Millions of investors have looked at marijuana stocks lately, in part because of their big gains and in part because of the rising popularity of cannabis. With many U.S. states and the entire nation of Canada now allowing recreational use of marijuana, the companies that are looking to grow, distribute, and sell the cannabis that consumers want look like prime candidates for investment money.

Yet even though ordinary investors have jumped into the cannabis industry, large institutional investors have taken a somewhat more measured approach. That's why it's surprising to see some of the biggest interest in cannabis stocks over the past few months come from well-known stalwarts of the money-management industry. In particular, a recent transaction from mutual fund and ETF giant Vanguard Group points to just how much marijuana investing is moving into the mainstream.

Pile of spread out cannabis leaves.

Image source: Getty Images.

Which cannabis stocks is Vanguard buying?

It's not always easy to tell exactly what institutional investors are doing with their money, because their reporting requirements don't always include up-to-date information. For instance, Vanguard Group is required to file a Form 13F disclosure with the U.S. Securities and Exchange Commission that discloses certain holdings, but it's only required quarterly, and companies have 45 days to get the filing to the SEC. As a result, as of this writing, Vanguard Group hasn't yet released its 13F filing for the third quarter.

However, there is evidence that Vanguard has been bulking up its cannabis stock holdings. The clearest evidence was the June 30 13F filing, in which Vanguard revealed an overall position of more than 4.1 million shares of Canopy Growth (CGC 0.30%) stock. That represented a roughly 2% ownership stake in Canopy at the time.

Since then, you can find that Vanguard has picked up a variety of cannabis stocks. Just looking at the most recent holdings of the Developed Markets Index Fund as of Sept. 30 shows the following:

  • Roughly 4.28 million shares of Aurora Cannabis (ACB -2.30%), with a reported value of $41 million at the time.
  • About 1.14 million shares of Aphria (APHA), worth almost $16 million.
  • The fund's shares of Vanguard's total Canopy Growth holdings amounted to almost 1 million shares, worth $48 million at the time.

Vanguard has joint share classes of its funds that match up with certain ETF offerings, so investors can also get exposure through the Vanguard Developed Markets ETF (VEA -0.24%).

Why is Vanguard buying pot stocks?

It might seem strange that Vanguard Group is buying cannabis stocks like Aphria, Aurora Cannabis, and Canopy Growth. The financial institution has a reputation for fairly conservative investing strategies, and it doesn't offer any mutual funds or ETFs that are laser-focused on the marijuana industry.

What Vanguard is good at, though, is managing index funds that track key benchmarks. That's the reason cannabis stocks have come into its portfolio, because the S&P/TSX Composite Index, which is the primary benchmark for Canadian stock market investors, chose to include the three cannabis stocks within its index. Canopy Growth joined the index in March 2017, while Aphria entered the index in December, and Aurora Cannabis became a constituent this past March.

Once cannabis stocks became part of a benchmark that the fund company tracks, Vanguard had little choice but to start buying shares. Otherwise, it would have potentially failed to match the performance of the index -- especially if the three cannabis stocks outperformed to such an extent that they materially affected the overall returns of the S&P/TSX Composite.

Are more buys on the way?

It's likely that a rising number of cannabis stocks will become part of major market benchmark indexes like the S&P/TSX Composite, and as that happens, major financial institutions like Vanguard Group will make sure to get their piece of the action. The lesson for marijuana investors is that as the cannabis stocks that they own grow their businesses, the possibility of being added to much-followed benchmark indexes could lead to institutional buying that, in turn, could lead to better returns in the long run.