Investing in ADRs: A Guide

American Depositary Receipts (ADRs) offer U.S. investors a unique opportunity to gain exposure to international equities without the need to trade on foreign exchanges. In this guide, we will delve into the world of ADRs, exploring their benefits, risks, and how they work.

What are ADRs?

ADRs are negotiable securities issued by a U.S. bank that represent a specified number of shares in a non-U.S. company. These securities are traded in U.S. dollars, providing investors with a simplified way to invest in foreign companies without the complexities of dealing with foreign currencies and local markets.

Types of ADRs

ADRs can be issued as either sponsored or unsponsored. Sponsored ADRs involve the foreign company actively participating in the issuance and retaining a controlling relationship. These ADRs typically list on national exchanges in the U.S., such as the New York Stock Exchange (NYSE) or NASDAQ, and must meet certain qualifications. Conversely, unsponsored ADRs do not involve the foreign company and are only traded in the Over-The-Counter (OTC) market.

Benefits of Investing in ADRs

Investing in ADRs offers several key advantages:

1. Simplified Dividend Payments: The issuing financial institution collects dividend payments from the foreign issuer and converts them into U.S. dollars for the investor. This simplifies the process of receiving dividends and eliminates the complexity of currency conversion.
2. Enhanced Access to Financial Information: ADRs listed on an exchange must file quarterly results with the U.S. Securities and Exchange Commission (SEC). This provides investors with access to more detailed financial information than they would have if they invested directly in the foreign company.
3. Potentially Lower Dividend Withholding Taxes: Depending on the country and account type, applicable dividend withholding tax percentages may be lower for ADRs compared to foreign ordinary shares.
4. Increased Liquidity and Trading Options: Some listed ADRs are marginable and may have options available, providing investors with more flexibility.

Risks of Investing in ADRs

While ADRs offer convenience and potential benefits, it's essential to be aware of the associated risks:

1. Pass-Through Fees: The institutions that issue ADRs may charge quarterly or annual 'ADR Pass-Through Fees,' which include custody fees and fees for processing dividends and corporate actions. These fees can add to your overall investment costs.
2. Liquidity Issues: Liquidity for some ADRs may be low, potentially affecting bid/ask spreads. Additionally, it's important to note that not every non-U.S. company has an ADR available.
3. Program Termination: Although rare, the bank offering the ADR may decide to terminate the program for various reasons, including lack of investor interest. This could result in a requirement to liquidate the position or convert it to the underlying foreign ordinary shares.

Examples of ADRs

Numerous prominent foreign companies have ADRs listed on U.S. exchanges. Here are a few examples:

• Diageo (DEO): This alcoholic beverage company based in the United Kingdom has one ADR representing four ordinary shares.
• Infosys Limited (INFY): This India-based IT company provides business consulting, information technology, and outsourcing services.
• Siemens (SIEGY): This German energy conglomerate has two ADRs representing one ordinary share.
• Novartis (NVS): As one of the largest pharmaceutical companies globally, this Swiss multinational healthcare company provides a range of healthcare solutions.
• Total S.A. (TOT): This France-based energy company stands as the world’s fourth-largest international oil and gas company.

How to Invest in ADRs

Investing in ADRs is a relatively straightforward process. You can purchase them through various brokerage firms that offer international trading services. Follow these general steps:

1. Choose a Brokerage Firm: Select a reputable brokerage firm that offers ADR trading services.
2. Research the ADR: Thoroughly research the company's financial health, market performance, and any relevant news or events that might impact its stock price.
3. Open an Account: Create and fund an account with your chosen brokerage firm, ensuring you have the necessary funds to make your desired investment.
4. Place an Order: Use your online trading platform or contact your broker to place an order for the specific ADR you wish to purchase.
5. Monitor Your Investment: Regularly track your investment's performance and adjust your investment strategy as needed to align with your financial goals.

Conclusion

ADRs present U.S. investors with a versatile tool for diversifying their portfolios and gaining exposure to international markets. While risks such as pass-through fees and liquidity issues are inherent in ADR investments, the benefits of simplified dividend payments, access to comprehensive financial information, and potentially lower withholding taxes make them a compelling option for many investors.