COVID-Induced Economic Pain Creates The Perfect Storm For U.S. Cannabis Legalization (Podcast Transcript)


Editors’ Note: This is the transcript version of the podcast we published last Wednesday with Ted Waller. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast, embedded below, if you need any clarification. We hope you enjoy!

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Jonathan Liss [JL]: For reference purposes, this podcast is being recorded on the morning of Wednesday, July 15, 2020.

My guest today is the CEO of Global X ETFs, Luis Berruga. Luis joined Global X in 2014. He is responsible for advancing Global X’s leadership and providing intelligent investment solutions. In doing so, he leads the organization of the senior management team to drive execution across all areas and planning and implementation of the firm’s strategic vision.

Prior to joining Global X, Luis served as an investment banker in the Financial Institutions Group at Jefferies, where he advised the Board of Directors and executive management teams, public and private companies on acquisitions, divestitures, and capital raises. Prior to that, he was at Morgan Stanley, where he focused primarily on technology and operations strategic planning within the Wealth and Asset Management.

Luis earned his MBA from the Kellogg School of Management at Northwestern University. Anyway, enough of an intro. Welcome to the show, Luis.

Luis Berruga [LB]: Thanks, Jonathan, and thank you for having me.

JL: Yes. It’s truly great that you’re here. I’m a big fan of Global X. And what has been for many, many years, I think, one of the great niche issuers in terms of thematic. So truly great that you could be here.

LB: No, thank you so much for having me. I’m very, very excited to talk to you about Global X and some of the more recent developments in terms of cloud development and some of the very interesting things that we are doing in the context of global distribution and also in the context of thematic investing.

JL: Sure. So you started out on the investment banking side of the business, and six years ago, you pivoted over to exchange-traded funds when you joined Global X. What was it about the ETF space specifically that drew you in?

LB: And to be honest, I think, it’s a passion for the ETF product itself. Like you were saying before, Jonathan, even before investment banking, I worked at Morgan Stanley in Chicago within their Wealth and Asset Management Group. And in that role, I really had a chance to dig deep into multiple product structures and investment styles, right?

So from a stock picking to mutual funds, closed-end funds, UITs, annuities and, of course, ETFs. And the more that I learn about how ETFs work, the more convinced I became over it many benefits of the ETF structure. I was truly fascinated by the elegance of the ETF structure as an investment solution, because think about it, Jonathan, right?

So you have easy access to dozens, if not, hundreds of companies around the world in just a single trade. You have liquidity. You can easily buy and sell throughout the day in the secondary market. If you are an institutional client and you need to trade a large blocks of shares, you can do that in the primary market through an authorized participant.

You also have tax efficiency, thanks to the custom basket and the creation redemption process. ETFs tend to be more tax-efficient than mutual funds, which at the end of the day, that means money in the pocket of our investors, right.

And last, but not least, typically lower cost. When I was looking into ETFs, 10, 12 years ago, like it was mind-blowing to me seeing some of the difference in the cost structure of ETFs versus other investment vehicles. So when I saw all of those benefits put together, it became very clear to me that ETFs were ready to disrupt the asset management industry. And they did, right?

So if you look at assets and ETFs, like 10 years ago, it was not even a trillion-dollars in AUM. And when you look at assets in the ETF industry, just in the U.S., it’s about $4.4 trillion in AUM. So from that standpoint, obviously, being part of a fast-growing industry that is really contributing to democratize investing around the world, I think, is a very fascinating story and I definitely wanted to be part of that.

JL: Yes, absolutely. It really is an amazingly elegant piece of financial engineering. So Global X has really established itself over the years as a niche ETF issuer, focused on all kinds of different thematic funds. You have some really just hugely successful funds in spaces like robotics and artificial intelligence, in e-commerce. Cloud computing has been a big successful space for you as well as your first thematic ETF, Lithium and Battery (LIT), which has almost $700 million in AUM. More recently, you got into the cannabis space and that actually was a space in 2019 that saw many funds launch.

And so I’d love to get into just an understanding of first how you see the space and then how you approach it specifically with the Global X Cannabis ETF (POTX), another great ticker symbol.

So you launched this fund in September of 2019. This is really a very highly saturated space in terms of the number of funds. There’s nine different ETFs traded in the U.S. alone that offer exposure to this space. And, of course, in Canada, there’s a bunch of funds also, which makes sense based on how many of the publicly-listed companies are domiciled in Canada.

And so I’m just curious, particularly considering how disappointing the returns have been across the Board in this space really going on almost two years now. Let’s start out by just talking about what’s your current view of the industry?

LB: Yes. I mean, well, the industry definitely expanded very rapidly in 2018. And quite frankly, in my opinion, I think, probably a little bit too rapidly, given that the business models and the legal and operational frameworks of many of these companies were not yet fully developed. And my view is, at that point in time, I think, the market didn’t fully price in many of these uncertainties.

So it’s – so because of that, I don’t think it’s unusual to see some level of near-term contraction and consolidation in the industry, right? So weaker players will shake out and a lot of your players will eventually grow market share, which is not a – it’s a natural evolution of a growing industry.

Now, if you fast forward to where we are today, I think in the current environment, there is a strong upside, given the potential legalization of cannabis at the state level. And why do I think so, right? If you look at state governments, I mean, they are dealing with major budget deficits, right? And the current state of the economy because of COVID-19 is not particularly good, either.

So with that context, I think, there will be greater momentum for the legalization of cannabis to simply help increase tax revenues and create more jobs. And I was really talking about this with our research team earlier this week. And there are literally estimates that nationwide legalization in the U.S. could generate over $130 billion in aggregate tax revenue by 2025.

And in terms of jobs for that same period of time, we will be talking about job creation of over 1 million jobs. That’s a very strong incentive for state governments to look at the potential legalization of cannabis. And I used to live – now I live in Brooklyn, but I used to live in New Jersey. I think, New Jersey is looking in-trade, I think, in November of 2020. And if they were to legalize cannabis, I think, New York and Connecticut would be pressure to fall like a similar path.

So I think that is definitely a ton of upside. And again, let’s not forget that if you look at a global sales, only 10% of cannabis sales are made through legalized market. So I think this thing remains quite powerful. There is proven demand. There is growing social acceptance. And like I said, I think there is a regulatory tailwind, because state governments are looking for ways to increase in tax revenues and improve the situation with some of their budgets.

JL: Sure. In terms of federal legalization in the U.S., though, there is the possibility that, that could still be off in the distant future somewhere, I think, particularly if Trump wins again in November, and you have some at least republican veto over legislation that may come through Congress, even if the democrats retake that. And I’m wondering how investable the U.S. market is when you only have legalization at the state level and not at a federal level?

LB: I mean, politics is always like a very difficult risk factor to predict, right. And with the elections coming up in November, it’s even more difficult. So right now, we do think it’s unlikely that we see federal legalization under the current administration, and let’s not forget that we have a Sphere Congress.

But that being said, I mean, I think it’s an issue that continues to gain more support across the political spectrum, just because social norms around cannabis are definitely a volume.

So in terms of whether we think that federal legalization is necessary for the industry to turn a corner and to provide more growth, we don’t think so. Because, obviously, that will be the ideal situation, right? It’s legalized at the federal level, but we’re seeing more and more states in the U.S. legalizing cannabis for recreational use or medical use. So we do think the upside is definitely there, even without federal legalization.

That being said, we do think that if it’s not legalized at the federal level, we would like to see some improvements for the industry to realize its full potential, right? So we would like to see a streamlining of regulations across the various states. We would like to see an allowance for across the state sales, because ultimately, that would help reduce costs of these companies involved in the cannabis industry, at the same time, that it would make the industry more competitive.

JL: Sure. And without federal legalization, it becomes a harder theme to invest in. Does it not, I mean, you can’t really list publicly at least in the U.S., just because it’s legal in your state if it’s not legal, federally, at least if you’re selling on the recreational level, I believe, probably, even on the medical side.

So you can have the Canopies (CGC) and Auroras (ACB) and Aphrias (APHA) and all the Canadian LPs and other players listing, because it’s federally legal in Canada. So they can list on the New York Stock Exchange or the NASDAQ. But in terms of the true growth potential of the American space, it is somewhat dependent, at least, in terms of playing this via publicly-traded companies. It is somewhat necessary for federal law to change in the U.S., is it not?

LB: Yes. I mean, obviously, we’ve had a doubt. I mean, for the industry to realize its full potential, obviously, federal legalization would make things a lot easier, just fully in terms of access to capital, it would be a significant tailwind for the industry.

But again, like I was saying before, Jonathan, again, the amount of activity that you see at the state level, and if the companies are meeting all of their regulatory requirements at the state level, the companies can continue to function. So we continue to see a lot of upside.

And again, think about a very important – the numbers that I was suggesting before in the context of tax revenue for the government, just in the state of Colorado, if you look at tax revenue, and this is not an estimate, these are real numbers in terms of tax revenue.

In 2019, alone, the Department of Revenue in Colorado generated over $300 million in tax revenue from activities related to cannabis. So, again, that’s a very strong incentive for more and more states over time to legalize cannabis. And basically, at the end of the day that means that there is more investment, there’s a bigger market.

And if you look at many of the different themes that we follow at Global X, cannabis is still one of the highest when it comes to expected sales growth rates. And that doesn’t even include any potential new states legalizing cannabis, it’s just with the existing number of states that have legalized cannabis.

So again, I completely agree with you that federal legalization would be the ideal situation and the best-case scenario for the industry. But we still see a significant amount of upside, just with more states legalizing cannabis.

JL: Sure. That makes sense. In terms of how you think about cannabis as a product, is it a consumer staple? Ultimately, is your expectation or their research team at Global X’s expectation that more of the growth will ultimately come on the medical side of things or on the recreational side of things?

LB: So good question. So, going back to why I think the industry has a phenomenal amount of potential in the U.S. and, quite frankly, in other potential countries like New Zealand or Mexico are actually looking at the space as well. That is a very interesting data point for the industry, which is the number of venture capital activity that we have seen in the space, because I think one of the things that we also need to see in the cannabis space industry in the U.S. is more professional management and better access to capital. And I always like to use our venture capital activity as a leading indicator of where some of these younger industries are going.

If you look at 2019 alone, there were 307 venture capital deals, involving 277 cannabis-related companies. That’s a pretty big numbers. I mean, in terms of a dollar amount, that was a $2.6 billion investment going into the industry. What that ultimately means is more professional management, more talent, a risk management, better policies and procedures.

So I do think that is, again, a very telling indicator of where the industry might be going. And to answer your question specifically about whether is it a consumer staple, it’s a really good question, and I’ve had this conversation multiple times. And I think the answer is yes, right?

I mean, at the end of the day, a consumer staple is something that consumers will continue to buy, even in a negative economic environment, right? So you can think of food and basic goods like toothpaste, toilet paper and those type of things. But we have seen that same type of behavior extend to other areas like alcohol and cannabis, right? And in the context, for example, of COVID-19…

JL: I would say, alcohol has done quite nicely as a result of COVID-19.

LB: Very well, very well. I can definitely agree with that point. But we have seen, Jonathan, a very similar behavior in the context of COVID-19. So you have many consumers that have dialed back spending due to concerns around unemployment or uncertainty around the economy.

However, when you look at cannabis sales in some states like California, Colorado, Oregon, or Alaska, sales have actually gone up by 50% year-over-year. So to answer your question, I mean, I think that’s – that speaks to like a very consumer staple type of behavior.

And to your last point about where we see – where we expect the growth to come from, where is more medical use or recreational, I think that recreational use is by far the main driver. I think it’s a huge market. And from a regulatory perspective, it still lags behind medical use from an approval rate standpoint. You have states like Colorado, for example, recreational sales are three times higher than the medical.

So while we expect to see growth on both fronts, I think recreational is the biggest market and therefore, should be the biggest driver of growth for the industry. I mean, things could change, to be honest with you, because there could be like a major breakthrough. I know there are some biotechnology companies looking at the space like if there were any material change in the medical use of cannabis, that could change. But as of right now, with information that we have, we do think that recreational use would be the main driver.

JL: Sure, that makes sense. So I’d love to look just five or 10 years out and try to get an understanding of how many of the big names have today, the Canopies and the Auroras and the Aphrias and the OrganiGrams (OGI). And what you think the situation with those companies will be? So we’ve discussed other thematic funds. And in those cases, you’ve spoken about how the – these are winner-take-all or winner-take-most types of industries and we just haven’t seen that happen in the cannabis space.

And so I’m wondering how many of these names that are considered big household names at least to people that are in the know in this space. Today, we’ll still be standing, let’s say, five or 10 years out from now. And then I think this could be a great argument for needing to buy an ETF in this space as opposed to taking on single stock risk, because there really are no blue chip companies, I think, today?

LB: I think the main point here is that, we do expect, like the early movers and larger companies in the space to stick around in the long run, just because they’ve built already somewhat the skill that is much needed in the context of this industry and they already have more access to capital than the new entrants in the space.

But the reality, Jonathan, is that it’s really very hard to tell, right? Because we are in the very earliest stages of the cannabis industry. And like with any other young theme, ultimately, it is very difficult to know who the winners and losers will be, in my opinion, and obviously, I’m biased to some degree. But that’s why I think gaining access to the cannabis theme through an ETF makes a lot of sense, right? Because you cannot eliminate or at least mitigate that single stock risk over time, right?

Our view – and that’s true for pretty much all of our thematic investing ideas. But I think even more so for the cannabis industry, specifically because of some of the nuances around their regulatory risk. Our view is that the real value creation for our investors over time is going to come up more from having broad exposure to the theme, rather than from picking the right stock, which is always very difficult to do in any industry, but even more so in the context of cannabis.

Another argument of why I think gaining exposure to the theme through an ETF makes a lot of sense is that, it is important to recognize that this industry has multiple angles to it, right?. So you have distribution, you have production, you have retail, legal compliance, specialty finance.

So there are many companies that we expect will emerge over the coming years that will naturally become eligible for inclusion in the ETF structure. So I think that incremental diversification when getting access to the cannabis theme is particularly, particularly important.

JL: Yes, sure. That makes a lot of sense.

In terms of the composition of Global X Cannabis ETF, ticker symbol, POTX, I just want to give listeners a little bit of an understanding of how the fund is constructed underlying index is put together.

So just taking a look at the holdings, this is clearly not a cap-weighted ETF. Aurora is your top holding right now that stock has obviously gone through a lot of pain, the whole space has. But I think, Aurora, in particular, has gone through a lot of pain over the last year or two.

And so if you could talk a bit about the underlying indexing methodology here, and how that shakes out in terms of the breakdown of the holdings in terms of how many of them are in different parts of the space so recreational versus medical versus other usages, maybe people that are landholders or that are selling farming equipment to grow this stuff. And I think that’d be very instructive for listeners?

LB: Great. So in terms of like the actual the Global X Cannabis ETF products, it invest broadly in all companies that are involved in the cannabis industry value chain. So more specifically, and this includes companies involved in the legal, production, growth and distribution of cannabis, companies involved on providing financial services to the cannabis industry, and also companies involved in the development of pharmaceutical applications of cannabis.

So let’s talk a little bit in terms of how the exposure works. Now in terms of how the portfolio is constructed, this is actually, Jonathan, also like a modified market cap-weighted approach. And we do have a cap also by individual holding at 8%.

I think the main difference here and that’s why you probably may have seen a holding that goes beyond that typical 8% limit is that is free float, which basically what that means is that in-between rebalances if a stock goes up in price in-between rebalances, that particular holding can go beyond that 8%, but at the next rebalance period would fall back in line to 8%.

So similar to where we do for all of our other thematic products, we use this modified market cap-weighted approach, which again, I think is the best and most effective way to provide exposure to the theme, because again, you are trying to capture the dynamics of the industry. But ultimately, only most – more of those companies that are winning in the space and owning less of the companies that are not doing as well. In terms of the more details about how the product was constructed…

JL: Interesting. So, for example, the reason that Aurora would be the top holding that is, because even though it’s obviously done poorly, it’s doubled in price over the last few months. So that would explain why it’s the top holding there?

LB: You’re right. [ph] And then the next rebalance period, it will be brought back in line by our portfolio management team to the cap of – I believe, that cap is 8% in this given product. So, again, this modified market cap-weighted approach is something that we applied very consistently to our thematic products.

More specifically, I think, in the context of cannabis, portfolio construction is particularly important. And we literally, and hopefully, you will appreciate this. We spent nearly three years looking at the space, Jonathan, because obviously, launching a cannabis ETF is not like launching any other ETF out there because of some of the sensitivities around the exposure and also because of some of the legal and compliance complexities…

JL: Sure.

LB: … that have to do with the product itself. However, quite frankly, we saw an opportunity to bring a product of institutional quality to the market. And some of our clients were actually asking us to move forward, because they definitely like our approach to thematic investing and they definitely trust our risk management approach to building a product.

So with all of our feedback, we saw the opportunity. Our clients were asking for the exposure, so we decided to move forward. And it literally took 18 months from the day that we decided to move forward until we actually were able to bring them the product to market. And you were saying before, it’s a crowded space, right?

So in 2019, we saw multiple ETFs coming to market. But we do think – I’m particularly proud of what the team was able to do with this product, because I think our value proposition is very clear, right? So it’s a product that is constructive, very, very well. So it’s what we refer to as institutional quality, which I think is particularly important in the context of the cannabis space for two main reasons.

One, because the underlying companies tend to be much more volatile than in other industries. And because going back to the pure play exposure, there are really not that many companies that generate a significant amount of their revenues through the cannabis space.

So because of those two reasons, we had to do a lot more work than what we typically do in other ETFs to figure out what was the right market-cap approach, liquidity filters, and other things, our portfolio management and product development team work together on.

Then the other component that I think makes us very, very unique is, again, the legal and compliance framework that we came up with just to make sure that every single company that mix it into their fund is in compliance with all of the relevant rules and regulations. And, Jonathan, I have had more conversations with lawyers. So you can imagine. I bought [ph] this a specific product.

I didn’t know that there was an area of law, which was just cannabis and there are people that are experts in this space. And I do think it’s a very growing segment of the market as well. And the whole idea is that we engage with an outside law firm, where we literally are constantly looking at the regulatory framework in all of these regions in which these companies operate to make sure that companies that are part of the fund are in compliance with all the relevant regulations.

And then finally, low costs, we came to market at 50 basis points, which we think makes the product very, very competitive. And again, I’m a 100% buyer, so take whatever I tell you with a grain of salt. But I do – I’m particularly proud of what the team was able to come up with this product, because it was a lot of work. And again, I don’t think there is any other product out there as robust across all of these different dimensions as our products ETF.

JL: Sure. And you are the indexer on the product, are you not?

LB: No. No, no, no, we are not the index provider. We don’t use self-indexing.

JL: Oh, okay fine. I know I was just looking at the webpage for the fund, which will give people a heads up on its And I did not – I just saw the fund objective that it follows the cannabis index. So unlike with your other funds, where you’ve listed Solactive or an INDXX or MSCI, CBOE, NASDAQ, S&P whatever, I didn’t see that index – indexer’s name on the description there.

LB: So third-party index, I think we actually use Solactive. I don’t know if the name actually shows up on the website or not. But we don’t use self-indexing for any one of our blogs. Our view there, to be honest, Jonathan, is that we are very well – very good at building products and index providers are very well-positioned to do all of the data management that comes to maintaining an index. And we work with pretty much all key or major service providers.

We work for – with Solactive, INDXX, MSCI and S&P. At the end of the day what we try to do is, we look at the strengths and weaknesses of the different index providers. And we identify who the right partner is for us to be able to bring the desired exposure to our clients.

And specifically for thematic products which people you work with, with Solactive and INDXX, because again, these are great, great index providers when it comes to develop customized indices that we develop for – from the ground up and cannabis is specifically because of all the reasons that I just shared with you that our ability to customize the exposure was particularly important and we decided to work with Solactive for this product.

JL: Interesting. Yes. They are definitely very reputable in the thematic space. Specifically and, of course, not that this is necessarily the case when firms self-index, but it definitely resolves any theoretical questions of conflict of interest there. So that definitely, I think, reassuring to listeners and potential investors in the fund as well.

Anyway, Luis, I want to thank you for being so generous with your time today. This has been incredibly fascinating and illuminating lots for listeners to go back and research further. Where is the best place for listeners to go and research everything we’ve been discussing here today online?

LB: I think the best place to go is our website. So that’s And there you can find information about our funds, our research, our ETF model portfolios, so I think that’s definitely the best place to go.

JL: Sure. And you have some great pieces of research on there also. So you have a great piece in the cannabis space, particularly about How the Cannabis Industry is Coping in 2020, and you have many other great pieces of thematic research there also. So certainly, it’s something worth checking out also. And then what about social media?

LB: I think we are very active in pretty much all platforms, LinkedIn, Facebook and everything else, but particularly active in Twitter. So you can follow the company @globalxETFs. And you can also follow me directly @LuisBerruga. That’s L-U-I-S-B-E-R-R-U-G-A.

JL: Excellent. I’m following you as we speak. I already was following Global X. But no, I’m following you. I started following you last week, I think, so.

LB: I will follow you back.

JL: Thanks. And we will tweet out this podcast, of course, and publish an accompanying article on Seeking Alpha, and you can always do further research on these particular funds on Seeking Alpha Quote Pages also. Anyway, I want to thank you again, Luis. You definitely have to rejoin the show.

LB: Absolutely. It’ll be my pleasure to join. I really enjoyed the conversation with you. And, to be honest, we have a lot of new ideas coming to market. So I think we’ll definitely be ready to have another conversation hopefully in just a few months.

JL: Definitely. That sounds great. Thank you.

LB: Thank you.

JL: For disclosures, Luis Berruga is long POTX. Jonathan Liss is long Canopy Growth Corporation. Ticker symbol, CGC.

Disclosure: I am/we are long POTX, CGC. 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.

Additional disclosure: Luis Berruga is long POTX.

Jonathan Liss is long CGC.

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