Cannabis ETFs in 2025: Custodians vs. Broker-Dealers and What Investors Should Know

Andy Smith, a Certified Financial Planner (CFP®), licensed realtor, and educator, brings over 35 years of expertise in personal finance, corporate finance, and real estate, guiding thousands toward financial success.

The legalization of marijuana is unlocking vast business opportunities. As of February 2024, recreational cannabis is legal in 24 states, Washington, D.C., and three territories, with an additional 16 states permitting medical cannabis use. This evolving landscape has prompted the launch of several exchange-traded funds (ETFs) focused on the cannabis sector.

Cannabis ETFs offer investors access to companies directly and indirectly involved in marijuana cultivation, as well as those providing software, technology, and ancillary services supporting the industry. Top-performing cannabis ETFs have the potential to deliver significant returns.

However, due to the complex legal environment surrounding cannabis, ETF issuers face unique challenges—most notably concerning custody. Unlike traditional ETFs that rely on custodians to safeguard assets, cannabis ETFs often must work with broker-dealers because marijuana remains federally illegal in the U.S.

Understanding the distinction between custodians and broker-dealers is essential for investors interested in cannabis ETFs. Let's dive deeper into these roles and their implications.

Key Insights

• Custodians are major financial institutions responsible for securely holding clients’ securities.
• Broker-dealers facilitate buying, selling, and holding securities on behalf of clients.
• Traditional ETFs typically utilize custodians, but cannabis ETFs may depend on broker-dealers due to federal restrictions.
• Some cannabis ETFs partner with bank custodians but must disclose detailed investment information upfront.

Custodians vs. Broker-Dealers: What Sets Them Apart?

Custodians are large, regulated financial institutions that hold securities for clients, ensuring asset protection whether in physical or electronic form. They often provide additional services such as tax reporting, account administration, transaction settlement, and interest payments.

Broker-dealers vary widely in size, from small independents to subsidiaries of major investment banks. They actively buy and sell securities for clients and can also hold securities similarly to custodians. Importantly, broker-dealers operate outside the scope of federal banking laws.

Traditional ETFs depend on custodians to manage payments and securely hold portfolio assets. However, cannabis ETFs face custody complications because many prominent banks hesitate to handle funds linked to cannabis due to its federal illegality.

While recreational cannabis is legal in many states, the patchwork of state laws and ongoing federal prohibition create uncertainty. Banks risk federal legal repercussions when servicing cannabis-related companies, complicating the custodian role.

Even if cannabis companies operate in fully legalized states, banks must comply with federal regulations and oversight by agencies like the Department of Justice. Consequently, a bank custodian for a marijuana ETF could face legal challenges arising from cannabis’s status as a controlled substance.

Investor Advisory

Investors considering marijuana industry exposure should carefully evaluate their capital allocation, investment horizon, goals, and risk tolerance—just as they would with any other sector.

Implications for Cannabis ETFs

ETF issuers must navigate custody issues carefully, as some banks remain reluctant to hold cannabis-related securities. However, evolving laws are gradually encouraging more banks to accept the associated risks.

For example, the U.S.-based ETFMG Alternative Harvest ETF (MJ), managing $241 million as of February 2024, experienced a custody shift in 2018 when U.S. Bank ended its custodial relationship without explanation. The fund temporarily transferred assets to broker-dealer Wedbush Securities before resuming its partnership with U.S. Bank.

Some cannabis ETFs mitigate legal risks by investing in companies involved in medical cannabis research or financing rather than recreational marijuana production, focusing on entities compliant with federal law.

Potential Additional Costs

While custody arrangements may seem technical, investors should be aware that cannabis ETFs might incur higher costs. The Securities and Exchange Commission (SEC) mandates annual audits for custodians of ETFs, which can increase expenses if broker-dealers—who are not always subject to these audits—are involved.

Top Cannabis ETFs in 2024

The largest cannabis ETF available to U.S. investors is the AdvisorShares Pure US Cannabis ETF (MSOS), managing $961 million with holdings in 24 companies as of February 2024.

Highest-Performing Marijuana ETFs

The Roundhill Cannabis ETF leads with a 53% one-year return as of February 2024, followed closely by AdvisorShares Pure US Cannabis ETF at 44%.

Best Performing Cannabis ETF of 2024

The AdvisorShares MSOS 2x Daily ETF (MSOX) has delivered the highest returns in 2024, gaining 69% year-to-date as of February. This leveraged ETF aims to provide twice the daily returns of MSOS but carries increased volatility and expenses.

Final Thoughts

The cannabis industry is evolving rapidly at the state level, yet federal restrictions persist. Investors should approach cannabis ETFs with caution, mindful of potential additional fees and legal complexities. Thorough research and understanding of the custody landscape are vital before investing.

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