With ADRs, you can invest in international markets outside the United States with the ease with which you buy a stock. Here’s what they are, how to invest and the risks associated with them.
ADRs, or American Depositary Receipts, are financial instruments issued by United States institutions and traded on US stock exchanges. These financial instruments offer American investors easy and direct access to international companies without the need to deal with the hurdles associated with directly purchasing foreign stocks.
Simply put, ADRs act as a “bridge,” simplifying the path for investors looking to diversify their portfolio with companies across national borders.
In this guide, we will explain in detail what ADRs are, how to invest in them, and the risks to consider before approaching this type of investment.
What are ADRs
ADRs, an acronym for American Depositary Receipts, are ingenious financial vehicle that allow US investors to navigate without complications through the waters of shares of foreign companies listed on US stock exchanges. Issued by US financial institutions, ADRs simplify the foreign investment process, eliminating the need for complex foreign currency transactions and paving the way for dividends and profits paid directly in US dollars.
For non-US companies, ADRs are an effective way to raise capital and gain exposure to the vast universe of American investors. This instrument also lends itself to a more speculative use, allowing traders to operate on the shares of their market even outside the stock exchange closing hours.
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How do ADRs work?
An ADR represents a block of shares of a specific company and trades on US exchanges just like a domestic stock. The process for creating an ADR involves a financial institution, typically a U.S. bank, acquiring a substantial number of shares of a foreign company and releasing them on the market, establishing the number of shares corresponding to a single ADR.
Characteristics of ADR
ADRs are not all the same, but are distinguished into:
- sponsored or not sponsored,
- listed or unlisted.
Sponsored ADRs involve a legal agreement between the bank and the foreign company, allowing the foreign company to maintain control while the bank handles the transactions.
Unsponsored ADRs can be issued without the permission of the foreign company, allowing multiple U.S. banks to offer shares of the same company.
ADRs can be listed or unlisted depending on where they trade. Those listed are subject to the listing standards of recognized stock exchanges such as the New York Stock Exchange, while those unlisted may be traded through over-the-counter markets (OTC).
Getting even more detailed, ADRs are classified into three levels depending on the degree of compliance with US Securities and Exchange Commission (SEC) requirements and access to US stock markets.
- Level 1 ADR: Non-SEC compliant companies, traded only on the OTC.
- Level 2 ADR: companies registered with the SEC, listed on the NYSE or NASDAQ.
- Level 3 ADR: SEC-compliant companies listed on a US stock exchange and authorized to raise capital in the United States through ADRs.
How to invest with ADR
Investing with ADR requires careful planning and some key steps to follow:
- Deciding how much to invest: after having established the total amount to invest, the number of ADR shares is calculated based on the current or closing price.
- Choose a broker: since ADRs are treated like normal shares, it is necessary to select a broker authorized to trade ADRs, verifying the transaction costs and services offered.
- Purchase ADR shares: once ready, you can proceed with the purchase of ADR shares as if they were normal shares.
The risks of ADR
ADRs are a highly effective tool for investors who wish to diversify and personalize their portfolios. They are particularly useful for those who intend to expand their presence in international markets rather than limiting themselves to only domestic stocks. However, investing in ADRs is not suitable for all investors and has some significant limitations and disadvantages:
- Limited selection: Not all foreign companies are available as ADRs.
- Liquidity: Some ADRs can be traded in a limited way, affecting their liquidity.
- Political risk: ADRs are sensitive to the political situation of the country of origin and are exposed to possible trade sanctions.
- Exchange rate risk: despite being quoted in dollars, ADRs are exposed to fluctuations in foreign currencies.
- Higher Fees: Fees for trading ADRs may be higher than those for traditional shares and include custodian services.
Original article published on Money.it Italy 2023-12-17 07:46:00. Original title: ADR, cosa sono? Come investire e rischi
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