US investors can invest in many foreign companies via American Depository Receipts(ADRs). They are basically share ownership in a foreign firm in an indirect way. In order to create an ADR for the US market, a brokers buys ordinary shares of a foreign in the domestic market and delivers them to a US-based depository bank such as BNY Mellon. Then the depository issues ADRs that are traded on the organized exchanges or the OTC market.
With that brief introduction to ADRs, below are xx of the advantages of investing in ADRs:
- Easy accessibility: Setting up trading accounts to buy in the local market in many foreign markets is difficult and complex. Many brokers may not allow direct access to overseas markets that will allow investors to buy and sell stocks in that country’s local market. So ADRs eliminates this issues and allows investors to access companies in far away countries easily. For example, it is not easy to simply open an account with a broker in Chile and buy Banco Santander-Chile in the Santiago Stock Exchange. But buying the ADR (BSAC) on the NYSE does not require any extra effort for an investor
- Diversification: The second most important advantage of owing ADRs is diversification. Since emerging, frontier and developed vary in economic growth ADRs provide an opportunity to diversify across countries. So while the US economy and the equity market may in doldrums, countries in emerging markets like Brazil or Indonesia may grow. Owing ADRs from those countries could help to boost the portfolio returns. In addition, investors can invest in hidden companies in places like Thailand or Jamaica via ADRs that institutions and others are unaware of.
- Taxes: Owing ADRs eases the pain of dealing with various tax issues. If an investor sells a common stock in a domestic market like Germany for example, then he.she is subject to the tax rules of Germany, If there is a capital gain, then the investor has to calculate and fill up the paperwork and pay taxes in Germany. Buy buying the same company’s ADR this problem does not exists. Since all dealings are in US dollars any gain or loss is easily reported to US tax system.
- Security type and currency denomination: ADRs are basically like any other US security. So they provide that benefit of reporting financial date to US authorities like the SEC. And ADRs are denominated in US dollars making it very easy for Americans to invest in them without worrying much about currency conversions and other issues.
- Dividends: All dividends paid out by foreign firms are paid out in US dollars to their ADR holders. Hence an investors is not burdened with the converting dividends from local currency to US dollars. All currency-related work are taken care of by the ADR issuer.
- Settlement cycle: Because ADRs are US securities and held in US-based depositories they follow the typical settlement cycle. This is a big advantage as some countries have settlement cycles that run into many days.
- Vast Universe: Currently over 3,000 ADRs trade on the US exchanges or the OTC market. Hence this greatly expands the pool of companies to explore and invest in for American investors. They are no longer restricted to the limited number of US firms that trade publicly. Moreover this ADR universe continues to grow as more and more foreign firms try to access capital in the US.
- Benefit from currency fluctuations: When a foreign company pays out dividends they are paid to investors in local currency. If the local currency appreciates then the US holder of the ADR will benefit since the dividends have to be converted to US dollars. Because the foreign currency has gained in value, the dividends paid out in US dollars will be more. So in addition to any gains from price appreciation of the ADR, an investor can also benefit from currency volatility. But it is also possible to receive in dividends when the same foreign currency depreciates against the dollar.
- Liquidity: Many ADRs offer ample liquidity when an investors wants to buy or sell. Sometimes an ADR may have more daily trading volume than the ordinary trading in the home market since stock market participation rate may be low in that country. This is especially true in many emerging and frontier markets where stocks are considered as highly risky by ordinary people. So an investor in the US holding a company’s ADR avoids this issue.
- Information flow: Firms that have ADRs distribute all information to investors widely in English. This allows ADRs to keep themselves fully informed of all the news regarding that company. Such information not only includes statements filed with the SEC but also includes things like press releases. For example, Colombia oil major Ecopetrol(EC) released a press release for about their divestment plan for equity held in another company. An ADR holder did not have to know Spanish or visit the firm’s website to find this information since it was distributed widely including in Yahoo Finance. Sometimes other information such as options to receive dividends in cash or stock, proxy votes, splits, rights offers, etc. are all submitted by the firms to their ADR depository and investors can go the depository site to find all the info. Big companies also send important info to ADR holders’ email if they are registered for this option.
Of course, investing in ADRs have disadvantages also. We will discuss about the disadvantages in a future post.
- FAQ: Investing Internationally With ADRs, Renaissance Investment Management
- Advantages of American Depository Receipts, American Depository Receipt.com
Disclosure: Long EC