Depositary Receipts 102: Going Global for Individual Investors Has Never Been Easier
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Anthony Moro makes it possible for Americans to buy foreign stocks. As the Managing Director and Head of Emerging Markets for Bank of New York Mellon’s (NYSE: BK) depositary receipts business, he is one of the key people in the world driving globalization in practical, tangible, and (often) profitable ways. In addition to talking about the DR business, he also took time to answer basic questions about DRs not covered by BNY Mellon’s DR website (which after researching the DR business, this author can say – without reservation – is the most user-friendly DR information source currently available to the individual investor).
Nick Slepko: Bank of New York Mellon has created the most depositary receipts to date and claims 62% of the market under that metric. The remainder of the market is divided amongst three other depositary banks [Citigroup (NYSE: C), Deutsche Bank (NYSE: DB), and JPMorgan (NYSE: JPM)]. What ’s the benefit to international investing for individual investors, and what role do depositary receipts (DRs, ADRs, GDRs, etc.) and BNY Mellon and the other depositary banks play?
Anthony Moro: Portfolio theory says to be on the efficient frontier of risk and reward you should diversify within the US as well as diversify a percentage of your holdings outside the US. So, once an investor decides to invest a portion of their portfolio outside the US they have choices. Do you buy an ETF, a mutual fund, or do you pick stocks? If you choose to pick stocks you have two choices: Do you buy in the local market or do you buy the American depositary receipt [ADR] that trades in the US? Once you come down to those two choices, it’s a no-brainer if you are an individual investor. For cost, convenience, and liquidity reasons you are going to want to buy the depositary receipt.
Slepko: How much does an investor need to know about foreign currencies to analyze an ADR – or does the ADR being in US dollars take that factor away completely?
Moro: It does add an element of diversification that modern portfolio theory says you should have. So you should welcome the currency fluctuation. But an investor should have a view on what the local currency will do against the dollar. You could pick the right stock, but you could lose on the currency. So, if you picked a Brazilian company that gained 20% in the last six months, but the currency has lost 20% in the last six months then you have broken even. Conversely, if the stock went up 20% and you had a view on the currency that went up 20%, then you’ve just hit a 40% increase. So, yes, currency is important – especially in these times with the dollar being so volatile against emerging market currencies.
Slepko: Are there special fees with DRs investors should consider, like when they look at ETFs and other funds?
Moro: You buy and sell them just like a regular US stocks, so there’s no difference in buying Toyota (NYSE: TM) versus Ford. Where you do have to be careful investing in foreign companies is that currency movements will affect the dollar price of the stock. So if the yen is up or down the price of the DR will reflect that. Of course, one of the reasons you invest internationally is for that kind of diversification. But that is one thing investors need to be careful of.
Slepko: What’s the deal with the ratio? With some, one share of the ADR is equal to one share of ordinary stock. Others are a hundred to one. What’s the reasoning behind the ratios?
Moro: It comes down to local market preferences. So in the UK, it’s okay to trade at 40-pence, whereas a 40-cent stock on the New York Stock Exchange wouldn’t be appropriate. So we would make it 10 or 100 ordinary shares to 1 DR to get the price to USD 4 or USD 40. Whereas, in Switzerland it’s appropriate to trade in USD 4,000 or USD 10,000 per share, so we have to create the opposite effect to bring the price down. In the US, you want an ADR to trade in the range of its US peers. So you want a bank to trade in the 30s or 40s, not in the 3,000s and certainly not in the penny stock range.
Slepko: Do ADRs require a special kind of reporting? Are there specific parts of annual reports that are particular to ADRs and separate from their ordinary shares?
Moro: It is slightly different. US companies do a 10-K. Foreign companies do a 20-F. They aren’t materially different…However, anything that trades over-the-counter is exempt from doing a 20-F...They get a Rule 12g3-2(b) exemption that says that if they make their financials and other critical information on their websites available in English and are listed on a foreign exchange then they are allowed to trade on the US over-the-counter market.
[continued in part 2]
Nick Slepko (hukgon) has no position in any company mentioned here at the time of publication. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
