QQQ - Cannabis ETF Deep Dive

2023-11-15 11:00:00 ET

Summary

• ETF expert Rob Isbitts discusses his thesis on cannabis ETFs and the importance of understanding their structure and holdings.
• Isbitts categorizes cannabis ETFs into two tiers based on structure and performance.
• The need for a diversified but not overly diversified portfolio and the importance of technical analysis in evaluating ETFs.

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Do ETFs make sense for everyone? ETF expert Rob Isbitts spells out his thesis on cannabis ETFs (8:00) Laying out his 2 tier system (12:30) Using technical analysis (24:50)

Transcript

Rena Sherbill: Rob Isbitts, welcome to the Cannabis Investing Podcast. It's great to have you on the show.

Rob Isbitts: Well, thank you very much, Rena. Thank you so much for inviting me on. A lot going on.

RS: Absolutely. If there's something that I like in our podcast, in our Seeking Alpha podcast world, it's the synergies between all the podcasts. And so today we're talking ETFs.

You've talked about ETFs and covered call ETFs on Investing Experts. You talk about the market and stocks, also ETFs and general market topics on Wall Street Breakfast sometimes. And I thought today would be a great opportunity to talk cannabis ETFs with our cannabis investing audience.

A, because I think there's a lot of misinformation and perhaps points that need more clarification when it comes specifically to cannabis ETFs. And then I think also we would benefit from an outside cannabis perspective, but inside ETF perspective. So, that's what I'm hoping that you bring to us today.

I'd love it in that vein if you could share with the audience, what makes you an expert in the ETF space? What's your background and what are you bringing to the conversation?

RI: Sure, sure. And let me say in terms of how you described it before you're talking about me, I think you got that right. There's a lot of stuff going on out there, and the way the markets are behaving right now, a lot of things I'm going to say about cannabis ETFs are things that at a higher level apply to many different industries, sectors, themes that one might consider investing in an ETF.

I'll also say this, obviously, my focus, my whole career, I'm a former advisor for a long time, about 27 years, sold my practice a few years ago and focused now on research at places like Seeking Alpha.

And when it comes to the cannabis industry, other than having a high level view of some of the pertinent issues as I would for just about anything. I would say, if you want to know how much of an expert I am about cannabis, well, go back to my earliest involvement with the industry. I grew up in the 70s and the 80s in the Northeast U.S., and Steve Martin came out with an album, comedy album called “Let's Get Small.” And that was supposed to be a metaphor for, for let's get high.

And so, yeah, let's put it this way. I have lots of areas of expertise. I do believe ETFs certainly one of those, technical analysis of ETFs is another, that's what people, I think, know me for on Seeking Alpha and elsewhere. And so now, like you say, we'll make this very synergistic for the rest of the conversation with that disclosure out of the way.

RS: Early Steve Martin is very excellent. Recommend to anyone who hasn't listened to early Steven Martin.

In terms of cannabis ETFs and ETFs in general, I would say the prevailing wisdom is that they're further more passive investor, perhaps the more novice investor. Would you agree with that sentiment off the bat?

RI: For some people, yes. For other people, no. And I don't mean to be wishy-washy, so let me explain. So, I think where I differ from, probably the majority of ETF investors is that, what I love about ETFs, among other things, but this is what I really, really love about them, is that if you think of a spectrum between, oh, I don't know, an ETF or a mutual fund that owns 300, 400, 1,000 stocks. And then you look – to me, in a lot of cases, you've over diversified yourself away.

Yet a single stock, especially in the cannabis industry, has the potential to break my first rule of investing, which is avoid big loss. Everybody has a different definition of what big is, but I think anybody who's followed this industry and the volatility certainly can relate to that. And I'll get into that in a little bit more detail when we talk.

So, to me, and again, there are 7 cannabis ETFs. I've kind of reviewed them all in preparation for this. And I have thoughts on them. You can put them into a couple of different tiers so we can talk about that. The way I judge them as ETF vehicles, not particularly the holdings, but to me, some of the best ETFs are the ones that don't own that many stocks. So, they are diversified, but they're not hyper diversified. And there are some in that category within the 7 that I researched.

RS: And why do you like that better?

RI: Because to me, as a tactical investor, you know, every time I buy something, I'd like to hold it forever, but in the market environment, we've had the last few years especially, that almost never happens unless it's like a T-Bill ETF or something.

The equity markets are so chaotic and I'm not one of these people that says, “Oh, I'm a long-term investor. It's okay if I lose 90% peak to trough in a cannabis investment because one day it'll come back.” Well, no, you have to make like 11 times your money just to get above breakeven.

And so, to me, I want to have some diversification, but I also want to know what I own. As an example, one of the ETFs we'll talk about, it only has 15 stocks. Well, I can look at every one of those stocks, put it up on a screen of my own, a watch list every day, understand better how the ETF is going to operate. And for a very small price, the expense ratio, you can get that basket. And I wouldn't call myself a basket trader, but I am definitely a tactical basket rotator.

And so, when I say, okay, one of the baskets I want in my portfolio is, XYZ industry, cannabis, for instance, well then I want to know what I own and not just get all 400 some odd cannabis companies. And of course, I know it's a little bit different in this industry because you've got the heavy Canadian influence, yet at the same time in the U.S., you've got ETFs. And they, from what I can tell, they kind of have to jump through a few legal hurdles, which changes the way they're structured. Well, I'll make sure we cover that too.

RS: So, maybe it would make sense for you just to lay out your general thoughts on the ETFs as you've reviewed them to give an overview at the outset?

RI: Let me start with the 2 tiers.

So, there are 7 Cannabis ETFs that I looked at. I put 3 of them in what I would call the A tier and 3 of them in the B tier. And then I will explain why as I go through.

Let's start with this. Out of 7 ETFs, there are 3 that I would say are a cut above the way they are structured as ETFs. Remember, not making really any fundamental comments here on the industry. So, the 3 that are in the top tier, symbols, ( MSOS ), which is the largest one, over 400 million in assets, is an actively managed fund and it's one of the newer entrants, 2020.

Second one is ( MJ ), which I think was the largest for a long time. I think assets probably peaked at close to half a billion. Now, it's about 188 million because of the price declines and all that.

It has a lot of option activity on it. I have personally invested more in options on MJ than on MJ as a position because we can talk about the options market and these things too. But MJ, I mean, it's got a little bit of a quirk in that 50% of it is in ( MJUS ), so kind of like a subsidiary. I assume that's a legal thing they need to do, but it does cut the attractiveness, but still big – been around for a while, is the first one I believe listed in 2015.

So, there's MSOS, there's MJ, and the third one is ( POTX ). That is the Global X Fund. And here, as they might say, I'm a big horse racing fan. I'm kind of going with the jockey even more than the horse. I have a lot of respect for Global X and granted this is a pretty small ETF, it's only got about 27 million in it. But like we were saying before, 15 holdings, very transparent, well-run ETF issuer that makes its living on coming out with niche products.

So again, I don't spend thousands of hours in the cannabis industry, but when I look at kind of right off the top, MSOS, MJ, and POTX are the three, I would call it top tier if I were going to evaluate, hey, what makes a solid ETF investment now that I've decided I want to invest in this space?

And then quickly, the other four that I studied, which for different reasons, let's say make Tier B, would be ( YOLO ), which is the AdvisorShares Pure Cannabis; ( CNBS ), which is Amplify Seymour Cannabis ETF; ( THCX ), which is AXS Cannabis ETF; and ( TOKE ), which is run by a great firm, Cambria, but it's a $9 million ETF and prefer them be a little bigger than that.

What do you look at in general in starting your analysis of ETFs? And let me just say, Rena, I believe that ETF analysis is entirely misunderstood. And we don't have enough time today to go into all of the reasons for that, but suffice it to say, I think there's much more to ETF analysis than crunching a few numbers.

And here, let me use POTX as an example, okay? If I want to own POTX alright, and remember this is from all my years as an advisor, CIO, I was a mutual fund manager on three different occasions, so I've kind of sat in both seats. POTX, okay, if I want to understand what Global X is doing in there, I can look through to the 15 stocks.

And in fact, a lot of what I do as an ETF analyst, with only 15 holdings, I can pull those up on Seeking Alpha's quant grades. I can get all the quant scores and I can do whatever I want with them. I can weight them according to how the positions are weighted in the basket that is the ETF. I can look at them six ways to Sunday, all that before I go and chart it, which is my last step.

But I don't think a lot of people do that. I think what people tend to do is they just sort of scrape a few numbers off the top. So, remember, these are baskets of securities. And I mean, look, take the S&P 500, actually even more, the ( QQQ )s, the Nasdaq, okay?

The Nasdaq-100 is 100 companies or is it, you know, it's like 8 companies with 92 others that happen to be on the roster, you know, like the kid who makes their high school sports team, but they never get in the game. The weighting is so awkward. And granted, there are equal weighted ETFs, which solves that problem.

But guess what? A lot of people don't look at the equal weighted stuff. They don't look at anything other than the headlined version of something. And what I also see is that people draw incorrect, inaccurate conclusions - well, this ETF stinks because blah, blah, blah.

Well, it might be structure. It might just be, I mean, look at the cannabis, look what we're talking about, right? I mean, if you said to me, well, which one looks the best from a past performance standpoint? I would say none of them.

Yet at the same time, again, understanding the industry and what's been going on with legalization and all that. MSOS, okay, it's the biggest one. And granted, it's got a little bit of a ding on it to me because a lot of their exposure, they get through swaps, not by buying the stock outright in the market. Well, this is something that you wouldn't necessarily get on a very high profile statistical report.

It will say, well, MSOS owns this many positions, okay, but there's a difference between owning a stock and owning a swap contract with a counterparty, okay? And again, in a worst case, everybody remember Bear Stearns and Lehman or the 1987 crash? It was all about counterparty risk. So, it doesn't mean that it changes buy or sell decision, but it's another factor that isn't seen on the surface of all you do is crunch numbers at a high level. You have to look at the holdings and really understand what you own.

And just on volatility, you know, MSOS, pretty good example of why past performance analysis, I mean, there's two things. First of all, I mean, the some of them all are highly correlated to each other. There is definitely some overlap in holdings for that, but the cannabis industry at this point, perhaps until it's a little bit further down the line from a regulatory acceptance standpoint, it's going to almost trade like one big basket at times.

MSOS has gone from $5 to $10 and back to $5. And I'm only talking about September and October of this year. So, it's hard to do traditional number crunching, whether it's performance, that type of thing. So, instead, things like assets under management, having enough to be liquid, volume. The number one thing, I think in the comment section of my articles about other ETFs that I try to correct people on is they say, oh, well, I would never buy that. It only has, I don't know, POTX, 27 million assets.

Well, it all depends on what the underlying securities in the basket are. So, as an example, okay, if you and I started a Dow Jones 30 ETF, and it had $10 million in it. Nothing in the ETF business. I mean, not even on the radar. Well, if all we do every time we get an order to buy or sell is transact 30 highly liquid stocks, the ones in the Dow Jones, because we're replicating that index, then that's liquidity enough.

It's the underlying holdings, not how much volume the ETF trades in most cases. And as long as you're not getting like a gigantic bid offer spread when you buy or sell the ETF, then I think by default it is liquid.

The other things just to mention briefly, kind of top level things. I look at things like volatility. Okay. Every security, especially ETFs, has their own version of the VIX like the S&P does. You just have to find the data. Obviously they're all like down 90% roughly from their all-time highs. Expense ratio to me is less relevant here.

People harp on expense ratio, but look, when you have this much volatility even intraday in something like a cannabis ETF or, or, you know, some of the smaller areas of technology, cloud computing, cybersecurity, micro-caps, whatever, whenever you're dealing with something isn't like the S&P 500 or something very large and liquid, then to me, the expense ratio, you get what you pay for. I don't pinch pennies when it comes to that.

And then one last thing. 3 of them are active and the active ones have benchmarks. You can look at the prospectus for any fund or you can see it online. And it has a benchmark that the manager has decided this is what we want to be judged against.

I found it curious that the 3 active funds, their benchmark is the S&P 500, whereas all the passive ones that are based on following an index, when the index is adjusted, the fund holdings are adjusted like clockwork. So, they all have cannabis-related indexes, which frankly were probably created in order to develop the product.

Let's create a Cannabis Index, then let's create a portfolio around it, bring it to market as an ETF, and that's how that works. But I was kind of surprised because if you're going to devote an active fund to the cannabis industry, is the S&P really your best benchmark? Probably not, because I know the S&P is not down 90% from its peak.

If it's a trading vehicle, if I'm buying out of the money call options or something like that to put a small amount of money in the possibility that it zooms higher at some point in the next few months. Kind of the nature of how I work with options. Very small amounts of money, don't put up more then you can lose.

For that, anything that has a liquid options market like MJ is good enough, even if it's maybe not the purest. So there's a difference between looking at ETFs for trading, looking at ETFs for option work, if that's part of what people do, and looking at ETFs for buy and hold as a replacement for maybe what we use to use mutual funds for, or to say, I don't want to own all 30 Dow stocks by buying them individually, just buy an ETF. ( DIA ) has that.

So, those are some of the things that I look at in evaluating ETFs as an ETF geek, obviously, and trying to apply that to this niche, fairly narrow slice of the market cannabis.

RS: Do you want to talk a little bit about the technicals in terms of ETFs and how you look at that?

RI: Yes. Well, I have a few basic rules about technical analysis. I look at multiple timeframes. I look at them frequently.

And when I say multiple timeframes, I mean, I look all the way out to monthly and quarterly charts, charts of monthly and quarterly prices, all of it down to a 1 minute and 5 minute charts when I've decided I am absolutely buying something today, but I want to figure out how I can get the best price.

So, I look at multiple timeframes. I look at multiple – I look at a multiple times, you know, frequently, and I look at many, many, I mean, you know, at our publication, ETFYourself.com , I've tracked about 200 ETFs, but they're a vast array of different styles, approaches, themes, sectors, long, short, et cetera. And I turn everything into, is it offense or is it defense? And at a high level, I try to use technical analysis to help me determine across any portfolio I'm overseeing, how much offense and how much defense should we be playing right now?

So, let's imagine for a moment that we have a mandate where the only two items I can go in would be a cannabis ETF and a T-Bill ETF.

RS: Sounds like a healthy breakfast.

RI: Oh, yeah. I run something called a ROAR Score and I run on the S&P 500. It's just how much you have in S&P or similar and how much you have in T-Bills, okay? Because as much as people say, oh, I'm 60:40, I always want to have 60% in equities.

You don't want to be a 60:40 when you have markets like we had last year and people found that out. So, let's say that we were just going between cannabis and T-Bills. Okay? What I see right now, I mean, look, the prices have fallen so far, but this is not unique to the cannabis market. This is most of the stock market right now.

So, I guess they are at the point technically where I would say, it's a very Missouri market for them. Missouri in the States, as you may know, is the show me state. Cannabis ETFs have to show me and probably a lot of other technicians that their stock prices or prices of the ETFs can really get out of the basement.

And that is going to come when there is a sustainable move off of these very depressed lows that it seems like none of the ETFs have been able to escape. So, right now, if I'm running that 0 to 100 portfolio, the position in the cannabis ETF is going to be close to zero or very, very low.

However, if I'm thinking longer-term, I'm dipping my toe in simply because it's down so much that is generally not an investment tenet of mine. I think there's too much of that going on right now. Oh, you have to buy it. It's down 90%. Well, it could go down to another 90%. That's how the math works. It is a mistake people made way back in the dot com era.

So looking for signs of positives, there aren't a whole lot now, but what I can do for any ETF is, I can use a combination of, kind of experienced set of eyes. I've been charting for 43 years, so I'll consider that experience. And I can see that there was at least a threat back in that October boost, that it was breaking a downtrend. Again, I'm just looking at MJ as a proxy.

Downtrend all through 2021, all through 2022, through most of 2023, and it always keeps sort of knocking its head on the same place, but then it burst out in September and October, mostly October, and then right back down again. Actually, let me see here. I'm sorry, September was the breakout and then fell right back in October. And that's where even solid technical analysis is tougher to apply.

And I would say, as I looked at all the charts on this, including some of the stocks, really tough to apply right now, because it is obvious that these stocks are not being driven by technicals, let's say like an S&P 500 or the long-end of the treasury market or many industries might be at times like this, it is driven by, I'm guessing, potential for legalization, how many companies will stay in business, will there be consolidation, who are the winners? And that's where you get into stock picking.

So that's a sort of off the cuff look at the technicals. There will be a time. And again, when I have bought call options or taken a small trading position for myself in a cannabis ETF, it has always been because I had the technical evidence, but in the back of my mind I'm thinking, but don't assume the technicals work as cleanly as they do here. There's too many moving parts, there's not enough liquidity and a host of other reasons.

RS: Yeah. I think that's an interesting point to keep in mind and something we echo in various ways about the cannabis industry that it's hard to have a complete sense as investors, as long-term investors, we have to keep measuring, I think, at different intervals. And anybody following along would be nodding their heads that it's definitely very catalyst-driven industry right now, or lack of catalyst-driven industry.

RI: The other thing that comes to mind based on what you just said is that when you have this many, I'm just looking at the individual prices of the ETFs. Obviously, they're all fairly low. In fact, one of them, I believe was THCX, did a one for 10 split.

In other words, the price was so low, they didn't want it to get so low that some investors maybe couldn't trade it. I think it was down under $2. So, they did a reverse split to make it $20. It usually goes the other way, just to show you, kind of the hard times that are occurring, at least in the price action. But I would say this, okay, a lot of these trade for well under $10 a share. When I buy, call or put options on an ETF, the options, sometimes I'm paying a dollar, maybe $2, $3.

So, the other way to look at this is, I mean, and again, as a small part of a much bigger portfolio, okay? Somebody said to me, all right, Rob, you must own cannabis in your broader, generally conservative model portfolio. I'd say, all right, I will take a 1% position. And if I see good signs from all the things we talked about today, fundamentally, technically, etc., then maybe I'll be ready to increase the position 2%, 3%, 4%, maybe even 5% of the portfolio.

But that 1%, if it goes to zero, it's only had a 1% impact on my portfolio. And this is what I think a lot of folks, we need to have more education about portfolio construction.

If you put up 1% of your portfolio and you lose a 100% of it, that is dollar-wise identical to putting 10% of your portfolio in an S&P index and having the market go down 10% like it just did. It's still 100 basis points or 1% of the value you put up. You had $100,000, you're out $1,000 either way.

One of them was just a case where you put a small amount of money in and it went to 0, OMG. So that’s, to me, it's fitting cannabis ETFs into a broader portfolio, like any other analysis of fitting a, call it a sub segment, it's I guess, part of consumer discretionary or healthcare, I'm not sure, but it's not even like investing in let's say a broad-based healthcare consumer discretionary ETF, it's a sub-sub-segment of that, a much narrower niche.

Everything in its proper place, and as I like to say, I'm not afraid to take big shots with small amounts of money. And I would say this is one of many sort of micro sectors that I would put potentially into that category, just not right now the way that the technicals look.

RS: I think that's a nice way of articulating things. So, winding things up here for our first conversation and I appreciate it. I think there's a lot to chew on here. Not much is spoon fed. There's a lot to digest. There's a lot to cut up and think about, I think for investors, especially ones that aren't used to such deep dives into the intricacies of ETF work.

So, appreciate it, Rob. And for those who want to follow Rob on Seeking Alpha, check out Sungarden Investment Publishing . That's where he publishes. He also has ETFyourself. com. And again, he's on Wall Street Breakfast, he's on Investing Experts, he's on our family of podcasts often, so you can hear Rob's analysis in many different mediums. Happy to leave you the last word, Rob, and anything else you think maybe we missed or that you think that cannabis investors in particular would be wise to remember?

RI: Sure. Well, I think we covered a lot of the blocking and tackling. I would just quickly say this. First of all, thank you, Rena, for all the work that you do with the podcast. I mean, obviously I've had a chance to, sort of sprinkle my thoughts into a few of the different podcast programs. And it's just an absolute pleasure. I love this stuff and I'm an investment file and an ETF geek, so great to be able to share what I've been toiling around with for 30 some odd years.

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