By Peter Mastrantuono
American Depository Receipts (ADRs) are tradable certificates issued by American banks that represent a defined number of shares of a foreign company. For example, one ADR may represent two shares of a company based overseas.
The process of creating an ADR is simple: The sponsoring U.S. bank accepts shares of the foreign company, and, in turn, issues ADR certificates to investors over an exchange, after which they trade like any publicly traded U.S. stock.
Where there is an agreement between the bank and foreign company to offer an ADR, these ADRs are known as sponsored ADRs. In some cases, a bank may issue an ADR without a legal agreement with the underlying company. These ADRs are known as unsponsored.
There are a number of advantages and disadvantages to investing in ADRs.
Advantages of ADRs
- Access to overseas investment opportunities is made much easier, avoiding the complications of executing trades on a foreign exchange and the foreign tax implications of buying and selling shares in a different country.
- Investors do not need to open a foreign brokerage account or work with an overseas brokerage firm to trade in stocks that are available in ADR form.
- All pricing is based in U.S. dollars.
- Trading occurs during normal U.S. market hours.
- Companies whose shares are available through an ADR generally adhere to Securities and Exchange Commission (SEC) rules on information dissemination and financial reporting.
Disadvantages of ADRs
- ADRs have the same risks normally associated with international investing, including currency, political and social risks.
- There is a limited selection of ADRs, so not all large companies in all major markets are available, which may limit its value in creating a diversified international exposure in investor portfolios.
- While ADRs may be a way to express an outlook on a particular country’s economic growth prospects, the available ADRs of companies in that country may not be an effective proxy for investing in a particular country.
- ADRs may not be as liquid as U.S. stocks, meaning that entry and exit points on any trade may not always be done at the best or most efficient price.
- Dividend payments may be subject to foreign taxes, in addition to U.S. taxes.
- Unsponsored ADRs do not provide investors with voting rights.
- Unsponsored ADRs may not be in full compliance with SEC rules and regulations.
Three Levels of ADRs
An ADR program exists on one of three levels, which differ in terms of listing and financial reporting requirements.
Under Level One, ADRs are traded Over-the-Counter and have minimal reporting requirements. With Level Two, ADRs are listed on a U.S. stock exchange and the company must meet that exchange’s listing requirements, as well as certain, though not all, SEC reporting requirements. Level Three, which is typically used when seeking to raise capital, companies must meet substantially the same reporting requirements of a U.S. company.
ADRs may not be the best approach to creating an internationally diversified portfolio, but they may be appropriate for investors looking to make tactical investments to enhance portfolio returns. Individuals looking to invest in ADRs may benefit from the experience of a financial advisor and the research resources to which he or she has access.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.