As Ahrens explained, the listing requirements at the major North American exchanges—the NYSE and the Nasdaq in the U.S., and the Toronto Stock Exchange and the TSX Venture Exchange in Canada—require that a company be legal in all places they operate whether on a state, provincial or federal level.
As such, the patchwork U.S. legal system regarding cannabis makes MSOs verboten to these major exchanges. Instead, these MSOs, some of which are multi-billion dollar companies, are relegated to trading on the OTC market in the U.S. and/or on the Canadian Securities Exchange, an electronic alternative stock exchange for micro-cap and emerging companies.
“It took a great deal of behind-the-scenes work to get this fund approved,” Ahrens said. “The SEC asked us to get a third-party legal opinion written specifically for how this fund would invest, and we provided that. And the NYSE (MSOS is listed on the NYSE Arca exchange) lawyers pushed a rule filing amendment with the SEC specifically for how this fund would invest, and it took time to get that order granted.”
In short, the MSOS fund doesn’t invest directly in U.S.-based MSOs. As noted by Ahrens, the legal opinion obtained by AdvisorShares, along with what’s stated in the fund’s prospectus, stipulate that MSOS can invest directly only in the equities of companies listed on the four major exchanges mentioned above.
Instead, the fund uses swap options to obtain indirect exposure to MSOs. Swaps are derivative contracts where two counterparties agree to exchange or swap payments regarding stocks, interest rates or commodities.
As of now, eight of the top 10 holdings in the MSOS fund involve swaps. Ahrens said the swaps aren’t leveraged, so they don’t add risk to the fund in that regard.
“There’s counterparty risk whenever you use a third-party contract, but it’s important to realize we’re getting exposure to total return swaps in a one-to-one ratio,” he said. “If I’m getting exposure to $1 million in Curaleaf, for example, we have $1 million in cash to cover that.”
Ahrens also employs swaps to invest in MSOs in the YOLO fund, and he noted that this practice differentiates these two funds from their rivals. As such, he believes, this helps explain why YOLO has been the best-performing ETF among those primarily focused on cannabis.
Granted, this outperformance is on a relative basis: YOLO is up 2.4% year to date, while the MJ fund and products from Amplify ETFs, Cambria, Global X and Innovation Shares are down roughly 10% to 36%, depending on the fund. The year-to-date return on S&P 500 Index is 6.9%.
On a one-year basis, YOLO has fallen 29%, while the other ETFs in the cannabis group have lost more than 40%. (This analysis doesn’t include the two ETNs in this category, which follow a different structure). The S&P 500 is up almost 19% during the past year.