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New Canadian Marijuana ETF - Flying High

As soon as I saw the ticker chosen for the new Horizons ETF (HMMJ), "Mary Jane" came to mind, and clearly, the ETF launch didn't go up in smoke. Within the first 13 minutes of trading, the ETF exceeded seed capital and ended up trading over $20M on the first day. In the world of ETF launches this was a huge success.

HMMJ will try to track the 16 companies that make up the North American Medical Marijuana Index (NAMMAR), offered through Solactive, net of expenses. NAMMAR should not be confused with another North American Medicinal Marijuana Index which has 32 companies. Although there is some overlap between the indices, the market capitalization, trading volume and dollar volume filters used by HMMJ and NAMMAR skew the holdings in the ETF to larger and more liquid stocks to ensure liquidity of the ETF (implied liquidity).

HMMJ will be rebalanced quarterly and each holding will be market-capitalization weighted, to a maximum of 10% of the Net Asset Value of the ETF. All this for a management fee of only 0.75%, which is good considering ETFs have no minimum holding periods and liquidity throughout the trading day.

The marijuana business breakdowns into 6 basic areas: Medical Dispensaries, Infused Product Manufacturers, Wholesale Cultivators, Testing Labs, Ancillary Services, Ancillary Technology and Products; with the most profitable being the testing labs. Unfortunately, the labs are in private hands and will likely stay that way. When looking at the rest, at least 75% of companies in each business line are running at a break even or better.

Why HMMJ, and why now? Many countries are moving toward the legalization of marijuana for medicinal purposes. Most recently, Germany announced that medicinal marijuana will be eligible for insurance coverage. This was great news for Cronos Group, Canopy Growth and other companies as they extended their reach into Germany through joint ventures and outright acquisitions. Aphria also just announced that they are entering the Florida market by acquiring one of seven legal medicinal marijuana manufacturers in the state. All three of these companies are holdings in HMMJ.

With regard to the US market, there seems to be a lot of confusion. Medicinal use of marijuana is legal in most states. It is the recreational market where state laws can vary. Although many states have passed decriminalization laws for recreational use, the Trump administration has not yet decided on how to deal with this issue, as it falls under federal jurisdiction. The same situation is true for Canada. At present, recreational use of marijuana is illegal, although it appears that the Trudeau government may legalize it by sometime in 2018. This brings forward another key benefit to holding HMMJ. Given the legal issues surrounding recreational use, the index has been constructed to avoid companies that are in this segment of the market in both Canada and the US.

HMMJ provides investors exposure to a highly regulated business with high hurdles to entry. You can't just buy some hydroponic equipment, some seeds and open up shop. To enter the marijuana business legally involves a seven step process to become a licensed producer, including security screening. As at August 1, 2016, 1561 applications were received in Canada, 253 refused, 419 in progress, 54 withdrawn, 801 were incomplete and returned.

Rather than sifting through the 200+ marijuana related stocks wondering whether they are liquid enough, and what type of business and legal exposure they have, HMMJ does the work for you. You get the diversification you need in a business that can provide some great opportunity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Ray Dragunas Investment Consulting is an independent ETF Strategist focusing on capital preservation strategies using ETFs, and is a registered member of the Canadian ETF Association. This post is intended for information purposes only and is not an offer to sell securities.