Nanotech: Huge Focus on a Small Science

Nanotechnology, the practice of manipulating matter on the atomic scale, may demand an exact science. But so far, nanotech investing has not.

A few short years after Wall Street's first flirtation with the science routinely touted as the next big wave of innovation, there is more misunderstanding about nanotechnology among investors -- and more confusion than information. And it's not just the little guys who get befuddled; it's also big investment banks like Merrill Lynch.

On April 1, 2004, Merrill and its highly respected tech analyst, Steve Milunovich, launched the Merrill Lynch Nanotech Index, injecting a jolt of volatility into many of the 25 small-cap components. A week later, the firm quietly swapped out Cabot Microelectronics(CCMP Quote) for Cabot Corp.(CBT Quote). A week after that, Merrill pulled six companies out of the index after some of them -- including Applied Film(AFCO Quote), Emcore(EMKR Quote) and Three-Five Systems(TFS Quote) -- complained that they didn't see themselves as nanotech plays. It also added three others.

In one of the most eloquent admissions of error in the history of analyst reports, Merrill wrote, "Given the difficulty in defining nanotechnology, along with the dynamic nature of this emerging technology, we believe these changes will enhance our index, making it more useful to the marketplace."

By Merrill's own definition, the index has only grown more "useful." Nearly a year on, nine of the companies in the original Merrill Nanotech Index have been jettisoned, without the mergers or delistings that normally occasion such changes. Ten of the 27 companies in the current version were not included at the start.

Given all the volatility and uncertainty about nanotech stocks, why does anyone bother? Because as nanoscience reaches its adulthood and more laboratory breakthroughs transfer into commercial applications, the ability to engineer at the nanoscale has the potential to transform nearly every industry, just as assembly-line manufacturing did in the 19th century and networked computers are doing now. Merrill's index may have been embarrassing, but the fundamental point was right: Something big is shaping up in nanotechnology -- and Merrill was smart to pursue it.