Looking to Hit That Pot ETF? Here’s What It Could Look Like

Pot has been generating lots of buzz both in the public and private sectors.

Twenty-three states and the District of Columbia have legalized marijuana, either for medicinal or personal use, while an additional 13 have planned votes by 2016. If the trend toward legalization continues, there’s big profit potential, considering $2.5 billion in legal sales last year—and the estimated $60 billion in illegal sales.

There is an ETF for just about any investing theme you can think of. Still, marijuana is a relatively new legal industry regionally, with very few legitimate public companies in the sector that have generated revenues and that have been run by officers who know what it takes to be a public company.

Companies that would be included in any serious ETF would likely be limited to legitimate reporting companies. Some of these companies included in an ETF would almost certainly be companies that service the marijuana industry but that are much larger and focus on farming and cultivating throughout the broader agricultural sector.

One ETF inclusion would be a so-called hemp-friendly bank, which is yet to be determined. Federal laws and regulations still make the business of marijuana almost impossible to bank on. It is currently a high-cash business. You know that one bank will be the first to embrace the industry, and marijuana entrepreneurs and store owners almost certainly will flock to that bank. Again, this bank is a draft to be announced at a later date

However, if we look on the other hand, pot may be a perfect example of when an exchange-traded note (ETN) makes more sense than an ETF. ETNs don’t have to hold any of the stocks. The notes are unsecured debt obligations that are basically, promises to pay the returns of an index. So it doesn’t matter if the stocks are illiquid or not. What matters most is the creditworthiness of the ETN issuer.

ETNs were first introduced 10 years ago for this very purpose—to get into places that were particularly tough for ETFs to track. For example, the iPath India ETN (INP) was launched in 2006 to get around the strict foreign ownership restrictions that made an ETF impossible. It accumulated more than $1 billion within two years.

An ETN issuer could do the same thing, using a self-made pot index or something like the MJIC Marijuana Global Composite Index. The downside to ETNs is there is always risk that the issuer will default, just as with a bond. For investors “jonesing” hard enough for a pot ETF, this may not matter.

If you are interested in reading more on this subject, read this Bloomberg Business article.