13F filings show Hedge Funds aren't high on Marijuana Stocks


By Mark W. Gaffney

For WhaleWisdom

Legal marijuana may be the fastest growing industry since the dot com craze of the late 1990s, so it’s no surprise that the first marijuana ETF saw a burst of buying by cannabis investors eager to profit from the boom.

The Horizons Medical Marijuana Life Sciences ETF (HMMJ) began trading at CAD$10 on the Toronto Stock Exchange on April 5. First day volume was over 3 million shares, and buyers pushed the shares as high as CAD$11.84 by April 11.

While retail traders piled into the medical marijuana ETF, another group of investors appears to be far less sanguine – large U.S. money managers. If the stock holdings of hedge funds and other institutional investors are any indication, few marijuana-related stocks are worth owning.

13F filings as of year-end show U.S. investment funds are underwhelmed with the prospects for North American publicly traded cannabis stocks. An analysis of fund managers’ holdings using WhaleWisdom.com shows that as of year-end, large fund managers had significant positions in only four of the 14 stocks in the HMMJ portfolio. (Shaded rows).

U.S. funds with over $100 million in assets are required to report their public holdings in U.S. stocks quarterly via 13F filings. Analyzing 13F transactions allows investors to “pull back the curtain” on the secretive transactions of hedge funds and other large money managers.

An analysis of the universe of publicly traded marijuana-related equities (table above) finds that only eight stocks had 13F positions valued at greater than $5 million.

Essentially, U.S. fund managers -- who spend hundreds of millions annually researching the best investments in the world – see better places to invest than the current crop of marijuana stocks.

In should be noted that 13Fs reflect only U.S. funds’ holdings of U.S. stocks, options and ADRs. Canadian and other foreign stocks may be disclosed in 13Fs, but are not required to be by the SEC. Also, the portfolios of Canada-based fund managers are not reflected in 13F filings.

According to ArcView research, legal cannabis sales are expected to grow from 5 billion in 2016 to over $20 billion in 2020 with a projected compound annual growth rate of nearly 30% for the next few years.

The growth in legal marijuana recalls other booming industries from recent years – cable television in the 90s, broadband internet and craft beer in the 2000s.

However, there is one major difference between the cannabis business and those industries: The use of marijuana is illegal under U.S. federal law. Like heroin and LSD -- drugs deemed to have “no currently accepted medical use” -- marijuana has been classified as a schedule 1 drug since 1970. While the significance of marijuana’s schedule 1 status has blurred due to state legalizations, federal laws on the books still make possession of pot punishable by large fines and jail time. Regulatory risk remains high for marijuana businesses and investors.

 Source: New Frontier Data, graphic by The Cannabist

 Source: New Frontier Data, graphic by The Cannabist


But twenty-six states now allow the use of marijuana for medicinal purposes and eight states have legalized recreational use of the drug. Canada is considering legislation to legalize pot country-wide.

Industry analysts expect more U.S. states to legalize medical and recreational pot, so even without federal legalization, legal marijuana revenues are expected to grow steadily in the years ahead.

But that doesn’t mean today’s cannabis stocks will profit from the boom. Public companies in the marijuana business are the definition of risky. Most shares trade over the counter and do not have to file audited financial reports with regulators

Penny stocks are notorious for “pump and dump” schemes whereby con artists buy cheap shares, hype fraudulent stories, then sell their shares as the stock price spikes, leaving shareholders with nothing. Revenues from the legal cannabis industry could soar in the years ahead while investors in individual pot stocks lose all their money.

According to Morgan Paxhia, a managing director of San Francisco-based Poseidon Asset Management, “More than 90% of public domain marijuana-related stocks are very suspect.  Most are scams, just involved in taking investors’ money.”

Founded in 2013, Poseidon is one of the first hedge funds established to invest exclusively in the cannabis industry. Even though Paxhia follows cannabis companies closely and sits on the board of one small marijuana company, he’s not currently buying the publicly traded stocks. Paxhia believes it's “just too early for a marijuana ETF, but the underwriter of the ETF was intent on being first to market with the idea.”

He opposes the inclusion of the controversial company Insys (Nasdaq: INSY) in Horizon’s marijuana ETF. According to Paxhia, Insys spent $500,000 of its own money lobbying against legal marijuana in Arizona. The bill to legalize recreational marijuana in that state was ultimately defeated.

Insys is developing a pharmaceutical version of THC, the main psychoactive ingredient in cannabis. If approved for use, the drug could compete against legal marijuana. Despite the controversy, Insys does have a significant institutional following. Insys’ 13F shareholders can be viewed here.

“More than 90% of public domain marijuana-related stocks are very suspect.  Most are scams, just involved in taking investors’ money.”

Morgan Paxhia, managing director of cannabis-focused Poseidon Asset Management

Paxhia is also troubled by the “havoc” HMMJ is creating in the low-priced names in its portfolio. As funds flow into the ETF for investment, HMMJ managers must buy shares in the underlying stocks to replicate the North American Medical Marijuana Index it tracks. Likewise, when the inevitable selling comes, the fund must liquidate the underlying shares. The small stocks do not have the liquidity to absorb large volume, and their prices can get wildly volatile.

At some point down the road, when the cannabis industry is more established, there may be publicly traded stocks that are proxies for the sector – much like Craft Brewery Alliance (BREW) or Boston Beer (SAM) are for the craft beer industry. But most of the current bunch of pot penny stocks likely won’t be around long enough to see a more mature marijuana industry.

A good idea for anyone interested in legitimate cannabis investments, is to watch quarterly 13F filings to see which marijuana-related names may be attracting interest from professional money managers. Let the big money guys, with their elite teams of analysts, vet the group for you. Then piggyback on their ideas. For instance, in the fourth quarter of 2016, Zynerba Pharmaceuticals (ZYNE) saw 9 funds add to their positions, continuing a trend from previous quarters. ZYNE may merit further consideration. (Zynerba is a component of the HMMJ portfolio.)

13F filings are required to be submitted within 45 days after the end of a quarter, so look for an update of funds’ 1st quarter 2017 marijuana stock holdings on May 15.

While waiting on more and better publicly traded options for investing in the legal marijuana industry, investors interested in the broader health and biotech sector might consider following the 13F filings of hedge funds like Baker Bros Advisors. WhaleWisdom’s Backtester shows that a hypothetical portfolio equally weighted with Baker Bros top twenty picks, rebalanced quarterly, would have returned over 900% since 2001.


Mark Gaffney