| The benefits of international investing cannot be | | | | We can all agree that the purpose of including |
| denied. There have been countless articlesand | | | | foreign stocks in a portfolio is to control risk and |
| papers written on the subject already that are | | | | maximize return. However, these dual objectives |
| beyond the scope of this article. But whatexactly | | | | cannot be obtained solely with international large |
| is the best method of gaining international | | | | cap exposure (which is all that the ADR would |
| exposure in your portfolio? Should you consider | | | | provide). In order to accomplish your goal you |
| exposure to foreign companies via American | | | | should also include foreign value, foreign small, |
| Depository Receipts or are mutual fundsa more | | | | foreign small value and emerging markets. These |
| optimal solution? | | | | simply cannot be attained with ADR’s. |
| American depository receipts (or ADR’s) are | | | | So, for access to foreign markets, international |
| securities created by a U.S. bank that | | | | mutual funds are a better alternative. Theyhave |
| representshares in foreign companies that are | | | | the ability to provide broad global representation |
| held at the bank. An ADR may represent a | | | | while spreading risk across hundreds of |
| portion of aforeign share, one share or a bundle | | | | companies, sectors, and countries around the |
| of shares. ADR’s themselves are not stocks, | | | | world. The aforementioned asset classes like |
| but certificates held by U.S. banks. Like U.S. | | | | foreign small, foreign small value et al are all |
| common stock, ADR’s trade on U.S. stock | | | | available to investors. |
| exchanges and pay dividends (subject to U.S. | | | | It should be noted that because international |
| taxation). | | | | stocks are more costly to trade, foreign |
| ADR’s, like most foreign mutual funds, are | | | | fundstypically carry higher expense ratios than |
| denominated in dollars, but they do not eliminate | | | | their domestic counterparts. Furthermore, |
| the potential currency risk associated with | | | | thedividends of international stocks are subject to |
| investing in foreign markets. So, when the dollar is | | | | foreign taxation—even when the recipients |
| weak, investment returns in foreign positions are | | | | aretax-exempt in the US (like a pension plan). |
| usually more robust. Inversely, when the dollar | | | | Taxable investors, however, can receive credits |
| rallies against foreign currencies, ADR’s from | | | | for foreign taxes paid. Of course, cost conscious |
| those countries will fall more than if shares were | | | | investors should consider global index funds or |
| held by direct investors in the company. | | | | exchange traded funds to keep costs to a |
| Unfortunately, if your objective is to achieve | | | | minimum. |
| global diversification in your portfolio, ADR’s | | | | Yet despite the potential cost and foreign tax |
| are quite limiting. When you buy an ADR, you are | | | | implications, international mutual funds (unlike |
| gaining representation in one foreign company,a | | | | ADR’s) allow investors to capture a broad |
| concentrated risk by most prudent standards. | | | | array foreign exposure. When soundly combined |
| Furthermore, most ADR’s are limited to mid | | | | withother domestic asset classes, international |
| tolarge capitalization companies. So, even if an | | | | exposure is an essential building block in anyoptimal |
| investor owned every traded ADR on | | | | portfolio, and mutual funds (not ADR’s) |
| theexchange, he/she would end up owning | | | | provide you with the best tools to achieve |
| something similar to an EAFE index, but at a | | | | thatgoal. |
| muchhigher acquisition cost. | | | | |