An inexpensive way for ETF investors to access some undervalued sectors.
One nice thing for investors about exchange-traded funds is that they come in so many different sizes. Some are incredibly diversified, holding hundreds--if not thousands--of stocks, while others offer very concentrated exposure to a given sector or geographic region.
The quirky suite of equity sector-themed HOLDRS funds, issued by a Bank of America Merrill Lynch subsidiary, falls into the latter category. And right now, three HOLDRS ETFs (in technology, pharmaceuticals, and banking) are trading well below their portfolios' respective price/fair value valuations, as calculated by our equity analyst staff, and represent compelling opportunities for investors.
First, a quick primer on HOLDRS: While HOLDRS funds trade on an exchange, they do not-- unlike other ETFs--track indexes, and they do not add new holdings. Instead, they reflect whatever selections Merrill made at the funds' inceptions in 2000, with deletions taking place only as a result of corporate events such as mergers, acquisitions, and de-listings. Because Merrill doesn't reconstitute or otherwise tinker with its portfolios, the holdings coast along with the market.
These unusual rules have led to some strange current-day HOLDRS. Easily the oddest one (and the one that takes concentration to the extreme) is B2B Internet HOLDRS
Having said all that, we find most other HOLDRS generally to be good proxies for the respective industries that they cover. In addition, from a fee standpoint, HOLDRS portfolios require investors to make their purchases in round 100-share lots, with annual custody fees of $0.08 per HOLDRS share. Merrill waives these custody fees if the underlying securities fail to generate enough in dividends or cash distributions to cover the fees. For example, if a HOLDRS fund were trading at $50 per unit, investors would have to purchase 100 units for $5,000 and pay just $8 in total annual fees, which equates to a very cheap expense ratio of about 0.02%.
Right now, Morningstar's equity analysts' valuations of HOLDRS funds' underlying holdings reveal three HOLDRS funds to be incredibly inexpensive relative to the entire ETF universe. In fact, Morningstar.com's ETF screener shows that these three funds are among the 10 least expensive U.S. ETFs on a price to fair value basis, among all ETFs with a sufficient number of holdings covered by Morningstar's equity analysts. What's more, Morningstar's equity analysts generally have assigned "low (or at most, "medium") fair value uncertainty ratings to the stocks held in these three HOLDRS, suggesting that investors interested in these specific sectors can use these funds to get exposure to these sectors with fairly low risk, on top of the reasonable valuations and low fees. It's probably not surprising that the three funds in question are dominated by large-cap names and have fairly minimal small-cap exposure, since Morningstar's equity analysts generally find large-cap stocks to be cheaper than mid- and small-cap right now.
The three funds that we believe are especially undervalued follow.
Regional Bank HOLDRS
One important thing to highlight about this fund is its misleading label. Despite what its name would imply, the majority of this ETF's assets are invested in larger banking institutions that don't qualify any longer as regional banks. However, Regional Bank HOLDRS is a great way to get concentrated exposure to large national money-center banks, which Morningstar's analysts believe are significantly undervalued. The fund's top-three holdings--J.P. Morgan Chase