Editor’s Note: This article has been updated to correctly reflect Green Thumb Industries’ (GTI) holding in the MSOS ETF and to clarify the structure and risk factors associated with MSOX and MSOS. In addition, we have provided more detailed information on the liquidity of the ETFs and their underlying assets.
Cannabis investors navigate a complex and volatile market with two major ETFs, the AdvisorShares Pure US Cannabis ETF MSOS and its leveraged counterpart, the AdvisorShares MSOS 2x Daily ETF MSOXin the center of the storm.
Both ETFs have faced significant challenges in the form of regulatory uncertainty and underperforming stocks in the cannabis space, as new SEC filings show. But the potential for regulatory reforms — particularly the reclassification of cannabis under federal law — as well as emerging political momentum in favor of cannabis, offer a glimmer of hope that could give these funds and the broader market new momentum.
A closer look at MSOS and MSOX: Performance and market pressure
In the recent regulatory filings for MSOS and MSOX, we see a mixed picture of the ETFs’ positions and issues. MSOS, which tracks a broad range of U.S.-based cannabis companies, is under significant pressure due to the ongoing regulatory standstill in the U.S. and the economic downturn that is weighing heavily on growth-oriented sectors like cannabis.
The documents show that the ETF holds shares in well-known cannabis companies, such as Green Thumb Industries GTBIF, Verano Holdings Corp VRNOF And Trulieve Cannabis Corp TCNNF. These stocks have shown both potential and volatility, but have not been able to escape the general downturn in the cannabis market. MSOS reported a 25.48% stake in Green Thumb Industries, one of the most stable multi-state operators (MSOs), as of August 21, 2024, but the sector’s difficulties have prevented these assets from generating consistent gains. This stake includes a total return swap (TRS) position in Green Thumb Industries with a notional value of $18.39 million and unrealized appreciation of $9.53 million as of the last filing.
MSOX, the leveraged counterpart to MSOS, is designed for more aggressive investors who want to earn higher returns by leveraging the power of MSOS itself. However, this strategy also means higher risk, especially in a volatile sector like cannabis. Unlike MSOS, which directly holds positions in cannabis stocks and total return swaps (TRS), MSOX generates its returns by applying leverage to the entire MSOS portfolio rather than to individual stock positions. Although MSOS does have some exposure to 4Front Ventures Corp FFNTFits weighting is relatively low at 0.24% at yesterday’s closing price, further underscoring MSOX’s diversified yet leveraged risk.
Also read: Bioxyne supplies Australia’s first pharmaceutical cannabis gummies and increases its production capacity
Structural and liquidity problems with cannabis ETFs
The filings also shed light on some of the structural challenges facing these ETFs. Both MSOS and MSOX hold complex financial instruments, including total return swaps on large cannabis companies such as Green Thumb Industries, Verano Holdings and 4Front Ventures. While these swaps can yield potential gains, current market conditions have driven many of these positions into significant losses since May 2024.
MSOX, which leverages the performance of the entire MSOS portfolio, has lost value due to the general market decline. While MSOS holds TRS positions, such as a $462,000 loss on 4Front Ventures and a $1.22 million devaluation on swaps traded on Vapen MJ Ventures Corp, MSOX does not hold individual stock positions or swaps, but amplifies the overall return and risks of MSOS.
These derivatives positions are often tied to companies that are under pressure, not only due to declining share prices, but also due to liquidity constraints and difficulties in raising capital due to the regulatory environment and limited access to traditional financing options. While the ETFs themselves, especially MSOS, are highly liquid, with an average of 9 million shares traded daily over the past 10 days, the underlying assets, such as cannabis stocks, can be less liquid. Many of these stocks fall into the microcap category, where liquidity is often more limited compared to larger market cap stocks. This lower liquidity of the underlying assets can still contribute to volatility, especially in leveraged products like MSOX, where market moves are magnified.
In addition, regulatory uncertainty, particularly related to federal cannabis reform, has made institutional investors cautious and limited inflows into cannabis stocks and ETFs. These structural factors have contributed to the subdued performance of MSOS and MSOX.
Possible reclassification of cannabis: A glimmer of hope
Despite these challenges, potential catalysts could significantly change the landscape for cannabis stocks and ETFs. One of the most important developments on the horizon is the potential reclassification of cannabis from a Schedule I controlled substance to a Schedule III one. This change would be a monumental step for the industry and would alleviate many of the financial and operational burdens cannabis companies face due to federal prohibition.
Reclassifying cannabis would remove major hurdles related to taxation (particularly the burdensome Section 280E of the Tax Code), access to banking, and investment restrictions. This move could unlock broader institutional investment that has largely eluded the cannabis sector due to federal illegality.
Cannabis companies could also use it to deduct normal business expenses, which would significantly increase their profitability. The market is already speculating that the debt restructuring could trigger a wave of new investment in the sector and boost ETFs such as MSOS and MSOX.
Legal Dynamics: Harris and Walz’s Pro-Cannabis Formula
At the legislative level, cannabis-friendly politicians such as the Democratic presidential candidate and Vice President Kamala Harris and her running mate, the governor of Minnesota. Tim Walz help advance cannabis reform. The Harris-Walz formula aims to advance legalization and cannabis-friendly policies that focus on progressive reforms and social justice initiatives. Harris is a vocal proponent of cannabis legalization, and her influence and growing bipartisan support could accelerate the progress of reform efforts at the federal level.
Walz, meanwhile, has been instrumental in driving cannabis reforms at the state level and advocating for broader changes at the federal level. His focus on legalization and progressive cannabis policy in Minnesota could serve as a blueprint for federal policy should he be elected. These initiatives, coupled with broader political momentum, are creating a more favorable environment for cannabis legislation, which could ultimately benefit ETFs like MSOS and MSOX.
Key catalysts: banking reform, international expansion and SAFE banking
In addition to debt restructuring, other legislative and regulatory changes could also provide significant tailwinds to the cannabis sector. Another key focus is the SAFE Banking Act, which is designed to provide cannabis companies with access to traditional banking services. Cannabis companies have limited access to banking services, forcing many to operate in cash – a risky and inefficient model that hampers growth. The passage of the SAFE Banking Act would provide cannabis companies with much-needed financial services, reduce operational risks and make the sector more attractive to institutional investors.
International markets also offer growth opportunities for cannabis companies. Germany, for example, has become one of the most significant medical cannabis markets in Europe and recent regulatory developments suggest the country could become a global cannabis leader. US-based cannabis companies, many of which are part of MSOS and MSOX’s portfolios, have already begun expanding internationally and success in international markets could help offset some of the domestic challenges.
The way forward for cannabis ETFs
While the environment remains challenging, the future holds several potential catalysts for the cannabis sector. Cannabis reclassification, regulatory reforms, and international expansion offer promising growth opportunities. These developments could provide much-needed relief to ETFs like MSOS and MSOX, which will benefit from a more favorable regulatory environment and the resulting influx of institutional capital.
For investors, the key is to navigate the current volatility while keeping an eye on the potential for a turnaround due to regulatory and legislative progress. While ETFs like MSOS and MSOX have been hurt by recent market conditions, they remain well positioned to benefit from the upside when those catalysts come to fruition. The road ahead for cannabis ETFs may be rocky, but with the right mix of policy changes and market momentum, the sector could see a significant recovery in the not-too-distant future.
Read more:
This content was created in part using AI tools and reviewed and published by Benzinga editors.
Photo created using artificial intelligence.
© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
