Understanding Cannabis ETFs’ Wacky Divergence

One of the top-performing thematic segments this year is cannabis. A major catalyst has been the proposed descheduling of it from a Schedule I to a Schedule III drug under the Controlled Substances Act (CSA). That means it would be reclassified into a lower category below hard drugs like heroin and cocaine. Back in August,. the Department of Health and Human Services formally made this recommendation to the DEA, resulting in many months of review. And now, there is rising support in Congress from Democratic senators to remove cannabis as a scheduled drug altogether. Twelve U.S. Senators, including Elizabeth Warren, John Fetterman, and Chuck Schumer, signed a letter urging the DEA to reschedule or deschedule marijuana.

Cannabis has been classified as a Schedule I drug since 1971, signifying it has a high potential for abuse without medical uses. That viewpoint has obviously changed as 40 states and Washington D.C. have legalized cannabis for medical and/or recreational use. Investors continue to look for ways to play the trend toward eventual Federal legalization in the U.S.

The year-to-date performance of cannabis ETFs features a wide dispersion of returns. These funds with U.S. exposure, particularly MSOs (Multi-State Operators), have outpaced their peers. As a workaround to Federal legalization, those ETFs gain exposure to MSOs through swap options. That is why, if you look at the underlying holdings for many of these ETFs, it looks like you are holding a high cash position and/or U.S. Treasuries. Those positions are actually a hedge for the swap exposure.

AdvisorShares was the first ETF issuer to utilize swaps in this way to overcome custody issues with the launch of the AdvisorShares Pure US Cannabis ETF (MSOS ) in 2020. U.S. chartered banks were unwilling to hold these stocks that “touched the plant” in the U.S., given their federal illegality status. The issuer has a good explanation of the process and MSOS’s holdings on its website.

Several other firms with ETFs in the space have also followed suit with MSO exposure via swap. AdvisorShares launched the AdvisorShares MSOS 2x Daily ETF (MSOX C), which offers 2x leverage on the MSOS ETF for investors who want to amplify their exposure further. MSOX is up 88.4% YTD.

Below is a table with all the ETF players sorted by YTD performance. The performance leaders include those ETFs with U.S. MSO swap exposure, while the performance laggards like the AXS’ Cannabis ETF (THCX ), the Cambria Cannabis ETF (TOKE ), and the Global X Cannabis ETF (POTX ) lack that exposure. In fact, THCX is slated to close at the end of this month, and POTX is on Global X’s announced list of 19 ETF closures.

Amplify completed its acquisition of most of ETFMG’s ETFs at the end of January. The renamed Amplify Alternative Harvest ETF (MJ B-) is something of a hybrid, getting its MSO exposure by owning its sister ETF (also an acquisition from ETFMG), the Amplify US Alternative Harvest ETF (MJUS C+), for that exposure instead of swaps.

All of this is a classic case of needing to know what is under the hood when you make investment selections to gain exposure to an investment theme. In this case, the exposure is very much tied to the pending regulatory environment for cannabis. It remains to be seen whether the rescheduling of the product is already priced into these ETFs or if this performance trend will continue. Regardless, cannabis ETFs, or at least those with U.S. MSO exposure, have been one of the positive performance surprises of the year thus far.

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