What is ADR?
Key Takeaways
● An American Depositary Receipt (ADR) is a certificate issued by a US bank that represents shares in foreign stock.
● ADRs represent an easy, liquid way for US investors to own foreign stocks.
● The pros of ADR include easy tracking and trading, availability through US brokers, denomination in dollars, and may help provide portfolio diversification.
● The cons of ADR include double taxation, a limited selection of companies and other fees that investors may incur.
Understanding ADR
American Depositary Receipt (ADR) refers to a negotiable certificate issued by a US depositary bank representing a specified number of shares of a foreign company's stock.
The ADR trades on US stock markets as any domestic shares would. ADRs offer US investors a way to purchase stock in overseas companies that would not otherwise be available.
Foreign firms also benefit as ADRs enable them to attract American investors and may be able to raise capital without the hassle and expense of listing on US stock exchanges.
ADRs are created when a non-U.S. company or an investor who holds the underlying foreign securities delivers them to either a "depositary" bank in the U.S. or a custodian in the foreign company's home country.
ADRs are listed on either the New York Stock Exchange (NYSE) or the Nasdaq, but they are also sold over-the-counter (OTC).
An ADR may represent the underlying shares on a one-for-one basis, a fraction of a share, or multiple shares of the underlying company. The depositary bank will set the ratio of ADRs per home-country share at a value that they feel will appeal to investors.
Because of arbitrage, an ADR's price closely follows that of the company's shares on its home exchange. (Note: Remember that arbitrage refers to buying and selling the same asset at the same time in different markets, which allows traders to profit from any differences in the asset's listed price. )
Before ADRs were introduced in the 1920s, American investors who wanted shares of a non-US listed company could only purchase them on international exchanges, an unrealistic option for an average person back then.
ADRs were developed due to the complexities involved in buying shares in foreign countries and the difficulties associated with trading at different prices and currency values.
J.P. Morgan's (JPM) predecessor firm Guaranty Trust pioneered the ADR concept. In 1927, it created and launched the first ADR, enabling US investors to buy shares of famous British retailer Selfridges and helping the luxury department store tap into global markets. The ADR was listed on the New York Curb Exchange.
After a few years, in 1931, the bank introduced the first sponsored ADR for the British music company Electrical & Musical Industries (also known as the EMI), the eventual home of the Beatles.
Advantages and Disadvantages of ADRs
As with any investment, there are distinct advantages and disadvantages of investing in ADRs. We've listed some of the main points below.
Advantages
As previously stated, ADRs are like stocks. This means that they trade on an exchange or over the counter, making them relatively easy to access and trade.
Purchasing ADRs is easy because they're available directly through American brokers. And since they're available domestically, shares are denominated in US dollars, which means you avoid any direct risks associated with exchange rate fluctuations.
One of the most obvious benefits of ADRs investment is that investors may help diversify their portfolios.
Disadvantages
The main problems associated with ADRs are double taxation, both locally and abroad.
Unlike domestic companies, there are a limited number of foreign entities whose ADRs are listed for the public to trade.
Even if investors can avoid any direct risks brought by currency exchange, they may incur fees (such as fees relating to the distribution of dividends, foreign currency exchange, voting of shares, etc.) when investing in ADRs.
(Note: Diversification is an investment strategy that can help manage risk within your portfolio, but it does not guarantee profits or protect against loss in declining markets. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks.)
Difference between ADR and ADS
American Depositary Receipts (ADRs) allow foreign equities to be traded on US stock exchanges. In fact, this is how the stock of most foreign companies trades in US stock markets. Meanwhile, an American Depositary Share (ADS) is the actual US dollar-denominated equity share of a foreign-based company available for purchase on an American stock exchange.
For instance, if a US investor wanted to invest in CanCorp, the investor would need to go to their broker and purchase a number of ADRs that match the amount of CanCorp shares. In this case, the ADRs are the receipts that the investor has to purchase, whereas the ADSs represent the underlying shares (CanCorp) that were invested in.