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Cannabis ETFs boom as HHS recommendation to ease restrictions raises hopes for federal reform

Lisi Niesner | Reuters
  • Cannabis ETFs are soaring as investors warm up to the industry again.
  • Last month, the U.S. Department of Health and Human Services called on the Drug Enforcement Agency to ease restrictions by changing marijuana's Schedule I classification to a Schedule III substance.
  • The uptick in the ETFs ends a dry spell for an industry that has been hemmed in by federal regulations.

Marijuana-related ETFs are soaring in September as investors flood back into the sector after months of waning interest.

The upswing in the funds, the most significant seen in recent years, stems from last month's recommendation by the U.S. Department of Health and Human Services to ease restrictions on marijuana after a review of its classification under the Controlled Substances Act.

It marked a swift turnaround for a quasi-legal industry curtailed by the anemic pace of federal reform. The spike caps several quarters of slow growth, and even losses, for some funds.

ETFMG Alternative Harvest (MJ) and AdvisorShares Pure US Cannabis (MSOS), in particular, are vastly outperforming the Dow Jones Industrial Average and the S&P 500 so far this quarter as of Tuesday afternoon. MJ and MSOS have soared about 47% and 56%, respectively. The Dow and S&P are both up marginally, by about 0.5%.

"This is effectively a continuation of what's the most material element in how these stocks trade, which are federal catalysts," said Canaccord Genuity analyst Matt Bottomley. "Velocity is so much higher on these federal headlines."

Last month's announcement also sent shares of several cannabis companies higher, including Canopy GrowthTilray Brands and Cronos Group.

Marijuana equities have suffered in recent years, as many investors pulled away from the industry, leading to a capital crunch. Even as 39 states have legalized marijuana for recreational or medical use, the sector has struggled because the Schedule I classification and federal prohibition have limited access to financing and a broader market.

AdvisorShares, the largest cannabis fund manager, saw its Poseidon Dynamic Cannabis ETF shutter last month. The fund's last day of trading was Aug. 25. On Sept. 1, it liquidated assets and paid out its shareholders.

At the time of the closure announcement, fund co-founder Morgan Paxhia told CNBC that it was not "immune to the broader macroeconomic environment and, more specifically, the dramatic shift in investor sentiment that has impacted the cannabis industry."

Federal reform looms

The HHS recommendation, made at the direction of the Biden administration and addressed in a letter to the Drug Enforcement Agency, has signaled to stakeholders that more robust federal reform could be around the corner.

Potential changes include the Secure and Fair Enforcement Banking Act (SAFE), a congressional bill that will enable banks to provide services to legal marijuana businesses. Substances under the Controlled Substances Act present a risk for banking institutions while federal laws remain unchanged.

"Each time legislation like the Safe Banking Act has been presented, we've seen a corresponding uptick in investor interest," said Sundie Seefried, the CEO of Safe Harbor Financial, a digital-first, commercial-banking institution. "This milestone could be a turning point, offering the much-needed stability in the regulatory environment that investors have long sought."

SAFE Banking is making its way through Congress, with a Senate Banking Committee vote expected soon. Meanwhile, the DEA has initiated its review of marijuana's classification and will send a proposal to the attorney general, who has the final say about whether to reclassify it.

Bottomley said it will become "more and more likely that institutional capital that otherwise wouldn't be invested in the space starts entering the space," as these processes play out, but whether the momentum continues "really depends on, are we going to hear next from the DEA in time?"

"If it goes radio silent into the fall, and then into January, I wouldn't be surprised for the sector to go sideways," Bottomley added.

— CNBC's Christopher Hayes contributed to this report.

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