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Investors buying into psychedelics such as psilocybin are treating is more of a ‘biopharma R&D play’ that requires patience.

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Could the burgeoning psychedelics sector end up spawning a major stock rally that could dwarf the cannabis-driven market mayhem of the past decade?

According to Maruf Raza, a partner and national director of public companies at MNP LLP in Toronto, “From a market perspective, you could argue the blue-sky opportunity for psychedelics is far, far greater [than for cannabis].”

Mr. Raza is part of a growing group of market watchers expecting vast sums of money to pour into companies studying psilocybin, ketamine, LSD and other so-called “hard drugs” for medical purposes. But because the nascent sector is largely organized around disrupting the global anti-depressant market, which is worth tens of billions of dollars annually to pharmaceutical giants, investors see less policy risk.

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“It is going to be easier [for advisors and investors] to get on board with psychedelics than it has been with cannabis,” says Patrick Moher, chief executive officer of Microdose Psychedelic Insights. “Cannabis was legalized in a recreational context, [but] it’s going to be the exact opposite with psychedelics.”

The future tense “is going to be” highlights what is perhaps the biggest reason why many investors remain wary of the space. While most psychedelics companies have legal authorization to work with controlled substances for research and development (R&D) purposes, they remain illegal for any commercial use.

“Is legalization one year away, five years, or more? For investors I think that is an important consideration, that there are political aspects here that are unknown,” Mr. Raza says.

Brandon Roop, vice-president of investment banking at Stifel GMP, says that “it’s kind of a black box in terms of what federal governments are going to do” regarding the legal status of psychedelics in the coming years. That’s why he believes investors considering buying into this space should weigh it similarly to another nascent and highly speculative industry.

“People should be looking at this in the traditional biotech sense of early preclinical assets that they are going to flesh out and take through the drug development process, which people should know has many stages where each one costs tens of millions of dollars and it is a multi-year process,” Mr. Roop says.

As such, psychedelics investors are buying into more of a “biopharma R&D play,” that “is a patient game, it is not a quick hit,” Mr. Raza says.

“Clearly, a lot of smart people who are used to being patient investors have looked at this and do see a significant opportunity,” he says, “but it is not something that those same smart people are planning to exit within 10 or 18 months.”

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Trying to pick which individual players might be among the top finishers in a multi-year race is a nightmare scenario for many financial advisors. Steve Hawkins, president and CEO of Horizons ETFs Management (Canada) Inc., says that’s exactly why his company decided to launch a new exchange-traded fund (ETF) that tracks the psychedelics space in January.

“Why we actually felt that now was the right time to launch this particular ETF was to get out in front of situations in which the investment advisor has clients asking, ‘I’m seeing all this news on psychedelics, why am I not invested in any of this?’,” he says.

Horizons Psychedelic Stock Index ETF PSYK-NE, which began trading on the NEO Exchange on Jan. 27, contains a basket of 17 companies, composed mostly of smaller companies focused exclusively on psychedelics research, but also some existing large drug companies. The ETF is weighted almost 5 per cent toward pharmaceutical giant Johnson & Johnson JNJ-N, for example.

Mr. Hawkins says Horizons ETFs “learned a lot by launching [Horizons Marijuana Life Sciences ETF HMMJ-T in 2017] and the evolution of an early-stage sector in a very specific theme and how to really focus the product and the index on what people were ultimately going to be looking for to invest in the space.”

As such, he notes that psychedelics is “a very, very young, early-stage industry and a very new asset class, but one with great potential.”

Although Horizons Psychedelic Stock Index ETF and Horizons Marijuana Life Sciences ETF were launched under similar circumstances, they do have their differences. Most notably, none of the stocks in the psychedelics ETF trade on the Toronto Stock Exchange and neither does the fund itself. The main consequence of that is limited liquidity when compared to cannabis stocks in that sector’s early days.

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“There was more liquidity in the cannabis stock market in early 2017 when we launched HMMJ than there is in the psychedelic stock market today,” Mr. Hawkins says. “It’s not that they don’t trade a lot from a volume or a number of shares perspective, they do. It’s just the value of that trading, in total, is substantially lower when compared to the cannabis space a few years ago.”

That’s why building the index for Horizons Psychedelic Stock Index ETF was such a nuanced process that Mr. Hawkins says began almost five months before the ETF actually debuted.

“We started breaking down all the different companies in terms of how much potential exposure to psychedelics they had,” he says. “Were they life sciences companies that were focused on psychedelics or delivery mechanisms for them? We looked at some of the drug companies like J&J as well because it had a ketamine-based nasal spray.”

The amount of time required to build a representative index is part of the reason Mr. Moher of Microdose Psychedelic Insights believes the psychedelics sector can reach massive proportions without any recreational element.

“You’re going to have biotech and drug development, of course,” he says, “but then you’re also going to have clinics, therapists, ancillary companies, data companies, and so on. Who’s to say an entire industry won’t be built around it?”

Progress is indeed already occurring outside of laboratory settings. Clinical psychologist Tatiana Zdyb started MindSetting in London, On.-based in the autumn of 2020 utilizing ketamine-based therapies. Such businesses are rarely publicly-traded, though Mr. Hawkins expects that to change within the next year.

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“There are probably less than 100 public companies in the world in the psychedelics space,” he says, “but there are also probably 100 companies that are still private but want to go public.”

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