Navigating Uncertainty in the Cannabis Market: Insights for Investors

Navigating Uncertainty in the Cannabis Market: Insights for Investors

The recent proposal by the Department of Justice (DOJ) to reclassify cannabis from Schedule I to Schedule III of the Controlled Substances Act (CSA) has raised questions among investors in the growing cannabis sector. As regulatory tides shift, investors are preparing themselves for potential impacts on market dynamics, investment strategies, and the overall landscape of cannabis-related businesses.

As one of the leading public cannabis investment managers in the U.S, AdvisorShares represents approximately seventy percent of cannabis investors, invested in cannabis exchange traded funds (ETFs), as of May 28th, 2024(1). We aim to offer our investors insights into the potential impact that rescheduling could have on the industry:  

Regulatory Changes: The future potential uplisting of U.S. multi-state operators (MSOs) onto major exchanges would be a pivotal milestone, offering greater investor access and bolstering investment opportunities. Rescheduling helps legitimize MSOs operations which had previously deterred many institutional investors from actively investing in them. However, it also introduces a new layer of regulatory scrutiny via the U.S. Food and Drug Administration. Investors should be aware of potential increases in regulatory burdens, compliance costs, and the uncertainty surrounding future regulations.

Market Volatility: The cannabis sector is no stranger to market volatility and it may persist as these regulatory changes come into effect. The market doesn’t like uncertainty and uncertainty remains regarding implementation timelines, legal challenges, and potential market disruptions which could lead to continued volatility in cannabis stock prices, posing risks for investors. We anticipate a dampening of volatility as the sector matures and institutional investors move into the space. 

Access to Capital: Rescheduling may improve access to traditional banking services and capital markets for cannabis companies but these improvements are not guaranteed or instantaneous. While a shift to Schedule III could alleviate some banking restrictions, cannabis companies still face present challenges in accessing financing, capital markets, and banking services. As cannabis becomes more normalized and it becomes easier to invest in cannabis companies, this may allow institutional capital to enter the space after spending years on the sidelines.

Tax Relief Opportunities: With rescheduling, U.S. MSOs stand to benefit from tax relief previously blocked by IRS Code Section 280E(2). State-compliant cannabis companies will now be allowed to deduct ordinary and necessary business expenses related to their operations. This is a change that should significantly enhance these companies cash flows while also unlocking shareholder value. To put it in perspective, under 280E, state-legal cannabis companies were forced to pay more than $1.8 billion in excess taxes compared to non-cannabis businesses in 2022(3).

Broader Market Competition: New players and increased competition could be attracted to the cannabis market because of rescheduling. Established pharmaceutical companies, biotech firms, and entrepreneurial businesses exploring the medical applications of cannabis may enter the market and intensify competition. Even so, American-based tobacco, alcohol, and pharmaceutical companies continue to face limitations in deploying capital into the U.S. cannabis sector because of the potential risk for exchange delisting under current law. Consequently, investment in the sector has remained predominantly constrained to opportunities beyond U.S. borders.

International Implications: The proposed rescheduling could have ripple effects beyond U.S. borders, impacting international cannabis markets and trade dynamics. Investors are closely monitoring global regulatory developments to assess potential implications for cross-border investments, partnerships, and market expansion strategies. This includes countries such as Canada, Germany, Australia, the United Kingdom, Mexico, and Spain, among others, each with varying regulations and frameworks for medical cannabis use.

Legal Uncertainties: Despite anticipated rescheduling, cannabis remains illegal under federal law, posing legal uncertainties and risks for investors. Legal challenges, enforcement actions, and shifting political landscapes could undermine investor confidence and disrupt investment plans in the cannabis sector. Amidst these complexities and uncertainties, it seems likely that individual state rights will persist within the framework of federal law. However, securing active and unhindered access to capital markets is crucial to fully capitalize on the economic and social potential of the cannabis industry.

Domino Effects: Rescheduling represents a crucial step toward normalizing cannabis’s status from an investment perspective. This move could potentially trigger a series of regulatory and investment-related changes for the cannabis industry. While uncertainty remains regarding the passage of the SAFER Banking Act, which would offer “safe harbor” provisions for banks and SEC-regulated activities such as investment banking, custody, and stock exchanges, rescheduling could lead the U.S Treasury Department to update the necessary FinCen framework. This framework might provide the necessary protections in the absence of dedicated legislation like the SAFER Banking Act. 

Strategic planning, due diligence, and risk management will be paramount as investors navigate the evolving regulatory landscape and evaluate the potential impacts of cannabis rescheduling. Stay informed and stay tuned for further updates as the cannabis industry continues to evolve. We urge all investors with an interest in the cannabis markets to participate in the comment period for the DOJ’s cannabis rescheduling. Your input is crucial in shaping the future of cannabis regulations and the growth of your investments.

For more insights and updates, join us on the AlphaNooner each weekday at 12:00 pm ET. Visit AdvisorShares.com/events for links to watch.

• 1) Based on assets under management (AUM) from Moringstar Direct as of May 28, 2024.

• 2) Section 280E of the Internal Revenue Code was originally created to prevent drug traffickers from deducting standard business expenses from their gross income from the illegal sale of Schedule I & II drugs. Currently with cannabis being a Schedule I drug, state-compliant companies are also subject to 280E and it greatly increases their tax bill. 

• 3) Source: Whitney Economics.

*IMPORTANTLY– Know What You Own: It is crucial for investors to have a thorough understanding of their investments, especially in the cannabis sector. Blindly investing in cannabis can lead to misinformed decisions. Many prominent cannabis companies currently operate exclusively in Canada, where economic conditions differ significantly from those in the United States. As a result, these companies may not directly benefit from US regulatory reforms.

About AdvisorShares
AdvisorShares is a leading provider of actively managed ETFs. For financial professionals and investors requesting more information, call 1-877-843-3831 or visit www.advisorshares.com. Follow @AdvisorShares on Twitter and Facebook for more insights.

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The Fund is not suitable for all investors. The Fund is designed to be utilized only by knowledgeable investors who understand the potential consequences of seeking daily 2x investment results, understand the risks associated with the use of leverage, and are willing to monitor their portfolios frequently. The Fund is not intended to be used by, and is not appropriate for, investors who do not intend to actively monitor and manage their portfolios. An investor could lose the full principal value of their investment within a single day.

The Fund is an actively managed ETF that seeks to provide investment results that are two times (2x) the daily total return, before fees and expenses, of the US Cannabis ETF, an affiliated ETF, by entering into one or more swaps agreements on the US Cannabis ETF. The Fund does not seek to achieve its stated investment objective for a period of time different than a single day.

The Fund will enter into one or more swap agreements intended to produce economically-leveraged investment results relative to the returns of the US Cannabis ETF. The Fund may use a combination of swaps on the US Cannabis ETF and swaps on various investment vehicles that are designed to track the performance of the US Cannabis ETF. The Fund expects that cash balances in connection with the use of such financial instruments (“Collateral”) will typically be held in money market instruments or other cash equivalents.

Cannabis-Related Company Risk. Cannabis-related companies are subject to various laws and regulations that may differ at the state/local and federal level. These laws and regulations may (i) significantly affect a cannabis-related company’s ability to secure financing, (ii) impact the market for marijuana industry sales and services, and (iii) set limitations on marijuana use, production, transportation, and storage. Cannabis-related companies may also be required to secure permits and authorizations from government agencies to cultivate or research marijuana. In addition, cannabis-related companies are subject to the risks associated with the greater agricultural industry, including changes to or trends that affect commodity prices, labor costs, weather conditions, and laws and regulations related to environmental protection, health and safety. Cannabis-related companies may also be subject to risks associated with the biotechnology and pharmaceutical industries. These risks include increased government regulation, the use and enforcement of intellectual property rights and patents, technological change and obsolescence, product liability lawsuits, and the risk that research and development may not necessarily lead to commercially successful products.

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