Should a client’s investment plan include American Depository Receipts (ADRs) for international exposure?

“ADRs can play a significant role,” says Joe Costigan, director of equity research at Bryn Mawr (Pennsylvania) Trust, cautioning that investors shouldn’t rely solely on them for international diversification. To do so would compound the risks of investing in individual stocks.

ADRs, bank-issued securities that represent shares of foreign stocks that trade in the U.S., can provide the benefits and drawbacks of individual U.S. stocks.

“The best strategy for advisors can be mixing ADRs with funds to get the desired international coverage,” says Jun Zhu, a senior analyst with the Leuthold Group, an institutional research firm in Minneapolis. She also likes GDRs, global depository receipts that may trade on the London, Frankfurt and Luxembourg stock exchanges.

“If an advisor’s firm has the capacity to analyze stocks, ADRs and GDRs can play a role in international allocations,” she says.

MULTIPLE BENEFITS

Costigan notes that because funds and other pooled investments come with costs, clients can eliminate a layer of costs, potentially boosting returns, by investing in ADRs. “You also have more flexibility and control with ADRs,” he adds.

Clients often can do more tax planning if they can take gains or losses on individual ADRs, according to Costigan. “Investors can be more specific about industry sectors and end markets, too,” he says. “If an advisor wants emphasis, say, on energy or health care in China, that might be accomplished by choosing selected ADRs.”

Costigan provides the example of a client with an international equity allocation in the 20%-30% range. “An advisor might use ADRs for one-third of that allocation,” he says, “and use pooled investments for the other two-thirds. That would drive down the total costs and allow the advisor to tailor the client’s international equities in the desired manner, coordinating the ADRs with the fund holdings. Altogether, it’s hard to make a case for not considering ADRs.”

LEARNING THE LIMITS

He warns, however, that “ADRs from the developed markets of Western Europe might resemble U.S. stocks in the quality of their reporting and the depth of the market. However, ADRs from developing countries may be more volatile, if the home capital markets are thinner.”

Zhu notes that depository receipts typically represent large-cap companies, and they might have limited sector exposure. “ADRs and GDRs from emerging markets often are financials or energy companies,” she says, “while consumer discretionary issues may not be available. The best strategy for advisors can be mixing ADRs with funds to get the desired international coverage.”

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.