Marijuana rescheduling could mean more investment in US weed stocks. There aren’t many ways in.
“Yes, institutional capital will go into the underlying names. The question is: How fast?" one weed company chairman said.
President Trump signed an executive order directing regulators to reclassify marijuana as a less dangerous drug, a move that may open the door for more institutional investors to buy weed stocks.
The executive order directs the attorney general to expedite the process of changing cannabis from a Schedule I drug, like heroin and LSD, to a Schedule III drug, like testosterone. That would give American cannabis operators tax treatment that's more in line with other businesses, immediately making them more profitable.
It may also set the stage for cannabis to be removed from compliance department blacklists for major stock exchanges, banks, and asset managers.
While cannabis would still be illegal on a federal level, rescheduling removes significant "red tape" and compliance barriers, making cannabis stocks far more palatable for institutional compliance departments, according to Frederico Gomes, director of institutional research in life sciences at ATB Capital Markets.
“With the expectation of rescheduling — and potential executive action — we are already observing an uptick in institutional interest,” Gomes said ahead of Thursday’s announcement.
The AdvisorShares Pure US Cannabis ETF, the benchmark ETF for US cannabis stocks known by its ticker MSOS, approached its all-time high in assets under management as of Wednesday’s close, near $1.3 billion compared to about $600 million a month ago. It is currently the primary way investors can gain exposure to US cannabis stocks, which are usually traded over-the-counter, and that probably won’t change quickly, said Bruce Macdonald, chairman of C21 Investments, a company that is in the MSOS basket.
"The ultimate answer is, yes, institutional capital will go into the underlying names,” he said. “The question is: How fast?"
What is MSOS?
Nasdaq or the New York Stock Exchange do not allow companies that grow or sell weed in the US to list on their exchanges, and that is not expected to change as marijuana is rescheduled.
Instead, US cannabis stocks trade on over-the-counter markets, which have less liquidity than major exchanges. MSOS debuted in 2020 with the goal of giving investors a convenient way to gain exposure to the US cannabis market. It is the primary proxy for investor access to US cannabis companies, which has also made it a major shareholder for some of the largest US operators.
That ETF is able to list on the New York Stock Exchange because it does not directly hold the stocks; it holds derivatives. AdvisorShares buys or sells swap contracts, usually from a couple of major banks like Nomura, that hold the underlying stocks.
In an email, Dan Ahrens, who manages MSOS, said so far he has seen “some institutional capital come into the ETF” but described it as “somewhat limited.” He said he is hopeful major banks and exchanges will reconsider their policies excluding cannabis if it becomes a Schedule III drug.
While typical ETFs hold giant, easy-to-buy companies like Apple or General Motors, MSOS indirectly holds illiquid micro-cap stocks susceptible to big price swings. It also has more intermediaries than a typical ETF, which can amplify that volatility.
Swap providers, typically large banks who own the underlying stocks, or market makers, could struggle to hedge their positions in either direction. The ETF’s prospectus warns “the absence of an active market could lead to a heightened risk of differences between the market price of the fund’s shares and the underlying value of those shares.”
Similarly, AdvisorShares’ leveraged ETF, MSOX, buys and sells shares of MSOS at 2x leverage, which can amplify volatility, said MacDonald, who was previously chairman of the Canadian Derivatives Clearing Corporation.
“It's a big pendulum, “ MacDonald said. "That's just the nature of the beast."
That amplified volatility was particularly visible on Thursday, when news the cannabis industry had been waiting for for years coincided with a 20% plunge in MSOS.
"It will normalize when we finally get directives to the money going into underlying names,” MacDonald said. “But until then, this thing is going to be the proxy for how to invest in the sector."
