How to Build a Diversified Cannabis Portfolio


Harrison Jordan

February 20th, 2018

Policy


You may have heard the term, “variety is the spice of life!” It’s an adage that we hold dearly when it comes to choosing the people we hang out with, choosing the fruits and vegetables we eat, and choosing the kinds of activities we do on a daily basis.

Variety is also a strategy that may form an important part of an investment strategy. In investing, this is called “diversification,” and it is a practice that many investors around the world undertake in order to make more prudent, risk-averse investment decisions.

What is Diversification?

Diversification is like playing a lot of different numbers in roulette rather than just a single number. Rather than investing all of your capital in a single stock, you invest in a variety of stocks, bonds, or even funds.

In addition to picking a variety of security types (such as stocks, bonds, and mutual funds), diversification also usually entails picking investments from a wide range of industries, and diversifying your investment portfolio may be the smart way to go for beginning investors. Here’s why: Stocks within a specific sector often ebb and flow together, which means that if there is a downturn in a industry, and you only hold stocks from that one industry, you could be in for a rude awakening when you check your portfolio. By diversifying you are reducing the chance that all of your stocks will drop together, and you improve the odds of having a portfolio that balances losses with gain – and at the end of the day we hope the gains made in some of our stocks outweigh the losses that may be materialize in the stock picks in other industries.

Diversification in Cannabis

You’re probably asking: But how does this apply to me if I just want to concentrate my investment in the marijuana industry? Well, to start, publicly-listed marijuana companies touch all aspects of the plant across the entire life-cycle of the marijuana plant: from seed, to sale, to consumption. There are even companies that do not touch the plant at all but merely provide services or goods to other companies that DO touch the plant. We call these companies “ancillary businesses,” and many may turn out to offer extremely valuable goods and services to the companies that do indeed produce the plant for sale to a general audience.

The Marijuana Index, a website that tracks the movement of publicly-listed stocks, has a page on their website that offers a great way to visualize and really drill down into the kind of diversification present in the cannabis industry. According to their website, there are actually three main segments. As mentioned before, companies that touch the plant are the first segment. According to The Marijuana Index, this includes biotechnology companies, those involved in the cultivation and retail of cannabis, and those that produce hemp and CBD-derived products. Ancillary business, according to the TMI, including consumption devices, investing and finance services, as well as tech and media companies. But there’s also a third segment that is somewhere in between, that TMI likes to call “Direct support.” These companies include ones that provide the real estate on which cannabis is grown.

Another way to diversify is by spreading investment around stocks that have a different range of market capitalization figures. Companies with smaller market caps may be riskier than others, but they have the opportunity to grow into larger-cap stocks – if you play your cards right. On the other hand, companies with larger market caps will tend to be less risky, but may not provide as much of an upside as stocks with smaller market caps. What’s the best way to diversify between companies of various market caps? It’s not hard to search for the market caps of publicly-traded companies online, and by identifying companies with a variety of market caps, you can spread out your risk across companies. HowStuffWorks suggests to create what’s called a “style chart,” a table that allows you to plot out companies of different market caps.

Should You Diversify?

While we’re talking about all the pros about diversification, it’s important to note that not all investment advisors and gurus believe diversification to be a proper risk-aversion strategy. If the cannabis sector is experiencing a boom that carries across the entire industry, you may lose out on potential gains if, say, only half of your portfolio consists of cannabis stocks. That may be one of the reasons why Warren Buffett, the famous investor from Berkshire Hathaway, shies away from diversification. As Buffett has been quoted as saying, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” Instead of diversification, Buffett practices portfolio concentration, the practice of concentrating investment into one or similar industries/verticals.

Do you think diversification is right for you? As always, speak to an investment advisor before making investment decisions. They can help you create a diversified portfolio that might just make you feel a little safer.

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