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B2B Internet ETF's Unique Characteristics

When analyzing the exchange-traded fund industry, investors love to know which fund has the lowest expense ratio ( Schwab U.S. Broad Market ETF (SCHB) and Schwab U.S. Large-Cap ETF (SCHX) both come in at 0.08%), most assets, or highest trading volume (both of the latter honors belong to SPDR S&P 500 ETF (SPY). Another record holder in the ETF space is the B2B Internet HOLDRS (BHH), although its distinctions are perhaps a bit less desirable.

This product (it's not technically an ETF) gives the largest allocation to a single stock, as Ariba (ARBA) accounts for a whopping 88% of total assets. And the remaining 12% weight is given to Internet Capital Group (ICGE), giving BHH the fewest components of any equity ETF. That's right, BBH has only two holdings. It is also currently trading around 45 cents, giving it the lowest per share market value of any U.S.-listed exchange-traded product.

HOLDRS are different from traditional ETFs in several ways.For one, the annual custody fee is not a percentage of assets, but rather a flat $2 fee for every round lot of 100 HOLDRS that is "deducted from any cash dividend or other cash distributions." So for BBH, that would imply an effective expense ratio of more than 4% ( Merrill Lynch waives any fee that exceeds cash distributions, so that 4% figure represents the maximum possible expense ratio).

Another unique characteristic of these funds is the manner in which they deal with acquisitions and divestitures. On the surface, the fact that BHH has lost more than 99% of its per-share value since the fund launched is alarming. But there's more to this number than meets the eye, just as there's a perfectly reasonable explanation for why there are only two components at present.

BHH's prospectus notes that "the companies whose securities were included in the B2B Internet HOLDRS at the time B2B Internet HOLDRS were originally issued were generally considered to be among the 20 largest and most liquid companies involved in the B2B segment of the Internet industry," indicating that once upon a time BHH was more than just ARBA and ICGE.

So what happened? The explanation is actually pretty simple.

HOLDRS treat acquisitions of underlying companies differently than most ETFs. If a stock included in a HOLDR is acquired, investors in the fund are treated as if they own the stock directly, meaning they receive a cash distribution. So following an acquisition there's no rebalancing. The acquired stock is simply removed, the cash proceeds from the sale are paid to investors, and the fund continues to trade.

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