A look at ADRs as an investment mechanism, along with the benefits and risks associated with the financial instrument.
After a strong monthly performance in August for stock markets in the United States, with the S&P 500 recording its biggest August gain since 1986, Wall Street’s rally in September came to a juddering halt on worries about the country’s economic recovery and deteriorating relations between Beijing and Washington. In fact, major indexes reported their first monthly decline in September since March, when a pandemic-led crash plunged the markets to multi-year lows. October has begun on a wobbly note as well, especially in the wake of U.S. President Donald Trump testing positive for the novel coronavirus.
Such market behaviour brings the focus back on reducing risks in an investor’s portfolio by widening the kinds of companies one invests in and choosing high-quality global names. But, is it possible for investors in U.S. equities to park their funds in an international firm such as Alibaba or Toyota Motor Corp that is not based in the United States but available to trade on U.S. exchanges? Here’s where you can look to another financial instrument — the American Depositary Receipt (ADR).
ADRs are shares issued in the United States from a foreign company through a depositary bank intermediary. The foreign company works with a U.S. depositary bank as the intermediary for issuing and managing the shares. With ADRs, investors can choose from a list of several global companies that are not based in the country but have strong growth potential or a proven track-record.
How does it work?
A U.S. depository bank will usually issue a negotiable certificate, an ADR, that will represent a specific number of shares of any non-U.S. firm. This ADR can then be traded on U.S. stock markets, just like other U.S.-based companies would. ADRs are also categorised into three levels — I, II and III. Level I can be traded over the counter without being listed on any exchange, while Level II and III must be listed on bourses. Level III also helps companies raise capital.
For instance, you can choose to invest in ADRs of China-based Alibaba Group that are listed on the NYSE.
ADRs assume significance for investors, especially after how 2020 has proven to be topsy-turvy. They are the right instrument that help in diversifying your stocks portfolio by adding high-performance companies or brands from around the world and cashing in on their growth stories. ADRs will also help offset risks from any weak performance in U.S.-based companies, thereby ensuring your portfolio does not suffer huge losses.
There are thousands of ADRs available for investors to trade in the U.S. markets. Investors can take their pick with marquee names such as Alibaba Group, electric-vehicles maker Nio, iron ore producer Vale SA, global automobile major Toyota Motor Co, or even AstraZeneca, the British-Swedish pharmaceutical company in the frontline to develop a coronavirus vaccine.
To help you understand the upbeat performance of ADRs even in a turmoil year like 2020, here’s a look at the year-to-date performance of some of these ADRs.
The above graphic exhibits some of the popular ADRs available for U.S. investors and their performance in 2020 so far. The likes of Nio Inc, BioNTech and JD have given multi-fold returns, while one of the most sought-after ADR, Alibaba Group, has also added nearly 36 percent to its value this year so far.
Investing in ADRs
While ADRs have their set of big advantages, no investment mechanism is devoid of risks or disadvantages. Investors must understand the risks associated with currency fluctuations as well as transparency challenges that come with different levels of ADRs.
In the interest of accessing good quality companies with a thorough track-record of disclosures, retail investors can consider between Level II and Level III ADRs to place their bets.