Legal marijuana has sparked an investing revolution, and companies have sprung up quickly to capitalize on the cannabis craze. With legalized recreational marijuana throughout Canada and in many U.S. states, there's plenty of opportunity for cannabis cultivators to sell their goods, and investors are finding that more companies are looking to go public and make their shares available to meet demand.

Despite the popularity of marijuana stocks, there's been a surprisingly limited number of options for investors who prefer the diversification that exchange-traded funds provide. Most of the business early on has gone to the ETFMG Alternative Harvest ETF (NYSEMKT:MJ), which recently topped the $1 billion mark in assets under management. Given the huge returns for shares of cannabis companies so far in 2019, there's huge pressure for that to change -- and fund companies are looking to overcome one big obstacle that's presented a challenge for would-be entrants to the pure-play marijuana ETF space.

Glass jar of dried cannabis next to seeds and roll papers on a wood table.

Image source: Getty Images.

Who's looking to join the marijuana ETF universe

Several fund companies have sought to create ETFs that track the cannabis industry. Last November, Innovation Shares filed to offer its Innovation Shares Cannabis ETF, which would focus on an index of Canadian and U.S. companies that are involved in either legal marijuana or similar products like hemp or cannabis-derived oils. Minimum market capitalization for marijuana stocks in the ETF would be $100 million, and weightings would be by market cap but with a maximum allocation of 7%.

Then, in late January, AdvisorShares joined the fray with a filing of its own. The ETF management company proposed the AdvisorShares Pure Cannabis ETF. The investment objective for the AdvisorShares fund would be similar to those of other pure-play cannabis ETFs, with at least 80% of assets invested in companies that get at least half of their sales from marijuana or hemp or that are registered with the U.S. Drug Enforcement Agency for handling marijuana, cannabis, or related products for research and development purposes. The fund would have active management in selecting cannabis stocks.

Finally, earlier this month, Amplify ETFs filed for its Amplify Seymour Alternative Plant Economy ETF. The fund seeks to be actively managed, with companies falling into one of three categories. The first includes cannabis and hemp plant specialists, including both cultivation and growth companies and pharmaceutical and biotech businesses. The ETF would also include support companies in areas like agricultural technology, real estate, and commercial services. Finally, ancillary companies could be included if they worked in areas like producing consumption devices and mechanisms, providing investing and financial services to the industry, or other related businesses.

The big hang-up for marijuana ETFs

Given how popular Alternative Harvest has been, it might seem like a no-brainer for competing marijuana ETFs to emerge. But the big problem that would-be ETF providers have faced is finding a financial institution that would be willing to act as custodian for the cannabis investments the funds want to buy. Federal banking laws create risk for financial institutions that hold custody of stocks that are involved with illegal drug activities, and because marijuana is still illegal under U.S. federal law, risk managers among potential custodial firms have been reluctant to get involved in the business.

Recently, there've been some political moves that have reduced those risks. The Justice Department has seen a change of leadership, and the new nominee to head the department has been more willing to recognize state law governing marijuana than the former U.S. attorney general.

Even so, the issue remains controversial. Alternative Harvest had a similar problem, initially having U.S. Bancorp (NYSE:USB) act as custodian, administrator, and transfer agent. But last September, the fund changed its custodian to L.A.'s Wedbush Securities, passing off other responsibilities to specialist institutions. It's likely that future marijuana ETFs will follow a similar path, seeking to use institutions that aren't traditional banks but that can still act as custodians under U.S. Securities and Exchange Commission rules.

Check out the latest earnings call transcripts for companies we cover.  

Look out for new marijuana ETFs

Whenever there's a successful new investing trend, fund companies seek to take advantage of it, and that's what's driving the push toward new marijuana ETFs. Challenges still exist, but it's likely that these and other new proposed funds in the cannabis space will make it through the SEC approval process. At that point, it'll be important to look at the differences among the marijuana ETFs and decide which offers the best way to invest in cannabis over the long run.