The ETFMG Alternative Harvest ETF (NYSEArca: MJ) and its Canadian counterpart, the Horizons Marijuana Life Sciences Index ETF (HMMJ), are two of this year’s best-performing non-leveraged exchange traded funds.

Both ETFs recently topped the $1 billion in assets under management and in the case of MJ, the dominant name among US-listed ETFs with cannabis exposure, that fund is up nearly 46% this year. While investors in the two cannabis ETFs are making money as the funds surge, the issuers of these funds have another revenue stream: lending underlying components in the funds out to eager short sellers.

“The two largest pot ETFs in North America — the Horizons Marijuana Life Sciences Index ETF and the ETFMG Alternative Harvest ETF — have made millions of dollars lending out their holdings to traders who want to bet against this year’s 60 percent climb in the red-hot market for cannabis stocks,” reports Bloomberg. “Both funds returned more than 45 percent in the first quarter, beating almost all non-leveraged ETFs in North America, data compiled by Bloomberg show.”

MJ seeks to provide investment results that correspond generally to the total return performance of the Prime Alternative Harvest Index. The index is concentrated in the pharmaceuticals and tobacco industries and tracks the performance of the exchange-listed common stock of companies across the globe.

Nothing New

Securities lending has long been a revenue stream for the ETF industry. Securities lending is a practice where mutual funds and ETFs pay agents to lend out shares in their portfolios – the funds are created with exposure to an underlying basket of securities – to other traders and thereby earn interest.

ETF providers would typically lend securities to investors who want to short a stock. The investors would have to borrow shares from the provider and sell them on the market, hoping that when it comes time to give the shares back, they would be able to repurchase shares at a lower price in the market and pocket the spread.

“While many ETFs engage in securities lending, it’s been a particularly lucrative practice for pot funds as many cannabis stocks have a small public float and aren’t readily available to borrow,” according to Bloomberg. “Pot securities cost about 15 percent to borrow versus typical rates closer to 1 percent for more prosaic shares, according Bloomberg Intelligence analysis. But borrow fees can rise to as high as 110 percent for popular short targets like Tilray Inc.”

For the ETF provider, securities lending can generate extra returns, which issuers argue can help reduce management fees and even enhance an ETF’s overall performance.

“Canadian ETFs can lend out as much as 50 percent of their holdings, while U.S. funds are capped at 33 percent, according to Bloomberg Intelligence.”

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