FA Playbook

What to watch out for if you want to jump on the cannabis investing bandwagon

Key Points
  • As pot stocks continue to hit the headlines, you may be tempted to put your money to work in this emerging space.
  • Venture capital funds, exchange-traded funds and mainstream companies looking to expand into this space could all offer exposure to this emerging industry.
  • But buyer beware: The biggest obstacle these companies, and you as an investor, face is overcoming a high federal legalization hurdle.
Snoop Dogg exhales a heart-shaped cloud of marijuana smoke while doing a Q&A with the audience after the screening of his documentary Reincarnated during the first-ever 'Green Carpet' event at the High Times US Cannabis Cup, April 19, 2013, Denver. (Photo by Seth McConnell/The Denver Post via Getty Images)
Seth McConnell | Denver Post | Getty Images

If you walk into one of MedMen's cannabis retail locations, you will be greeted with rows of tables equipped with tablets that you can use to browse for items. While the layout may resemble an Apple or other tech store, the products are much different.

MedMen's selection includes traditional marijuana products, including pre-rolled joints and/or plants sold in jars ready for smoking.

Also on sale are nontraditional items, such as water infused with Cannabidiol, or CBD, which is aimed at helping athletes' muscles recover after activity, or topical creams that can help with everything from pain relief to skin irritation.

The company has 14 locations in states such as California, New York and Nevada. But it has licenses for more than 50 stores, having just added deals for new locations in Florida. The company plans to add a new store to its roster every four to eight weeks.

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In addition, the company's employee ranks have grown to more than 800 employees today, from about 45 employees in 2016.

For investors the promise of explosive growth that these businesses offer have prompted one big question about the cannabis industry: How can I invest?

"This is a play for people who want to be early, and it's still early," said MedMen CEO Adam Bierman.

But just like trying to buy tech stocks in the late 1990s, "it's not for everybody," Bierman said.

A big reason for that is the great volatility the industry is experiencing. Investors in this space have to be able to stomach sharp ups and downs. For example, Tilray, a producer of medical cannabis, saw its stock sink more than 11 percent on Monday after posting a 12.8 percent gain last week.

And there's also the elephant in the room that will make or break the fate of many of these companies: whether marijuana use will become federally legal.

"You are investing in a great unknown," said JJ Kinahan, chief market strategist at TD Ameritrade. "The great unknown is going to be around legislation, and you always have to be careful when it comes to that."

If you still think you want some exposure to this space, there are several ways to do it beyond traditional pot stocks. But experts urge you still need to keep some key warnings in mind.

A blunt reality: The risks to pot stocks

Private funds

Multiple funds have been started to invest in companies in this market. Casa Verde Capital, a venture capital firm, is one such fund that has attracted attention for one well-known co-founder: rapper Snoop Dogg, whose real name is Calvin Broadus.

The private funds are aimed at helping to identify emerging companies in the marijuana space.

That is the case for another firm, Poseidon Asset Management, which launched its first fund in 2014.

The firm followed a hedge fund model for that first fund that totaled about $80 million, according to Morgan Paxhia, managing director at Poseidon. So far, it has invested in more than 45 companies in the past five years, and it still has a portfolio of 35 companies through the first fund, Paxhia said.

Now the firm is out fundraising a larger, second fund, which will follow a more traditional venture capital model. The key difference is that this time the fund will have a set commitment period, deployment period and return of capital, compared to the previous more evergreen fund, Paxhia said.

One thing will likely remain the same: Almost the entire investor base will be high-net-worth individuals and family offices.

For investors who want to be in on such an opportunity, you have to be an accredited investor. That means you have to have more than $200,000 in earned income, or a net worth of more than $1 million.

Chances are, this is the kind of opportunity you will not hear about from your financial advisor. Most advisors do not have these funds on their platforms and therefore cannot officially recommend these investments, Paxhia said.

"It really comes from the clients saying, 'I want this in my portfolio, whether you're going to let me do it or not,'" Paxhia said.

Some advisors will do some due diligence on behalf of their clients when it comes to these opportunities, Paxhia said. Your chances of finding one who will are better if you are working with a registered investment adviser rather than a professional who is tied to a major Wall Street firm, he said.

Phyto Partners, another venture capital firm that invests in companies that help other companies that grow or sell marijuana, is in the process of raising its second fund targeted at around $100 million.

"The phone has definitely started to ring a little more" with inquiries from potential investors, including family offices and high-net-worth individuals, said managing partner Larry Schnurmacher. "It went from curious, interested, 'Oh, wow, that looks really great, but not for me,' to 'How can I get in?'"

Traditional companies

One defining moment that sent pot stocks into the headlines, according to TD Ameritrade's Kinahan, is Coca-Cola's recent interest in potentially creating new drinks infused with marijuana.

"With that, our activity in pot-related stocks has increased significantly," Kinahan said.

This year millennials have increased their trading of pot stocks by 25 percent, Kinahan said.

Cathy Curtis, a certified financial planner and founder of Curtis Financial Planning in Oakland, California, said her younger clients are more likely to ask about these investments.

People want to be involved where there's excitement. Skydiving is exciting too, but I'm not running out to do it.
JJ Kinahan
chief market strategist at TD Ameritrade

The problem when investing in companies that may put money in the industry is that a lot of them are tobacco companies.

"Many of my clients are not interested in investing in things like tobacco," Curtis said.

Beer companies could also potentially make their way into this space, she said.

Exchange-traded fund(s)

At this point, there is just one ETF that offers exposure to the marijuana investment theme: ETFMG Alternative Harvest.

That fund, with $658.3 million in net assets, offers exposure to some of the bigger names making news in the marijuana space: Cronos Group, Canopy Growth and Tilray.

But because the fund just focuses on those kinds of emerging companies, there are two sides to its benefits and risks, according to Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA.

Investing in the fund means that company-specific issues will be more muted.

MedMen opens a shop on Fifth Avenue in Manhattan to sell medical marijuana.
Source: MedMen

"If one company fails to meet investor expectations, it won't necessarily drive the entire group lower," Rosenbluth said.

But the companies are still thematically related, which usually means higher volatility and similar potential pitfalls.

One of those — the legalization issue — will likely discourage more ETFs from jumping into this space, at least for now, Rosenbluth said.

"Banks don't want to be held responsible; they don't want to violate federal law," Rosenbluth said. "It's still a very new area of potential investment."

Key risks

Until the laws are changed to make marijuana federally legal, there are not a lot of great ways to invest without high risks, Curtis said.

"I'm definitely not planning on putting any client money in it right now," Curtis said.

As with all investments, you should keep your time horizon in mind if you do decide you want to put your money in the marijuana industry, Kinahan said.

Keeping your time frame in mind will help you to readjust if things do go poorly, he said. That goes particularly for developing industries, such as marijuana and bitcoin, which are likely to see peaks and troughs of interest, Kinahan said.

"This is exciting," Kinahan said. "People want to be involved where there's excitement. Skydiving is exciting too, but I'm not running out to do it."