What are American Depositary Receipts (ADRs)? They are a great way for investors to buy overseas stocks—but on a U.S. stock exchange

What are American Depositary Receipts? An American Depositary Receipt, or ADR, is a proxy for a foreign stock that trades in the U.S. and represents a specified number of shares in the 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.

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 on the exchange where it trades.

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

When an investor owns an ADR, a custodian—Citi, Bank of New York Mellon and JPMorgan 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. It will, in turn, then charge it to a client’s account.

Sometimes, however, the foreign company pays the fees in return for the exposure to the U.S. market.

What are American Depositary Receipts worth to an investment portfolio?

ADRs make it practical for increasingly global-minded investors to invest in foreign companies, despite language barriers, shifting foreign exchange rates and the difficulty of trading on a foreign stock market.

Foreign firms benefit from ADRs by letting companies offer dollar-denominated shares and raise capital in the U.S. Issuing ADRs also raises a non-U.S. firm’s liquidity and visibility in the United States and around the world.

We believe most investors could benefit from holding some foreign investments in their portfolios for added diversification—and that ADRs are a good way to do it.

What are American Depositary Receipts? For one, a good way to buy foreign stocks and cut your risk

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”—usually a bank or broker. Since ADRs trade on U.S. stock markets, you don’t have to worry about exchange rates, foreign stock-exchange rules, or the 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.

Although most foreign stocks that trade on U.S. markets do so through ADRs, other foreign stocks trade in the U.S. as stocks, just as they do on their local stock exchange. Canadian companies, for instance, trade as stocks rather than ADRs in the U.S. just as they do on Canadian markets.

As mentioned, we believe most investors could benefit from holding some foreign investments in their portfolios for added diversification. Still, investing internationally remains riskier than investing in North America. With stock markets around the globe, you may face, apart from language barriers, uncertain investor-protection laws, and in some cases a less pronounced commitment to openness, fairness and other qualities that we tend to take for granted in established markets.

You’ll need to be highly selective with these investments. Yet they can help you cut risk, because American Depositary Receipts must follow some U.S. Securities and Exchange Commission and New York Stock Exchange rules. Note that at the same time, if you want to buy or sell stock in a company that only trades on a foreign stock market, and does not trade as an ADR, your broker may be able to process your order for you.

Bonus tip: Here’s our three-part Successful Investor approach

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight. 

Have you tried direct foreign stock market investment? What was the result?