American Depository Receipts (ADRs) are growing in popularity as investors increasingly set their sights on foreign equity markets. Demand for global investments has intensified since the 2016 U.S. presidential election, which signaled a paradigm shift in domestic politics. Although optimism about President Donald Trump’s pro-growth policies remains high, income investors are concerned about a political backlash should the proposed agenda fail to make headway. This could not only unravel the monumental gains enjoyed on Wall Street but also undermine confidence in the financial markets.
An ADR is one such way for investors to diversify into foreign equity markets without having to invest through international mutual funds or purchase stocks on foreign exchanges. An ADR represents a share in a foreign company trading on one of the main U.S. stock exchanges, such as the New York Stock Exchange, Nasdaq or over-the-counter market. Technically speaking, an ADR is a negotiable certificate issued by a U.S. bank that represents one or more shares in a foreign equity. The number of shares is usually disclosed in the company’s ADR prospectus.
Investors have many options in choosing ADR stocks. One of the most popular European ADR stocks is Unilever NV (UN ), a London-based household products company that has one of the highest trading volumes of any ADR. The company’s ADR ratio is 1:1, which means one ADR represents one underlying Unilever share. For Unilever’s complete dividend history, click here.
While you are on UN, you can also see our dedicated page on high-yield foreign dividend-paying stocks.
Through ADR stocks, investors can realize the capital gains and dividend gains in U.S.-denominated investment accounts. ADRs are likely to grow in popularity as investors seek greater exposure to foreign dividend stocks to protect their portfolios against uncertainty stemming from the Trump administration. As the global economic recovery gathers pace, investors will also seek to capitalize on expanding markets in both advanced and emerging economies.
ADR Structure and Settlement Process
An ADR is structured uniquely in that U.S.-listed companies are backed by foreign company shares held in trust by a U.S. bank. ADR shares may be fixed as one, as is the case of Unilever, or any specified number of the foreign stock exchange shares. This figure is usually expressed as a ratio, such as 1:1 or 3:1. Income investors must know the translation rate to calculate share prices and dividend payment.
The trustee bank that holds the foreign shares backing an ADR will collect dividends paid in foreign currency and convert them into U.S. dollars to be paid out to the U.S. shareholder. Due to currency fluctuations, investors won’t know the dividend amount until the actual payment date. In most cases, the dividend is subject to taxes that are withheld prior to the payment being issued. However, U.S. investors may claim a tax credit if their ADR shares are held in a taxable account.
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Advantages of ADR Stocks
ADR stocks have numerous advantages, including the following:
- Diversification: ADR stocks are one of the best ways to gain diversification into foreign stocks. Diversification in international markets is an essential element of a well-rounded portfolio.
- Investing in U.S.-Denominated Accounts: Rather than convert your cash into a foreign currency, an ADR allows your foreign investment to be made in U.S. dollars.
- Dividend Payments: Income investors looking for the benefits of recurring dividend payments can find great benefit in ADR stocks, which are also eligible for dividend payments.
- Convenience: An ADR is the most convenient way to invest in foreign stocks. Rather than exchange your currency and buy foreign stocks listed on foreign exchanges, you can use greenbacks to invest in that company directly on a U.S. exchange.
- Participate in Currency Movements: Since ADR stocks are converted into U.S. dollars from their source currency, investors can capitalize on favorable currency fluctuations.
Disadvantages of ADR Stocks
Though providing significant benefits, ADR stocks also have several disadvantages. Those include:
- Currency Risk: Foreign currency exposure is a two-sided coin. Although your ADR stock benefits when the dollar rises, it can also weaken in the event the U.S. currency tumbles against its foreign counterpart.
- Selection Choice: Unfortunately, not all leading foreign stocks are available via ADR, which means your choice is often limited.
- Illiquidity: Some ADRs may also be subject to poor liquidity, especially if they aren’t as well known in the United States.
- Taxes: Since the underlying investment is held overseas, ADRs may be subject to taxes on dividend payments.
- Additional Fees: The holding vehicle for the ADR stock is subject to other incremental fees, such as the cost of managing the entire investment process.
The following table includes vital information for five popular ADR stocks, as of June 2017.
|ADR Ticker||Stock Name||Headquarter(s)||Dividend Yield||Annual Dividend||Stock Price|
|London, UK and Rotterdam, Netherlands||2.35%||$1.30||$55.38|
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The Bottom Line
Although U.S. stocks continue to trade near record highs, uncertainty is driving market participants to greener pastures in foreign markets. Fund managers have already begun to pivot toward Europe, according to Bank of America Merrill Lynch (BAC ), which recently said that a record number of fund managers believe U.S. stocks are overvalued. As the global economy regains momentum, the push to globalize investment portfolios will only grow.
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