Foreign stock investing with ADRs
For a generation following World War II, investors in the United States could safely stick close to home since the American stock market represented about two thirds of all the stocks in the world. No more. Today the total market cap of U.S. stocks makes up just one third of global market value, and the trend is accelerating. Prudent investors must look for opportunities outside the U.S. in markets that are growing more rapidly and which offer diversification to enhance returns and reduce risk.
But buying shares of stock in foreign companies directly on native exchanges involves establishing separate brokerage accounts and dealing with the conversion of foreign currencies, obstacles that are too high for most of us. Fortunately, shares of many non-U.S. firms are available for purchase by American investors through the use of ADRs.
American Depositary Receipts were first created by JP Morgan in 1927 to allow American investors to purchase dollar-denominated shares in a British department store chain. Today, shares in many of the world’s finest companies can easily be purchased stateside without the hassle of currency exchange or foreign accounts.
Shares of Boeing (BA) or Microsoft (MSFT) trade directly on the stock exchanges since they are listed in the U.S. and are subject to all U.S. laws regarding accounting practices, regulatory filings and so on. Foreign firms could choose to list in the U.S. (and a very small number do). However they would be subject to substantial additional costs associated with regulatory and reporting burdens necessary to gain a U.S. listing.
Enter the ADR. Essentially a derivative security, the ADR represents a claim on a fixed number of shares of the foreign company’s stock which are held in trust. Foreign firms listing ADRs in the U.S. are still required to make certain periodic financial filings, but are frequently allowed to follow international accounting standards rather than U.S.-specific rules. Some large issuers may be required to conform to U.S. reporting standards if they wish to raise significant new capital in U.S. markets or be listed on a major U.S. exchange.
Many of the world’s biggest banks serve as trustees for ADR programs. A typical scenario is a “sponsored” ADR, where a foreign company partners with a depositary bank. A fixed number of the foreign stock certificates are deposited into the bank’s trust account and held there as security. The bank then issues new stock certificates that will trade on the NYSE, NASDAQ or Over-theCounter (OTC) markets in U.S. dollars. However, the traded shares are really just placeholders for the actual company stock sitting in the bank vault. In essence a new security is created which should be expected to perform very similarly to the original company stock over time but allows ordinary American investors to purchase indirect ownership in the foreign company.
The custody bank also tracks and transmits dividend payments, stock splits and other transactions and forwards them to the U.S. ADR owners. Owners of ADRs are also subject to foreign taxes just as if they owned the actual company stock. It is an elegant solution for American investors seeking an easy way to own non-U.S. companies without the foreign exchange risks. Typically, a small custody fee is charged by the bank, which is deducted from any dividend payments prior to distribution the shareholder.
There are nearly 2,000 ADRs listed on US exchanges or available OTC. Many familiar global brands including Toyota, BP, Nestle, Sony and Volkswagen are available to American investors via ADRs, and the list continues to expand as globalization proceeds inevitably forward. Fortunately, as the world becomes more interconnected, we can all benefit by investing in global growth right here at home.