Old Upset

Is Merrill Lynch Tipping its Hand with HOLDRS?

Old Upset

Mainstream broker Merrill Lynch has introduced HOLDRS, a growing line of exchange traded index funds. They may not be for mainstream portfolios.

Merrill's massive buying of underlying stocks ahead of demand has led to substantial run-ups just prior to HOLDRS being sold to retail investors. Most exchange traded funds grow incrementally as demand grows. On September 22, 1999, the day before trading began for its internet HOLDRS product, the stocks underlying Merrill's internet HOLDRS rose over 7%. Shares for the biotechnology HOLDRS rose more than 6% one day before that product's debut on November 22, 1999.

Initiated this fall, HOLDRS trade just like a stock but represent dozens of top companies in each sector. Currently available are HOLDRS for biotech, internet, internet business-to-business, telecom, and pharmaceutical sectors. Unlike most exchange traded index products which cover broad markets, these address some of the most volatile sectors of North American equities. HOLDRS stands for HOlding Company Depository ReceiptS, and the underlying securities are held in trust by The Bank of New York. Merrill selects the stocks making up the indexes and lists them publicly.

The Wall Street Journal has reported hedge funds poaching on the products. Institutional traders were quoted as saying they were enthusiastically attacking stocks on the list of the HOLDRS indexes based on leaks of impending Merrill buying sprees. This would be expected to drive up the cost for small retail buyers when the HOLDRS are released for sale to the public. Prospectuses for the products offer disclaimers that the products could run up just prior to small investors selecting them, and fall soon thereafter.

Merrill is estimated to have pocketed tens of millions of dollars in the run-up of its index products prior to their marketing to retail investors. The brokerage firm, however, bears the risk of a market fall during its buying process. The firm also discloses in its prospectuses that it stands to earn investment banking fees from firms in each index.

Clearly HOLDRS are popular. On Friday, March 3, the business-to-business internet HOLDRS (BHH) was the 6th most active stock on the American Stock Exchange.

Downloadable prospectuses include:

Internet HOLDRS

Biotechnology HOLDRS

Pharmaceuticals HOLDRS

Telecom HOLDRS