Legal restrictions hinder AdvisorShares Pure Cannabis ETF’s growth

The AdvisorShares Pure Cannabis ETF has plummeted in 2022 thanks to ongoing delays to cannabis legalisation reforms across the US. Despite losses among some of the fund’s top holdings, including Village Farms and Jazz Pharmaceuticals, cannabis stocks have reason to rally.

The AdvisorShares Pure Cannabis ETF [YOLO] has been on a steep downwards trajectory in 2022 with a drop of 63.9% year-to-date. Over the last month, however, it has climbed up 10.2% boosted by a cannabis policy overhaul.

The fund rallied on 6 October after President Joe Biden announced he would pardon previous federal offenses of cannabis possession. “No one should be in jail just for using or possessing marijuana,” he said in a statement from the White House, which he echoed on Twitter later that day.

AdvisorShares’ Pure Cannabis ETF jumped by 26.3% from its close on 5 October to $5.48 the next day. While the fund has since lost some of those gains, it remains elevated above its price before the announcement, and 13.7% higher than its 52-week low of $4.11 from 27 September.

While recent legislative changes seem afoot, the cannabis market has more to contend with than the macroeconomic challenges facing other industries. In fact, BTIG analyst Camilo Lyon says it is facing a “regulatory recession”. Despite strong earnings and growth, investors still seem wary due to legal restrictions. However, the industry's long-term future appears more positive, and companies in the AdvisorShares Pure Cannabis ETF may benefit.

Cannabis stocks struggle

The AdvisorShares Pure Cannabis ETF was one of the first the first actively-managed US-listed cannabis fund, focusing on companies in the US, Canada and across the globe. As of 21 October, it had 23 holdings, with the four leading companies holding a disproportionately large slice of the pie. At the top of the list is the AdvisorShares Pure US Cannabis ETF [MSOS], which is its sister fund focused on US cannabis companies, including multi-state operators, with a hefty weighting of 39.52%.

Next is Village Farms [VFF] at 14.45% and Jazz Pharmaceuticals [JAZZ] at 9.31%, followed by Tilray [TLRY] in fourth place with 6.1%. YOLO also holds high-profile cannabis companies, including Canopy Growth [CGC], with a weighting of 1.75%. The fund is managed by Dan Ahrens, MD and COO of AdvisorShares.

Many of the ETF's key holdings have struggled lately. Year-to-date, the share price of Canadian recreational cannabis grower Village Farms is down a colossal 68.7% while cannabis-lifestyle company Tilray has plummeted 52.2%. The AdvisorShares Pure US Cannabis ETF has fallen by 57%, though similarly to the Pure Cannabis ETF, it has rallied 9.3% since Biden’s announcement on 6 October.

Slow moving policy changes

However, it's not all bad news. The share price of Jazz Pharmaceuticals, a leader in cannabinoid science, is up 6%. The company’s focus on pharmaceuticals made with FDA-approved cannabinoids means its performance is less vulnerable to the regulatory issues affecting some stocks.

Cannabis has proved a volatile sector. While companies like Tilray [TLRY] and Canopy Growth [WEED] attracted investors back in 2018 when Canada legalised cannabis, the ensuing rally soon collapsed.

BTIG analyst Camilo Lyon recently told Bloomberg: “Cannabis, with its many federal and state regulatory restrictions still in place, has been driven into recession by slow-moving policy changes.”

President Biden’s 6 October statement was part of his well-publiciadvisorsharesed plan to review the classification of cannabis, with a majority of US citizens reportedly supporting legalisation. Recreational usage is now legal in 19 states, while 37 allow for its medical use.

While Biden’s announcement of impending decriminalisation of the plant is a step forward, it remains illegal at federal level. The industry will benefit from the President’s SAFE Banking Act, which will allow financial institutions to offer banking services to legal cannabis firms without regulatory penalties.

Analysts cautiously optimistic

While many companies in the AdvisorShares Pure Cannabis ETF may be facing pain, a dramatic shift could lay ahead. Cannabis is currently classified as a Schedule I substance under the Controlled Substances Act, deeming it a substance of no accepted medicinal use with high potential to be abused, alongside heroin and LSD. Reclassification in acknowledgment of its medical potential would have a significant impact on the outlook of many companies in the AdvisorShares Pure Cannabis ETF.

In the summer, Tilray CEO Irwin Simon told Yahoo Finance the US cannabis industry was a “$100 billion opportunity”. ResearchandMarkets' Legal Cannabis 2022 report, meanwhile, said the market could "grow at a healthy CAGR" to 2029, forecasting "staggering demand from millenials and emerging markets", but noted that factors including growing competition, regulatory restrictions and fluctuating raw prices could dampen sales.

For now, sentiment amongst analysts for the AdvisorShares Pure Cannabis ETF’s top holdings seems mainly positive. At Financial Times, the consensus among eight analysts is that the stock will ‘outperform’, and its median 12-month price target is a 173.6% upside on its latest close. The 18 analysts providing ratings regarding the Jazz Pharmaceuticals share price had the same consensus, and gave a median price target 45.5% over its most recent close.