CB1 Capital Mid-Year Review
“The trader in me wants our positions to go up every day. The investor in me wants our positions to trade lower, so we can buy more.” – Todd Harrison
As Bitcoin, cannabis and large-cap tech orbited the earth into the end of 2017, we warned investors not to confuse brains with a bull market; true to form, the Global Cannabis Stock Market Index has since lost 29.5%—almost one-third of its entire value—while bitcoin has lost twice as much. Meanwhile, the NASDAQ rallied 10% despite continued late-stage signs in the technology sector.
Given a confluence of first-half headwinds that included (1) our hedges rallying more than 10%, (2) steady softness in Australia and (3) our largest position losing 14% of its value in June alone, we suppose it could have been worse. The fact that our performance flipped 10% in the final few sessions of the month speaks to the wicked volatility in our space.
While some managers may take solace in outperforming their benchmark by a double digit percentage, we are decidedly not among them—relative performance can’t be spent and we simply hate losing money. Still, we expected a bumpy ride as the conditional elements of our thesis evolve through the clinical, political and, increasingly, democratic processes, and we’ve most certainly had one.
Thankfully, we’ve also seen definitive progress—FDA-approved medicine derived from the cannabis plant and orphan status for other ECS-targeted therapeutic treatments, voter-led changes at multiple state levels, and proposed bipartisan legislation ahead of the mid-term elections—which serves to reinforce the confidence we have in our strategy and our portfolio.
Given our 5-10-year time horizon, we manage risk two ways: Within the sector, we’ve diversified across verticals and geographies and as the space matures, we intend to construct pairs-trades to capture valuation disparities. We manage market risk through defined-risk non-correlated delta-hedges, such as index puts and put spreads, and as a point of reference, the Wellness portfolio was delta-long 70-90% for the majority of the first half of 2018.
One of the reasons we have offered the Pure Wellness strategy—the same Wellness portfolio without the non-correlated hedges—is to better serve our investor base. Some clients prefer a hedged book, while others have their own hedging strategies in place through their own broader portfolio mix. We encourage you to consider which strategy is best-suited to your individual circumstances.
Our collective success will be a function of patience and staying power, given that most of our holdings have yet to be discovered by financial institutions or Wall Street analysts. We view this as a valuable first-mover advantage, albeit one that is often ripe with frustration as we await market efficiency. To help illustrate the types of companies that we tend to favor, we wanted to share a few examples. Please note that these companies are not necessarily indicative of the average market capitalization of the holdings in our Wellness strategy.
1. GW Pharmaceuticals: GW received FDA approval for two childhood onset epilepsy indications in June with wide off-label usage expected. We continue to use dips to accumulate exposure as we don’t believe the street understands the underlying science. In fact, as the efficacious agility of cannabinoid wellness migrates through several ongoing clinical trials, we believe GW will emerge as a robust oncology platform.
2. Revive Therapeutics Ltd. is a pharmaceutical company focused on ECS-targeted therapeutic treatment of the liver. On June 27, 2018, the FDA granted Revive orphan drug status for CBD in the treatment of Autoimmune Hepatitis. This action helps bolster our thesis that the ECS is a valid target for the treatment of rare diseases. Revive also is in partnership with a Canadian LP to supply Revive’s IP to the Canadian medical cannabis program for indications of the liver.
3. Elixinol Global Ltd. is an international hemp/cannabis company focused on CBD tinctures, hemp food and medical cannabis. Elixinol is the current Australian revenue leader in the space and is looking to take a dominant position in the U.S. following the Farm Bill/Hemp Amendment. They have a unique formulation on their CBD oil that uses liposomal technology to increase bioavailability, and they recently reported $13.3m in revenues for fiscal 2017, up 86% from fiscal 2016. They also have a 25% interest in Elixinol Japan—which we believe is an ideal population for CBD oil due to the aging demographics of its residents.
4. EVIO Inc. is a company focused on the laboratory testing of cannabis standards. The requirements for medical and adult-use Cannabis are poised to become more stringent as state and federal programs move toward further regulation and adoption. We believe that EVIO is positioned to benefit as they are active in Oregon and California and have holdings in Canada and other parts of the U.S. We believe the laboratory space may be the ultimate “picks & shovels” play in this sector as there must be an internationally-compliant ‘handshake’ for cannabis producers, consumers and patients.
5. Therapix Biosciences Ltd. specializes in the development of cannabinoid-based combination therapies by using proprietary formulations for the treatment of central nervous system and pain disorders. A recent successful Phase 2a Tourette’s Syndrome (refractory) trial has helped to bolster the theory of efficacy through targeting of the ECS. Therapix also is pursuing MCI (mild cognitive impairment), chronic back pain and antimicrobial therapies.
Shifting our attention to the emerging cannabis landscape, and consistent with our thesis, we’ve seen several large institutions buy into the space. Vanguard, Blackrock, TIAA-CREF, State Street and others are now prominent front-page institutional shareholders of Canopy Growth Corporation, Aurora Cannabis Inc., and other Canadian majors. Liquidity breeds liquidity so it’s no surprise to us that the large-cap players continue to attract institutional (and ETF) flow.
While Canada is certainly the most developed cannabis market, we see some uncertainty surrounding the United Nations treaties and the ability of certain countries (including Germany) to import cannabis from countries that have legalized adult-use (we saw similar sentiment surrounding Uruguay’s legalization activities earlier this decade). Until we have better visibility, we intend to remain underweight Canadian operators with a focus on what we perceive as deep-value discounts up North.
We currently see better values in the U.S. market and are focused on operations with exposure to Florida (given the age demographics and extremely high average per capita prescriptions) and the northeast (NY / NJ / MD / MA); we have 1-2% positions in several emerging biotech companies at various stages of the FDA clinical process, and are building hemp exposure that should begin to gain traction with passage of the Farm Bill.
We were early to Australia and have averaged into several core holdings (the largest of which is Elixinol). Australia may stand to benefit if Germany pivots away from Canada but again, that situation is fluid. Ultimately, we expect that each country will produce its own cannabis, but until the supply-demand equilibrium smooths and treaties are amended, there will be opportunities on the margin for regional players.
Through a technical lens, the BI Global Cannabis Competitive Peers Index ended 1H18 under the 50-, 100- and 200-day moving averages, which suggests still lower prices. As frustrating as that is for the trader in me, the investor in me knows that lower prices are our friend and one man gathers what another man spills. We are early, we know, but we continue to like our book.
If you have any questions about the Wellness or Pure Wellness strategies, please don’t hesitate to set up a call or a meeting.