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By Shehryar Khan, CFA |

Use caution when chasing the latest investing trend

Marijuana-focused funds have produced spectacular returns this year, but they come with significant risks.

Securities mentioned in this video
Horizons Marijuana Life Sciences ETF

Shehryar Khan: The more we learn about our own behavioural biases, the better we understand that the fear of missing out is a common problem that plagues investors. Especially when they hear about how hot the markets are in cryptocurrencies or cannabis stocks, the latter of which are sure to gain further attention with today's legalization of the recreational use of Cannabis going into effect in Canada.

Here at Morningstar Investment Management, we tend to shy away from investing in the latest trends in the market. Investors should remember how things turned out for last years investing craze: Cryptocurrencies: The price of Bitcoin, for example, surged to almost US$20,000 per coin in late 2017, and has since fallen back to earth at just about US$6,500 per coin, which represents more than a 60% decline. Ethereum, another popular cryptocurrency, reached a high of over US$1,300 per coin in January of this year, and now trades at below US$230, more than an 80% decline. In the world of trendy investments, the tide can turn against you quickly.

In the case of Cannabis stocks, like anything else, it is important for investors to do their research. On their own, Cannabis stocks can have merit, as companies ranging from Shoppers Drugmart to Coca Cola either are or are considering entering the cannabis market. Investors do have to ask themselves though: do the companies they are buying have earnings? What are their valuations like compared to the broad market? How transparent are they? On Oct. 10, for example, Canadian regulators declared that their review of publicly listed Cannabis companies discovered several problems in the quality of their disclosures.

For investors, the hardest thing to do is ignore sky-high returns. For example, the Horizons Marijuana Life Sciences ETF has delivered a year-to-date return of over 40%. However, investors should take a look under the hood to get to know what they are buying. Over 40% of the ETF is invested in three stocks, accounting for a significant part of that return. On the flip side eight out of the ETFs 39 holdings have lost over 30% of their value year-to-date, making the ETF likely unsuitable for investors with faint hearts.

Investors who insist on giving into their urges to invest in the latest trend should incorporate some of thinking of Daniel Kahneman, the Nobel prize-winning psychologist who advocates that investors divide their investable assets into buckets. In this case, have a "trend" bucket, but make it a very small portion of your overall portfolio, so that any missteps will not have an outsized impact on your long-term goals and returns, because while trendy investing may seem like fun, it can often be a real downer.

For Morningstar Investment Management, I'm Shehryar Khan.

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