ESG investors face recreational cannabis conundrum

More than 180 public companies are already exposed to cannabis

ESG investors face a conundrum when it comes to investing in the nascent legalised cannabis industry due to a limited pool of companies focused solely on medicinal cannabis.

The number of countries decriminalising the drug for both medical and recreational purposes has been growing, but with a large majority of ESG funds screening out tobacco, it bears the question of where it stands on an ethical stance.

In 2018, Canada became the first G7 country to allow recreational use of the drug and last year the UK government also approved the use of medical cannabis.

Currently, cannabis is listed as a Class B in the UK which could see anyone caught with it potentially facing up to five years in prison. But, earlier this week, a group of cross-party MPs backed the legalisation of it and said they predict cannabis will be fully legalised within five to 10 years after a fact-finding trip to Canada.

According to a report by Sustainalytics, 181 public companies with a collective market cap of $41bn are already involved in the global cannabis industry. Only 16% of these target the recreational market.

The main index, which launched in 2015, comprises 46 constituent stocks, 25 US and 21 Canadian, with stocks required to have a business strategy ‘focused on the legal marijuana industry’. Major stock constituents include Canopy Growth Corp, Aurora Cannabis Inc, Cronos Group Inc, and Aphria Inc.

Recreational versus medicinal

The two potential uses of cannabis – medicinal and recreational – creates a conundrum for investors.

According to the NHS website, with regard to the former, cannabis can be used to relieve the pain of muscle spasms in multiple sclerosis and is sometimes used to relieve sickness in people having chemotherapy for cancer.

Edentree head of responsible investing policy Neville White points out medicinal use could fit within its health and wellbeing theme, which invests in companies improving mental and physical health.

White says Edentree is “alive” to opportunities in this space, as long as it was tightly regulated and controlled. In contrast, he would not allocate client capital to firms heavily exposed to recreational cannabis on the basis the drug can lead to addiction or psychotic conditions.

Investing solely in medicinal cannabis is not straightforward, though.

White says: “Medicinal and therapeutic cannabis is unlikely, in our view, to be sufficiently revenue-accretive as a sole strategy, suggesting companies may seek to develop dual strategies to diversify revenue to assure growth. Investment on these terms would be problematic from an ethical point of view, where recreational cannabis derived revenues could outstrip medical. Our approach to this emerging issue is therefore cautious, with a predilection not to invest.”

Wider ESG issues

The ESG concerns could potentially represent speed bumps to an industry Morningstar predicts will grow nine times by 2030.

Schroders noted in a recent sustainability report the high environmental costs of sourcing and manufacturing cannabis as its production relies on intensive farming practices with a high energy and emissions footprint, and involves significant discharges to water, air and land, and the use of toxic pesticides and associated chemicals.

It also said many were overlooking the regulatory effects on the industry due to public health and safety concerns, pointing to growing research outlining adverse acute and chronic health impacts – particularly related to mental health disorders like psychosis and substance dependence.

Few ESG investors have a policy on cannabis despite the increasing number of jurisdictions decriminalising the drug, says KBI Global Investors head of responsible investing Eoin Fahy. This is because decriminalisation of the drug is still relatively new and geographically limited so far, he adds.

“It’s difficult to know for sure whether, in time, as many investors will exclude investments in cannabis as currently exclude investments in tobacco, but on balance this seems reasonably likely to us.”

Investors may still end up with exposure

Investors who introduce negative screens to exclude cannabis may still have exposure.

Fahy says the exclusions for tobacco typically relate to manufacture, but investors may still have exposure via retailers or other types of businesses. “So even if decriminalisation of cannabis leads to well-known retailers or pharmacy chains selling it, that should not be expected to lead to those companies being excluded for many investors’ portfolios.”

Many investors will also take a more sophisticated approach than a simple black and white screen, he adds.

“This type of investor will, when considering an investment in a company involved with cannabis, consider a range of issues such as the carbon footprint of that company, whether it has a good standard of corporate governance, how it treats its workers, whether it has a good or bad track record on issues like pollution and health and safety violations, as well of course its involvement with cannabis and the impact in terms of public health and product safety that arises from that.”

Fahy says it’s early days to be sure what approach these investors will take.

“It seems likely to us that this class of investors will regard involvement with the manufacturing/growing of cannabis to be a negative factor, offset in part by the positive medicinal benefits,” he adds.