February was another positive month for the cannabis sector as the group continued to bounce from the December lows. While it seemed stocks were up every day in January, February was a different story. Volatility began to return to the group and there were more intraday swings, albeit with a positive bias.

With the positive sentiment around the group, financing activity picked up. American multi-state operators (MSOs) continued their ‘land grab’ by locking up capital. In February alone, we saw at least three MSOs raise capital to go public. Purpose Marijuana Opportunity Fund (MJJ) participated in two of these raises, Grassroots Cannabis and Vireo Health, Inc., getting in to ground-floor opportunities ahead of the passive indices. Additionally, smaller Canadian operators raised capital dedicated to premium grow operations. While appetite remains healthy in the group, it’s notable that not all deals are getting completed within the deal terms. This could be a signal of buyer exhaustion and maybe a near-term top for the group.

Valuations in the sector are close to all-time highs, propelled by the passing of the 2018 Farm Bill in the US and marijuana legalization becoming a ballot topic for the 2020 elections. We have become wary of the excessive valuations and investors that are beginning to price in expectations that may be difficult or impossible to achieve. As such, we maintained a 20% cash level in MJJ for most of February, eager to deploy at any downturn. Despite the heavy cash balance, the Fund was able to maintain a strong upside capture while minimizing volatility.

As for March, we remain more defensive than during other periods over the last year. We continue to deploy cash into promising private plays and saving our dry ammo for the next big down day. Exciting opportunities are emerging around extraction, branding and international opportunities, such as Mexico.

The Canadian LPs are reporting mixed results as many struggle to meet market expectations and their own targets. The delays in rolling out recreational retail stores in Ontario and BC are being used as an excuse for most of these misses, but at some point we must see profits. By the second half of 2019, there likely won’t be as much tolerance for earnings misses and we should start to see even more separation between winners and losers.

— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments and Nawan Butt, CFA is an Associate Portfolio Manager. Together, Greg and Nawan manage Purpose Marijuana Opportunities Fund.

All data sourced to Bloomberg unless otherwise noted.

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