“It has been my experience that folks who have no vices have very few virtues.” – Abraham Lincoln
Why build an exchange-traded-fund centered around vices? Human self-control is known to be in short supply. As a result, investments that benefit from excess tend to perform well through all economic climates. Junk food, beer, cigarettes, casinos, and more – as long as we’re human, many of us are likely to indulge in these sorts of things from time to time.
Thus the Advisorshares Vice ETF (ACT), an ETF that is set to profit from this fact. The Vice ETF has been positioned as a marijuana play, and thus many investors (including myself) had ignored it. But it’s not actually a cannabis ETF, and the portfolio is a fascinating one you look under the hood.
Not Really A Cannabis ETF: That’s A Good Thing
From a quick glance at the Vice ETF, you might get the impression that the ETF is betting big on Cannabis. In fact, if you look at the ETF’s sector breakdown on its website, it appears heavily tilted to cannabis:
Yet, when you look at the ETF’s holdings, it doesn’t have positions in the traditional cannabis names. Aurora (OTC:OTC:ACB), Canopy (OTC:OTC:CGC), Tilray (TLRY) and so on – you won’t find them here. I’d been prepared to write off this ETF given the cannabis exposure. I certainly don’t want to own a bunch of cash-burning marijuana start-ups. But that’s not what the Vice ETF is at all.
So how does it get all this cannabis-related exposure then? The answer is through a combination of life sciences and picks and shovels play. Here are the top 10 holdings:
Source: ACT’s website
From their top holdings, you can see there’s a bunch of things that would not normally be considered vices.
What’s Thermo Fisher Scientific (TMO) – the second-largest holding in the ETF – doing here, you might ask. As a scientific tools and instruments company, it’s not the sort of thing you’d usually think of as an un-virtuous investment. However, as part of their testing business, Thermo Fisher does marijuana compliance work:
Other top 10 holdings like Novartis (NVS) and Catalent (CTLT) are similarly broad-diversified businesses that have a marijuana or THC angle. It’s unlikely in these cases that marijuana will be the decisive factor that makes these stocks long-term winners. But it’s something that could help at the margins.
Arguably, the most direct bet on marijuana within the Vice ETF is Scotts Miracle Gro (SMG). Even that isn’t producing or selling cannabis directly. However, the company’s hydroponics equipment and fertilizers have gotten a large boost in demand. Any time you get a large surge in interest in a high-value crop people are willing to invest in, it’s going to have a significant knock-on effect on the suppliers like Scotts.
In fact Scotts was essentially a no-growth business up until 2016, but now has turned into a (volatile) growth play as marijuana legalization rolls out around North America:
What’s this all mean in practice? It turns out that while the ETF may be positioned to have 40% of its funds in cannabis, it doesn’t actually track the marijuana ETFs at all. Seeking Alpha’s ETF comparison tool lists the pot ETFs as its peers, but there’s a 50% alpha benefit to Vice ETF this year:
That’s right, ACT’s share price is actually up 8% over the past year, while the other marijuana ETFs are down between 38% and 54% respectively.
Vice ETF: Some Quirks, However It’s A Good Product
While the Vice ETF has been marketed as a cannabis play, I’d argue it’s much closer to a combination of alcohol stocks and life sciences names. It’s got a potent tobacco piece in there as well.
Overall, these have been fantastic sectors to go fishing in. Over the past 80 years, up through the mid-2010s, here are annual returns by industry sector:
Original source. And my extensive discussion of this data here.
As you can see, tobacco and beer are your #1 and #2 categories of stocks over the past decades. And it wasn’t even especially close. Life sciences largely fall in the healthcare and medical equipment bucket, which was 6th best. And the Vice ETF’s other category – restaurants and entertainment stocks – also comfortably slots into the top half of the market.
If you own a bunch of stocks from industries that tend to crush the market, you in turn should do pretty well.
What could go wrong for the ETF? Some of life science names are really expensive. Thermo Fisher, for example, now trades at 45x its FY’ 19 earnings and the stock has soared 50% over the past year. It’s a great company, but even great companies struggle to produce near-term returns when purchased at 45x earnings.
Some of the life science plays may also be value traps. AbbVie (ABBV) in particular looks like a potential redux of Gilead (GILD) circa 2015 as it approaches a massive patent cliff. It’s not something I’d stick in a vice ETF (though you can make the case via its sales of Botox) and certainly not something I’d make a top five position.
Within the beer and liquor stocks, I’m also a little skeptical of holding more than 10% of the entire Vice ETF in Boston Beer (SAM). It’s been great in recent years, but do you want to bet a major chunk of the fund’s future returns on whether the hard seltzer trend continues or not? I’d much rather have a bigger position (they’re both 1% range holdings in Vice) in global giants like Diageo (DEO) or Ambev (ABEV) rather than having a huge piece of my alcohol exposure in Boston Beer at 80x earnings.
Finally, there are the ETF-specific concerns. The expense ratio of 0.99% is high in this day and age. You’re getting contrarian management from an advisor, Dan Ahrens, that literally wrote the book about the vice industry. Ahren’s Investing in Vice: The Recession-Proof Portfolio of Booze, Bets, Bombs & Butts came out in 2004, so he’s clearly been thinking about these industries for awhile.
As a side note, I read the book, and it’s quite well-done. That said, the book’s discussions of individual companies is now way out of date, so don’t pick it up expecting any current discussion of specific situations.
His overall philosophy has become increasingly relevant with passing years, though. In fact, he says, the impetus for his book was ESG funds. In his research, he discovered that the very best performing stocks historically were precisely the stocks that the social governance funds were choosing to exclude. With ESG investing turning from a novelty in 2004 to a massive trend nowadays, it’s created even more opportunity for investors willing to push back against the do-gooders.
In any case, if you were thinking who you should put in charge of a vice ETF, Ahrens is a logical pick. This portfolio – a contrarian concentrated bet on quite a few under-the-radar stocks – would have worked in the mutual fund days.
I’m not sure there’s demand for it in 2020 though, ACT has only pulled in $10 million in funds despite being listed for several years. The combination of higher management fee, and low assets under management/liquidity might not make this a great choice for investors. The marijuana stock craze petering out certainly didn’t help matters either.
However, the general concept of a vice ETF is a worthy one. Tobacco and alcohol stocks were the market’s two best over the past 80 years. While tobacco has slowed down a bit, alcohol remains as strong as ever. And now new opportunities are emerging.
One quibble with Ahren’s present-day portfolio is that cannabis has displaced many other vices. In Ahrens’ book, he discusses industries such as defense and casinos/gaming that are essentially absent from the Vice ETF now. However, online gaming is booming, and the defense industry isn’t going anywhere either. If I were building a vice portfolio, I’d still include those sectors.
That said, the cannabis exposure in this ETF comes in a novel way, buying up a bunch of suppliers and lab equipment companies that make marijuana operations possible. This is a far better way to play the industry than buying the marijuana farming companies outright.
All in all, the Vice ETF should be applauded. In an ETF landscape increasingly full of boring cookie-cutter products, this is a unique offering. Even if the high expense ratio or lack of liquidity dissuade you, it’s worth poking around the ETF’s holdings for stocks to add to your watchlist.
This is an Ian’s Insider Corner report published August 16th for our service’s subscribers. If you enjoyed this, consider our service to enjoy access to similar initiation reports for all the new stocks that we buy. Membership also includes an active chat room, weekly updates, and my responses to your questions.
Disclosure: I am/we are long DEO,ABEV,GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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