PM Philip Morris International Inc

By Simon Constable 

A burning desire for pot stocks may leave unwary cannabis investors with more speculative investments than they realize.

Take two exchange-traded funds focused on the cannabis industry: ETFMG Alternative Harvest (MJ) and the recently launched AdvisorShares Pure Cannabis (YOLO). While they both purport to track the same industry, they are actually quite different.

"One is much broader and expansive; the other one is at the extreme end of what is already extreme," says Ben Johnson, director of global ETF research at Morningstar. "Less than half of their holdings are common across the two portfolios."

More specifically, the Alternative Harvest (AH) fund includes companies that will indirectly prosper from the cannabis industry, such as plant-food firm Scotts Miracle-Gro and tobacco companies such as Philip Morris International. Both are leaders in their fields and could quickly profit from the burgeoning marijuana business.

"We want to own everything in the space because trying to pick winners is extremely difficult," says Chris Yeagley, managing partner of Prime Indexes -- the index provider for the AH fund. He likens it to investing in the 1848-1855 California gold rush, where some miners did well, but so did the sellers of picks and shovels, the tools required for mining.

The Pure Cannabis (PC) fund, meanwhile, focuses on more direct beneficiaries of the industry such as WeedMD, which is a federally licensed grower and distributor of medical-grade cannabis, and Charlotte's Web Holding, which makes and distributes hemp-derived cannabidiol (or CBD) wellness products.

"The Pure Cannabis fund goes much further down the market-cap spectrum into microcap," says Mr. Johnson. In other words, the stocks are tiny.

This different focus also means that the PC fund has more speculative securities than the Alternative Harvest fund. For instance, as of July 2, Pure Cannabis had a mere four stocks in its top 25 holdings that had earnings, according to data from Morningstar. That compares to 14 of the top 25 holdings for the Alternative Harvest ETF. Note that the PC fund is actively managed, while the AH fund tracks an index.

Having unprofitable firms in funds can be a red flag, some experts say.

"There is greater risk in investing in a portfolio of companies where profitability doesn't exist and where you are investing on potential," says Todd Rosenbluth, senior director of ETF and mutual-fund research at New York-based CFRA.

Dan Ahrens, the Dallas-based portfolio manager of the Pure Cannabis ETF, says he isn't worried about the lack of net income from the companies in the fund's holdings. "Old-fashioned analysis doesn't work for these startups," he says. "Instead we want to know that they are reinvesting on future production and scaling up capacity."

He also notes that while the ETF invests in startups, it doesn't "invest in Bobby on the street corner; these stocks are listed on the Nasdaq, NYSE and the Toronto exchanges, not the more speculative pink-sheets," he says.

The two ETFs are similar in at least one way: Annual fees are 0.75% for the Alternative Harvest fund and 0.74% for the Pure Cannabis fund.

Mr. Constable is a writer in Edinburgh, Scotland. He can be reached at reports@wsj.com.

(END) Dow Jones Newswires

July 08, 2019 22:18 ET (02:18 GMT)

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