You can count the number of exchange-traded funds (ETFs) focused on the cannabis industry using your fingers. Until a couple of weeks ago, though, there weren't any marijuana exchange-traded noted (ETNs), which, unlike ETFs, don't hold positions in stocks but instead are unsecured debt securities issued by a financial institution.
Now, though, there are two marijuana ETNs available on the market: the MicroSectors Cannabis Index ETN and the MicroSectors Cannabis 2X Leveraged ETN. I'd avoid both of these new ETNs like the plague. Here's why.
The dangers of leverage
There's a simple reason I'm not a fan of the new MicroSectors MJO cannabis ETN: I think that using leverage can be dangerous. The MJO ETN is engineered to go up twice as much as its underlying index, which in this case is the MicroSectors North American Cannabis Index.
The idea might sound great at first blush. But it's easy to overlook the downside of using leverage. If the index does down, your investment goes down twice as much. Actually, it can be even worse than that. While leveraged ETNs (and ETFs) attempt to track their underlying indexes by the specified multiple, it's not an exact science.
If you're an investor with a long-term perspective, leveraged ETFs and ETNs aren't alternatives to seriously consider. Even if you're a short-term trader, using leverage can quickly lead to huge losses.
In addition to the leverage for the MJO ETN, the two new MicroSectors cannabis ETNs are especially risky for two other reasons.
First, they're brand new. That means you can't really evaluate the track records because they only go back a few days. Buying a new ETN, especially one that's leveraged, is closer to gambling than it is investing.
Second, the underlying index for the ETNs includes only 23 constituents. Over half of the MicroSectors North American Cannabis Index is tied to just five stocks: AbbVie, Agilent, Mettler-Toledo, Thermo Fisher Scientific, and Waters Corporation.
There's also the tiny little detail that none of these are really marijuana stocks. Why are they in the index at all? It comes down to the criteria that MicroSectors uses for its cannabis index. Companies that "provide products or services related to the medical or industrial use of cannabis or cannabis derivatives" are included.
That definition provides plenty of leeway. AbbVie qualifies probably due to its marketing of Marinol, an FDA-approved drug that contains a synthetic cannabinoid. The other companies made the index by supplying instruments used by some cannabis-related businesses.
My view is that owning shares of any of the top five constituents of the MicroSectors North American Cannabis Index is a better option than owning either of these two new ETNs. But if you're really looking to profit from the cannabis industry, there are even better alternatives.
Innovative Industrial Properties (NYSE:IIPR), for example, is a cannabis-focused real estate investment trust (REIT). The company is profitable. Its dividend yields close to 5.5%. And IIP is growing rapidly by reinvesting its money into new medical cannabis properties that it leases out.
Valens GroWorks (NASDAQ:VLNCF) is a great picks-and-shovels marijuana stock. The company provides cannabis extraction services to several of the top Canadian cannabis producers. With Canada's cannabis derivatives market just opening for business, Valens should be poised for strong growth in 2020.
If you're looking for a pure-play cannabis stock, you might like Cresco Labs (OTC:CRLBF). The company recently won the "U.S. Cannabis Company Game Changer Award" at the inaugural MJBizDaily Awards last week. Cresco should benefit from its home state of Illinois launching its recreational marijuana market in 2020 as well as the pending acquisition of another fast-growing cannabis company, Origin House.
Sure, Innovative Industrial Properties, Valens, and Cresco have their own risks. But they're relatively tame compared to putting your money in a brand-new ETNs.
Editor's note: A previous version of this article incorrectly stated that the MJJ ETN was designed to go up 2X the underlying index and the MJJ ETN was designed to go up 3X the underlying index rather than 1X and 2X, respectively. The Fool regrets the error.