Millions of people are excited about the investment possibilities for the budding marijuana industry. With a growing list of states legalizing recreational marijuana use and the country of Canada set to join the ranks of pot-friendly jurisdictions later this year, publicly traded companies whose business models are related to cannabis are seeing huge gains.

Yet those who remember the internet craze of the late 1990s know that even a successful industry can be full of winners and losers, and choosing the wrong marijuana stock could leave you facing a total loss instead of the huge gains that the leaders of the industry could enjoy. Because of that, a diversified approach toward marijuana investing has real advantages, and the marijuana-focused exchange-traded fund ETFMG Alternative Harvest ETF (MJ -2.49%) offers a chance to get exposure to multiple marijuana stocks through a single investment.

Indoor growing facility with dozens of marijuana plants under lamps.

Image source: Getty Images.

What is the Alternative Harvest ETF?

The ETFMG Alternative Harvest ETF has as its investment objective matching the performance of the Prime Alternative Harvest index, which includes companies chosen because of the index manager's belief that they'll take advantage of event-driven news and long-term trends related to marijuana. Stocks include both companies directly in the cannabis industry and some in other industries that are likely to be influenced by efforts to make medicinal and recreational marijuana available in new jurisdictions across the globe.

Among the marijuana ETF's roughly 40 holdings, you'll find some of the best-known companies in the business. Many of them -- including Canopy Growth (CGC -1.36%), Cronos Group (CRON -3.97%), and Aurora Cannabis -- are headquartered in Canada. But there's also a good group of other stocks among the list, including U.K.-based GW Pharmaceuticals (GWPH) and a handful of American pharmaceutical companies looking to use cannabinoid-based medications to solve health problems.

How has the marijuana ETF done?

Performance for the Alternative Harvest ETF has reflected the ups and downs in the industry over the roughly three years of the fund's existence. Early on, excitement about potential legalization sometimes gave way to disappointment about delays in implementing marijuana-friendly laws. Early in 2018, the ETF soared along with the rest of the industry, but over the course of the rest of the year, the fund gave up all of its gains and then some. Only in the past month, with news that Constellation Brands (STZ 0.02%) had taken a sizable stake in Canopy Growth, has the fund reacted strongly to the upside -- and even now, it's still below its January highs. Overall, the fund is down 17% year to date, following gains of 15% in 2016 and 39% in 2017.

The reason why has to do with the portfolio of stocks the ETF has chosen. Although top players like Canopy and Cronos have soared, some smaller Canadian cannabis companies and U.S. pharmaceutical stocks have suffered significant losses in 2018. The competitive nature of the industry will inevitably reveal some leaders in marijuana while leaving behind a host of also-rans. Given the highly fluid situation with legalization measures and commercialization, moreover, even companies that look promising now won't always be able to execute on their growth opportunities. Some have pointed to high taxes on marijuana as well as regulations that are difficult to meet as holding back the industry from its full potential.

The price of diversification

One challenge that U.S. investors face is that because many marijuana companies trade primarily in Canada, buying shares can require either purchasing relatively illiquid over-the-counter securities in the U.S. or opening a brokerage account that allows the direct purchase of Canadian stocks. The marijuana ETF avoids this headache, as its shares are listed on a major U.S. exchange.

The trade-off for diversification and convenience is a fairly substantial price tag. Fund shareholders pay an annual expense ratio of 0.75% for management of the portfolio. Although that doesn't make the Alternative Harvest ETF the most expensive fund available, it's still on the high side among a broader range of exchange-traded funds.

Track the whole marijuana industry

Even with its shortcomings, if you're convinced that marijuana is the next gold rush, the Alternative Harvest ETF is the best-suited investment to give you broad-based exposure to companies specializing in cannabis. You won't be able to match the explosive gains that the top individual stocks in the industry produce, but you'll also probably avoid the total losses that some players will face as they strive to reach the top of the marijuana industry heap.