Invest Internationally with ADR’s
Posted by Richard on March 13, 2014
The potential benefit of global investment has tantalized investors for decades.1 A portfolio whose holdings are diversified across national borders may have lower overall volatility and higher average returns than a collection of investments in any single economy.
While the bottom-line benefits of foreign investment may be attractive, the purchase of stock through a foreign stock exchange can be a protracted and costly process. What’s more, investors in international securities may face additional risks. Currency market volatility can have an impact on asset values that is independent from the performance of the asset, and political instability may be greater than U.S. investors are accustomed to.
American Depositary Receipts (ADRs) can eliminate many of these investment risks and costs.2 An ADR is like a stock certificate good for a specified number of shares in an overseas company, and the price of an ADR is linked to the price of the company’s stock in its home country. ADRs are denominated in U.S. dollars, with dividends paid in U.S. dollars. Foreign companies that sponsor listed ADR programs in the United States issue financial reports in English, and these reports generally conform to U.S. accounting conventions. These companies also file required disclosure statements with the Securities and Exchange Commission.
Companies that meet all U.S. reporting and disclosure rules are permitted to raise capital directly from U.S. investors by issuing new stock specifically to be represented by ADRs. Companies that meet a more limited set of SEC reporting requirements are permitted only to sponsor ADRs that represent shares previously issued in their home markets.
It’s important to remember that even though they are denominated in dollars, ADRs are not immune to currency fluctuations. Because shares and distributions from the underlying stock originate in the foreign company’s native currency, any movements in that currency could affect the ADR’s share price and the value of distributions.
The main appeal of ADRs for American investors is convenience. They allow for ownership of shares in foreign companies without the worry of complications such as trading on foreign exchanges or currency conversion. Tax treatment also is similar to that of U.S.-based stocks except that dividend payments might be subject to a withholding tax from the stock’s home country.
There are costs associated with this convenience, however. The issuing depositary bank often charges a fee for administration of the ADR and this is usually subtracted from dividends to be paid out to shareholders. If the foreign company underlying the ADR doesn’t pay a periodic dividend, shareholders might be charged a fee directly.
There are currently more than 2,000 ADRs from over 70 countries, including Great Britain, Japan, China, and Brazil. Some of these companies are listed on the major exchanges (New York Stock Exchange or Nasdaq). Additionally, there are ADR indexes and exchange-traded funds that track them.
1Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, and may not be suitable for all investors.
2Investing in stock involves risk, including loss of principal.
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