Vanguard: Navy Capital is lead by, from left, John Kaden, Kevin Gahwyler and Sean Stiefel. Picture: BLOOMBERG
Vanguard: Navy Capital is lead by, from left, John Kaden, Kevin Gahwyler and Sean Stiefel. Picture: BLOOMBERG

Navy Capital’s one-room office in midtown Manhattan could probably fit in the coat cupboards of many of its competitors. But the hedge fund’s digs belie the firm’s success in betting on something few of its peers will touch: cannabis.

Since the Navy Capital Green Fund launched in May 2017 the company says it has increased assets under management to almost $100m from $10m and returned more than 100% net of fees in 2017.

As for 2018, "we’re having a good year so far", Sean Stiefel, Navy Capital’s 30-year-old founder, said.

As Canada moves towards the legalisation of recreational marijuana on October 17 and the US shows signs of growing leniency, hedge funds such as Navy are leading the advance of institutional money into a sector that’s so far been dominated by retail investors.

Institutions account for only a fraction of shares held in many cannabis companies: big firms hold 6.5% of Aphria and just 5.2% of Aurora Cannabis, both members of Canada’s S&P/TSX composite index. By comparison, 76% of portfolio stalwart Rogers Communications Inc. is held by institutions.

For the few cannabis companies that are cross-listed on US exchanges, institutional ownership is higher. About 18% of Canopy Growth, which trades on the New York Stock Exchange, is held by institutions, while Cronos Group, listed on the Nasdaq, is at 22%.

Canadian cannabis stocks have had a wild ride in the past year with the BI Canada Cannabis Competitive Peers index surging about 250% from October to December as the road to legalisation became clearer in Canada, before dropping by about 36% in 2018. The index is up about 109% since it began in January 2015.

Navy Capital’s foray into cannabis investing started in 2016 when a Canadian broker urged them to look at ICC Labs. Navy bought in at a C$40m ($30m) valuation before ICC listed on Canada’s TSX Venture Exchange. Four months later, when it had reached a market value of C$160m Canadian dollars, they sold. It’s worth about C$206m Canadian dollars now.

About half of Navy’s portfolio is now invested in Canadian companies that it considers "properly valued", including CannTrust Holdings. The remainder is split between the US, Europe, Israel and Australia. The fund invests in both public and private companies and sees the best investment opportunities shifting from Canada to the US, Europe and Latin America.

Canadian cannabis stocks have had a wild ride in the past year with the BI Canada Cannabis Competitive Peers index surging about 250% from October to December as the road to legalisation became clearer in Canada, before dropping by about 36% in 2018. The index is up about 109% since it began in January 2015.

While hedge funds such as Navy are embracing cannabis, pension and mutual funds are still reluctant, said Chris Barry, a Seattle-based lawyer at Dorsey & Whitney who works with cannabis firms.

That’s not because the funds don’t see a compelling investment opportunity.

"I know personally of a number of occasions where a company has walked into a major mutual fund … and said, ‘How about it?"’ Barry said. "And people around the table have said, ‘Oh, our fund couldn’t possibly consider doing that,’ and then they pulled out their cheque books and invested personally," he said.

Many US funds don’t want to run afoul of investors and regulators in a country where marijuana is illegal at the federal level. That’s less of an issue for specialty hedge funds and family offices that fly under the radar. "It’s much easier for them to decide to assume the legal risk that [US attorney-general] Jeff Sessions is going to show up at the door someday than it is for a publicly listed mutual fund or a union pension fund," Barry said.

Pension giants the California Public Employees’ Retirement System and the Canada Pension Plan Investment Board said they had steered clear of the sector, while The Vanguard Group said it only invested in the stocks through its indexed products.

BlackRock declined to comment.

Some cannabis firms are hiring people with capital markets experience to help lure institutional investors to their stocks. Khiron Life Sciences appointed Chris Naprawa, formerly a partner at Sprott Capital Partners and head of equity sales at Macquarie Canada, as its president in June to boost the Vancouver-based company’s visibility to institutions. Naprawa said he had not seen much appetite from large Canadian investors, but US family offices and hedge funds were starting to buy into the space.

Investors say the industry has received three stamps of legitimacy in the past 12 months: Tiger Global Management, a $22bn investment firm, bought a stake in San Jose, California-based cannabis software start-up Green Bits; alcohol giant Constellation Brands bought a 9.9% stake in Canopy Growth; and GW Pharmaceuticals received approval from the US Food and Drug Administration for a cannabis-based epilepsy treatment, the first marijuana-derived medicine to get the green light in the US.

Breaking down stigmas

"Those types of breakthroughs are breaking down stigmas," said Charles Taerk, CE of Toronto-based Faircourt Asset Management, which runs the cannabis-focused UIT Alternative Health Fund. The fund, which has about C$20m Canadian dollars in assets, caters primarily to retail investors.

San Francisco-based Poseidon Asset Management, one of the longest running hedge funds in the cannabis space, said it was seeing tentative interest from bigger institutions but they may not take the plunge until US federal laws change.

"They’re all interested in getting educated but they don’t feel necessarily compelled to jump in yet," said Morgan Paxhia, who co-founded and co-manages Poseidon with his sister Emily. "We’re just trying to build those relationships for when they do."

Another factor keeping the biggest investors away from the space is that most cannabis firms were still relatively small, Kaden said.

"The reality is the Blackstones of the world can’t make this a core part of their business because it’s not going to move the needle for them," he said. "They have to be able to deploy $1bn to move the needle and right now it’s hard to deploy a couple hundred million."

It may only be a matter of time. There are at least 91 publicly traded companies in Canada with a combined market value of more than C$30bn.

"I find this space so exciting, it’s like getting involved in liquor right before prohibition’s about to be eliminated," said Navy Capital chief financial officer Kevin Gahwyler.

Bloomberg

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