Opinion: It's Time To Have Active Managers Run Cannabis Investments

September 17, 2018 3:41 pm
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Cannabis is an emerging asset class and, as such, represents an attractive investment option. This industry counts about 32,000 businesses and is worth roughly $12 billion; growing at 27 percent, its expected to double in size every 32 months for the foreseeable future.

In this context, the cannabis industry is poised to add over 500,000 new jobs by 2021, and to exceed $50 billion by 2026. Furthermore, experts anticipate the industry could reasonably exceed $100 billion in size as use becomes ubiquitous.

However, this torrid pace of growth is accompanied by a rapidly shifting regulatory environment. This means a deep and diligent approach to a generational investment opportunity is needed.

Investment Options And Active Managers

Cannabis investment options include investor groups, incubators, direct investments and crowd-funded solutions. However, their returns are highly skewed, with over 80 percent typically concentrated in the top 10 percent of investments.

Challenges in this space include fragmentation, opacity, innovation, adoption and a rapidly changing regulatory landscape. This is where active managers come in.

Active managers have a distinct advantage in emerging markets. As such, a professionally managed solution is often an attractive option for effective cannabis alpha capture. However, these sorts of asset managers are still rare in the industry.

Compared to the 10,000 active funds in the industry at large, the 40-50 cannabis funds pale in comparison.

One of the main reasons behind this low number of active funds stems from cannabis’ lingering Schedule I status, as most active funds’ mandates prohibit managers from investing in illegal substances. Meaning pension funds or traditional institutional capital in the cannabis space is largely absent.

Importance Finds A Way, Its Absence Finds An Excuse

Professionally managed solutions offer many advantages to emerging market investors. Namely:

Diligence: Investment returns tend to be correlated to conducted diligence, and managers with venture and emerging market experience can add value beyond their fees from a sustainable return perspective. In aggregate, more hours of diligence mean greater returns over time.

Experience: Professional managers typically have extensive experience in their industries. When combined with in-depth research, active managers can explore market inefficiencies and divergent legal structures to uncover mispriced opportunities.

Participation: Post investment operational and strategic assistance is usually also tied to higher returns over time. Experienced professionals with an outside perspective can add effective balance to the inside view focused entrepreneurs inevitably develop. Mentoring, coaching and strategic introductions often have an outsized impact on company performance.

Knowledge: Emerging markets often exhibit levels of opacity and information inefficiency, and the cannabis industry is no exception. While many investors are already exposed to the most popular companies, outsized investment returns can be focused in the rough diamonds often first discovered by diligent professionals.

Legal Oversight: The growth of the cannabis industry can be attributed more to changing laws than to changing habits. Legal professionals are essential in helping navigate a landscape defined as such, and many professional funds employ legal expertise to assist with investment decisions and term negotiation.

Capitalization: Professional funds can continue to provide growth capital that allows corporate management space to focus on running their underlying businesses. A symbiotic relationship between management and investors is not only healthy, it also plays an important role in helping shepherd businesses towards optimal outcomes.

Diversification: Investors can capitalize on lower minimum investment sizes to gain healthy diversification across their portfolio. Perhaps the only free lunch in the investment world, sector diversification in a fragmented and emerging market is paramount to adequate risk mitigation.

Negotiation: Sophisticated capital sources often play a lead investment role and as such can negotiate favorable investment terms typically unavailable to retail investors. Board seats and pooled investment representation also mean important influence over investment target decisions.

Portfolio Connection: A professional manager is incentivized to generate high overall portfolio returns. As such, they are encouraged to make strategic introductions and promote potential partnerships across their portfolio companies. In a landscape that will exhibit incredible consolidation, achieving ecosystem strength may be the key to a company's survival.

Responsible Stewardship: Cannabis businesses have the dual responsibility to provide constituent return and to finance those organizations fighting to promote laws that support market growth and industry sustainability. Funds can act as responsible stewards of capital by supporting those businesses that nurture their environment in addition to their bottom line. It is ultimately a poor business that makes nothing but money.

Overcoming Investment Challenges

The cannabis industry is an extremely attractive and potentially daunting emerging market with global implication. Over 500 bioactive compounds in the cannabis plant can address 750 disease conditions, while hemp's ~50,000 uses range from boats to blenders and batteries to buildings.

Fragmentation, opacity, fracturing and a rapidly evolving legal landscape can make informed investing a difficult task. Professional managers provide diversification, diligence, knowledge and oversight — factors that often lead to consistent emerging market outperformance.

Cannabis legalization has tremendous implications for social justice as well as civil liberties, and funds that invest in a socially responsible context can provide incredible holistic value. Investors are well served to explore a professionally managed solution when considering investment in this exciting and high-growth industry.

Sumit Mehta is the CEO of MAZAKALI. Javier Hasse, Director of Benzinga’s Cannabis Newsdesk, contributed to this report.

Related Links:

Cramer's Cautious Take On Cannabis Stocks: 'Your Gains Could Go Up In Smoke'

Giving The Green Light To The Future Of Cannabis Genetics

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