Investing in exchange-traded funds (ETFs) can be a great way for investors to diversify their portfolios without having to individually buy several different stocks. That might be especially important when it comes to the marijuana industry, where there may be concern about individual companies, but the sector as a whole still shows a lot of growth potential. That's where an ETF could help minimize the company-specific risk while giving investors the ability to benefit from long-term gains in the sector.

Have marijuana ETFs been good buys?

One of the better-known ETFs is the Horizons Marijuana Life Sciences Index ETF (OTC:HMLSF), which holds some of the top players in the industry, including Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB), among many others. Unfortunately, because those big companies have made up a sizable proportion of the ETF (Canopy at 10.8% and Aurora at 9.5%), they've also exposed the fund to their struggles.

The ETF has fared no better and no worse than Canada's top two pot stocks; it has fallen 31% since the beginning of the year, which is in line with both of their performances thus far. On a positive note, the ETF has been able to avoid the collapse that's crippled CannTrust (NYSE:CTST) investors by having a more diversified portfolio, and while it might have included the stock in the past, it doesn't today.

Cannabis plant

Image Source: Getty Images.

The downside of an ETF like Marijuana Life Sciences is that its diversification will also ensure that an outstanding performance by an individual stock won't have a big impact on its overall returns. If we look at the past two years, from November 2017 through to November 2019, the Horizons ETF has still fallen by about 15%. This time, those returns are worse than the 4% gain that Aurora generated over that period and nowhere near Canopy Growth's returns of 36%.

Is more exposure to the U.S. market key?

An alternative to the Horizons ETF for investors is the AdvisorShares Pure Cannabis ETF (NYSEMKT:YOLO), which holds a much more diverse set of cannabis stocks, including big names in the U.S. like Curaleaf Holdings (OTC:CURLF). With Canopy Growth and Aurora making up just 2.9% and 1.8% of the fund's holdings, respectively, there's less exposure to the bigger names in this ETF.

Unfortunately, since its inception back in April, the fund hasn't fared much better than the Horizons ETF, with both funds declining close to 50% as of Nov. 1. That being said, neither ETFs suffered the 60% loss that Aurora did or the 56% decline that Canopy Growth experienced during that time.

The challenge with investing in pot stocks

While there's definitely evidence to suggest that these ETFs could have saved you from some of the larger losses incurred by some cannabis stocks this year, an argument could be made that there's simply not enough of a benefit there. Losing 50% rather than 60% might not have provided investors with much consolation for what's been a dreadful year for the industry on both sides of the border.

The big danger when investing in marijuana stocks is that they can and often do move together. A bad earnings performance by one of the bigger stocks like Aurora or Canopy Growth could spark concerns for investors in others. After all, if those larger companies are running into problems, the smaller players could face similar challenges.

What does this mean for investors?

The marijuana ETFs listed above can give cannabis investors a lot more diversification and a bit more safety. However, generally, cannabis investors should be aware that the risk of investing in cannabis stocks, especially at this juncture of the industry's growth, is still very high. And regardless of how many different types of stocks are held in an ETF, it can't entirely protect your portfolio if things go bad.

Investors would be better off doing the research and finding one good marijuana stock to invest in, whether it be Aurora Cannabis, Canopy Growth, or some other company, rather than holding an ETF when it may not be advantageous to do so.