Investment Thesis
With Treasuries mostly yielding less than 1% and the S&P 500 yielding less than 2%, dividend income seekers are going to have to venture outside of more conservative asset classes to find higher yields.
That means assets such as MLPs, REITs and junk bonds. But one sector you'd probably never consider as a yield play has actually been yielding 6-7% over the past year - marijuana.
While the sector can be expected to remain volatile over the coming years, the yield does have some sustainability and could remain well above average, but you have to be comfortable with some risk.
Overview
The FOMC just announced that it plans on keeping interest rates at near record low levels until at least 2023. If you're an equity investor, that's probably good news as it clears the way for easy money, cheap borrowing and higher stock valuations for the foreseeable future.
If you're an income seeker, not so much.
Unless the Fed somehow creates the hyperinflation scenario it hasn't been able to since the early 1990s, get used to 0% savings rates, CD rates of less than 1% and only ~3% yields on even the longest-term investment-grade corporate bonds.
Investors looking for higher yields should be prepared to dive into riskier securities, including high yield bonds, REITs, MLPs, closed-end funds and other unconventional asset classes, to find the yields they won't be able to in the fixed income universe.
But if you're willing to venture pretty far outside the box and go with an unconventional yield pick, check out pot stocks.
The Marijuana Sector As A Yield Play
It's understandable if you wouldn't think of the marijuana sector as a high yield opportunity. After all, these are the dividend yields of the top 7 holdings from the ETFMG Alternative Harvest ETF (MJ), otherwise known as the marijuana ETF.
Not a single dividend to be found among them. This isn't surprising coming from an industry that's still in its infancy and focused on rapid growth instead of income. With marijuana legalization and sales expected to grow quickly, companies are directing every available dollar into growing the business, not paying shareholders.
The ETF, MJ, however, is a different story from its underlying components. Take a look at the trailing 12-month dividend yield on the fund.
The yield was fairly modest in its early days following the fund's late 2017 conversion from a Latin America real estate fund. But it's been steadily growing for more than a year and now sits north of 7%.
So what is going on here? Why does MJ yield 7% when more than half of the portfolio's underlying components yield nothing?
The fund's high yield comes not from the companies it invests in, but the securities lending process the fund's managers take advantage of. They're lending out the fund's shares to short sellers and pocketing the interest charged.
Securities Lending Boosts Income
While the marijuana sector has some of the highest growth potential in the economy, it's also incredibly overvalued. Buyers bid up the prices of the industry's biggest players, including Tilray (TLRY), Aurora Cannabis (ACB), Cronos (CRON) and Canopy Growth (CGC), to ridiculous levels. Even optimistic growth projections haven't been able to justify current prices, despite severe pullbacks.
That's made the sector an ideal short candidate. Granted, they're not quite as shorted as many of the flailing retail names or companies, such as Virgin Galactic (SPCE) and Tanger Factory Outlets (SKT), but there's enough short demand there to make their shares a target.
And that makes MJ compelling. With more than $500 million in assets, MJ has plenty of shares outstanding and short sellers can use MJ shares to short the entire sector. The fund's managers have taken advantage of this and used short selling as a means of generating a significant income stream for the fund.
Producing A 6-7% Yield
While the fund is no longer producing an 8% yield as it has on a trailing 12-month basis, the forward looking yield is still an impressive 6%.
And, while there is some disconnect between measurement periods and methodologies for calculating percentages, we can conclusively say that nearly all of the fund's income that is being generated is coming from securities lending.
One of the benefits of using securities lending to generate income is that it can be a fairly sustainable process. As long as individual stocks or even entire sectors are in demand by short sellers, there will be a market for owners willing to lend out their shares.
Securities lending is something that many ETFs engage in, although with much less yield generated. Even the biggest funds, such as the SPDR S&P 500 ETF (SPY) generate minor amounts of income from securities lending. MJ is an exception in that it produces such a high lending yield, but it's reasonable to believe that this number can be maintained as long as marijuana remains a "buzz worthy" industry.
Other Considerations
Outside of the potential for the yield to decrease if short interest begins to wane, the tax treatment of any income received could be less advantageous. Traditional dividends potentially qualify for a more tax-advantaged rate. Since securities lending income isn't a traditional company-issued dividend, it may end up being taxed at a higher rate.
Conclusion
It may not be dividend income in the traditional sense, but it is a high yield nonetheless. The Marijuana ETF is a bit of an unusual entrant in the high income space, but it does have the characteristics of a sustainable 6% yield in the current economic environment. As it stands, the marijuana sector is one of the more popular areas for shorting. If the fund's managers can take advantage of that in order to reward shareholders with an unusually high yield, that's a win.
Of course, the market for short selling can change over time and the yield will probably come with an above average degree of volatility, but I like MJ as a satellite holding in a broader income-generating portfolio. I certainly wouldn't make this fund a cornerstone within it, but adding a modest allocation to boost yield via an asset class that's likely lowly correlated to other sectors makes a lot of sense.
