The marijuana industry has truly been something special this year.

For starters, Canada became the first industrialized country in the world to legalize recreational cannabis on Oct. 17. When the industry is fully up to speed, Wall Street believes it could be generating in excess of $5 billion in annual added sales, atop what it was already bringing in from medical weed sales and exports to medically legalized foreign countries.

Aside from Canada's making history, two new states -- Missouri and Utah -- have joined the ranks of the medically legal in the United States. Meanwhile, residents of Michigan voted to become the 10th state to legalize adult-use pot during midterm elections. We've also seen many of the largest marijuana deals in history in 2018, as well as the first cannabis-derived drug approval in the United States. As I said, it's been a special year.

A frustrated stock trader grasping the top of his head while looking at losses on his computer screen.

Image source: Getty Images.

This popular cannabis ETF is plunging

Yet what might be described as the most encompassing measure of success for marijuana stocks, the Horizons Marijuana Life Sciences Index ETF (HMLSF 0.62%), has been pummeled as of late. Currently holding 49 different pot stocks, including growers and ancillary players, the Horizons Marijuana Life Sciences ETF has lost a third of its value in less than six weeks.

Mind you, longer-term investors in this exchange-traded fund aren't exactly hurting. Shares of the ETF are up 80% since inception in Canada, and 66% since being listed on the over-the-counter exchange in the United States. But these same investors are down 27% year to date (in the U.S.), and have seen a third of their investment disappear in just over a month. These results are particularly disappointing since the decline almost perfectly correlated with the legalization of recreational pot in Canada.

So what the heck has suddenly happened that marijuana stocks, and the very first marijuana ETF? If you're looking to point the finger of blame, place it on Horizon's management team, as well as on unrealistic investor expectations.

A cannabis leaf lying atop a hundred dollar bill and partially obscuring Ben Franklin's face, save for his eyes.

Image source: Getty Images.

Unlucky timing

One of the oddest quirks about the Horizons Marijuana Life Sciences ETF is that, despite Tilray's (TLRY) debut as a billion-dollar company in late July, and its move precipitously higher to reach a peak intraday valuation of $28 billion, it was never added to the ETF. That changed on Sept. 21. However, the addition of Tilray came well after its big run-up, which was fueled by a combination of expected deal-making and extremely high borrowing costs to short shares of the stock. Instead, the Horizons Marijuana Life Sciences ETF has taken it on the chin as Tilray, which now has the highest weighting in the portfolio at 12.3%, has moved lower from its bubble. 

And this wasn't the only instance where the Horizons Marijuana Life Sciences team dropped the ball. Aleafia Health (ALEAF 10.22%), a small-cap cannabis grower and provider of medical consultation services for medical pot patients, was added in mid-September. However, Aleafia Health had run up nearly 600% leading up to its addition to the fund. Aleafia's surge in price appears to be tied to a partnership with Cronos Group on a sleep study, as well as the expectation of 38,000 kilograms of annual production by 2019. Since its addition, shares of the company have fallen. 

Microcap Choom Holdings, a medical cannabis grower, was also added in September, and has since lost more than half of its value. 

In other words, part of the blame goes to bad timing on the part of the fund's managers for not having these names in the ETF in the first place.

An indoor commercial cannabis greenhouse.

Image source: Getty Images.

Unrealistic expectations

The other problem here is that investors had (and still have) unrealistic near-term expectations for marijuana stocks.

Just hours after legalization, a number of provinces were already experiencing supply issues. Some of these issues could extend for months or years. The reason? Growers aren't anywhere near their full production capacity yet -- but for some reason the stock market has been valuing them as if they were.

For example, with the completion of its ICC Labs acquisition, Aurora Cannabis (ACB -3.37%) should be on pace for at least 700,000 kilograms in peak production. This includes Aurora's previous estimate of 570,000 kilograms prior to ICC Labs closing, and the addition of ICC's 92,000 square feet of existing production, and slightly more than 1.1 million square feet of greenhouses under construction. But as of November 2018, Aurora Cannabis was only producing at an annual run rate of 70,000 kilograms. It and its peers are going to need years to get their production up to expectations. And while investors are waiting for that to happen, operating losses are likely to continue.

Production is also being constrained by a backlog of cultivation licenses and sales permits at Health Canada. It can take months (or longer) to receive approval to cultivate cannabis, and then up to another year for the OK to sell it.

Long story short, investors are realizing that the marijuana industry won't be seeing green nearly as quickly as many expected. That bodes poorly, at least in the near term, for the Horizons Marijuana Life Sciences ETF.