At a recent meeting of Internet executives in California, Amazon.com Inc. founder Jeff Bezos took the stage waving a thick printout of the names of hundreds of companies from the 1920s. Most had the word "motor" in their names, all were caught up in the car craze, and of the lot of them, only two or three exist today.
If you had invested a dollar in each one, Bezos calculated, you'd still be in the red. That's what's going to happen to the Internet economy, he predicted, only faster. Of the hundreds of Internet companies now, 10, 20 maybe, will survive.
As an investor, I say thanks, Jeff, I needed that.
It's the seminal Darwinian Internet economy truth--that a few will make it, most won't, and we can't say now which will and which won't. It's the reason most of us who are interested in Internet investments--bubblephobia notwithstanding--don't want to put our money on just one or two companies but on 10 or 20 or even 30. If this be roulette, let's spread around the chips.
An increasing variety of investments now exist to facilitate this, including mutual funds that invest in Internet companies and publicly traded holding companies such as CMGI Inc. and Internet Capital Group.
And now, from Merrill Lynch & Co., comes an entirely new animal, aimed at affluent though not necessarily rich investors, called holding company depositary receipts, or Internet HOLDRs. It's traded on the American Stock Exchange as HHH, which we shall henceforth call it.
By buying HHH--which you can do through any broker, on or offline--you own shares of the 20 largest Internet companies in America, including America Online Inc., Yahoo Inc., Amazon and eBay Inc. You are purchasing a basket of stocks, chosen for their size (market capitalization) and liquidity (the volume of shares traded each day).
This is not a mutual fund. It's not completely new either. Merrill Lynch in 1998 coordinated the roll-up into a single security of all of the spun-off parts of Brazil's telecommunications giant, Telebras, calling the resulting product "Telebras HOLDRs."
Close cousins are the popular and delightfully acronymed securities that trade on the American Stock Exchange as if they were stocks but are based on indexes and structured to move with indexes--such as the Standard & Poor's 500 (SPDRs, or, affectionately, Spiders), the Dow Jones industrial average (DIAMONDS), world equity benchmark (WEBS) and the extremely popular Nasdaq 100 Tracking Stock listed as QQQ.
These vehicles are relatively unmanaged, so they don't have the management expenses of mutual funds. Plus, you can control the timing of buying, selling and resultant taxes. Unlike a unit investment trust, with HHH you actually own the underlying stocks. So, if you want to trade, you can either sell the HHH on the exchange or you can redeem your HHH shares at the Bank of New York--the official depository for the actual stocks--which will give you all the underlying stocks in the HHH basket for a hefty fee.
They are designed to appeal to the growing desire of individual investors for greater personal control over investments, said Pat Dorsey, a senior stock analyst at Morningstar Inc. "For those who've got to have their 200-proof Internet experience, it's probably pretty good," he said.
Henry Hu, a University of Texas law professor specializing in banking and finance, believes individual investors should stay away from the Internet, in or out of special funds and devices. "Do people realize the risks they're taking? Diversification protects you a little bit," he said, but if Merrill Lynch's product does indeed correlate with the Internet market generally, it will go up with it and come tumbling down with it as well.
Asked to divorce the Internet factor from his analysis, he said these kinds of products have "significant advantages" over mutual funds because a lot of the funds are "sitting on huge capital gains and you avoid that hidden tax liability. You can control when you sell, much more like a regular stock."
HHH hit the market on Sept. 23, trading at about $103 per share. By the end of last week, the security had shot up to $123.75 after Yahoo released a highly favorable earnings report. Internet stocks have tended to move up and down sharply in a pack, and HHH will follow that pattern. The volume has been as low as a quarter-million shares and as high, on Oct. 7, as a million and a half.
Hu and others noted that HHH might have some appeal to big players trying to hedge or speculate (and the volume Thursday suggested that institutions are getting involved). I suspect that "momentum" traders may find HHH quite useful, especially with the availability of after-hours trading. For example, when Yahoo beat earnings expectations this week, the whole sector popped, not just its stock.
Whatever your view on Internet stocks, HHH is definitely for affluent investors. You must buy in round lots of at least 100. In other words, you've got to feel free to invest, at the moment, roughly $12,300 in a highly volatile sector. That should be a big hurdle for many people--a volatile sector such as the Internet should probably not constitute more than 5 percent, or maybe 10 percent, of your total equity investments. So, if you've got at least $120,000 in stocks and you can do without the money for three years and tolerate a substantial loss if, as skeptics claim, it's all a big bubble, then maybe it's for you.
If it's a more significant share of your assets, watch out. Internet mutual funds--if that's your interest--tend to have minimums of about $2,000 or $2,500, though they charge significant fees. The Bank of New York and Merrill Lynch made most of their money through the underwriting fee they charged the initial purchasers when the security was issued.
Even if you're affluent, you still might want an Internet mutual fund in preference to HHH. HHH is pretty much pure Internet. The mutual funds, even those that call themselves Internet funds, tend to be tempered. The Munder NetNet Fund, for example, includes Cisco Systems Inc., Dell Computer Corp., Intuit Inc. (the software company), and Intel Corp. WWW Internet Fund includes among its top holdings, Sun Microsystems Inc. and Microsoft Corp. A variety of "technology funds" provide an even greater mix.
HHH brings you the most successful Internet companies, so far at least, from a standpoint of market capitalization. You'll immediately own the biggies that everyone is talking about. That's potentially good and potentially not so good.
On the one hand, to the extent that there is an Internet establishment, these are the members. One of the reasons they have such large market capitalizations is that lots of people and institutions believe they're really good companies.
But owning stocks according to market capitalization, owning the biggies in order of bigness, means less diversity. Few mutual funds can (or would) put 20 percent into a single company, as HHH does in America Online, for example.
Some of the mutual funds regard a few of these companies as warmed over, however. For The Internet Fund, America Online is kind of soggy toast. "It cannot repeat its earlier 'hyper growth phase,' " said the fund's latest stockholder letter." The Internet Fund is looking for incubator companies--such as Safeguard Scientifics Inc. (SFE) that will, in turn, fund rapid-growth companies that are now in their "early life-cycle."
HHH will be doing no rotating. The companies will stay the same unless they shrivel up and go away or get bought. If enough of them fizzle, Merrill Lynch will probably come out with HHH 2, a new basket of the then-current darlings.
As with the Internet itself, none of these investment possibilities has a long track record. The funds have relatively inexperienced managers; HHH is less than a month old.
I sent a copy of the prospectus to Hu, an expert in investment products, and asked him if he saw any potential pitfalls (apart from the giant crater into which he personally would throw Internet stocks). He noted that if there is a trading halt in a single company in the bundle, HHH would also halt trading. He noted that the prospectus itself acknowledges straightforwardly that HHH may or may not always be completely in sync with the prices of the combined value of the underlying stocks--it could be worth more, and, more important, it could be worth less.
History shows that in times of market stress or panic, everyone wants to be in Treasury bonds or blue-chip stocks, so the number of investors willing to buy complex, fancy-pants investment vehicles such as HHH shrinks dramatically. If HHH does trade at a significant discount to the underlying shares, though, the investors could always head to Bank of New York to redeem their HHH shares and get the underlying stocks.
As with any passive strategy (unmanaged) fund, new companies will never be included in HHH, however dynamic it might be. And old companies will stay in even if they morph completely into something else, or deteriorate commercially.
Brian Mattes, spokesman for the Vanguard fund family, which essentially invented index funds, said he does not see exchange-traded securities such as HHH or SPDRs as a threat to traditional funds: "They're designed to appeal to short-term market traders. They're priced minute by minute to appeal to people who want to trade vigorously in and out of them. . . . These are two different animals."
(The companies held by HHH are, in order of size, America Online, Amazon.com, At Home Corp., Yahoo, E-Trade Group Inc., Ameritrade Holding Corp., Network Associates Inc., Priceline.com Inc., eBay, CMGI, RealNetworks Inc., Exodus Communications Inc., Lycos Inc., Cnet Inc., Inktomi Corp., PSINet Inc., MindSpring Enterprises Inc., EarthLink Network Inc., DoubleClick Inc., Go2Net Inc.For more information, go to www.ml.com/woml/press_release/ 19990923.htm)
Fred Barbash (barbashf@ washpost.com) is The Washington Post's business editor.
What They've Get
The current top holdings of Internet HOLDRs and two top Internet funds:
Internet HOLDRs Percent of assets
At Home 7.0
Munder NetNet (A)
Cisco Systems 4.3
MCI WorldCom 3.8
Security First Tech 3.5%
Exodus Communications 3.3
EchoStar Communications (A)2.8