THE Tel Aviv Stock Exchange, the body entrusted with compiling the stock indices, announced last week that as of August 4 the TA Cannabis Index, made up of Israel’s largest cannabis stocks, will cease to exist.
The index, which was announced in December 2020, is considered to be the worst performing index in recent times recording a total decrease of about 68% since its official launch.
Some news outlets reported that the reason behind its cancellation was the sharp drop in the value of cannabis shares on the stock exchange. While this is undoubtedly a significant factor, it may not be the only reason.
There are many in the capital market who believe that the reason is a ‘strange’ calculation that the stock exchange decided to implement in the index, according to which every cannabis company in the index, no matter how big it is, cannot exceed a ceiling of 15% of the total weight of the index.
How was the Tel Aviv Cannabis Index Calculated?
According to the stock exchange’s formula, even when a stock rises and its weight in the index increases, the figure returns to 15% on the determining date. According to the stock exchange “this is in order to limit the influence of a single stock on the index.”
If in practice, after calculating the weight of the stock according to the real data, if its weight exceeds the ceiling an appropriate calculation will be made to lower the weight to the 15% ceiling.
“The mechanism that adjusts (reduces) the weight of the stock from the ‘original’ weight to the weight at the height of the ceiling – is the factor that is used to calculate the actual weight of the stock in the index,” a Tel Aviv Stock Exchange spokesperson told The Israeli Cannabis Magazine.
From the moment the data of the companies’ shares are “reset” to 15% on the determining date, the data presented will be affected by the activity of the stock from that moment.
For example, if stock X, which is the smallest in the sector, increased by 1%, it will be displayed as 16%, while stock Y, which is worth twice as much and decreased by 1%, will be displayed as 14%.
As a more concrete example, Intercure appears as having a weight of about 15.9% in the index, a significantly smaller weight than the weight of the companies Shih (17.22% of the index) and Tikun Olam (16.26% of the index) – even though Intercure is significantly larger than the latter companies in all financial parameters.
As a result, Cannabis Index investors without an in-depth knowledge of the sector were more exposed to loss-making and small companies and less exposed to the leading companies, contrary to what the Stock Exchange is supposed to do.
How will Cancelling the Tel Aviv Cannabis Index Affect Cannabis Stocks?
Regardless, the impact of the index’s cancellation on cannabis stock prices is expected to be minimal.
Unlike other indices, no ‘mimetic fund’ was established on the Cannabis Index. Mimetic funds, like with the Tel Aviv 124 Index, purchase shares in the index according to the weight of each share.
Private investors and large entities can thus invest in the imitation fund and thus be exposed to companies in the same index of the stock exchange.
If an imitation fund existed for the Cannabis Index, its cancellation would have had a much wider impact, seeing all the holdings in cannabis shares sold and money returned to investors, thus driving down the price of those stocks.
It is understood that initial concerns regarding the way in which the Cannabis Index was weighted was the reason no imitation fund was created.
The Cannabis Bubble Burst
Despite the above, there is little double the bursting of the cannabis bubble and subsequent drop in stock prices was a significant factor in the stock exchange’s decision to cancel the TA Cannabis Index.
Cannabis shares at the height of the bubble, mainly in 2019-2020, were worth hundreds of millions of Israeli shekels (₪). In recent weeks, these values have dropped as low as around ₪13-14m.
Such a low value often results in pressure from investors on the board of directors to put an end to the failed activity and replace it with activity in another, more profitable field.
For example, the value of a ‘stock market skeleton’ with no activity at all can reach up to ₪20m today, so there is little reason for investors to want a company to continue operating at a loss when they can enjoy the sale of the skeleton for another activity.