For the most part, ETFs are pretty similar regardless of which issuer is behind the fund. But as many investors know, there’s one notable exception to this rule. The HOLDRS products from Merrill Lynch are similar to traditional ETFs in many ways, but also feature some nuances that make them very different in others. HOLDRS stands for Holding Company Depository Receipts, and are securities that represent an investor’s ownership in the common stock or ADRs of specified companies in a particular industry. HOLDRS are designed to offer investors a way to achieve exposure to a basket of stocks in a cost-efficient manner while preserving ownership benefits related to the underlying stocks.
Below, we profile five facts about HOLDRS every investor should know before making an investment:
5. Voting Rights
HOLDRS represent an ownership interest in the stocks of selected companies, meaning that owners of HOLDRS have the right to vote shares and receive all shareholder disclosure materials and proxy materials distributed by the issuers of the underlying securities. This is a significant difference from most ETFs, which retain the right to vote on behalf of shareholders on corporate matters (see this feature for a look at potential issues this can cause). A study completed by the IRRC Institute (PDF) last year looked into some of the issues surrounding proxy voting habits at major ETF issuers, uncovering some potentially alarming trends in the process.
4. Round Lot Rules
Unlike many ETFs, HOLDRS can only be acquired in a round lot amount of 100 shares, meaning that the minimum investment amount will generally be higher than the comparable amount for other ETFs. The current share prices of HOLDRS range from less than $1 to more than $125, so the effective minimum purchase amount will vary depending on the fund.
3. Concentration Is Common
|HOLDRS||Ticker||Holdings||Top 3 As % Of Total|
|As of 3/8/2010|
Investors first embraced mutual funds because they offered a relatively efficient means of establishing diversified exposure to an asset class of sub-class without requiring a significant initial investment. This is one area in which ETFs and mutual funds are extremely similar, and the instant diversification ETFs offer has attracted buy-and-holders and short-term traders alike.
HOLDRS, however, tend to be concentrated among a relatively small number of stocks. The B2B Internet HOLDRS (BHH) is the most extreme example: this fund allocates 89% of its holdings to Ariba (ARBA) and the remaining 11% to Internet Capital Group (ICGE). While most HOLDRS products aren’t quite this top-heavy, it isn’t uncommon for a handful of individual stocks to make up a significant portion of total assets. Most HOLDRS have less than 20 individual holdings, and the top three holdings often makes up 60% or more of total holdings. As such, these products can be impacted (and often are) by company-specific developments.
2. Unique Expense Structure
ETF investors are used to analyzing fund expenses as a percentage, but the HOLDRS use a different structure to generate management fees. The Bank of New York (BK), the trustee and custodian for the HOLDRS, charges a quarterly custody fee of $2 for each round lot of 100 HOLDRS, to be deducted from any cash dividend or other cash distributions.
For the B2B Internet HOLDRS (BHH), which is currently trading at about $0.45 per share, this can translate to an expense ratio in excess of 15%. But for funds like the Oil Services HOLDR (OIH), which is currently trading at about $125 per share, the effective expense ratio can be as low as 6 basis points.
1. Unique Creation And Rebalancing Rules
One of the interesting elements of HOLDRS is the manner in which they are created and maintained. When a new HOLDR is developed, a group of underlying stocks to be included is selected on the basis of objective criteria such as market capitalization, liquidity, P/E ratio or other measures. Once determined, these stocks may be weighted equally or on a modified market cap basis. After creation, the share amounts represented in each round lot of 100 HOLDRS won’t change. As such, because the relative weightings of the stocks are a function of market prices, these weightings can (and often do) change substantially over time.
For most ETFs, the acquisition of an index constituent spurs a rebalancing in the related benchmark. But HOLDRS are a different animal altogether. When a component of a HOLDRS is acquired or spun-off, investors are treated as if they owned the underlying stock directly. If a component company is spun off, the HOLDR owner will receive that security in their brokerage account. When a component company is acquired, the proceeds from the sale of the company will be distributed to shareholders.
So when you see a chart that looks like the one below, it isn’t necessarily reflective of a big drop in value:
In this specific case, Genentech (DNA), a major component of BBH, was acquired by Roche Holding AG. Genentech was deleted from the index underlying and the cash proceeds from the sale were distributed to BBH shareholders. “To some this looked like a 2:1 split,” explained Ron Rowland. “Others thought maybe it was just an April Fool’s hoax. In reality, it is just one of the many quirky features of investing in HOLDRs.”
This last point can (and often does) have important tax ramifications for investors, depending on the type of account holding the fund and the nature of any potential distribution.
Disclosure: No positions at time of writing.