U.S. depositary receipts are a pure investment play But beware lack of liquidity, effects of exchange rates.
Want your investment portfolio to keep time with the sizzling hot emerging markets of India and China, but you’re leery of the fee structures woven into many mutual fund products?
Ideally, Canadian investors would be able to play worldwide stock markets — even those in developing countries run by less-than-democratic governments — with the same ease with which we now buy shares on the New York Stock Exchange or even on the London Stock Exchange.
Just try asking your Canadian broker to pick you up some shares of China National Offshore Oil, which is listed on the Shenzhen Stock Exchange, however, and watch how quickly her eyes glaze over in consternation.
Even if your broker accepts your audacious challenge and is able to find a trusted foreign-licensed broker to help her wade through the morass of bureaucratic red tape, institutional inefficiencies, stamp taxes and other state levies, fees and commissions — possibly even expectations of graft — entrenched in the equity trading regimes of some developing countries, you’ll pay dearly for the privilege.
Along with your broker’s standard commissions, you’ll be charged a hefty “jitney fee,” which can range from 20 to as high as 200 basis points for trades on smaller exchanges in developing countries, for your time-consuming overseas transaction.
Your share purchase may also not be processed at the time you expect either — resulting in some potentially nasty surprises on both foreign currency conversions and on your trading price — due to differences in time zones, and local trading hours and customs, not to mention wildly unpredictable “settlement dates,” which on some smaller exchanges take place only once or twice a month.
“There are some jurisdictions in developing economies that make it exceedingly difficult for foreigners to trade on local stock exchanges,” says Jim Porter, an executive vice-president with HSBC Securities Canada Inc.
“For a Canadian investment firm settling a transaction in a European country, even the U.K. or the Far East, for example, can be quite time-consuming and difficult and expensive.”
Fortunately, there is a much easier way for sophisticated investors to get a pure investment play in foreign-listed shares, thanks to American depositary receipts, which were created in 1927 to make it more convenient and less costly for U.S. citizens to invest in Mexican companies, says Porter.
Depositary receipts — known as ADRs south of the border and global depositary receipts (GDRs) in Canada and overseas — are foreign-listed shares held by U.S. banks, trust companies and other financial institutions (or Canadian or European financial institutions in the case of GDRs) and bundled into packages that are represented in a receipt that is then traded on the New York Stock Exchange, Amex or Nasdaq or another major exchange as if it were normal stock.
The underlying shares for the ADRs stay with the depositary institution and never change hands, although any distributions are passed on to ADR holders, where they receive the same tax treatment as any other share dividend.
Because share prices in developing countries are often very low by North American standards, making them affordable to local citizens, ADRs often bundle several shares into a single unit to make the U.S. listing price more substantial.
“For the average or smaller investor, ADRs are much more convenient and less costly typically than investing in the shares by purchasing them through a brokerage overseas through a North American brokerage,” says Porter, who notes that many large institutional money and fund managers trade in ADRs as well.
In fact, you don’t even need your broker to buy an ADR for, say, shares in China National Offshore Oil on the New York Stock Exchange, but could easily do so using your low-fee online direct trading account, says Peter Beck, president of Swift Trade Inc.
Certainly there’s no shortage of ADRs to choose from. According to the Bank of New York’s dedicated website, http://www.adrbny.com, there are ADRs representing 2,085 different foreign-trading stocks currently trading on the New York Stock Exchange, Amex or Nasdaq.
The website also tracks ADRs in 57 indexes grouped by sector, region and country. There are 141 listings for ADRs of shares offered by India companies and 60 listings for China.
In Canada, depositary receipts are not widely used, with none currently listed on the TSX, perhaps because the trading volumes needed to support a non-mainstream product just isn’t there, say those in the financial services industry.
“We had a few list GDRs in the ’90s, but they have all subsequently delisted. They typically had liquidity issues because investors trade where there is liquidity and the GDRs lacked liquidity,” says Steve Kee, director of media relations for the TSX Group Inc.
“I think GDRs were typically mining companies. We now are seeing foreign companies listing here directly or Canadianizing instead.”
Attractive as depositary receipts are, they are high-risk vehicles only suitable for sophisticated investors, with some unique issues to watch out for, caution advisers.
While most ADRs are sponsored independently by respected banks and financial institutions, which require detailed financial disclosure from the company, a few companies solicit institutions to sponsor their shares as ADRs to gain exposure to North American markets.
“It’s critical Canadian investors should look very carefully at foreign investments, whether it be in China, India or so on, and seek advice beforehand from companies and advisers who have specific knowledge in those regions,” says Porter.
“The other side is that while the ADR does represent shares in the underlying company, the tracking of share price may not be perfect,” he says.
“That may be for reasons of liquidity. It may be exchange rate, timing differences and so on. It’s a pretty darn good representation of the underlying shares but it’s important for the investor to know that it may not track exactly at the same level.”
Arbitrage activity can often be seen when an ADR’s price veers too far from the price of the foreign-listed share, he says.
As well, most ADRs are nowhere near as liquid as the underlying foreign-listed stock so it just won’t trade in the same kind of volumes and is spread in a relatively small market, though a retail investor’s ability to see is rarely a problem, says Porter.
(Institutional interest helps along many of the blue-chip ADRs, such as those built on the Finland-listed shares of Nokia Corp., for which almost 34-million ADRs changed hands in a single day in January.)
As well, of course, the downward movement of the American dollar in comparison with the loonie could diminish the value of your U.S.-listed ADR holdings.
By Beth Marlin
Source: Toronto Star
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