Globalization of world securities markets has sparked many American investors to look overseas as a way to diversify their portfolios. For most of them, mutual funds provide the easiest way to invest in Nestle, Louis Vuitton, Sony, Mazda and other major foreign companies.
Investors who prefer individual securities have two choices: buy individual shares directly from overseas stock exchanges, or buy American depository receipts (ADRs), which allow U.S. investors to buy and sell in this country shares of companies traded on foreign exchanges.
Many American investors will get their first taste of ADRs without even asking for them. In the wake of the merger between Chrysler and the German auto manufacturer Daimler-Benz AG, Chrysler shareholders will be issued American depository receipts in place of their Chrysler stock.
So, what exactly are American depository receipts? Technically, they are negotiable registered certificates that stand in for the underlying stock (or in a few cases, bonds) of foreign companies. The certificates are quoted in US. dollars and dividends are paid in US. dollars. ADRs are traded on the major U.S. stock exchanges or over-the-counter.
ADRs are issued in two basic versions. The most popular version today (a reversal of only a few years ago) is "sponsored" ADRs. These are created when a foreign company appoints a depository, typically a US. bank with a branch or correspondent in the company's country.
The bank then issues certificates that represent claims on the foreign shares. A single ADR may represent a single share of the company, a portion of one share or several shares, depending on what will make the newly issued ADR share price reasonable by American market standards.
There are actually three forms of sponsored ADRs: Level I, II or III. Level I requires less financial disclosure by the foreign company. These are not listed on U.S. exchanges but are traded over the counter.
Level II and Level III require more disclosure, the translation of financial statements into English and the reconciliation of financial statements with U.S. accounting standards.
Unsponsored ADRs don't have the direct participation by the company and offer even less information than Level I sponsored ADRs. There were roughly 1,500 sponsored ADRs, the bulk of them Level I, at the end of 1997, and only 320 unsponsored ADRs.
Although ADRs are more liquid and generally easier to trade than owning individual foreign stocks, there are not nearly as many ADRs as there are foreign stocks.
That's one reason international mutual funds are often a better choice for many investors, because they can get access to stocks not available through ADRs. Also, American investors hold misconceptions about ADRs that can lead to costly investing decisions.
First, although an ADR can be bought on a U.S. stock exchange in American dollars, the underlying shares still trade in the currency of the country that's home to the company. Thus, ADRs are subject to currency risk.
If the price of the ADR rises, but the currency weakens against the dollar, the gains may be reduced or wiped out. The investor could be hit with a double whammy if both the stock price and the currency weaken simultaneously. (This isn't as much of a problem if the company is a multinational operation, but it's still a risk.)
A second issue is the foreign withholding of taxes on dividends. An American investor's dividends will be smaller than publicly stated because foreign taxes are withheld.
Investors may get back the dividends withheld to pay for the foreign taxes when they file their U.S. tax return, but it can be complicated. (The same issue applies to any foreign investing, including through mutual funds.)
Nonetheless, American depository receipts are growing in popularity. Sophisticated investors who prefer to invest in individual stocks instead of mutual funds, and who want to broaden their horizons beyond American shores (two-thirds of the world's market capitalization lies overseas), may find ADRs a useful vehicle.
(The preceding article was produced by the Institute of Certified Financial Planners and provided by William O. Woody, CLU, ChFC, CFP, of Stovall Woody Associates.)
American depository receipts are quoted in
and dividends are paid in U.S. dollars.[[In-content Ad]]
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