Beware These "Very Attractive" ETFs

A recent Forbes blog post found "lots to love" about health care exchange-traded funds. Unfortunately, the two ETFs it found most appealing, the Biotech HOLDRS (NYSE: BBH  ) and Pharmaceutical HOLDRS (NYSE: PPH  ) , have several not-so-attractive traits. While I agree that these are two very appealing fields, due to our growing and aging population, I think that you might want to invest in them in other ways.

Critics charge that most HOLDRS' components are not updated and changed, beyond the effects of mergers, bankruptcies, and spinoffs. Each started out with 20 holdings, but more than a decade after Merrill Lynch created these vehicles, they're now generally much more concentrated. The B2B Internet HOLDRS is down to just two stocks, with 91% of its assets in Ariba alone.

Talk about concentration…
The Biotech and Pharmaceutical HOLDRS are not that concentrated. Biotech sports 12 holdings, while Pharmaceutical has 14. That may seem reasonable, but in Biotech, a whopping 85% of assets reside in just three stocks: 35% in Amgen (Nasdaq: AMGN  ) , 25% in Biogen Idec, and 24% in Gilead Sciences.

Pharmaceutical isn't much more diversified, with 24% of assets in Johnson & Johnson, 20% in Pfizer (NYSE: PFE  ) , and 16% in Merck (NYSE: MRK  ) . If you think that Amgen's fastest growth is behind it as it morphs into a big pharmaceutical company, or you're worried about the looming patent expirations for Pfizer's Lipitor or Merck's Singulair, you may not be excited about these funds' concentrations -- or their prospects.

The problem with concentration
If you expect the HOLDRS to give you a fair representation of an industry, think again. The Biotech one, for example, excludes some of the biotech industry's biggest denizens, such as Celgene (Nasdaq: CELG  ) and Illumina (Nasdaq: ILMN  ) . You won't benefit from their work on cancer-fighting treatments, immune-inflammatory disease solutions, or gene sequencing.

The funds' concentration also explains why they were deemed "very attractive" by the folks at Forbes: As each fund component is assessed according to the methodology, funds with a few high-scoring holdings comprising most of their portfolios will get high marks.

Approach HOLDRS with caution, but don't automatically dismiss them. If one of these HOLDRS happens to contain your most favored biotech or pharmaceutical stocks, it might make a good investment for you. If not, you have other good options.

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Longtime Fool contributor Selena Maranjian owns shares of Amgen, Gilead Sciences, and Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services have recommended Illumina, Gilead Sciences, Johnson & Johnson, and Pfizer; and have also recommended creating a diagonal call position on Johnson & Johnson and a short position on Ariba. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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