Safety Abroad

Look beyond North America’s borders and benefit from ADR investing

ADRs, or American Depositary Receipts make it easy for you to buy overseas companies and provide you with an extra measure of safety that you would not get with a direct stock investment.

That’s because stock certificates of a foreign company are registered in the name of a U.S. trust company or bank, which holds them for safekeeping. Then the institution issues receipts against the shares. These receipts trade on U.S. stock markets just like ordinary stocks.

ADRs let you diversify by country and industry. Correlations between many overseas / global stocks and North American stocks are fairly low. ADRs can reduce the risk of your portfolio.

You can also buy stocks in industries Canada lacks or has in short supply. And some foreign companies offer greater potential than their North American counterparts.

ADRs also offer you safety in another way. Since they trade on U.S. stock markets, overseas companies must meet the requirements of the SEC: transparency, timely disclosure of material information, fair treatment of minority shareholders, and so on.

Below, I have included a table of 17 foreign companies that are based outside the U.S. but trade as ADRs.

Many benefits

ADRs, give you benefits. One is diversification. 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. They also let you diversify by currency.

I think ADRs have a place in most portfolios (ADRs and U.S. stocks should make up a quarter or so of your stock portfolio, depending upon your circumstances).

My ADRs include companies from so-called ‘emerging markets’. These 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.

Investing in emerging markets raises your risk. But they 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 be closer when financial markets fall, which reduces the advantage of diversification.

ADRs also let you buy into industries you can’t buy here. For instance, Japan’s Canon Inc. has no Canadian peers. This global manufacturer of photocopiers, printers, cameras and flat-panel display screens, among others, and many of my 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. For example, compare General Electric to Siemens, or Unilever PLC to Procter & Gamble.

Keep in mind that ADRs protect you from weaker reporting rules in some global markets – because they must file their U.S. financial statements in English using U.S. accounting rules.

My ADRs 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 my ADR list includes 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.

Reduce Risk

One way American Depositary Receipts, or 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. My 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 stocks 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.

But correlations rise when global stock markets fall. That is, diversification offers less just when you need it the most.

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.

 

ADRs for your portfolio

Here are 17 foreign companies based outside the U.S. but trade in the U.S. as American Depositary Receipts, or ADRs. I have included each company’s 2013 earnings per share and estimated earnings per share for fiscal 2014 and the industry to help differentiate between stocks. They are all buys.

 

Click below to enlarge

ADRs for your portfolio

 

The MoneyLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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