Dear Dagen: Yet Another Way to Invest in the Internet

There are now two ways to send your questions to Dear Dagen -- via email, as usual, and on our new Dear Dagen message board. Dagen will jump on the board every Thursday afternoon to answer questions posted during the week.

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New year, new Internet play.

In the first quarter of 2000, investors will have another way to bet on the Internet.

Share your mutual fund and investing questions on the Dear Dagen board Salomon Smith Barney, a division of Citigroup (C), is planning to launch an exchange-traded mutual fund that will track its own existing Internet-stock index: the Salomon Smith Barney "T" Series Internet index. (The ticker symbol for the index is NIX.)

This product, which will likely be the first Internet-index mutual fund to trade on an exchange (the American Stock Exchange), will give investors another way to passively invest in this fast-growing sector. But unlike a traditional mutual fund that prices once a day, you'll be able to trade this vehicle throughout the course of each trading day.

Although the product won't be available until early next year, a close look at the already existing index reveals its basic features.

Salomon Smith Barney Internet Index
Company	Initial Weighting*
America Online (AOL)	20%
Yahoo! (YHOO)	9.97
eBay (EBAY)	3.31
Excite@Home (ATHM)	3.61
Internet Capital Group (ICGE)	1.91
Amazon.com (AMZN)	3.74
priceline.com (PCLN)	2.28
CMGI (CMGI)	3.94
RealNetworks (RNWK)	3.06
Inktomi (INKT)	3.21
Intuit (INTU)	3.72
eToys (ETYS)	2.98
Exodus Communications (EXDS)	3.59
VeriSign (VRSN)	3.44
Sabre (TSG)	1.19
E*Trade (EGRP)	3.3
TD Waterhouse (TWE)	0.62
DoubleClick (DCLK)	3.21
Phone.com (PHCM)	2.08
Lycos (LCOS)	2.36
BroadVision (BVSN)	2.73
CareInsite (CARI)	2.7
Ameritrade (AMTD)	1.4
CNET (CNET)	1.61
PSINet (PSIX)	2.23
Rhythms NetConnections (RTHM)	0.96
TMP Worldwide (TMPW)	1.71
USWeb (USWB)	2.24
InfoSpace.com (INSP)	1.04
Verio (VRIO)	1.87
*As of Sept. 22. Source: Salomon Smith Barney.

The modified, float-weighted index consists of the 30 largest publicly traded Internet companies in the U.S. It will trade on the American Stock Exchange. As of Sept. 22, holdings included bellwethers like America Online (AOL) and smaller names like Phone.com (PHCM).

In order to make the index, a company must derive at least 50% of its revenue from businesses directly related to the Internet. Eligible businesses would include content providers, media and advertising firms, software companies, online financial firms, e-commerce companies and Internet-service providers.

This revenue requirement should ensure that the index will only contain pure Internet companies and should prevent more peripheral plays, like Cisco (CSCO), for example, from entering the index.

Many indices are weighted according to the market capitalization of the underlying stocks. (This was discussed in a recent column about how to analyze an Internet index.) This Salomon Smith Barney index uses a capitalization weighting that adjusts for float, defined as the number of shares of a company's stock that are available for trading by the public.

A market-cap-weighted index should typically reflect a stock's liquidity, giving larger companies a bigger position than smaller ones. If a fund wants to mimic a market-cap-weighted index, that fund won't be forced to buy a lot of some less-liquid stocks.

Salomon Smith Barney's methodology, using this float adjustment, ensures that a stock's weighting in the index will reflect the actual number of shares that can be bought and sold in the market by the investing public.

This feature may be particularly important in the Internet sector, where some companies with large market caps have small floats. In those cases, most shares are held by insiders.

In addition, the weighting of any single stock is capped at 20% of the total value of the index, which is rebalanced every quarter. That should prevent a few stocks from completely overtaking the index.

Actually, this index looks a lot like the Dow Jones Composite Internet index, which tracks 40 stocks. That Dow Jones index doesn't have a corresponding fund at the moment, but Barclays Global Investors is planning to launch an exchange-traded fund based on that index sometime next year.

Right now, the only available exchange-traded Internet portfolio is the Merrill Lynch Internet HOLDRs (HHH:Amex). The HOLDRs represent a fixed basket of 20 stocks, and they can only be traded in round lots (increments of 100 shares), which effectively eliminates small investors as customers.

However, you'll be able to trade this Salomon Smith Barney index fund in lots of any size, like the very popular Spiders (SPY) and the Nasdaq 100 tracking stock (QQQ).

Like the Spiders and QQQs, the underlying portfolio of the Salomon index fund will issue and redeem shares in increments of 50,000. This process doesn't directly affect how investors buy and sell shares in the secondary market. It does, however, represent the arbitrage mechanism that should keep the security price trading close to the portfolio's net asset value. The Merrill Lynch Internet HOLDRs portfolio issues and redeems shares in 100-share increments.

You'll also see other noticeable differences between the Salomon index fund and the Internet HOLDRs security. New stocks will not be added to the Internet HOLDRs basket. If one company is acquired by another, that stock will disappear from the basket. The Salomon Smith Barney index can change.

Investors can already see what type of stocks the Salomon Smith Barney portfolio will hold by looking at the existing index. But one key detail is unknown: the cost.

Like a stock, you'll have to pay a commission to buy and sell these securities. That's for sure.

And, like any mutual fund, this product will include an underlying expense ratio, and that figure hasn't been revealed. The Merrill Lynch Internet HOLDRs portfolio doesn't carry an underlying expense ratio.

The expenses on the Salomon Smith Barney portfolio should be reasonable given that the product is an index fund.

But that important detail should be a primary factor in deciding to buy this fund or not.

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