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The second quarter of 2020 was a rollercoaster for marijuana stocks. Coming out of the worst of the COVID-19 equity market sell-off in mid-March, returns in marijuana equities soared as data showed dramatic increases in sales. However, this momentum slowed considerably during the months of May and June.

The Horizons Marijuana Life Sciences Index (HMMJ), which can be used as an indicator for the North American marijuana sector, was up 15.59%  as at the June 30th quarter end, but lost 8.00% on a one month basis as at June 30th on a total return basis, despite positive returns in the broader equity market. The Horizons US Marijuana Index ETF (HMUS), the only ETF in the world focused exclusively on U.S. Marijuana production and distribution companies, was up nearly 24% as at the June 30th quarter end, but down more than 12% on a one month basis as at June 30th on a total return basis.

Why the divergence in performance?  A lot of it has to do with the fact that marijuana sales remain strong in the U.S. while Canada continues to struggle with retail distribution, particularly in its largest provincial market: Ontario.

By all accounts, despite being illegal at the federal level in the U.S, U.S. marijuana sales have soared during the first six months of 2020, relative to this same period last year. According to Marijuana Business Daily (https://mjbizdaily.com/chart-adult-use-marijuana-sales-show-resiliency-in-may-despite-pandemic/), the major state markets, apart from tourism-reliant Nevada, have seen double-digit surge in sales relative to the same period as last year. In U.S.’s largest market, California, sales have remained near their March highs, suggesting that the U.S. sales trend in the wake of COVID-19 may continue.

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Canada has not seen the same level of sales success, although it’s modestly on the rise so far this year. From the same source, Marijuana Business Daily (https://mjbizdaily.com/canadian-cannabis-sales-remain-strong-in-april-despite-covid-19-pandemic/)we see that based on the most recently reported sales data, Canada generated about C$180 million in recreational marijuana sales in April 2020, keeping it near its all-time record hit in March. However, this is a national number – only about 55% the total being generated in the state of California.

These sales figures hide a much more problematic figure for Canadian producers: excess supply. The chart below highlights that the amount of unprocessed supply in Canada is beginning to overwhelm actual packaged inventory available for sale. Canadian Licensed Producers (“LPs”) are simply growing way more than they can sell, and are limited by the smaller Canadian market and limited distribution avenues available to them outside Canada.

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What’s perplexing is why there hasn’t been more divergence in the equity valuations of the U.S. producers relative to the Canadian LPs. A lot of it has to do with the actual market dynamics of the capital markets.

The marijuana equity market is based in Canada and the largest subset of investors in these stocks are Canadian retail investors. While marijuana remains a federally illegal narcotic in the United States, the U.S. Multi-State Operators (“MSOs”) cannot get listed on the large U.S. stock exchanges, or even the largest Canadian stock exchange, the Toronto Stock Exchange. Meanwhile, large LPs like Canopy Growth, Aurora, Aphria and Cronos have dual listings and access to the U.S. securities market.

This means that dollars are heavily diverted towards the big Canadian names which are investable for U.S. investors. They have access to a much larger swath of foreign investment. For example, Curaleaf has guided to US$1 billion in annual revenues this year and is currently producing comparable revenue to Canopy Growth, but is trading at a much lower overall valuation. Again, this is likely due to market access, and despite the smaller amount of investor dollars able to chase U.S. names —  essentially Canadian retail investors and U.S. retail investors in the over-the-counter market — at some point, the revenue-generating potential of the U.S. names cannot be ignored, which is likely why the sector saw strong returns in Q2 of 2020.

As we have highlighted before, according to BDS Analytics and Arcview Research, the U.S. cannabis market sales closed in on nearly US$12.2 billion in sales in 2019, roughly ten times the sales generated within Canada. Key state recreational markets that have recently come online, such as Illinois and Michigan, is projected to add about US$700 million in annual revenue this year, according to BDS Analytics  and Arcview Research . Those states join other major state markets such as California, Colorado, Nevada and Washington State as key hubs for recreational sales.

It begs the question, why bother investing in Canadian LPs at all?  Or more specifically, why hold HMMJ versus our U.S. focused ETF HMUS?  The one potential reason is scale and investment. The Canadian LPs still have decent access to equity financing and available cash on hand to acquire U.S. producers if and when the regulatory environment allows them to do so.

For example, Canopy Growth was able to renegotiate its potential acquisition of Acreage Holdings, which allows Canopy to provide crucial cash flow with an upfront cash payment of US$37.5 million under the revised terms, adding to the previously announced US$300 million payment to Acreage, a major MSO, while retaining its right to purchase the company if/when legalization occurs in the U.S. market. Canopy, for all intents and purposes, remains a company anchored to the anemic growth of the Canadian cannabis market, but with the ability to quickly access the exponential growth potential of the U.S. market.

Valuations

Valuations remain elevated on HMMJ and its top holdings, and this is potentially being supported by recent growth in sales. At this juncture, these stocks would not be considered undervalued, but strong revenue growth alongside improving economic backdrop in North America would seem to support the current valuations.

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Source: Bloomberg, as at June 30, 2020
*HMMJ Inception Date: April 4, 2017;
**HMUS Inception Date: April 17, 2019

The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the Horizons Exchange Traded Products or returns on investment in the Horizons Exchange Traded Products.

Growth with Yield

An overlooked aspect of HMMJ and HMUS is that both ETFs pay a distribution. Typically, companies in early stage industries aren’t expected to generate any significant yield for their investors. That’s certainly true of marijuana-focused companies, which are not typically expected to pay out any dividends.

Securities lending is a common practice with mutual funds and ETFs. In fact, one of the reasons that many large ETFs can charge low management fees is because they can offset many of their operating costs by lending out up to half of their underlying securities and earn additional income.

Due to a number of factors that include, but are not limited to, volatility and the amount of free market float and available lenders, many of the stocks in HMMJ and HMUS can generally be lent out at higher-than-average lending rates compared to what is available for traditional large-cap equities.

This yield can be quite attractive; the current yield on HMMJ is 10.88% and the current yield on HMUS is about 3.61% as at June 30, 2020

This income could potentially  provide an important offset for investors, particularly during periods of higher than normal volatility.

An estimate of the annualized yield an investor would receive if the most recent distribution rate stayed the same for the next twelve months, stated as a percentage of the net asset value per unit on the date before the ex-dividend date of the most recent distribution

Quarterly Rebalance

This most recent rebalance of HMMJ and HMUS at the end of June 2020 resulted in very little turnover, with the addition of CBDMD Inc. being a major addition to each holding. CBDMD is a seed-to-sale provider of legal CBD products, which is a federally legal cannabis-related product in the United States, which is why it could be added to both portfolios.

HMMJ is the world’s first ETF that offers direct exposure to businesses with activities in the marijuana industry. This quarter, two constituents were added to HMMJ’s portfolio:

Additions

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HMMJ seeks to replicate, to the extent possible, the performance of the North American Marijuana Index, net of expenses. This index is designed to provide exposure to the performance of a basket of North American publicly listed life sciences companies with significant business activities in the marijuana industry. The North American Marijuana Index selects from a current universe of companies that have operations that may include one or more offerings of biopharmaceuticals, medical manufacturing, distribution, bio-products and other ancillary businesses related to the marijuana industry. Securities within HMMJ’s index generally have a market capitalization of greater than C$75 million.

Rebalancing of the North American Marijuana Index, and consequently HMMJ, occurs each calendar quarter. At that point, all stocks eligible for inclusion in the index are generally re-weighted by their respective market capitalization.

The holdings of HMMJ and its current portfolio weights are regularly updated and available at https://www.HorizonsETFs.com/HMMJ. It is important to note that HMMJ may not hold all of the constituent names in its index. Horizons ETFs may, through the use of a stratified sampling, invest HMMJ in securities that closely match the investment characteristics of its index, provided they are consistent with the ETF's investment objectives and strategies.

HMUS

HMUS is the world’s first U.S.-focused marijuana index ETF. HMUS seeks to replicate, to the extent possible, the performance of the US Marijuana Companies Index, net of expenses. This index is designed to provide exposure to the performance of a basket of publicly-listed companies having significant business activities in, or significant exposure to, the marijuana or hemp industries in the United States. Constituents of this index are selected from Canadian and U.S. exchanges. While some securities may be listed on major North American exchanges, the majority of the securities currently trade on North American exchanges that include but are not limited to the Canadian Securities Exchange and the Aequitas NEO Exchange.

This rebalance resulted in one addition and one removal from the portfolio:

Additions

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Deletions

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Rebalancing of the US Marijuana Companies Index, and consequently HMUS, occurs each calendar quarter. At that point, all stocks eligible for inclusion in the index are generally re-weighted by their respective market capitalization.

The holdings of HMUS and its current portfolio weights are regularly updated and available at https://www.HorizonsETFs.com/HMUS. It is important to note that HMUS may not hold all of the constituent names in its index. Horizons ETFs may, through the use of a stratified sampling, invest HMUS in securities that closely match the investment characteristics of its index, provided they are consistent with the ETF's investment objectives and strategies.

Commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the "Horizons Exchange Traded Products"). The Horizons Exchange Traded Products are not guaranteed, their values change frequently and past performance may not be repeated. The prospectus contains important detailed information about the Horizons Exchange Traded Products. Please read the relevant prospectus before investing.

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.
 
HMUS is expected to invest in the Marijuana industry in certain U.S. states that have legalized marijuana for therapeutic or adult-use, which is currently illegal under U.S. federal law. HMUS will passively invest in companies involved in the marijuana industry in the U.S. where local state law regulates and permits such activities, as well as in companies involved in the Canadian legal Marijuana industry. Neither HMMJ nor HMUS will be directly engaged in the manufacture, importation, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the respective prospectus before investing.
 
HMMJ will not knowingly invest in any constituent issuers that have exposure to the medical or recreational marijuana market in the United States, unless or until it becomes legal. HMMJ will not be directly engaged in the manufacture, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the prospectus before investing.

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Commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the "Horizons Exchange Traded Products"). The Horizons Exchange Traded Products are not guaranteed, their values change frequently and past performance may not be repeated. The prospectus contains important detailed information about the Horizons Exchange Traded Products. Please read the relevant prospectus before investing.

The Horizons Exchange Traded Products include our BetaPro products (the “BetaPro Products”). The BetaPro Products are alternative mutual funds within the meaning of National Instrument 81-102 Investment Funds, and are permitted to use strategies generally prohibited by conventional mutual funds: the ability to invest more than 10% of their net asset value in securities of a single issuer, to employ leverage, and engage in short selling to a greater extent than is permitted in conventional mutual funds. While these strategies will only be used in accordance with the investment objectives and strategies of the BetaPro Products, during certain market conditions they may accelerate the risk that an investment in shares of a BetaPro Product decreases in value. The BetaPro Products consist of our Daily Bull and Daily Bear ETFs (“Leveraged and Inverse Leveraged ETFs”), Inverse ETFs (“Inverse ETFs”) and our BetaPro S&P 500 VIX Short-Term Futures™ ETF (the “VIX ETF”). Included in the Leveraged and Inverse Leveraged ETFs and the Inverse ETFs are the BetaPro Marijuana Companies 2x Daily Bull ETF (“HMJU”) and BetaPro Marijuana Companies Inverse ETF (“HMJI”), which track the North American MOC Marijuana Index (NTR) and North American MOC Marijuana Index (TR), respectively. The Leveraged and Inverse Leveraged ETFs and certain other BetaPro Products use leveraged investment techniques that can magnify gains and losses and may result in greater volatility of returns. These BetaPro Products are subject to leverage risk and may be subject to aggressive investment risk and price volatility risk, among other risks, which are described in their respective prospectuses. Each Leveraged and Inverse Leveraged ETF seeks a return, before fees and expenses, that is either up to, or equal to, either 200% or –200% of the performance of a specified underlying index, commodity futures index or benchmark (the “Target”) for a single day. Each Inverse ETF seeks a return that is –100% of the performance of its Target. Due to the compounding of daily returns a Leveraged and Inverse Leveraged ETF’s or Inverse ETF’s returns over periods other than one day will likely differ in amount and, particularly in the case of the Leveraged and Inverse Leveraged ETFs, possibly direction from the performance of their respective Target(s) for the same period. For certain Leveraged and Inverse Leveraged ETFs that seek up to 200% or up to or -200% leveraged exposure, the Manager anticipates, under normal market conditions, managing the leverage ratio as close to two times (200%) as practicable however, the Manager may, at its sole discretion, change the leverage ratio based on its assessment of the current market conditions and negotiations with the respective ETF’s counterparties at that time. Hedging costs charged to BetaPro Products reduce the value of the forward price payable to that ETF. Due to the high cost of borrowing the securities of marijuana companies in particular, the hedging costs charged to HMJI are expected to be material and are expected to materially reduce the returns of HMJI to unitholders and materially impair the ability of HMJI to meet its investment objectives. Currently, the manager expects the hedging costs to be charged to HMJI and borne by unitholders will be between 10.00% and 45.00% per annum of the aggregate notional exposure of HMJI’s forward documents. The hedging costs may increase above this range. The manager publishes on its website, the updated monthly fixed hedging cost for HMJI for the upcoming month as negotiated with the counterparty to the forward documents, based on the then current market conditions. The VIX ETF, which is a 1x ETF, as described in the prospectus, is a speculative investment tool that is not a conventional investment. The VIX ETF’s Target is highly volatile. As a result, the VIX ETF is not intended as a stand-alone long-term investment. Historically, the VIX ETF’s Target has tended to revert to a historical mean. As a result, the performance of the VIX ETF’s Target is expected to be negative over the longer term and neither the VIX ETF nor its target is expected to have positive long-term performance. Investors should monitor their holdings in BetaPro Products and their performance at least as frequently as daily to ensure such investment(s) remain consistent with their investment strategies.

Horizons Total Return Index ETFs (“Horizons TRI ETFs”) are generally index-tracking ETFs that use an innovative investment structure known as a Total Return Swap to deliver index returns in a low-cost and tax-efficient manner. Unlike a physical replication ETF that typically purchases the securities found in the relevant index in the same proportions as the index, most Horizons TRI ETFs use a synthetic structure that never buys the securities of an index directly. Instead, the ETF receives the total return of the index through entering into a Total Return Swap agreement with one or more counterparties, typically large financial institutions, which will provide the ETF with the total return of the index in exchange for the interest earned on the cash held by the ETF. Any distributions which are paid by the index constituents are reflected automatically in the net asset value (NAV) of the ETF. As a result, the Horizons TRI ETF receives the total return of the index (before fees), which is reflected in the ETF’s share price, and investors are not expected to receive any taxable distributions. Certain Horizons TRI ETFs (Horizons Nasdaq-100 ® Index ETF and Horizons US Large Cap Index ETF) use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF use cash accounts and do not track an index but rather a compounding rate of interest paid on the cash deposits that can change over time.

*The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF. Only the returns for periods of one year or greater are annualized returns.