Should You Invest in This Marijuana ETF?

Exchange traded funds (ETFs) can be a good way to invest in a particular industry without having to pick individual stocks. With the medical marijuana industry still in its infancy and the drug not being legal on the federal level in the U.S., it makes sense that investors would want to invest in an ETF.

Unfortunately there are slim pickings for the top marijuana ETF with just one available, Horizons Medical Marijuana Life Sciences Index ETF (HMMJ 0.10%), and it trades on the Toronto Stock Exchange. Earlier this year, ETF Managers Trust filed with the SEC to start a marijuana ETF on a U.S. exchange -- the Emerging AgroSphere ETF that has appropriately reserved the ticker symbol "WEED" from NYSE Arca -- but it hasn't started trading yet.

Data source: SEC and Horizon website N/D= Not disclosed yet.

Horizon's EFT invests in stocks in the North American Marijuana Index, which "tracks the performance of a basket of North American publicly listed companies with significant business activities in the marijuana industry." The 19 companies in the index break down into four major categories:

• Companies producing or supplying marijuana or cannabis directly, such as Aphria (TSE: APH).
• Biotechs, such as GW Pharmaceuticals (GWPH) and Insys Therapeutics (INSY) developing prescription drugs containing cannabinoids that are found in marijuana.
• Companies selling supplies and equipment to cultivate marijuana, such as Scotts Miracle-Gro (SMG -1.80%).
• Companies leasing property to growers, such as FutureLand, although the penny stock isn't currently in the index.

Image source: Getty Images.

A better choice

Rather than investing in a marijuana ETF that covers a wide range of businesses and includes some pretty small, thinly-traded stocks while giving the ETF managers a sizable chunk of the investment each year, investors are likely to be better off picking individual stocks in one of the categories above that offers the best risk-reward profile.

Investing in companies that grow marijuana is difficult because the companies either have to sell in Canada where the drug is legal for medical use on a federal level, or if they're U.S. based, they're likely trading on the over the counter exchange where there's less financial regulation.

Investing in companies, such as Scotts Miracle-Gro, which sells hydroponics and other supplies to the industry -- although it's harder to find solid companies in the marijuana industry -- is a good way to take advantage of the growth. After all, the suppliers were the ones that made the most money during the gold rush. Keep in mind that Scotts Miracle-Gro sells products for other agriculture and home gardens, which will dampen growth, but also provides some insurance if the federal government started cracking down on growers.

But the best way to take advantage of medical marijuana without having to worry about whether the federal government is going to trump states' laws is to invest in companies that are studying the beneficial properties of marijuana and then turning them into pharmaceutical products that are regulated by the FDA like any other prescription drug.

GW Pharmaceuticals has already posted positive clinical trial results for Epidiolex, which contains cannabidiol derived from marijuana, in patients with two rare types of epilepsy, Dravet syndrome and Lennox-Gastaut Syndrome. The company is currently filing a rolling marketing application with the FDA and plans to submit the equivalent application in Europe during the fourth quarter. GW Pharmaceuticals is also testing Epidiolex for other rare epilepsies and has other marijuana-derived pharmaceutical products that are in clinical trials.

After waiting awhile for the Drug Enforcement Agency to schedule its drug, Insys Therapeutics launched Syndros at the end of July to treat weight loss in patients with AIDS and for nausea and vomiting associated with chemotherapy in cancer patients. The active ingredient in Syndros is dronabinol, which is chemically synthesized but essentially the same as THC found in marijuana. Investors will get a first look at how sales of the drug are going when Insys releases third-quarter earnings toward the beginning of November. Just keep in mind it'll be the first quarter on the market and only represent two months of sales.

Both companies come with risks associated with biotech companies, but those are easier to identify than the risk of what the U.S. federal government might do, especially given the potential turnover of lawmakers and the executive branch every two to four years.