May 4, 2001

HOLDRs face off with mutual funds

Business Report Correspondent

Folks who play the stock market are always looking for the next hot item to invest in, even in down times such as these when earnings are slipping, and layoffs and mergers seem to happen every day.

Often, the secure way to go is with a mutual fund in which you, as the investor, own stock in several companies of the same industry, and a broker is making sure the fund is loaded only with performers. Diversification, after all, is one way to hedge your bets. But the associated fees can make mutual funds an expensive tool for average investors.

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But a relatively new investment tool called Holding Company Depository Receipts, or HOLDRs, has revolutionized diversified securities. Offered by Merrill Lynch for the stock investor, a HOLDR is a basket of 20 stocks held in one industry such as telecom or biotech, which can be traded like stock. HOLDRs must be purchased in round lots of 100, so as not to own a fraction of a stock.

On April 5, the cost of 100 shares of the Internet Infrastructure HOLDR was $685, down from its 52-week high of $7,275 in April last year. For your money, you get some number of shares of 20 different companies, not necessarily an even split of five shares of each company. And with HOLDRs, if you find that one of the 20 stocks is performing poorly, in order to dump

it, you must sell or transfer the entire 100-round lot. Then you become the owner with the same rights and privileges as a person who bought those stocks individually.

A word of warning from the Merrill Lynch Web site about the risk associated with HOLDRs: “The underlying stocks in HOLDRS were selected without regard for their value, price performance, volatility or investment merit. They may or may not have been recommended by Merrill Lynch.”

Obviously, some sectors are showing their volatility. The business-to-business Internet

HOLDR had a 52-week high of approximately $68 a share last year. As of April 5, it was

valued at $5 a share. So you can get a basket of B2B HOLDRs inexpensively at $500, but would you want to?

The first HOLDRs were issued in the summer of 1998. They included Europe 2001 (EKH), Market 2000+ (MKH), Oil Service (OIH), Regional Bank (RKH), Semiconductor (SMH), Software (SWH), Utilities (UTH) and Wireless (WMH).

Since then, eight others have been introduced, including the four Internet versions: B2B, Internet Architecture, Internet Infrastructure and Internet. Additionally, Telecom (TTH), Pharmaceutical (PPH), Biotech (BBH) and Broadband (BDH) were introduced. For long-term investors who can afford to buy 100 shares at a time, HOLDRs are a powerful competitor to mutual funds.

Bill Mann, senior analyst for Alexandria, Va.-based Motley Fool, criticizes HOLDRS because you can’t dump one or a few of the 20 companies without dumping the whole lot. “What happens is the companies they put in were relevant when they put them in, but they have no way to change them later on. It could be that another B2B could come along that is doing better (than the original companies),” Mann said. “You have companies that go out of business, you have companies that merge out, and certain companies that aren’t represented may turn out to be better than any of them.”

But, a benefit to owning a basket of HOLDRs is the tax break. Unlike with a managed mutual fund that is taxed with each transaction the broker makes, there are no transactions to tax with HOLDRs, unless you exchange the basket for the securities and then sell them.

Let’s say some of your HOLDRs stocks have gone up hundreds of points, but others have declined sharply. If you sell your shares in the market, you’ll generate taxable capital gains on the sum of this performance.

With HOLDRs, however, you can exchange them through Merrill Lynch for the underlying securities. So instead of owning 100 shares of Broadband HOLDRs, you suddenly own two shares of Applied Micro Circuits, nine shares of Corning Inc., 29 shares of Lucent Technologies, eight shares of Qualcomm and so on.

This exchange is not a taxable event. You can sell the stinkers, generating tax losses, and hold onto the winners. And, Mann said, “You don’t pay any of the fees for management on an annual basis as you would for a sector mutual fund. Those can be severe.

“I prefer the HOLDRs to any managed sector fund,” he says. “They really are for people who want to play certain sectors. But if you are going to play, ?Invest and forget,’ buy an S&P index fund because these (HOLDRs) are going to be volatile.”

Business Report Correspondent

Folks who play the stock market are always looking for the next hot item to invest in, even in down times such as these when earnings are slipping, and layoffs and mergers seem to happen every day.

Often, the secure way to go is with a mutual fund in which you, as the investor, own stock in several companies of the same industry, and a broker is making sure the fund is loaded only with performers. Diversification, after all, is one way to hedge your bets. But the associated fees can make mutual funds an expensive tool for…

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