Some HOLDRs Turned Out to Be Folders

People are always looking for signs of a market top: increased takeover activity, lowered savings rates or stretched valuations.

Now there may be yet another indicator: Merrill Lynch's (MER Quote) HOLDRs.

The most recent of these exchange-traded baskets hit the market right about the time their respective sectors hit the skids. Investors who bought any of the last four HOLDRs portfolios have seen a lot of red and very little green. (Holdings of these baskets can be found in a recent story.)

HOLDR On To Your Hat It has been a straight trip down for many HOLDRs launched this year.
HOLDRs In Order of Appearance	First Trading Day	% Change Since First Day of Trading	Assets at Launch ($mil.)	Current Assets ($mil.)
Internet (HHH Quote)	9/23/99	8.9%	$408	$794
Biotech (BBH Quote)	11/29/99	26.5	491	1,449
Pharmaceutical (PPH Quote)	2/1/2000	-1.9	637	700
Telecom (TTH Quote)	2/1/2000	-7.9	887	797
B2B (BHH Quote)	2/24/2000	-63.9	333	399
Internet Architecture (IAH Quote)	2/25/2000	-13.2	255	257
Internet Infrastructure (IIH Quote)	2/25/2000	-56.5	474	302
Broadband (BDH Quote)	4/6/2000	-25.7	556	416
Source: Merrill Lynch, Baseline

Everyone can learn some lessons about concentration and speculation from the crash of these securities. Some of these concentrated baskets invest in over-hyped, unproven areas of the market. On the other hand, some HOLDRs containing more established companies came out of last week's carnage relatively intact and may prove to be better investments for the long haul.

The B2B (BHH Quote), Internet Architecture (IAH Quote), Internet Infrastructure (IIH Quote) and Broadband HOLDRs (BDH Quote) are all sporting double-digit losses.

Okay, those numbers aren't so surprising given the plummet in the Nasdaq. The Composite has fallen 34.2% since March 10. However, the B2B HOLDRs has dropped a shocking 68.6% over the same time period. The Internet Infrastructure HOLDRs are down 61.6%. Both started trading at the end of February.

These plunges perfectly illustrate the shortcomings of these products.

HOLDRs are each concentrated in just 20 stocks -- a very small number by anyone's count -- that can make these baskets extremely susceptible to wild swings in price. Moreover, these baskets are focused on very narrow, often very new, areas of the market. And a single stock can command more than 20% of a basket once the portfolio has started trading. For example, as of March 1, Yahoo! (YHOO Quote) represented almost 27% of the Internet HOLDRs (HHH Quote) basket. Since then, Yahoo! has plunged 26.8% in value.

And, as we have seen, the newer HOLDRs seemed to take concentration to extremes, tracking unproven subslices of the Internet market that happened to be the flavor of the moment.

B2B, or business-to-business, stocks experienced a meteoric rise backed by lots of hype, but then analysts and investors started questioning the revenue models of some companies, and larger, more established companies began moving into this emerging world. The Internet Infrastructure HOLDRs also include some companies, like NaviSite (NAVI Quote) and Alteon WebSystems (ATON Quote), that are less-than-seasoned. (Both went public late last year.)

These HOLDRs seem to have arrived at the worst time for investors -- the very pinnacle of these very narrow sectors. This phenomenon is inherent in the brokerage business.

The brokerage industry isn't called the sell side for nothing. These products are designed to be sold. Firms will come out with products they know investors will be eager to buy.

As the saying goes, money goes where it's been treated the best. If Internet stocks have been hot, an Internet basket is going to be the easiest product to sell.

Very often that means a brokerage is launching a product at its peak, which appears to be the case with B2B stocks.

Despite the failings of some HOLDRs, their original benefits still stand true. With one purchase and one commission, you get a basket of 20 stocks. Like a stock, you can buy and sell shares throughout the trading day. Plus, you can easily exchange your HOLDRs for the underlying shares of stock in the basket. You can only buy them in lots of 100 shares, but owning them costs very little. The only recurring fee is a is a $2 quarterly custody charge per 100 shares. And whatever portion of that fee that isn't covered by dividends is waived.

In the future, you may want to stick with the HOLDRs that invest in the more established companies that have not been the subject of the latest buzz. Pharmaceutical (PPH Quote) HOLDRs, for example, tracks a sector that is not an untested, nascent market. This portfolio actually fell when it first started trading and then surged.

Other HOLDRs that appear to be better long-term prospects are the Telecom (TTH Quote) and Internet Architecture (IAH Quote) baskets, which invest in time-tested stocks like AT&T (T Quote) and IBM (IBM Quote), respectively.

Also, the two original holders, Internet (HHH Quote) and Biotech (BBH Quote), invest in more established companies that ought to recover, although who knows how quickly.

Despite the recent results, investors are still interested in these securities.

Reader Dawn Imber wrote to say she believes, "they may offer an attractive way to get into several segments on the recent downturn."

Of course that's assuming there will be a rebound.

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