Here's Why Quants Are Getting Into Cannabis Investing

Cannabis investors have seen several cycles of hype and disappointment over the years. But quantitative investors are eyeing some opportunities in the sector today.

The Motley Fool sat down with Meb Faber, CEO and CIO of Cambria Investment Management, to talk about Cambria Cannabis ETF (TOKE -6.21%). The quant firm's low-cost cannabis fund seeks exposure to the broader marijuana industry with top holdings including GW Pharmaceuticals (GWPH), Altria (MO 0.02%), and Canopy Growth (CGC -23.12%).

Corinne Cardina: Hello there, Meb. How are you?

Meb Faber: What's up?

Cardina: Welcome to Fool Live. We're live.

Faber: Great to be here. Good morning.

Cardina: Good morning. So great to meet you. I was just telling our guests, we are so excited to welcome you, CEO and CIO of Cambria Investment Management. You all have an ETF called Cambria Cannabis ETF (TOKE -6.21%), and the ticker is TOKE, so that's pretty fun. I'm going to put that in the chat, so that our attendees can get that ticker, if they're interested. We're going to spend the next 15 minutes talking about this ETF and zooming out a little bit to the cannabis landscape. Then the second 15 minutes, I'm going to bring on a Fool.com contractor to dive into some pot stocks. But Meb, I would love to dive in to the sector, and talk about the strategy behind TOKE ETF. Can you tell us a little bit about the investment thesis?

Faber: Sure. Great to be here, guys. Let me give you a little background, it's foundational, because it's important, because I don't think thematic funds offer value. That's a weird way to start a podcast about a thematic fund from someone who manages one. We manage 12 ETFs, and for those who have followed us for long enough, would realize that we're mostly a quant shop. We've been around since before the last financial crisis, so over 10 years, and manage funds that represent all sorts of things, real estate, asset allocation, tactical, quantum value, everything else. We manage almost a billion dollars. What are we doing launching a cannabis thematic fund? When you think about thematic funds, in my opinion, there's only three reasons to ever consider one. Is there a factor that works particularly well suited to a certain sector or industry or theme? We say themes, it could be something like a sector or industry like cannabis, or something like emerging Africa, or companies in Nashville, or companies developing cancer drugs. Some are sensible and some don't really make much sense, they tend to be marketing oriented. So there's really three reasons to think about doing a thematic fund. First is factor-based. Is there a factor that applies specifically to a certain theme? A good example would be real estate, something like funds from operations. Or you apply factors across the sectors. I mean, one of the oldest strategies out there ever is a sector rotation strategy. People have been doing that for decades. Or something like old-school value.

One of our largest funds picks the 12 cheapest countries in the world stocks, so it's like a value rotation. Second, would be if someone wanted exposure to a theme based on what we call mean reversion. If you go back to our very first investment book, and most of our books are free on our website, if you go, you can download them, called the Ivy portfolio, we wrote about mean reversion. We took the French pharma data, which is free online, you guys can go download it for free, all the way back to the 1920s for any sector in the U.S. You could take it back to the 1920s when you bought sectors that were down 60, 70, 80, 90 percent, usually, they had good returns the next following three years. That's going to become relevant in a minute as we talk about cannabis as well. Lastly, is structural. Is there a structural reason why someone should be interested in a theme that has some sort of inefficiency? The classic example, somewhat tangentially related to cannabis and that's tobacco. I grew up partially in a town in North Carolina, where literally, my high school was named after a tobacco company. People could smoke in high school. Not inside, but you could still smoke in restaurants at that time. But tobacco, obviously, one of the most maligned sectors or industries on the planet. Every single ESG fund on the planet doesn't own tobacco stocks. Meanwhile, if you go back 1920, what is the single best performing industry in history? It's tobacco. There are these structural inefficiencies, so long-winded example of why we are getting to cannabis now. As a quant, I saw this setup where you had a few of these factors aligning. The first is, you had the structural inefficiency, so you couldn't own many cannabis companies. We had this fund filed for a really long time, and none of our service providers would let us launch it. If you remember the history of cannabis funds, the first one that came out actually wasn't a normal launch, it was a conversion of a Latin American real estate fund into a cannabis fund. So it was a bit of a work around. But we saw the scenario, and many people have talked about this, but we put some numbers to it. By the way, cut me off if I'm droning on too long.

Cardina: No. Great stuff.

Faber: Highly resembled is set up from almost a century ago, and of course, that's prohibition. It's pretty rare to have a market that has a built-in customer base, a customer base that's pretty adamant. It's not seen for many people, as a discretionary purchase as part of their life, but it's also a black market that's becoming opened up. So that's obviously what's happening with cannabis not just here, but all around the world. But if you go back to the 1930s, the fun part, is you can do quant studies on how did the alcohol companies perform in 1933 and the decade following? We ran through all these numbers and found out that sure enough, that had you invested in these companies post prohibition, you would have had excellent returns. I think it was 20% returns for straight-up decade. I didn't look at it past a decade because the catalyst was probably baked in at that point. What's interesting also, was that the performance, a lot of it came in the second half of the decade when all the pump and circumstance of probation lifting may have gotten baked into the stocks, but really once you had the maturation of the actual industry, as you saw a lot of the big returns. So we saw the possibility of a lot of these factors aligning when we eventually put together to fund. I'll wind down here. The problem with a lot of funds, as we all know, in not just thematics and cannabis, but everywhere is of course, fees. We write ad nauseam about fees, and Cambria is proud, all 12 of our funds are cheaper than their category averages and some of them they're cheapest fund in the entire category. That's the case of course, with cannabis fund where it's the cheapest fund, but that has a huge impact on long-term performance. I'll wind down. That was my basic intro on why we were attracted to this space.