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Short Sellers and Easing Rules Boost Pot ETF Higher

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The cannabis-related ETFMG Alternative Harvest ETF (MJ - Free Report) has been outperforming this year so far, surging about 46%. The surge was driven by easing of rules and regulations on the highly guarded drug for recreational and medical usage (read: ETFs That Topped & Flopped in Q1).

In fact, its popularity has been rising since Canada legalized recreational cannabis last year and become the second country in the world to do so on a national level. Additionally, a number of states in United States have also joined the race of marijuana legalization. The White House, Congress and U.S. regulators have also softened their stance on the drug’s legalization. All these developments have injected strong optimism into the emerging marijuana industry, spurring deal activities and pushing marijuana stocks higher.

The tremendous success of the pot industry is showing no signs of slowdown with short-sellers piling up heavy losses. That said, short-selling of the stocks also led to the spike in the MJ ETF.

Inside The Short-Selling Mechanism

Short selling or securities lending is another revenue stream for ETF issuers through which they can make additional money. Securities lending is a practice where mutual funds and ETFs pay agents to lend out underlying components in the funds to other traders and thereby earn interest. ETF providers typically lend out securities to investors who want to short a stock. Investors borrow shares from the provider and sell them on the market, hoping that they will be able to repurchase the same at a lower price in the market, thereby gaining from the spread.

Per Bloomberg, while many ETFs engage in securities lending, it’s been a particularly lucrative practice for pot funds as many cannabis stocks have a small public float and aren’t readily available to borrow. The funds charge a fee to borrow the shares, generating additional income that can help boost their performance. Pot securities cost about 15% to borrow versus typical rates closer to 1% for more prosaic shares. But borrowing fees can rise to as high as 110% for popular short targets like Tilray Inc (TLRY - Free Report) (read: Tilray Earnings Impressive: More Reasons to Buy Marijuana ETFs).

Marijuana ETF can lend out 33% of their holdings, according to Bloomberg Intelligence. Income from short sellers added 0.58 percentage point to MJ’s overall performance in the first three months of the year, according to Sam Masucci, chief executive of ETF Managers Group, which runs the fund.

Some of the most shorted cannabis stocks include Tilray, Canopy Growth (CGC - Free Report) , Cronos Group (CRON - Free Report) , Aphria (APHA - Free Report) and Aurora Cannabis (ACB - Free Report) (read: Marijuana ETF Outperforms in Q1: 6 Stocks Leading the Rally).

Let’s take a closer look at the fundamentals of MJ.

MJ in Focus

This is the first and only ETF focusing on the cannabis/marijuana industry. It tracks the Prime Alternative Harvest Index, designed to measure the performance of companies within the cannabis ecosystem, benefiting from global medicinal and recreational cannabis legalization initiatives. The fund holds 37 securities in its basket with higher concentration on the top firms. Canadian firms make up 62% of the portfolio, while American firms comprise 24.2%. The ETF has AUM of $1.2 billion and trades in a solid volume of around 928,000 shares. It charges 75 basis points in annual fees (read: Marijuana ETF Joins Billion Dollar Club).

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