What Were Holding Company Depository Receipts, and Why Did They Disappear?

Merrill Lynch invented Holding Company Depository Receipts (HOLDRS) in 1998 as a new form of investment vehicle. They were similar to Exchange Traded Funds (ETFs) in that they contained a “market basket” of stocks concentrated in a particular holding or sector, but they had major differences from ETFs – most of which led to the eventual downfall of HOLDRS.

There were 17 HOLDRS listed on the New York Stock Exchange representing a series of narrowly focused segments, with most of them residing in the tech Industry. The sectors were: Biotech, Broadband, B2B Internet, Europe 2001, Internet, Internet Architecture, Internet Infrastructure, Market 2000+, Money-Center Bank, Oil Services, Pharmaceutical, Retail, Semiconductor, Software, Telecom, Utilities, and Wireless.

The dated names of several of the HOLDRS give a clue to one of the major differences.

ETFs often track some form of index, and their holdings are managed and periodically adjusted to provide the best return possible within that index. By contrast, the composition of HOLDRS never changed, and could not change by definition. The only change allowable was through acquisition of a company whose stock was held in the HOLDR.

HOLDRs varied significantly in their composition, making them difficult to peg for risk and volatility without looking more closely at the individual holdings. Consider that the Biotech HOLDR was composed mostly of two stocks: 41.2% of Genentech (now part of Roche) and 27.1% of Amgen (NASDAQ GS: AMGN). ETFs are generally more diverse to spread risk while staying within a sector. With that level of concentration, a HOLDR did not provide much advantage over buying and holding the individual stocks.

The other main difference was that investing in HOLDRS gave you direct ownership of the underlying stock, and thus you retained dividend and voting rights. Further, you could “unbundle” a HOLDR at any time into its individual stocks for a minimal cancellation fee and take direct ownership of the stocks. By comparison, it is considerably more difficult and time-consuming to redeem an ETF. Put simply, a HOLDR functioned like a closed-end investment partnership, but with the easy ability to unwind one’s position.

What were the advantages of HOLDRS? For the average buy-and-hold investor, there weren’t many. HOLDRS had to be bought in lots of 100, requiring dollar amounts that were beyond many investors. The major upside was a very low transaction cost and annual custody fee – as you might expect, given that there was very little management involved.

However, if you were a frequent trader, you could use a HOLDR as a convenient mechanism to hold onto certain stocks and then unbundle them at strategic times according to your trading philosophy. They were also used by institutional investors for hedging purposes.

HOLDRS helped give rise to ETF’s, whose popularity eventually consumed some HOLDRS while causing others to be liquidated.

In December of 2011, 6 of the 17 HOLDRS were converted to ETF structures under Van Eck Global and now operate under the Market Vectors name: They are Biotech (NYSEARCA:BBH), Money-Center Bank (NYSEARCA: RKH), Oil Services (NYSEARCA:OIH), Pharmaceutical (NYSEARCA:PPH), Retail (NYSEARCA:RTH), and Semiconductor (NYSEARCA:SMH).

The remaining 11 HOLDRS were liquidated and investors were offered either direct ownership of the underlying stock, or coupons for cash redemption based on the underlying stock’s value at that time. At the time of liquidation, those 11 HOLDRS contained approximately $305 million in collective assets.

In the end, the explosion in ETF’s led to the demise of HOLDRS. The rigidity of HOLDRS became a liability compared to ETFs. ETFs and other vehicles were preferable to buy-and-hold investors, and active traders and institutional investors found better investment alternatives to meet the same purpose.

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