The company behind the popular Horizons Marijuana Life Sciences Index ETF (NASDAQOTH:HMLSF) wants to launch another marijuana-focused ETF that will seek to track junior (micro-cap) marijuana grower stocks on North American exchanges.

The new fund will be named Horizons Junior Marijuana Growers Index ETF and trade under the proposed ticker symbol HMJR in Canada, and may also trade over the counter in the United States, just as its sister fund does. Here’s what investors should know about this planned fund, based on information gleaned from its preliminary filings.

1. It will focus on really small marijuana growers
The key differentiating factor of this ETF is its focus on marijuana growers, rather than companies that generate revenue from marijuana derivatives, like the market’s many marijuana-based pharmaceutical companies and biotech start-ups.

Companies that grow marijuana for medical or recreational purposes will be included.

Officially, the fund will seek to track the Solactive Junior Marijuana Growers Index, which will include companies that are involved in the cultivation, production, and/or distribution of marijuana and have market caps ranging from $50 million up to $500 million at the time of inclusion.

Up to 20% of the fund’s assets may be invested in companies outside North America.

In contrast, the existing Horizons Marijuana Life Sciences Index ETF is focused on substantially larger issuers.

It tracks an index which includes companies that generally have a market capitalization of at least $250 million at the time of inclusion, while focusing primarily on marijuana-related biotech companies.

2. Management fees will be higher than other marijuana ETFs
As a general rule, sector ETFs are more expensive than broad-based index funds. The proposed ETF will carry an annual management fee equal to 0.85% of its assets, 0.10 percentage points higher than the fee on the Horizons Marijuana Life Sciences Index ETF.

It’s costly, to be sure, but given that marijuana ETFs are seemingly used more frequently as trading vehicles rather than long-term, buy-and-hold investments, the management fee probably won’t be a deal breaker for people who want quick-and-dirty exposure to companies that make their money growing marijuana.

3. What stocks this ETF might own
At this point, we only have preliminary filings for the Horizons Junior Marijuana Growers Index ETF. Furthermore, information on its underlying index isn’t yet available for public consumption. That means we can’t know for certain which stocks will be included in the ETF.

That said, I can speculate on what stocks this ETF might hold at launch, based on listed marijuana companies’ generic business models (does it grow pot as a key business line?) and its reported market capitalization. Five likely suspects are included in the table below, which is by no means exhaustive.

Let me repeat what I just wrote: I’m only speculating that these companies might go into the ETF, based on the available market cap data for each company and its purported business model. (To be frank, determining a marijuana stock’s market capitalization is difficult enough, given how often they’re issuing new shares and converting preferred stock into common stock, thus inflating their market caps.)

It’s likely that the ETF will seek to hold 20 or more companies, given that diversification is a necessary thing for any sector ETF. Since the junior marijuana ETF will be market-cap weighted, you can be sure that the largest companies by market value will make up the greatest percentage of the fund, up to 8% of assets at rebalancing, according to its preliminary prospectus.

Most marijuana companies (large and small) are losing money hand over fist, financing themselves with stock and debt issuance to stay solvent. You shouldn’t expect that the cohort of companies that will make up the Horizons Junior Marijuana Growers Index ETF to be any different. If anything, smaller companies are more likely to be losing money and have less access to financing than larger companies. This a very high-risk marijuana ETF.

4. More fuel for the pot stock bubble
The Horizons Junior Marijuana Growers Index ETF could get really messy, as investing in companies worth as little as $50 million could make it a driving force that inflates valuations in thinly traded, micro-cap marijuana growers should it prove popular with investors.

Already, I’ve observed that ETFs that focus on larger issuers, such as the ETFMG Alternative Harvest ETF (NYSEMKT:MJX) in the United States, are driving a large portion of daily trading volume in their underlying holdings. At one point, I calculated that over a seven-day period, roughly 40% of the volume in Turning Point Brands could be attributed to the ramp in assets in ETFMG’s marijuana ETF.

Even stocks that are traded more frequently aren’t immune to buying and selling caused by marijuana sector ETFs. The ETFMG Alternative Harvest ETF has made up as much as 5.1% of the trading volume for marijuana biotech company Cara Therapeutics, based on my analysis of trading volume since the ETF switched its focus to pot stocks.

Remember, when ETFs grow quickly, they often do so with indiscriminate, mostly price-insensitive buying of the stocks that make up the ETF. Since the proposed Horizons Junior Marijuana Growers Index ETF will invest in issuers worth as little as $50 million, it’s likely that as cash flows in and out of the ETF, it’ll drive share prices of companies in its index higher or lower.

With this in mind, know that this fund could ultimately inflate marijuana stock prices as interest in the sector soars, and pop bubbles when speculative interest wanes, only adding to the risk of investing in this already very risky junior marijuana stock ETF.

— Jordan Wathen

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Source: The Motley Fool