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Get Four
|  | AUGUST 22, 2005
 FUND INVESTOR By Palash Ghosh Know When to HOLDROften lumped in with ETFs, holding company depositary receipts are vastly different investments. They're appealing, but can be riskyThe rising popularity of exchange-traded funds (ETFs) has opened the door to other new investment products offered as alternatives to mutual funds. Among these are holding company depositary receipts (HOLDRs), a proprietary product of Merrill Lynch (ML ). The first HOLDR was launched in 1998. Currently, 17 are listed on the American Stock Exchange, with assets totaling $9.3 billion. In comparison, ETFs number 175 and have over $245 billion in assets. NARROW SLIVER. Both ETFs and HOLDRs share low-cost, low-turnover, tax-efficient characteristics and are often lumped together, but they are vastly different investments. In fact, many fund trackers, including the Investment Company Institute, don't even follow HOLDRs since they aren't issued by registered investment companies. There are key differences: Essentially, a HOLDR is a static basket of stocks selected from a particular industry. Thus it does not track an underlying index, as an ETF does, and represents a rather narrow slice of an industry. Not only are HOLDRs completely unmanaged, their components almost never change. Further, if a company is acquired and then removed from a HOLDR, its stock is not replaced. This can result in even more concentration and added risk. In contrast, indexes that ETFs invest in can change and rebalance with some regularity, and generally contain more components. Such is the case with Barclay's iShares and Vanguard's ETFs, called VIPERs (Vanguard Index Participation Equity Receipts), which collectively track Standard & Poor's and MSCI indexes. RISKY RATIO? Unlike ETFs, Merrill Lynch determines the composition of each HOLDR and the individual stocks' initial weighting. One HOLDR can vary radically from another. For example, stocks in some are initially equally weighted, while other HOLDRs' allocations are based on such parameters as market cap, liquidity, and price-earnings ratio. For example, the $1.42-billion Biotech HOLDRs (BBH ) has more than two-thirds of its assets invested in only two companies, giants Amgen (AMGN ) (27.1%), and Genentech (DNA ) (41.2%). For investors who might have expected broader diversification with a number of biotech issues, this HOLDR poses greater stock-specific risk and courts high volatility. "The majority of HOLDRs were based on some type of cap-weighting at the time of their launch," notes Scott Ebner, associate director of new product development at AMEX. "But others, like the Europe 2001 HOLDRs (EKH ) and the Market 2000 HOLDRs (MKH ), were initially equally weighted. Investors should consult the specific prospectuses for each HOLDR." BIG PLAYERS. The number of holdings in a HOLDR can vary widely. For instance, the tiny $21 million B2B Internet HOLDRs (BHH ) comprises only six stocks because of rapid consolidation in that industry. CheckFree (CKFR ) alone represents a whopping 66.9% of its assets. In contrast, Europe 2001 HOLDRs has 44 stocks, which helps to dampen volatility. HOLDRs typically don't place concentration limits on individual stocks. As a result, investors will have to look under the hood to determine what diversification they offer. Unlike ETFs, investors in HOLDRs have direct ownership in the underlying stocks. As a result, they have voting and dividend rights. However, HOLDRs can be quite expensive to buy since investors may only purchase them in round lots of 100. For example, the Biotech HOLDRs, priced at $188.87 as of Aug. 17, would require an investment of $18,887, not including commissions. This restriction excludes most small investors from participating in certain HOLDRs. UNBUNDLE OF JOY. On the expense side, however, HOLDRs feature low costs. Shareholders are charged a transaction cost and an annual custody fee, amounting to 8 cents per HOLDR, taken against cash dividends and distributions. This fee is waived if no dividends or cash distributions are paid on any of the underlying stocks. Also unlike ETFs, if an investor grows disenchanted with some poorly performing stocks in his HOLDR, he can "unbundle" it, thereby owning each underlying issue separately. (Once a single stock is taken out, however, the HOLDR can't be put back together as a unit.) Then he can sell off the unattractive names and take the related tax losses. The shareholder can also defer gains on his top-gaining stocks since he controls the decision to sell. Investors who unbundle have to pay a cancellation fee of up to $10 per round-lot of 100 HOLDRs. However, this transaction is not considered a taxable event. NOT BUY-AND-HOLD. HOLDRs offer two advantages to investors relative to ETFs, notes Srikant Dash, index strategist at Standard & Poor's. "First, they provide more of a thematic approach to investment and trading because they focus on such narrow sectors as broadband and Internet infrastructure," he explains. "The other advantage is that the underlying shares can be redeemed much easier than with ETFs, opening up various trading strategies like holding onto some stocks while selling others. Investors can also go 'long' on some issues, go 'short' on others. This appeals to certain sophisticated individual investors who can use the lower redemption facility." However, Dash cautions that HOLDRs are better suited for those focused on short-term tactical allocation, not buy-and-hold investing. "This is clearly not a product for a retirement plan, or a 401(k) plan, or for small investors. It's for people who are actively trading," he says.
Source: American Stock Exchange. Data as of Aug. 12, 2005. *There are also two HOLDRs listed on the New York Stock Exchange, including the very first HOLDR, Tele Brasil-Telebras Hldrs (TBH ), formed in mid-1998 in connection with the break-up of Telebras, the Brazilian telecommunications giant, into 12 new companies. Another NYSE-listed HOLDR, the Merrill Lynch Canada Canadian Pacific HOLDRs (HCH ), was formed in connection with the split-up of the railway Canadian Pacific Ltd. into five separate publicly traded entities. This HOLDR also trades on the Toronto Stock Exchange.  Ghosh is a reporter for Standard & Poor's Fund Advisor All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc. Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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