Not every investment that looks like an exchange-traded fund actually is one. Merrill Lynch's HOLDRs have sold rather well over the past decade, but the surprising quirks built into their design should prompt Fools to invest in them only with great caution.
ETFs based on indexes, such as the S&P 500-tracking SPDRs, are passive in nature, without frequent changes in their composition. Every now and then, some stocks are added or removed from the index, and the ETF makes its adjustments. HOLDRs, though, were created to each be a completely fixed basket of stocks from a particular industry or niche.
That might sound good -- hey, the folks putting this investment together must have a lot of confidence in its holdings! But changes do happen. Some companies go out of business, and are removed from the HOLDR. Some are acquired, but their acquirer doesn't replace them in the HOLDR. Some simply become unattractive … yet remain in the HOLDR.
For instance, the B2B Internet HOLDR
Had the investment been designed differently, it might hold shares of database powerhouse Oracle
Part of the initial appeal of HOLDRs was that they gave you an easy way to invest in a niche and be instantly diversified -- as many mutual funds and ETFs do today. But many of them today are dangerously underdiversified.
Not so bad
A few HOLDRs won't make you wince as much as the B2B one will. The Semiconductor HOLDR
If you'd like an easy and more balanced exposure to these businesses, however, consider the SPDR S&P Semiconductor (XSD) ETF. Or just carefully pick a few companies yourself, as part of a portfolio diversified across many compelling industries. HOLDRs may have seemed like a great idea once, but most seem well worth avoiding today.
ETFs don't have to be niche plays -- Dan Caplinger shows you how they can form the perfect portfolio.
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Longtime Fool contributor Selena Maranjian owns shares of an S&P 500 index fund. Motley Fool Options has recommended buying calls on Intel, which is a Motley Fool Inside Value pick. The Fool owns shares of Intel, Oracle, and Texas Instruments. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.