Recently, an acquisition between two companies illustrated how HOLDRs are different from exchange traded funds (ETFs).

BEA Systems Inc. (BEAS) was acquired by Oracle Corp. (ORCL) on April 29, 2008. BEAS was deleted from the index on April 30, and $193.75 in cash was distributed on May 5, which in turn caused the Internet Infrastructure HOLDRs (IIH) to fall nearly 33%. BEA Systems had been 31.2% of the fund and was its second-largest holding.

HOLDRs, or Holding Company Depositary Receipts, are a static basket of stocks selected from a particular industry. They don’t track an underlying index, but they do represent a narrow slice of a particular sector.

Their components never change, and in the case of BEA Systems and Oracle, when BEA was acquired, the stock was not (and won’t be) replaced. This results in more concentration of the remaining stocks, thereby increasing the risk for an investor.

Palash R. Ghosh for Investment Advisor wrote an article detailing how these unique instruments work. It’s a few years old, but it’s very interesting and informative.

Tags: Sector ETFs, Technology