A new frontier in passive investing

LAST APRIL, Horizons ETFs made history when it launched the world’s first cannabisbased ETF. Although the Horizons Marijuana Life Sciences Index ETF (HMMJ) had been in the works for some time, the timing was ideal, as Canada’s burgeoning cannabis industry made huge strides forward in 2017.

Aphria and Canopy Growth delivered the best returns (271% and 255%, respectively) of any company on the TSX over the course of the year, and a host of new producers joined the public markets. With the legalization of recreational use looming, Horizons ETFs saw fit to add a second cannabis-based ETF to its suite this February.

The Horizons Emerging Marijuana Growers Index ETF (HMJR) has both Canadian and US constituents, but bringing such a product to market is complicated. Cannabis remains illegal in most of the world, and its cultivation and possession is still a federal crime in the United States. That legal disparity has created a gap in the market, however, and it’s one Horizons ETFs is seeking to fill with its latest offering.

“A lot of the US companies that have stateapproved marijuana operations are coming to Canada for their securities listings because they can’t get a listing in the US,” says Steve Hawkins, president and co-CEO of Horizons ETFs. “The Canadian Securities Administrators issued guidance last year that basically said, ‘We will continue to allow Canadians to invest in cannabis companies with US operations with the proper risk disclosure.’”

In this case, ‘risk’ is the threat of enforcement of cannabis prohibition under the US Controlled Substances Act of 1970, which could result in, for instance, asset seizure by the federal government. This risk hangs over all cannabis producers that have operations in the US. Although eight states have legalized the drug, the current administration in Washington is staunchly opposed to following suit at the federal level. For that reason, investing in cannabis stocks remains a delicate process.

“For us in Canada, the Toronto Stock Exchange also issued guidelines that essentially said, ‘We don’t want any of our exchangelisted companies to have any US operating risk, and we will take action if you do.’ So you have seen companies like Aphria, which is listed on the TSX and is part of the S&P/TSX Composite Index, recently sell their US operations to maintain their listing on the TSX.”

Fortunately for Horizons ETFs and investors who want exposure to the US cannabis industry, the TSX isn’t the only game in town, so the firm approached another exchange to list HMJR.

“It is on the NEO Exchange, which has taken a broader view on investing in companies with US exposure,” Hawkins says. “As long as you are identifying the risks involved with those potential investments in compliance with the CSA guidance, then you can list your marijuana ETF on that exchange.”

Its predecessor, the Horizons Marijuana Life Sciences Index ETF (HMMJ), is listed on the TSX and has performed solidly since its inception. Originally, Horizons ETFs intended for HMMJ to focus on the medicinal market, but Canada’s proposed recreational legalization required shifting those parameters considerably. In Hawkins’ opinion, it’s hard to predict just where this sector will be in a year’s time, but the potential for growth is massive.

“A year ago, there were only around 40 licensed producers in Canada, and now there are over 90,” he says. “We have seen a huge increase in the number of producers and a huge increase in the number of public companies in this space.”

While the impressive returns generated by the likes of Aphria and Canopy Growth have converted plenty of skeptics into believers, Hawkins still advises caution when it comes to this sector. As with any new industry, it’s difficult to judge company fundamentals right now, although that won’t be the case for much longer.

“A lot of that potential growth is probably priced into the market right now because we are sitting on pretty huge price-to-earnings ratios,” Hawkins says. “A lot of the companies don’t actually have earnings, nor are they profitable, so nobody really knows what is going to happen to sales when the recreational marketplace becomes live. We have to look at states like Colorado, Oregon and now California to give us some sort of direction. Looking at those numbers, there are significant growth prospects for the cannabis market and Canadian producers.”

Another area where Horizons ETFs has demonstrated its commitment to innovation is in the tech space. Last October, the firm launched the Horizons Active AI Global Equity ETF (MIND), the first global equity-focused ETF to use artificial intelligence for security selections. The investment industry has woken up to the possibilities of AI in recent years, but it remains largely an untapped resource. Horizons ETFs has sought to address that with MIND, and Hawkins is excited for what the product might mean for investors.

“It uses AI as the actual portfolio manager,” he says. “It doesn’t select individual companies. Working with the AI developer, who already developed algorithms to do stock analysis and selection on a quantitative basis, we took those algorithms one step further and had AI become a global equity asset allocator.”

 The reason for that is simple – when it comes to analyzing data, the human brain simply can’t compete with a specially designed computer program. And for an index-tracking fund like MIND, AI appears to be a perfect fit.

“There is so much stock market data in the world right now, and that amount is growing every single day,” Hawkins says. “One individual, or even a group of individuals working together, can’t possibly look at all that information, digest it and make an informed decision – but AI can. It is working 24/7, 365 days a year, looking at that information and making decisions based on that information.”

MIND uses the risk/return profile of a world equity index as a starting point, so investors using the fund will gain exposure to companies not just in North America, but worldwide. It’s the next evolution of quasi-passive investing, Hawkins believes.

“We have given the AI system the standard deviation of returns on the index and its risk profile,” he says, “and have asked it to lower the overall risk to investors and to outperform. For MIND, it has created an asset allocation model to various countries’ equity markets and determines what the various exposures to those countries are.”