ADRs (American Depository Receipts) are a great way for investors to invest in foreign stocks

Our view on foreign investing is that for most investors, U.S. stocks can provide all the foreign exposure they need. We also feel that virtually all Canadian investors should have 20% to 30% of their portfolios in the U.S. stocks that we recommend in our Wall Street Stock Forecaster newsletter.

If you want to add more foreign content, you could buy individual stocks. But for most investors, directly investing in foreign stocks can add an extra layer of risk and expense. As well, timely and accurate information about overseas companies is not always available, and securities regulations vary widely between countries. It can also be hard for your broker to buy shares on foreign markets without paying a premium. Tax rules and restrictions on transferring funds between nations add further uncertainty and cost.

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Understanding the ins and outs of ADRs

All in all, we think the best way to invest in foreign stocks is to buy high-quality firms that trade on the New York Stock Exchange as American Depositary Receipts (ADRs). An American Depositary Receipt is a U.S. traded proxy for a foreign stock and represents a specified number of shares in that foreign corporation.

ADRs are bought and sold on U.S. stock markets, just like regular stocks, and are issued or sponsored in the U.S. by a bank or brokerage firm. If you own an ADR, you have the right to obtain the foreign stock it represents. However, investors usually find it more convenient to continue to hold the ADR and to sell the ADR when it no longer serves their needs.

One ADR certificate may represent one or more shares of the foreign stock. Or, if the stock is expensive, the ADR may represent a fraction of a share; that way the ADR will start out trading at a moderate price or be in the range of similar securities trading on the U.S. exchange.

When an investor owns an ADR, a custodian—Citi, Bank of New York Mellon, and J.P. Morgan Chase are among the largest—is in charge of holding it. The custodian also maintains the records and collects the dividends paid out by the foreign issuer. It then converts those payments into U.S. dollars and deposits them into stockholders’ accounts. For all these services, the custodian charges an ADR fee.

The custodian may deduct that fee from the dividends, or it may charge the ADR holder separately. If the ADR does not pay a dividend, then the custodian will charge that fee directly to the brokerage, which in turn will charge it to a client’s account.

There are no redemption dates on ADRs. The price of an ADR and its ups and downs are usually close to those of the foreign stock in its home market.

ADRs make foreign investing much easier and safer for individual investors. The foreign company must provide detailed financial information to U.S. regulators and to the sponsor, or “depositary,” bank or broker. Since ADRs trade on U.S. stock markets, you don’t have to worry about foreign currencies or foreign stock-exchange rules or a language barrier. Price information is readily available, and transaction costs are lower. Trades will clear and settle in U.S. dollars. As well, the depositary bank or broker will convert any dividends or other cash payments into U.S. dollars before it sends them on to you.

ADRs have been around a lot longer than most other investment products. They will probably be available for years to come. That’s because they offer a convenient and reasonably priced opportunity for investors who want to access select foreign stocks.

In summary, we feel you can find all the foreign investment variety and exposure you need by confining your purchases to U.S. and Canadian stocks, plus low-fee ETFs (exchange traded funds). However, if you want to invest in a particular foreign stock, it’s generally more convenient and economic to hold ADRs of foreign stocks, rather than the foreign stocks themselves.

Do you invest in ADRs? Why or why not?