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Mutual fund investors are missing out on one of the best rallies of the year

Growing flowers of cannabis intended for the medical marijuana market are shown at OrganiGram in Moncton, N.B., on April 14, 2016.


The resurgence of marijuana stocks over the past three months ought to be giving a nice boost to actively managed mutual funds that have made a big bet on the sector. But are there any?

Canopy Growth Corp., the biggest name in the cannabis industry and the sole marijuana producer to gain inclusion into the S&P/TSX composite index, has seen its share price rise more than 100 per cent since the end of August. Revenue at the medical marijuana producer has been growing at an impressive clip, more than doubling over the past year.

But perhaps more important than growth metrics – most valuations are absurdly high – is the idea that the industry is becoming more accepted. This level of acceptance was underscored in March when the company was added to the benchmark index.

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And it was underscored again in late October, when Constellation Brands Inc., which sells Corona beer and other brands of alcohol, announced a 9.9-per-cent stake in Canopy, then-valued at $245-million.

When pot can sit alongside a bottle of Corona, we have clearly left the era of Reefer Madness behind.

However, popular Canadian equity indexes aren't benefiting much, if at all, from Canopy's rally; nor are actively managed mutual funds that have been downplaying pot stocks.

TD Securities recognized this divide in its weekly Canadian Index and Market Structure Bulletin: "What started out as a humorous and seemingly innocuous one-off index inclusion of Canopy Growth (WEED), Canada's largest marijuana stock, turned into a serious problem for Canadian fund managers deciding whether to include marijuana stocks in active and passive mandates."

According to TD's figures, funds that haven't added Canopy to their portfolios are lagging the benchmark index by about 7 basis points (0.07 per cent) since March. These funds will of course continue to lag if the marijuana rally continues and more companies join the index, exerting additional pressure on fund managers to justify their decision to stay on the sidelines.

According to Fundata Canada, though, funds aren't exactly embracing pot stocks. Just 17 mutual funds have held Canopy, Aurora Cannabis Inc. or Aphria Inc. at some point this year – out of about 50 funds focused on Canadian small– and mid-cap equities and hundreds of other funds that could include these stocks in their mandates.

Curiously, there is no clear trend of funds increasing their holdings in these stocks. And a few funds that held large stakes in one of these companies this year have sold their entire positions.

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What's the takeaway for investors?

First, you have to put this index-lagging into perspective: The lag is small, and will remain small, for as long as the marijuana sector is a minor component of the index.

The benchmark S&P/TSX composite index includes Canopy in its ranks. But the company's relatively small size – its market capitalization is $3.5-billion – means that the stock ranks 114th among 249 members in terms of its weighting in the index. Above Canadian Western Bank, but below Yamana Gold Inc.

Since Canopy's latest rally began three months ago, its influence on the benchmark index has been remarkably slight: Although the stock price has more than doubled over this period, the rally has contributed just 12 points to the index, which has risen 1,072 points overall.

By comparison, the biggest five banks have contributed nearly 400 points.

Canopy's influence on the benchmark index ranks a distant 26th, behind Franco-Nevada Corp. and Restaurant Brands International Inc. – and miles behind Royal Bank of Canada and Toronto-Dominion Bank.

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Second, perhaps fund managers are wary of a sector that is defined by stretched valuations, rare quarterly profits and huge expectations among retail investors.

And don't forget: For every mutual-fund investor who might complain about missing out on the rallying marijuana sector, there are bound to be plenty of other investors who want no part of a sector associated with smoking.

For now, perhaps mutual funds aren't the best vehicles for pot stocks. But that could change.

Liberal MP Bill Blair says a proposed federal pot tax will keep the price low enough to compete with the black market. Ottawa is proposing an excise tax of $1 per gram, or 10 per cent of the retail price, in addition to sales taxes. The Canadian Press
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