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Big changes in the components of the leading pot-stock index have resulted in only a few tweaks to the leading cannabis exchange-traded fund, as its manager has decided not to sell the shares of several small companies that swooned last year.

In a quarterly rebalancing, the German firm Solactive has cut 12 stocks from its North American Marijuana Index, the basis for TSX-listed Horizons Marijuana Life Sciences Index ETF. While Solactive doesn’t comment on specific changes, the stocks seemed to have dropped below Solactive’s minimum market-capitalization threshold of $67.5-million in recent weeks.

The deletions, offset by five additions, took the index from 61 companies down to 54.

However, Mark Noble, a spokesman for Horizons, says it did not drop any stocks from the ETF – the largest cannabis-based fund with nearly $800-million in assets – when it adjusted its holdings after the Solactive rebalancing.

The move, atypical for an ETF that seeks to track an index, reflects the volatility in the pot-stock sector, with wild swings in share prices dramatically reshaping companies’ market value on a regular basis.The composition of cannabis funds – either index-tracking or actively managed – also draws more attention than the typical ETF because there’s frequently a hot new pot stock, and funds that follow an index have less discretion about when to add it – witness Tilray Inc., which rocketed out of the gate in 2018 and spent significant time last year up more than 500 per cent from its initial public offering price.

Mr. Noble notes that while the ETF’s goal is to replicate the index’s performance, the fund isn’t required to hold the underlying shares exactly in the same alignment as the index does. Indeed, five of the 12 stocks dropped from the index weren’t in the ETF to begin with, leaving seven index deletions Horizons has decided not to sell.

The concern for Horizons is managing trading costs, Mr. Noble said. The portfolio management team determined the dropped stocks are fairly close to the $67.5-million index minimum “and rather than sell them and have to potentially re-buy them shortly again if the market movement brings their market cap back over that threshold, we have opted to take a more wait-and-see approach with these names.”

Indeed, Lexaria Bioscience Corp., one of the stocks dropped by Solactive but remaining in the ETF, was back to about $75-million in market cap earlier this week. “Some of these names would probably be already back through the index inclusion threshold given the rally we’ve seen in marijuana stocks over the last two weeks,” Mr. Noble said in a Thursday e-mail responding to The Globe and Mail’s queries.

Mr. Noble said, however, that Horizons could indeed exit one or more of the stocks during the quarter, as Horizons rebalances at times other than Solactive’s quarterly announcement, sometimes in anticipation of changes in the index.

There are other differences between the index and the ETF: The TSX-listed HMMJ doesn’t include shares of cannabis firms that do most of their business in the United States, where the drug is illegal under federal law, because the TSX last year banned the listing of marijuana companies that breach U.S. federal drug laws.

While Horizons won’t comment specifically on how that affects additions and deletions, the three new companies in the ETF – Auxly Cannabis Group Inc., Khiron Life Sciences Corp. and Medipharm Labs Corp. – operate in Canada. the two additions to the Solactive index that didn’t join Horizons’ ETF – Harvest Health & Recreation Inc. and Trulieve Cannabis Corp. – are U.S.-based and sell in various states’ recreational markets.

Also, while a large number of companies were cut from the index, their small market capitalizations meant they didn’t take up a terribly large portion of the index, or of the ETF. At the close of trading on Jan. 10, the seven deleted index stocks represented 1.32 per cent of the HMMJ portfolio.“Keep in mind these are very small weights in the index and ETF so their impact one way or another is relatively marginal. This is isn’t like the Tilray scenario, where it became a significant portion of the index after its inclusion,” Mr. Noble said.

The stocks deleted from the Solactive index that Horizons is keeping, for now, are: Beleave Inc.; GTEC Holdings Ltd.; Indiva Ltd.; Inmed Pharmaceuticals Inc.; James E. Wagner Cultivation Corp.; Lexaria Bioscience Corp. and THC Biomed International Ltd.

With files from Clare O’Hara

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