Psychedelics stocks were all the rage a year ago. What happened?

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It was barely a year ago that psychedelics stocks were all the rage among investors, drawn to grandiose promises by companies that drugs such as LSD and magic mushrooms could produce game-changing treatments for anxiety, depression and addiction.

But that investor euphoria peaked in March, 2021. Since then, despite a handful of promising clinical trials, and a growing number of U.S. states introducing bills to decriminalize psychedelic substances, shares of many psychedelics companies have performed poorly, sharply declining in value over the past six months.

This disconnect, analysts say, can be blamed primarily on retail investors who seemed to associate psychedelics companies with sales-driven cannabis producers, rather than thinking of them as biotech firms that will take years to begin generating revenue.

While the performance of Canadian cannabis companies hinged on consumer demand for a product that became legal for recreational use in October, 2018, most psychedelics companies are involved in early-stage scientific research on how specific chemical compounds that make up drugs such as ketamine, LSD and MDMA could potentially be used in treating mental-health conditions.

“For the biggest companies in the space, their business model is fundamentally a biotech one,” explained Michael Freeman, a health care sector analyst with Raymond James Financial. “These are companies that will spend years running randomized, controlled, clinical trials of psychedelic molecules to determine their efficacy. It is a very different value proposition than cannabis.”

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The lacklustre performance of psychedelics stocks is clearly evident in how the world’s first psychedelics exchange-traded fund – a basket of stocks comprising more than 20 companies in the sector – has fared. Since its launch in January, the Horizons Psychedelics Stock Index ETF has plunged by 36 per cent.

Although the index is rebalanced quarterly, it was initially weighted heavily in favour of some of the most well-known psychedelics companies, such as MindMed Inc., and Compass Pathways Inc. The share prices of both companies have dipped by more than 40 per cent since the height of investor excitement in early 2021.

“People saw it as a get-rich-quick industry, but as the months went by investors realized this is nothing like cannabis. These are heavily regulated substances that have to go through many clinical trials, so you would want to stay with the company to reap the benefits,” said Tania Gonsalves, an analyst with Toronto-based Canaccord Genuity Inc.

MindMed was heavily promoted and championed by Shark Tank’s Kevin O’Leary, who famously told Business Insider in November, 2020, that investors burned by “bad bets” on cannabis startups should not be afraid to gamble on psychedelics.

The New York-based company specializes in developing molecules of LSD, MDMA and psilocybin – the hallucinogenic chemical in certain mushrooms – for the treatment of depression.

It was the first psychedelics company to go public (in March, 2020), on Toronto’s NEO Exchange, and now trades on Nasdaq as well.

But while MindMed shares have gained a whopping 425 per cent since the company made its public debut at 40 cents, they have declined by almost 50 per cent since the psychedelics market peaked in February, around the time Horizons launched its psychedelics ETF.

“Unfortunately we launched the ETF six months too late,” admitted Steve Hawkins, chief executive officer of Toronto-based Horizons ETFs Management Inc. “A lot of the companies in our portfolio are up triple digits since they went public. But on a six-month basis, many of them are down.”

Mr. Hawkins told The Globe and Mail that Horizons has had to consistently rebalance its psychedelics portfolio because the sector is volatile. “These companies are all over the place. All it takes is one piece of news – whether it be fact or fiction – to create significant volatility with the underlying portfolio.”

On Nov. 9, Britain-based Compass Pathways announced much-anticipated results of a 233-patient study of the use of psilocybin in treatment-resistant depression, finding that the patient group receiving the highest dose of COMP360 (a molecular derivative of psilocybin) exhibited significant reduction in depression symptoms compared with those who received a lower dose.

Analysts covering the company ranked the result as neutral to positive. Yet Compass shares sank roughly 20 per cent after the news, as many investors seemed to determine it was the right time to exit the stock.

Mr. Freeman said the reaction is typical in the psychedelics space, which is dominated by retail investors.

“Proper biotech investors make decisions based on when a company does data readouts, meaning, when [companies] have tangible results from a clinical trial that gets them to a new phase to proceed in research,” Mr. Freeman explained. “So biotech stocks generally move either up or down depending on which stage in the research process investors want to take their profit.”

Andrew Partheniou of Stifel Financial Inc., another analyst who covers psychedelics companies, said he was surprised at how the market reacted to Compass’s clinical trial results, which he deemed to be positive. “I think for retail investors, it might have brought up questions on how well Compass could actually scale its therapies and what its real addressable market might be like.”

Raj Lala, an investment manager and CEO of Evolve ETFs, a competitor to Horizons, said he chose not to launch a psychedelics ETF because he could not see the long-term growth potential of psychedelics companies. “It feels like a fad,” Mr. Lala added, drawing a comparison to the cannabis sector. Evolve had launched two cannabis ETFs, but terminated them less than two years later, after they lost more than 50 per cent of their value. “We did not have a good experience in that space,” he admitted.

But Mr. Hawkins of Horizons is in psychedelics for the long haul. “This is early stage biotech investing, there will be hits and misses. We’re going through a lull period right now, but I’m hoping investors will understand there is significant long-term potential in these drugs.”

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