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Cannabis plants grow at a facility in Sainte-Eustache, Que., on Feb. 20, 2019.

Ryan Remiorz/The Canadian Press

Cannabis exchange-traded funds have had a rough go since Canada legalized the drug just over two years ago.

Some North American ETFs are down as much as 70 per cent since inception, falling steadily after marijuana was finally legalized in Oct. 2018, and down as much as 50 per cent so far this year, according to data from Morningstar.

But some market watchers believe the sector is going through the expected growing pains of a nascent industry, arguing that the next several years hold more promise as the industry consolidates, more retail stores are added and consumption rises. There’s also an expectation that more jurisdictions across North America – particularly in the U.S. – will move forward with medical-marijuana regulations and decriminalize or legalize cannabis, regardless of who wins the U.S. election in November.

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“2020 is the year of bottoming for the whole industry,” says Tina Normann, a principal and technical quantitative analyst for Eight Capital in Toronto, noting that many cannabis stocks and ETFs hit their lowest points in March and have been recovering since. “Going into 2021 looks very promising for the whole industry,” she adds. “There’s a lot of running room over the next few quarters.”

The industry has gone from a euphoric-startup phase, a trading-and-bear-market phase, and now is entering a phase where these companies need to show solid metrics and start attracting institutional investors, says Michael Underhill, chief investment officer with Capital Innovations LLC in Pewaukee, Wis.

“As a long-term investor – three, five, seven years – getting in at this juncture is something that you want to do … Because structurally, the regulatory environment is becoming more conducive to the industry and these companies across cannabis and CBD (cannabidiol),” he says. “I think the worst of it is in the past, and there’s a tremendous amount of opportunity in light of everything we’ve seen.”

Some of the missteps in the Canadian market include the slow addition of retail dispensaries in key markets such as Ontario and Quebec, which caused supply to grow faster than demand, says Kristoffer Inton, director of equity research for basic materials, who follows the industry for Morningstar from Chicago.

For stocks, the “hype preceded the industry,” Mr. Inton says. “These are early-stage companies” and many that otherwise would have stayed private could only raise cash for growth on the public market.

The next stage of growth will come from an expansion of the market, he says, which includes edibles and beverages, and potential changes in the U.S.

“That’s still a step in the right direction,” Mr. Inton says, and any positive movements in the U.S. spill over into cannabis stocks in Canada. More companies have cut back on supply and over time, “the demand side is going to grow,” he adds.

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With cannabis ETFs, Mr. Inton sees “a lot of reward potential but a lot of risk as well.”

Mr. Underhill and Ms. Normann recommend cannabis-ETF investors choose funds that include a range of stocks from marijuana producers and retailers to fertilizer and health-care companies.

The two Mr. Underhill likes are U.S.-focused funds – AdvisorShares Pure Cannabis ETF (YOLO-A) and Amplify Seymour Cannabis ETF (CNBS-A), which give investors diversified exposure to the cultivation, consumer-packaged-goods and life-sciences segments of the market.

YOLO, launched in April 2019, has US$64-million in assets under management (AUM) and a management expense ratio (MER) of 0.74 per cent, according to data from Morningstar as of Oct. 26. The actively managed ETF is up nearly 1.5 per cent so far this year, although it’s down nearly 12 per cent in the past year. It hit a low of US$6.02 in mid-March and is now trading around US$12.

Its top holding is U.S. greenhouse operator Village Farms International Inc., which has recovered strongly, followed by Innovative Industrial Properties Inc., which holds industrial real estate used by cannabis companies and has a one-year return of 75 per cent. Mr. Underhill says Innovative Industrial is a stock he likes as a diversified play on the marijuana market.

CNBS, an actively managed U.S. fund established in July 2019, has US$6-million in AUM and an MER of 0.75 per cent.

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The fund is down 9 per cent year to date and up 8.3 per cent in the past month. Its top holdings include Canopy Growth Corp., one of Canada’s largest cannabis producers and retailers, GW Pharmaceuticals PLC ADR, which has a cannabis-based multiple sclerosis treatment, Innovative Industrial and hydroponics supplier GrowGeneration Corp., the latter of which is up nearly 366 per cent over the past year.

Ms. Normann says two U.S.-focused ETFs “are the leadership group,” in terms of relative price performance and have been on an uptrend since March – the Canada-based Horizons U.S. Marijuana ETF (HMUS-NE), which aims to match the U.S. Marijuana Companies Index, and a new actively managed U.S. fund, the AdvisorShares Pure U.S. Cannabis ETF (MSOS-A), which launched Sept. 1 and focuses only on U.S. cannabis stocks. MSOS already has nearly US$30-million in AUM and an MER of 0.74 per cent, and is up 18.6 per cent in the past month. HMUS has $23-million in AUM and an MER of 1 per cent. It has risen nearly 1 per cent year-to-date.

MSOS “has pure U.S. exposure, and that is where we’re seeing leadership in the cannabis space,” Ms. Normann says. “All of the components in there are definitely playing that whole U.S. multi-state operators, U.S. election thematic.”

The top holdings in MSOS include Innovative Industrial, GrowGeneration, health diagnostic firm PerkinElmer Inc. and CBD wellness-products maker Charlotte’s Web Holdings Inc.

“The election is the most meaningful catalyst,” Ms. Normann adds, no matter who wins, as it will give “clarity” to the industry “regarding the potential pathways for reform.” However, “a [Democratic candidate Joe] Biden win could probably re-accelerate [the industry] and put a fire under it because you’ll see a bigger push toward reform.”

The Canadian sector is down more than the U.S., Ms. Normann notes, but is “starting to play catch-up.”

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For liquidity, Ms. Normann’s top Canadian choice is the Horizons Marijuana Life Sciences ETF (HMMJ-T), the longest-running cannabis ETF, which launched in April, 2017. It has $334.5-million in AUM and an MER of 0.85 per cent. It aims to match the performance of the North American Marijuana Index. “It’s the largest, and it has all the key Canadian players in there,” she says, adding that it still has room to rise to return to the highest level it reached in the first quarter of this year.

The ETF is down nearly 25 per cent so far this year and is down 8.2 per cent over the past three years. Its top holding is Canopy Growth, followed by Innovative Industrial, GW Pharmaceuticals, producers Aphria Inc. and Cronos Group Inc., and fertilizer company Scotts Miracle Gro Co. The fund has 30 per cent of its assets in U.S. equities.

Ms. Normann also likes the actively managed Purpose Marijuana Opportunities ETF (MJJ-NE) “because it has exposure to a lot of the [stocks included in the] U.S. Marijuana Companies Index, and that’s why they’re outperforming.” It holds 42 per cent in U.S. equities.

MJJ has $7.4-million in AUM and an MER of 0.97 per cent. The fund is up 8.4 per cent so far this year. Its top holdings include Cresco Labs Inc., a Chicago-based cannabis and medical marijuana retailer, Curaleaf Holdings Inc., which operates dispensaries in 23 states, Green Thumb Industries Inc., a packaged goods cannabis maker and retailer, and Canadian retailer TerrAscend Corp.

From here, Mr. Underhill believes the cannabis industry has momentum and is "ready to stand on its own two feet.”

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