoneCastle Cannabis Growth Fund in September; and Toronto-based Ninepoint Partners LP’s Ninepoint UIT Alternative Health Fund, which focuses on medical marijuana as well as other alternative health products, was launched in early 2017. (Faircourt is this mutual fund’s subadvisor).

There also are several cannabis-themed ETFs available. In February, Purpose Investments Inc. launched Purpose Marijuana Opportunities ETF under its then-subsidiary, Redwood Asset Management Inc. In addition, Evolve Funds Group Inc. introduced Evolve Marijuana ETF and Horizons ETFs Management (Canada) Inc. launched Horizons Emerging Marijuana Growers Index ETF that same month. (All companies are based in Toronto.)

Horizons first introduced Horizons Marijuana Life Sciences Index ETF in December 2017. The ETF has since surpassed $1 billion in assets under management (AUM), making it the largest cannabis-focused ETF.

Besides the growth in AUM, Horizons Marijuana Life Sciences Index ETF also had significant growth in the number of stocks included in its underlying index.

Steve Hawkins, president and CEO of Horizons, says that when the ETF was launched, Horizons “had a very limited number of names in it.” Since then, though, the underlying index has grown to include 62 names. Says Hawkins: “It just shows the rapid increase of the changes in the capital markets for this industry.”

But while there may be many investment opportunities in this space, there also is plenty for you to do to prepare for clients’ questions about cannabis. More specifically, you have to do your homework on the cannabis industry to get to know the overall industry, the regulatory landscape and the individual companies.

“Not all companies are going to be created the same,” says Taerk. “They all might have a licence to produce, but their operational efficiencies are different; their management teams are different; and their market opportunities, given their supply agreements with different provinces, will be different.”

One thing you will have to pay closer attention to after Oct. 17 is the valuations of these stocks, which have been pushed higher on expectations for growth in the Canadian recreational market and the potential to expand into the U.S. and Europe.

“Valuations are going to matter,” says Bruce Campbell, founder and portfolio manager with StoneCastle. “They haven’t really mattered too much yet, but they will matter down the road.”

That means once legalization is in place, the market will be taking a closer look at matters such as: which companies are hitting their projected numbers; where are the companies selling their products and how much are they selling; and what their profit margin is.

Indeed, with the volatility in this industry and the uncertainty regarding which companies will live up to the market’s expectations, emphasizing the long term to your clients also may be a good idea.

“Time horizon and risk are going to be really important,” says Campbell. “If people have been in this industry for a while, they know how volatile the industry can be.”