There’s no doubt Canadian investors are getting excited about the marijuana sector – it’s new, it’s rapidly changing, and the growth prospects are encouraging.

In Canada alone, as many as 500,000 people are expected to use marijuana or cannabis-based products for medical purposes by 2021, representing demand for some 150,000 kg. And while many companies active in the sector got their start catering to the medicinal market, the forthcoming legalization of recreational marijuana has cemented Canada’s place in the world as the center of marijuana investment.

Marijuana is different than other new and emerging sectors of the economy because we know significant demand already exists for marijuana and marijuana-related products. Deloitte estimates the Canadian recreational market is valued at over $5 billion but could double or even quadruple in the next few years. For every dollar spent on medical cannabis products, there could be as much as $10 spent on recreational products. Large companies like Constellation Brands, best known for their portfolio of beer, wine and spirit brands, are making strategic investments that bet on the sector being the next big thing.

The biggest uncertainty for players in the sector is how smoothly the recreational market will transition from the dark shadows of the black market to the bright lights of Bay Street. The market expects recreational sales in Canada to begin in mid-to-late 2018, following the passage of Bill C-45 at the federal level and the establishment of a retail market at the provincial level. With each province is taking their own distinct regulatory framework, some may start retail sales while others are still working on the details. Other countries contemplating a similar move are watching and will learn from our experience.  Will the legal market be able to meet demand? Will the black market drive down prices, impacting growth in the legal market?

We believe some companies will be able to step up, adapt to changing circumstances, and meet the demands of the marketplace – but others may not be able to stay relevant, especially when considering Canada is not the only market where demand is expected to boom. More than a dozen other countries are moving forward in terms of legalizing either medical or recreational use. Even in the United States, where marijuana remains illegal under federal law, nine states and the District of Columbia have now approved legislation permitting the recreational use of marijuana, while 29 states, DC, Puerto Rico and Guam allow for the use of medical marijuana.

We are close to a tipping point where there are enough viable companies, enough diverse global markets, and enough investor interest to create a lasting spotlight on the sector. But as an investor looking to enter the sector, how do you make a smart bet? How do you know which companies will be sustainable over the long term? How do you adapt to rapidly changing regulatory conditions?

When we set out to create the Evolve Marijuana ETF, we asked ourselves the same questions. It quickly became clear this is a sector where active management can make a difference. To make this product truly effective, our investment team utilizes discretionary authority on a day-to-day basis to make changes.  The old buy-and-hold approach to investing simply doesn’t hold a lot of value in a new, emerging, and unproven sector.

How are we going to maximize the flexibility offered by active management? For starters, unlike passive funds, we can participate in private offerings or initial public offerings, getting in on day one. With consolidation afoot in the sector and more expected to come, we can adjust our holdings immediately in response to industry mergers and acquisitions. We can look closely at the fundamentals of companies, including their liquidity, and then hold companies anywhere from $25 million to $5 billion+ in value.

We see growth potential in both the medicinal and recreational markets. While most attention these days tends to be focused on the recreational side, there are many innovative approaches to medicinal marijuana that may fly under the radar of investors. This includes companies developing alternative forms of standardized delivery for medicinal purposes, which can be anything from cannabis oils to pills and capsules. The regulatory framework for medicinal products, in many countries, is well established and less volatile than on the recreational side, making for a more stable investment.

There is also the ability to invest globally – given the current regulatory climate, most US companies are presently off limits for our fund – but other markets have upside potential as well. We are currently investing in some Australian companies, and as other countries begin to participate in the marijuana market, we will consider those investments provided they meet our criteria – we have a global mandate. As active managers, we will make sure that we understand where these companies fit in their respective markets, and the ability of their management teams to deliver on the promises to investors.

It’s yet to be seen whether the sector lives up to its full potential, but the results in other states and countries have been encouraging. The State of Colorado was one of the first jurisdictions in the world to legalize the sale and use of recreational marijuana, and despite uncertainty caused by the federal ban, the industry collected $1 billion in revenue from the recreational market in 2016 alone. In 2017, revenues grew to $1.5 billion – providing $240 million in tax revenue for the state. Can this success be replicated in Canada – only the second country to legalize recreational marijuana after Uruguay – and elsewhere in the world? Only time will tell.