Once the darling of non-U.S. portfolios, American Depository Receipts (ADRs) are not discussed much any more, probably because of the popularity of exchange-traded funds (ETFs). Nonetheless, the ADR market is huge, representing more than $9 trillion, so someone holds them. How does the performance of ADRs compare with EAFE (Europe Australia Far East), the total foreign market, the U.S. stock market, and inflation over the past five years? The answers hold the key to vital decisions advisors face going forward.
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Investors who make the leap abroad and choose active management then face another set of choices. Should they choose managers who hold the ordinary shares of foreign companies, those who hold portfolios of American Depository Receipts (ADRs), those who hold portfolios of exchange traded funds (ETFs), or a combination of the above, known as “unrestricted”?
ADRs are offered on a wide variety of large foreign companies, and afford reasonable participation in foreign market performance with much more efficient trading, settlement and custody. ETFs offer similar flexibilities and efficiencies.
These choices should be guided by the investor’s assessment of manager skill – “Will I be rewarded for active management fees?” A new update
to my 2007 study, “Perspectives on ADRs,” compares and contrasts ADRs to the EAFE, to the total foreign market, to the U.S. market and to inflation, from 2000 through 2011.
EAFE is the most popular index for benchmarking non-U.S. performance, and it is also offered as an ETF. The total foreign market provides an unrestricted perspective, so you can see the effects of limiting investments to just ADRs or just EAFE stocks.
Exposure to foreign markets has been a good thing for U.S. investors so far in this century, although the past five years have been mixed. The best choice has been the total unrestricted foreign market, encompassing smaller companies and non-EAFE regions.
Looking forward, diversification into foreign markets should help stabilize performance, even if U.S. stocks regain the lead. Once the decision is made to diversify abroad, the “Update on Perspectives on American Depository Receipts (ADRs)” can help in choosing between active and passive management and between ADRs and ordinary shares.