American Depositary Receipts, or ADRs, give you ownership in companies based outside of Canada and the U.S. This can give you several benefits. One is diversification—geo-political and industrial. It’s tempting to call ADRs American ‘Diversification’ Receipts. They give you industries that Canada lacks or has in short supply. This can let you earn more while reducing your risk. ADRs also let you diversify by currency.
We think ADRs have a place in most portfolios. (ADRs and U.S. stocks should make up a quarter or so of a Canadian’s stock portfolio, depending upon your circumstances.) The Investment Reporter follows 47 ADRs that include companies from Belgium, China, Denmark, Finland, France, Germany, Holland, Israel, India, Italy, 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 growth. Most have younger populations than the industrial world. This adds to the demand for goods and services now. And in the future, they’ll add to the demand for financial assets.
ADRs let you diversify by country
ADRs let you buy into industries you can’t buy here. For instance, Japan’s Canon Corp. has no Canadian peers. It manufactures photocopiers, printers, cameras and flat-panel display screens globally. Similarly, many of the other ADRs operate in industries with few or no Canadian counterparts.
Even when you buy ADRs in the same industries as Canadian and U.S. companies, you can comparison shop and see where you’ll get the better deal, at home or abroad. Compare General Electric to Siemens, Unilever PLC to Procter & Gamble, Sanofi S.A. to Pfizer Inc. and so on.
Keep in mind that ADRs also protect you from weaker reporting rules in some overseas markets—because they must file their U.S. financial statements in English using U.S. accounting rules.
ADRs followed by The Investment Reporter deliberately exclude 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). So our ADRs include more of the manufacturing and consumer companies that are harder to find in Canada.
One important thing is to consider all your 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 and to get the benefits that ADRs can provide.
Profit from low correlations
Another way ADRs let you reduce risk is through low correlations (or dissimilar stock price movements) to each other and to U.S. stocks.
Canada is at the high end of the correlation range. Our stocks tend to closely follow U.S. stocks. With 1.0 equal to perfect correlation, one study found a correlation of 0.82 between Canadian and U.S. stocks.
Stocks on overseas exchanges—particularly those in emerging markets—have lower correlations with U.S. stocks. This can let you build a portfolio that protects you from wide market swings and lets you sleep better at night.
Stocks in South Korea, for instance, had a correlation of just 0.2 with the U.S. In other words, the ups and downs of these nations’ stocks have relatively little to do with the direction of U.S. stocks and a lot more to do with domestic matters.
As well, each emerging market typically has low correlations with other emerging markets—further reducing the risk of all your ADRs falling at the same time.
Emerging markets individually pose higher risk. Then again, they also offer high potential growth. That is, a basket diversified by country reduces your risk.
The Investment Reporter, MPL Communications Inc.
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