Vote with confidence. Get informed with our in depth election coverage.
Diversity in political representation
The Rise of the Independents in Cape Breton
The election’s on: Now Canadians should watch out for dumbfakes and ...
Political seeds planted by local activism
How could young voters affect this election?
Growing pains par for the course in this industry, so don’t put all your buds in one stock
When investors first heard that CannTrust Holdings Inc. was growing cannabis in unlicensed rooms, Bruce Campbell’s phone lit up with calls from panicked investors.
In a press release that was published pre-market on Monday, the Vaughn, Ont.-based producer warned customers to expect product delays after Health Canada placed a hold on 5,200 kg of dried cannabis harvested in the unlicensed rooms between October and March. Campbell, the founder and portfolio manager of Stonecastle Investment Management Inc., was fielding calls from investors who needed to know what to do with the stock.
There's going to be news that rocks the business both up and down that you can't mitigate around
They only had about an hour to decide how to deal with the latest bombshell to strike the cannabis industry. Last week, investors were in the same position when Canopy Growth Corp. announced that CEO Bruce Linton was leaving the company . Even if cannabis investors are well-versed on company fundamentals and news, they’re still at risk of being blindsided by the headline risk of a sector that for the most part isn’t profitable and trades on future expectations.
“This is what investors in the sector deal with every day,” said Campbell, who runs his firm’s cannabis growth fund. “There’s going to be news that rocks the business both up and down that you can’t mitigate around.”
CannTrust’s stock fell more than 20 per cent on the news, which Campbell described as a knock on the entire industry. Experienced cannabis investors may simply look at CannTrust as an example of a company playing fast and loose with the rules, he said. Those unfamiliar with the industry may inaccurately come to the conclusion that the entire sector is in “dirty business.”
“This is probably one of those growing pains of going from being an illegal business to a legal business,” Campbell said. “When it was an illegal business, people could do whatever they wanted and the only thing they had to watch out for was the RCMP showing up at their door.”
Retail investors may not have much in the way of recourse to insulate themselves from the risks associated with the sector, GMP Securities analyst Ryan Macdonell said. Diversifying is the first-step.
Even in smaller portfolios that are only made up of 10 stocks, retail investors should avoid owning shares of only one cannabis company, he said. Instead of attributing 10 per cent of a balanced portfolio to one cannabis stock, they could look into dividing it into three names.
Even then, diversifying still has its limits, he said.
“The only thing I can point to that would be possible preparation for days like this and news like this is diversification,” he said. “(But) there’s a certain amount of risk that’s company specific that you can’t diversify away.”
Along with diversifying, investors typically look to delve into the options market or deploy a long/short in high-risk growth sectors like cannabis. Unfortunately, neither one may accessible for retail investors, Purpose Investments portfolio manager Greg Taylor warns, because of how expensive the premiums for options and borrow fees to open short positions on cannabis stocks have gotten. To open cannabis shorts, short sellers are often on the hook for between 20 and 50 per cent in fees.
Even when investors can afford borrow fees, like in Campbell’s case, opening a short position on a cannabis stock immediately results in white-knuckling, he said, because any upward momentum can lead to disastrous losses. And so opening a position is often followed by prayers that no news affects it. When the closing bell rings, he breathes a sigh of relief, but in the middle of the night, he starts to worry again.
Taylor, who runs the Purpose Marijuana Opportunities Fund, said he finds his protection in the form of cash. The fund is an actively-managed one and Taylor has used it to go from being fully invested at the beginning of 2019 to accumulating a 15 per cent cash position, which not only allows him to protect the capital but reinvest it when stocks dip to a level that’s once again appealing. He’s slowly been shifting it toward the U.S. cannabis space and by the time of CannTrust’s meltdown, he only had a one per cent exposure, of which he said he sold half.
Accumulating cash may be a wise move in the event that Taylor’s prediction that the Canadian space will soon be witness to several bankruptcies rings true. For that, there’s no protection.
“We’re probably going to get into that period where we’re going to see the companies that just can’t get production up and running and can’t keep costs down and can’t deliver product on time,” Taylor said. “Those companies are either going to have be sold or go away.”
Copyright Postmedia Network Inc., 2019