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Are HOLDRS Still Worth Holding?

Remember the HOLDRS? During the dot-com era, these exchange-traded products were revolutionary and hot. They provided investors an exciting new way to trade a basket of stocks from a specific sector, industry or investment theme. Today, with the exception of a select few, many of the existing 17 HOLDRS look ancient and headed toward the same fate as VHS and Betamax.

HOLDRS, which stands for holding company depositary receipts, were created by Merrill Lynch between 1999 and 2001. That's why some of them still carry names like the Market 2000+, Broadband, Internet Infrastructure and B2B Internet. In a post dot-com-bust world, these names sound silly and obsolete.

So are HOLDRS still relevant, and even worth a look? It depends on the HOLDR and what you're looking for as an investor or trader. But before determining if they're right for you, it's important to know some background information on these unique products.

While HOLDRS may look and trade like traditional exchange-traded funds, they differ from ETFs in several ways, including their structure, round lot rules, management (or lack thereof) and costs. These differences can be appealing or appalling, depending on your investment strategies and goals.

Grantor Trust Structure

For starters, HOLDRS are structured as grantor trusts and registered under the Securities Act of 1933, compared with most equity mutual funds and ETFs, which are structured as open-end funds and registered under the Investment Company Act of 1940.

The grantor trust structure allows investors in HOLDRS to have direct ownership in the underlying securities in the basket. Basically, HOLDR owners are treated exactly the same as if they owned the underlying stocks.

This means that as a HOLDRS investor, you have full voting rights and will receive annual statements, proxy material and all other correspondence in the mail for each underlying security. (Those who don't want to be barraged with mail can request to get these materials by email.)

This unique structure also allows HOLDRS to have unlimited concentration and weighting in a select few companies without any restrictions (further details on this below). Any dividends are also directly distributed to shareholders and not reinvested.

Investors even have an option to cancel their HOLDRS and receive the underlying holdings unbundled for a small fee. Currently, the Bank of New York Mellon-the trustee and custodian of all of Merrill's HOLDRS-charges $5 per 100-share lot as a cancellation fee, although, according to the prospectus, it can charge up to $10 per 100-share lot.

Currently, HOLDRS are the only equity-based grantor trusts on the market, with most grantor trust structures seen in "physically held" precious metals ETFs, such as the popular SPDR Gold Trust (NYSE Arca:GLD) and the iShares Silver Trust (NYSE Arca:SLV).

Also, HOLDRS can only be bought and sold in round lots (100 shares). In contrast, most other exchange-traded products have no minimum share-trading rules. This means that for HOLDRS such as the Oil Services HOLDRS (NYSE Arca:OIH)-currently trading around $160 per share-an investor would need a minimum of $16,000, excluding any commissions paid to a broker, just to enter the position.

But on the flip side, investors interested in the Internet Infrastructure HOLDRS (NYSE Arca:IIH)-currently trading around $4 a share-would only need $400, again, excluding commissions.

No Management And Underlying Index

HOLDRS are completely unmanaged and don't attempt to track an underlying index. Most equity ETFs in comparison, with the exception of a few actively managed ETFs, focus on tracking a specific index through replication or sampling strategies.

The underlying securities in most HOLDRS were originally weighted by market capitalization or equally weighted. Because the portfolios are unmanaged, holdings are never altered-though they can change due to corporate actions, such as mergers and spinoffs, or if a company ceases to exist. In such situations, the company that drops out of the portfolio is not replaced.

Why is this relevant? Several reasons.

If a portfolio is completely unmanaged, the weightings of the underlying securities are eventually left solely up to market forces. Over time, this can leave the portfolio highly concentrated in a few leading companies within their respective sector, increasing the single-security risk in a variety of HOLDRS.

Take the Telecom HOLDRS (NYSE Arca:TTH) as an example. AT&T makes up an astonishing 53 percent of the portfolio weighting. In the Biotech HOLDRS (NYSE Arca:BBH), three dominant companies in the industry-Amgen, Biogen and Gilead-make up 85 percent of the weighting.

Meanwhile, the B2B Internet HOLDRS (NYSE Arca:BHH) now consists of only two holdings:Ariba at 91.5 percent and Internet Capital at 8.5 percent. This is a classic case of how consolidation and bankruptcies that occurred in this sector over the past decade have made this HOLDR almost obsolete.

However, there are some advantages to being completely unmanaged. Investors don't have to worry about any hidden capital gains taxes, as there's no manager buying and selling underlying securities, as seen in mutual funds. While the structure of traditional ETFs greatly reduces this risk of capital gains being distributed to shareholders, HOLDRS go a step further by having no turnover from trading.

Some investors actually prefer a completely unmanaged portfolio like the HOLDRS. By being unmanaged, the HOLDRS are essentially the "purest" market-cap funds on the market. Concentration can also have its benefits if you're looking for a portfolio that's weighted in the largest, most stable companies in a sector.

Different Cost Structure

HOLDRS have no expense ratio. Instead, the Bank of New York Mellon charges a quarterly custody fee of 2 cents per HOLDR per quarter. So if you own one round lot (100 shares) of a HOLDR, that means you owe $2 a quarter, or $8 a year.

The custody fee is only taken out of any cash dividends or distributions paid out during the quarter, meaning that if the HOLDR didn't pay anything out, no fee is charged. If the dividend paid is less than 2 cents per round lot a quarter, the investor only gets charged the amount of the dividend paid. This fee structure makes HOLDRs relatively cheap compared with ETFs that offer similar investment exposure.

Looking at the HOLDR-ETF fee comparison more closely, let's assume you have 100 shares in OIH and it pays out dividends and distributions greater than the custody-fee limit. OIH is currently trading around $160, meaning your HOLDR value is $16,000. If the maximum $8 is charged in annual custody fees, this is equivalent to an expense ratio of 0.05 percent, or just 5 basis points ($8 / $16,000 = 0.0005).

However, if you own 100 shares of the Telecom HOLDRS, currently trading around $29 a share, the yearly cost would be equivalent to roughly 0.28 percent, or 28 basis points ($8 / $2,900 = 0.00275). So the cost of your HOLDR depends on the share price, as well as how much it pays out in dividends and distributions.

Relevant-Or Not

The Market 2000+ HOLDRS (NYSE Arca:MKH) is a great example of how certain HOLDRS seem outdated. MKH was established in 2000, consisting of the 50 largest companies by market cap that were listed on a major U.S. exchange at that time. Similar to MKH, the Europe 2001 HOLDRS (NYSE Arca:EKH) originally consisted of the 50 largest European companies by market cap that were listed on a major U.S. exchange at the time.

As we all know, after the bursting of the dot-com and housing bubbles, the world markets are different today than they were a decade ago. Not surprisingly, MKH and EKH only have $13 million and $5 million in assets under management, respectively. Both also barely trade, with an average trading volume of less than 1,000 shares a day.

Other HOLDRS, such as the Internet Architecture HOLDRS (NYSE Arca:IAH) and Broadband HOLDRS (NYSE Arca:BDH), also seem obsolete as investment themes in a post-dot-com world. And, with both HOLDRS having less than $20 million in assets, it appears investors feel they're obsolete too.

Running On Autopilot

So why are some of these HOLDRS still around? I wish I knew. Unfortunately, there seems to be no contact at Merrill Lynch regarding the HOLDRS, which makes me wonder if there's anyone there even overseeing these products anymore.

On the brighter side, some HOLDRS such as the Oil Services HOLDRS, the Semiconductor HOLDRS (NYSE Arca:SMH) and the Pharmaceutical HOLDRS (NYSE Arca:PPH) are thriving, and these highly liquid HOLDRS are the leaders in each of their respective segments.

In today's world of $100+ crude oil prices, it makes sense why OIH would still be thriving. In fact, it's currently the second-largest energy fund in the country, with over $3 billion in assets and an average daily dollar volume greater than $760 million!

While the cost of getting into OIH is steep at current prices due to the round-lot trading rules, OIH is great for traders or institutions whose main concern might be liquidity. Even for long-term investors, its current equivalent expense ratio (custody cost) is dirt cheap.

PPH is also the clear leader in the pharmaceutical segment, with over $530 million in assets. With aging populations in much of the developed world and even in China, this segment continues to look relevant.

While PPH is highly concentrated in "the big three" (Johnson & Johnson, Pfizer and Merck make up 60 percent of the weighting), it has a maximum cost equivalent of 0.12 percent, or 12 basis points (calculated at the current $69 price). Compare this with the 35-basis-points cost of its closest competitor, the SPDR S&P Pharmaceuticals ETF (NYSE Arca:XPH), and PPH looks cheap.

At the end of the day, it's really a case of "to each their own." Whether you favor HOLDRS depends on your investment objectives. While HOLDRS might not be the play if you're looking for a truly diversified sector fund, they're great if you want nondiversified concentration in a few key players in a specific sector.

So, in the end, some HOLDRS will continue to thrive and be relevant, while others will struggle to stay alive in a world that no longer calls for their existence.

Ticker Name Inception Date Price per share Market Cap ($M) Number of Holdings Top 3 Holdings & Weightings
OIH Oil Services HOLDRS 12/12/2000 $160 $3,162.6 14 Schlumberger (18.5), Baker Hughes (15), Halliburton (13.6)
SMH Semiconductor HOLDRS 4/24/2000 $36 $589.0 18 Texas Instruments (21.8), Intel (18), Applied Materials (11)
PPH Pharmaceutical HOLDRS 1/24/2000 $69 $529.0 14 J & J (24.2), Pfizer (20.4), Merck (15)
BBH Biotech HOLDRS 11/22/1999 $113 $278.0 11 Amgen (33.5), Biogen (27.2), Gilead (24.5)
RTH Retail HOLDRS 5/2/2001 $109 $248.9 18 Walmart (17.6), Home Depot (13.8), Amazon (11.8)
TTH Telecom HOLDRS 1/24/2000 $29 $135.0 11 ATT (53.4), Verizon (27.4), BCE (5.8)
HHH Internet HOLDRS 9/2/1999 $75 $121.0 12 Amazon (44.6), eBay (20.5), Yahoo (11.8)
RKH Regional Bank HOLDRS 6/21/2000 $83 $101.0 17 JPMorgan Chase (23.6), Wells (19.5), US Bancorp (17.2)
SWH Software HOLDRS 9/27/2000 $52 $89.0 13 SAP (20.4), Oracle (16), Microsoft (14.7)
UTH Utilities HOLDRS 5/18/2000 $102 $43.0 18 Exelon (12), The Southern Co (11), Dominion (9.6)
IAH Internet Architecture HOLDRS 2/18/2000 $59 $32.0 14 IBM (36.9), Apple (23.8), HP (15.4)
BDH Broadband HOLDRS 3/22/2000 $15.40 $18.0 17 Qualcomm (59), Corning (11.8), Broadcom (7.8)
BHH B2B Internet HOLDRS 11/22/2000 $1.20 $17.0 2 Ariba (91.5), Internet Capital (8.5)
WMH Wireless HOLDRS 10/25/2000 $49 $16.0 17 Crown Castle (36.7), Qualcomm (19.8), RIMM (8.6)
IIH Internet Infrastructure HOLDRS 2/18/2000 $3.80 $13.0 8 VeriSign (58.8), Akamai (30.9), RealNetworks (5.5)
MKH Market 2000+ HOLDRs 8/29/2000 $52 $13.0 54 ATT (6.6), Exxon (6.4), IBM (6.3)
EKH Europe 2001 HOLDRS 1/17/2001 $62 $4.6 30 Millicom (13), ASMI (7.9), Ryanair (7.2)

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Copyright ® 2011 Index Publications LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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