Tetra Images / Getty Images The first ADR was created in 1927 by J.P. Morgan. This was to allow Americans to invest in shares of a British department store. Today, there are more than 2,000 ADRs available, representing shares of companies located in more than 70 countries. The Bank of New York, JPMorgan Chase, Deutsche Bank, and Citigroup are among the leading depositary banks, which create and issue ADRs. The popularity of ADRs has surged over the years. They have a number of distinct advantages that appeal to both small investors and professional money managers alike.
How ADRs Work
Let’s say you’re interested in investing in France. One option is to open a brokerage account in Paris, wire some money over there, convert your dollars into euros, and then go shopping for French stocks. This would be a difficult and time-consuming process. Also, your accountant would not be very happy with you at tax time. ADRs can eliminate these hassles. You won’t have to deal with currency conversions and opening foreign accounts. Instead, you can buy ADRs of French companies that banks and brokers make available on the American exchanges or over the counter.
Advantages and Disadvantages of ADRs
Advantages Explained
American Depositary Receipts have a number of benefits that make them an ideal opportunity for international investing, including:
Ease of use: ADRs can be bought and sold just like shares of IBM or Google.Same broker: You don’t need a foreign brokerage account or a new broker; you can use the same broker that you normally deal with.Dollar-based pricing: Prices for ADRs are quoted in U.S. dollars. And dividends are paid in dollars.Standard market hours: ADRs trade during U.S. market hours; they are subject to similar clearing and settlement procedures as American stocks.
Disadvantages Explained
By the same token, ADRs have some important limitations and drawbacks. These include:
Limited selection: Not all foreign companies are available as ADRs.Liquidity: Plenty of companies have ADR programs available, but some may be very thinly traded.Exchange rate risk: While ADRs are priced in dollars, for sake of convenience, your investment is still exposed to fluctuations in the value of foreign currencies.ADRs are like stocks: You need to buy enough of them to have enough diversification. So if you don’t have enough investment capital to spread around, say 25 to 30 ADRs (or more), you won’t be able to create a truly diversified portfolio on your own.Higher fees: ADRs can carry higher fees than traditional stocks.
Tax Considerations
ADRs have a number of unique differences relative to foreign stocks or traditional U.S. stocks that are equally important to consider. For instance, there is a significant difference in the way that taxes are charged on dividends. As with U.S. stocks, dividends are taxable in the U.S. Unlike U.S. stocks, the dividends may also be subject to tax by the company’s home country. However, they’re usually automatically withheld by the sponsor. Investors may choose to apply a credit to their U.S. taxes or apply for a refund abroad to avoid double taxation. Before investing in ADRs, you may want to consult with a financial advisor and a tax advisor to understand the implications for your portfolio.
When to Use ADRs
Once you have a bit of international investing experience under your belt, ADRs can be a powerful tool to customize your portfolio or make targeted investments in specific companies, sectors, and countries. The flexibility may be especially appealing to value investors looking to expand their reach into international markets rather than only being able to access domestic stocks. If you are just getting started in international investing, though, it’s much easier to stick with a good international mutual fund or ETF until you have a firm grasp of the basics.
