Diversifying your investment portfolio doesn’t just involve investing in different types of stocks or bonds. By investing in foreign markets, you can lower your overall investment risk and potentially increase your earnings at the same time. If you’re interested in investing in an international market, one way to get started is to get an American Depositary Receipt (ADR). Here’s everything you need to know about ADRs.
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When you invest in American Depositary Receipts, you’re essentially investing in foreign stocks. ADRs are certificates that represent negotiable securities, or shares, of a foreign company that trade in the United States.
ADRs are typically issued by U.S. banks and brokerage firms. Like regular stocks, they can be traded on major stock exchanges like the Nasdaq and the New York Stock Exchange and you can purchase them in denominations of U.S. dollars. The dividends you receive are also converted to U.S. dollars.
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Types of ADRs
There are four different types of ADRs to invest in. Unsponsored ADRs are traded on the U.S. over-the-counter market using existing shares without a formal agreement between the foreign company and the bank issuing the ADR. Unsponsored ADR programs are driven by broker and investor demand. Sponsored ADRs, on the other hand, always involve a legal relationship between a foreign company and an ADR. They each have different levels of regulation.
Sponsored level 1 ADRs trade in the over-the-counter market, but have low reporting requirements. The company does not need to issue reports in the U.S. or under U.S. accounting standards. They are listed on a foreign stock exchange and issue a report in English in their home country.
Sponsored level 2 ADRs can trade on a stock market like the NYSE or the Nasdaq. This means the company must register with the SEC and issue reports in the U.S. in line with U.S. standards each year.
Sponsored level 3 ADRs are for companies that want to raise capital and gain visibility in the U.S. financial markets. They are a public offering on a U.S. exchange. They are regulated to a higher degree, similar to the standard for domestic companies.
You should be able to buy ADRs through your usual stock broker. In some cases, however, you may need to call around until you find a broker who can help you make a trade. Once you understand how ADRs work and why you might want them in your portfolio, you can work with your broker or financial advisor to get started.
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ADRs offer an easy and affordable way to invest in foreign companies. They also reduce administration costs and foreign transaction costs. Despite these benefits, however, there are risks that go along with investing in ADRs.
Folks who invest in ADRs could lose money by investing in markets with unstable currencies. Inflation rates could also be an issue if high inflation reduces the value of the currency in the country you’re investing in. Political and social issues are two other problems that you might have to consider when investing in foreign markets.
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