When investors see an opportunity to make money, they pounce on it. That's never been clearer than with marijuana stocks, with a rising tide of ordinary investors looking for ways to cash in on the cannabis craze.
Yet what many investors who are new to a popular trend don't realize is that most investing fads eventually end -- and when they do, they can collapse just as quickly as they formed. For investors in the ETFMG Alternative Harvest ETF (MJ -0.26%), diversified exposure to cannabis stocks is a huge selling point. As quickly as assets have poured into the fund, however, they could easily reverse course if the reality of the marijuana industry doesn't live up to lofty current expectations.
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How Alternative Harvest has pulled in money
Alternative Harvest's primary appeal is the fact that it holds more than three dozen marijuana stocks. Some of them trade primarily on Canadian stock exchanges, making them somewhat less accessible for U.S. investors than the handful of cannabis stocks that trade on the New York Stock Exchange or Nasdaq Stock Market.
The speed with which Alternative Harvest's assets under management have taken off during the marijuana craze is impressive. After starting operations in late 2015, the ETF pulled in less than $3 million of investor capital in its first fiscal year of operations. The following year, interest in the ETF remained limited, and the fund had only $6.27 million in assets under management as of September 2017.
Once the ETF adopted its current name, it started to gain traction. As recently as last December, the fund had been known as Tierra XP Latin America Real Estate, focusing on a completely different investment objective.
From the fund's perspective, the gambit has worked. Alternative Harvest now has almost $679 million in assets as of Oct. 9. Much of that money has come in recently, with assets under management nearly doubling from their $368 million level as of the end of March.
What goes up can come down
Yet despite the popularity of marijuana stocks as an investment right now, there are reasons to be nervous about the future course of the industry. There are plenty of examples of ETFs that have soared to take advantage of a profitable investing theme that eventually resulted in huge losses.
One of the most recent examples of this phenomenon is the volatility ETF market. There have been funds that allow you to profit from movements in the VIX index, which measures investor perceptions of likely moves in the S&P 500 in the near future. During periods of market uncertainty, the VIX tends to rise dramatically, and volatility ETFs were designed to let investors capture returns from short-term spikes in the VIX.
Interestingly, investors found the best returns in an unexpected corner of this niche: inverse volatility ETFs. Back in 2012, there was almost no interest in inverse volatility ETFs, as investors had gotten burned by market choppiness during the financial crisis. That left the ProShares Short VIX Short-Term Futures ETF (SVXY 0.60%) with assets of less than $4 million on several occasions in early 2012. However, years of calm markets sent volatility levels to unprecedented lows, and investors who kept their money in inverse volatility ETFs earned several years of strong returns.
As you'd expect, as the trend continued, inverse volatility ETFs attracted more assets. By the end of 2012, assets for the ProShares short volatility ETF had ballooned to $83 million. Subsequent years saw even more growth, as the ProShares ETF had $142 million in assets at the end of 2013 and more than $500 million at year-end 2014. By early 2018, fund assets had soared to $1.89 billion.
Then, the bottom fell out of the market. On Feb. 5, volatility climbed dramatically, causing the fund to suffer a 96% loss in value in a single day. Another major short volatility ETF went out of business completely. For the ProShares fund, assets dropped below the $100 million mark overnight, and even though a rebound helped to send the ETF's asset levels back upward, the fund recently had less than $375 million under management -- down 80% from its highs.
Could marijuana ETFs be next?
Marijuana-stock bulls can argue that their investments haven't yet reached peak popularity. Many stocks still aren't readily available for investors to buy, and companies are moving quickly to list shares on more liquid exchanges as their improving financials make it possible to do so. It's entirely possible that the cannabis craze could move far higher before it hits its peak.
Nevertheless, what's important for would-be marijuana investors to understand is the risk that a reversal of fortune could wipe out their investment in the sector. That shouldn't necessarily stop you from devoting capital to the space, but recognizing the speculative nature of the cannabis industry right now is a critical part of managing the overall risk in your investment portfolio.
