American Depositary Receipts, or ADRs, give you ownership of companies based outside Canada and the United States. This will further diversify your portfolio by industry and geography.
ADRs give you industries that Canada lacks or has in short supply. This can let you earn more while reducing your risk. ADRs let you diversify by currency and country since they generate most of their sales and profits abroad.
We think ADRs have a place in most portfolios. (ADRs and U.S. stocks should make up at least a quarter of your stock portfolio, depending upon your circumstances.)
You should diversify by buying foreign stocks. When it comes to investing directly in foreign stocks, you could try to buy them on whatever exchange they trade on. Or you could invest in them through ADRs. These trade on American stock exchanges and give you an extra measure of safety through their registration with a U.S. trust company or bank.
Buy abroad what you can’t buy at home
Our ADR picks deliberately exclude most natural resources, financial stocks and some utilities. After all, the Canadian market offers lots of resource companies, financial institutions and high-yield utilities (that face no withholding tax but instead benefit from the Canadian dividend tax credit). That’s why our ADRs include more of the manufacturing and consumer companies that are harder to find in Canada.
One important thing is to consider all of your stock portfolios (including your spouse’s) as one and strike a suitable overall balance. Use ADRs to add to the manufacturing and consumer sections of your portfolio. We regularly advise you to hold from 10 to 30 per cent of your stock money in the manufacturing and consumer sectors. ADRs make this feasible.
ADRs provide you with safety
ADRs offer you safety in a second way. Since they trade on U.S. stock exchanges, overseas companies must meet the requirements of the Securities and Exchange Commission. These include transparency, timely disclosure of important information, fair treatment of minority shareholders and so on. Foreign companies must file their American financial statements in English using U.S. accounting rules.
ADRs offer you safety in a third way. They’re mostly high-quality companies with strong balance sheets and cash flows. Many have also built up worldwide operations in various industries. This further reduces their risk through diversification by geographic region and product lines.
Most are European or Asian
The ADRs we like include companies from Australia Belgium, China, Denmark, Finland, France, Holland, Israel, India, Japan, Mexico, South Korea, Spain, Sweden, Switzerland, Taiwan and the United Kingdom.
Some of the above are so-called ‘emerging markets’. Such markets hold the potential for faster economic growth. Some have younger populations than the industrial world. This adds to the demand for goods and services now. And in the future, they should add to the demand for financial assets.
Investing in emerging markets raises your risk. But many have low correlations with U.S. stocks and with each other. This can help offset the higher risk, particularly if you buy a mutual fund diversified by country. Even so, correlations tend to rise when financial markets fall, which reduces this advantage of diversification.
This is an edited version of an article that was originally published for subscribers in the October 21, 2022 issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846