(Bloomberg Business) – Pot has been generating lots of buzz.
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. ArcView Market Research estimates that the national cannabis market will reach $10.8 billion in sales (retail and wholesale) by 2019.
While there are exchange-traded funds for rare earth metals and for stocks headquartered in Nashville there are no ETFs that track pot stocks.
An argument against a pot ETF is that the stocks are tiny and volatile. That may actually be the best reason for such an ETF, since volatility can be lessened through diversification.
An example of how that can work is the PureFunds CyberSecurity ETF (HACK), which tracks another fledgling industry. It's also made up of largely super-jumpy stocks that no one has heard of and that have a far higher-than-average risk of blowing up. Those stocks have an average volatility four times greater than that of the Standard & Poor's 500-stock index. HACK's volatility level is "only" twice that of the S&P 500. Diversification basically cuts the volatility in half. That can make for a much more palatable investment into an upstart industry.
Still, while there are 55 public companies whose business is based largely or completely on marijuana, they have only a combined market cap of $4 billion — and most are miniscule, according to Bloomberg Intelligence. Even the iShares Microcap ETF (IWC), which tracks the smallest of the small stocks, has a portfolio of stocks whose total market cap equals $58 billion. In short, there just isn't enough liquidity or size yet for a robust, pure-play pot ETF.
That doesn't mean the idea should be abandoned. Here are two possible ways a pot ETF could be created right now. Pot stocks — and friends
One idea is to build an ETF that includes pure pot stocks, as well as "related" companies. That would help give the ETF more liquidity. For example, Scott's Miracle-Gro, maker of lawn care products, recently bought a hydroponics supplier and has said it plans further acquisitions to participate in the growth of legal pot. Scott's is a $3.7 billion company that trades about $10 million worth of shares a day. Not a direct hit by any means, but related.
