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Fund Spy

You've Got to Know When to HOLDR 'Em

Are Merrill Lynch's HOLDRs a good alternative to funds and ETFs?

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New, innovative exchange-traded funds covering commodities, currencies, and offering long and short strategies that push the boundaries of passive investing have gotten most of the attention recently. But we still get a lot of questions about an old standby: HOLDRs (Holding Company Depository Receipts). Investors often stumble across these close cousins to ETFs when looking for exposure to specific equity markets or market segments, which HOLDRs offer. The vehicles have some initial attractions--and some serious drawbacks. There are fewer than 20 of them on the market, and I'm not crazy about them because there are concentrated and hard to value. However, they are still worth knowing about because they are often some of the most actively traded exchange-traded portfolios around. (Semiconductor HOLDRs (SMH) and Oil Services HOLDRs (OIH) have been among the 10 most actively traded ETFs recently.) Furthermore, with more people than ever before trolling the ETF universe for investment ideas, we thought it would be a good time to look at the pros and cons of HOLDRs.

Hold What?
It's easy to confuse a HOLDR with an ETF. HOLDRs are essentially bundles of domestic, and in some cases international, stocks. Like ETFs they can be bought and sold throughout the day on the American Stock Exchange and have low expenses relative to the average conventional open-end mutual fund.

This is where the similarities end, though. Unlike ETFs, HOLDRs don't track indexes. They are baskets of about 20 or so stocks selected by Merrill Lynch to represent a market, sector, subsector, or industry. There are many more narrowly focused HOLDRs than broadly diversified ones; most of them focus on thin slices of the market, such as semiconductors, Internet, retail, regional bank, or biotechnology stocks.

Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.