Build a Global Portfolio With ADRs

American Depositary Receipts offer Canadian investors a lot of advantages for building a well-diversified portfolio.

| More on:
The Motley Fool
You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

With Canada comprising roughly 4% of the global stock market, the case for investing outside our borders is much stronger than it would be for American investors, who can get exposure to about half the world’s market cap strictly through U.S. stocks. Add the fact that many of those will be U.S.-based global multinationals, and an American is arguably getting a good dose of global exposure just by staying in the home market.

Not so in Canada, where the domestic market is concentrated in just three sectors of the Canadian economy: energy stocks, materials, and financials. There’s also a feeling among Canadian investors that for all the above reasons, the U.S. should be the first port of call for non-Canadian stock exposure. (I recall a long discussion forum thread once titled “The U.S. is the only market worth investing in.”)

Arguably no other country’s security markets have the rule of law and securities protection that America possesses. But once you leave the comfort of the North American market and perhaps a few major European centers—the U.K. and Germany, for instance—the risks go up. Just take a look at the bubble in the China market.

Yes, you can take a globally diversified approach through exchange-traded funds (ETFs) or mutual funds that have a global equity mandate, but if you prefer to invest in individual stocks that conform to U.S. accounting standards, you might want to investigate American Depositary Receipts (ADRs).

Wikipedia defines ADRs as negotiable securities that represent securities of a non-U.S. company that trades in the U.S. financial markets. ADRs are listed on the NYSE, Amex, Nasdaq, and over the counter. They tend to be large, well-known companies with a global footprint.

Examples from my own portfolio include the ADRs of Japan-based Toyota Motor Corp. (NYSE: TM), Netherland-based Unilever plc (NYSE: UL), and UK-based Diageo plc (NYSE: DEO). All of these are denominated in and pay dividends in U.S. dollars. As Wikipedia points out, they simplify investing in foreign securities by having the depositary bank “manage all custody, currency, and local tax issues.”

By the way, if you’re a fan of the PBS TV show Mr. Selfridge you’ll find it of interest that the first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges on the New York Curb Exchange, which was the precursor to the American Stock Exchange.

ADRs, explained

An ADR can represent a single share of a foreign security but it can also represent a fraction of a share or multiple shares. Whichever it is, the price will track proportionately that of the foreign security in its home market.

While I’ve never experienced it personally, ADR programs can be subject to possible termination and delisting, which may occur during reorganizations or mergers. This should be no more traumatic for the investor than with regular shares undergoing similar events. You’ll be notified 30 days in advance, after which you could surrender the ADRs and take delivery of the foreign securities represented by the ADR. Alternatively, you can tender the shares for cash.

There are several reasons why an American investor might want to use ADRs, but the biggest is that trading costs tend to be lower with ADRs than if you bought the equivalent security in its home market. Also, you do not have to pay capital gains taxes in the country of origin—just U.S. taxes.

Minor pitfalls

Like any investment, there can be minor disadvantages. There may be some delay in forwarding of regulatory documents like proxies, and there may be extra fees in certain countries. For example, in the UK, ADRs attract a 1.5% stamp duty reserve tax; there should be offsetting tax credits for most investors in this situation.

Finally, there is foreign exchange risk: while the ADR is in U.S. dollars, the underlying investment will be subject to fluctuations in the foreign currency. And, of course, a Canadian owning an ADR will also be exposed to fluctuations in the U.S. and Canadian exchange rate.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Jonathan Chevreau runs the Financial Independence Hub and can be reached at [email protected]. He owns shares in the ADRs of Toyota, Unilever, and Diageo.

More on Investing

Hands holding trophy cup on sky background

3 Growth Stocks That Could Be Huge Winners in the Next Decade and Beyond

Here are three top TSX growth stocks that may be worth a look, given the significant valuation declines these stocks…

Read more »

edit Back view of hugging couple standing with real estate agent in front of house for sale
Dividend Stocks

Why Real Estate Stocks Are a No-Brainer Addition to Your Portfolio

Real estate stocks, especially REITs, offer some distinct advantages over other types of stocks, making them must-have additions to most…

Read more »

Man data analyze
Stocks for Beginners

Beginners: 2 Market-Beating Stocks Just Getting Started

Brookfield Asset Management (TSX:BAM.A)(NYSE:BAM) and Constellation Software (TSX:CSU) are proven market beaters that could continue their ways.

Read more »

oil and natural gas
Energy Stocks

Small OPEC+ Oil-Output Hike: Buy More Energy Stocks?

Energy stocks could soar higher, because oil markets will remain tight due to the small production increase by OPEC+.

Read more »

Various Canadian dollars in gray pants pocket
Dividend Stocks

3 Top TSX Dividend Stocks to Buy for Monthly Passive Income

Top TSX stocks with monthly dividends now trade at cheap prices for investors seeking passive income.

Read more »

edit Person using calculator next to charts and graphs

Where to Invest $500 in the TSX Right Now

Long-term investors can look to buy stocks, including Suncor Energy and Shopify, as they are poised to outpace the broader…

Read more »

Canadian Dollars
Dividend Stocks

Create Free Passive Income and Turn it Into Thousands With 1 TSX Stock

If you can't afford to invest, you can certainly create passive income another way and use that to invest in…

Read more »

falling red arrow and lifting

2 Oversold TSX Stocks That Should Bounce Back

Stocks that are oversold without an external catalyst like a market crash or a weak sector might be risky buys,…

Read more »