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When we invest in the US market, we don’t just get to buy the largest US companies. Another draw for investors is that we get to invest in many of the biggest companies from around the world as well.
What some of us may not know is that we are usually investing in ADRs rather than shares of these global companies.
These include Chinese internet giants Alibaba and JD.com. We can also invest in popular Japanese electronics manufacturers and automakers like Sony, Mitsubishi, Toyota and Honda, as well as European pharmaceuticals Novartis (from Switzerland), AstraZeneca (from the UK) and Sanofi (from France).
What Are ADRs?
American Depositary Receipts or ADRs are certificates issued by a US bank, enabling us to invest in non-US companies on the US exchanges, the same way we would buy US shares.
Technically, an ADR represents a specified number of shares that are held with a custodian bank in the home country of the non-US company. A separate US-based depositary bank certifies the custodian holdings before issuing an ADR for the company to be listed on the NYSE or NASDAQ.
Even though we do not own the underlying share when investing in an ADR, we gain access to many of the same rights as common shareholders, namely voting rights, receiving shareholder communications and dividend entitlements.
According to the US Securities and Exchange Commission (SEC), there are currently more than 2,000 ADRs representing shares of companies from over 70 countries in the US. There are also several levels of ADRs, with some only traded on Over The Counter (OTC) markets. The ADRs that we find listed on the US stock markets are typically issued on behalf of the foreign companies. These are termed sponsored ADRs, which have a legal relationship with the non-US company. Global companies with sponsored ADRs work directly with the US-based Depositary bank for recordkeeping, shareholder communications, dividend payment and other investor services. This also requires them to comply with reporting requirements under the Securities Exchange Act of 1934 and accounting regulations in the US.
There are also unsponsored ADRs that can be set up without the agreement or cooperation from the non-US companies. As mentioned, these would typically be bought and sold on the OTC markets and may have less liquidity as well.
Do You Pay The Same Price For ADRs VS Its Locally Listed Shares?
Since ADRs give investors very similar rights to holding the underlying shares, its price should track its underlying shares closely. Any discrepancy in the share price may be closed quickly as individuals or institutions who want exposure to the company can simply purchase the ADRs instead of the underlying shares.
However, not all ADRs are sold at the same conversion ratio, which may result in the different prices we see. While most ADRs are commonly sold at a ratio of 1:1 (i.e. 1 ADR is backed by 1 underlying share), it can also be sold in multiples or fractions of the underlying shares.
For example, Alibaba’s conversion ratio is 8. This means that one Alibaba ADR (listed in the US) combines 8 of its shares listed in Hong Kong. Similarly, the AVIVA ADR has a conversion ratio of 2, and this means a single US-listed ADR combines two of its underlying UK-listed shares. Therefore, the ADRs should trade close to their respective multiples.
The intent of the conversion ratio is usually not to price the ADR too high – which will inhibit some investors from investing – or too low – which US investors who are accustomed to higher stock prices may perceive as riskier or penny stocks.
Certain Chinese stocks also do not have underlying shares in its home market. For example, when Alibaba first listed its ADRs on the NYSE, it did not have its Hong Kong listing yet. Similarly, other Chinese stocks are still not listed elsewhere.
In the example below, the Alibaba ADR (BABA) listed on NYSE (on the left) is trading at US$87.23, while the Alibaba share (09988) (on the right) is trading at HK$84.25 in Hong Kong.
Without having to do any math for the conversion ratio or foreign exchange calculation on our own, the moomoo app tells us that the Hong Kong-listed Alibaba shares are trading at a “Translated ADR Price” of US$84.675 – or below the Alibaba ADR price. While we may think there’s an opportunity for arbitrage here, the two counters trade in different time zones. The screenshot was taken during the daytime (as we live in Singapore!) and we can assume that it will be quite likely that the ADR price will be fairly reflected when the US market opens.
Left: Alibaba ADR (NYSE: BABA); Right: Alibaba share (HK: 09988)
(accurate as of 24 May 2022)
Source: Screenshot from moomoo app
ADRs are also quoted in US Dollars (USD), while most underlying shares will be listed in their home currency. As such, prices may fluctuate due to currency conversions to the USD as well. While an arbitrage opportunity arises whenever there is a price difference, we should expect ADRs that have good market liquidity to close these off relatively quickly.
Should We Invest In ADRs Or Stocks?
The main benefit of ADRs is that they enable non-US companies an easy way to list in the US. For these companies, they also gain access to investors in the world’s largest economy and biggest stock market. This also translates to greater visibility and better liquidity.
For investors, these are benefits as well. As Singapore investors, it is fairly straightforward to start investing in Singapore companies. However, if we want to invest in overseas companies, we need our stock brokerage account to offer us access. As there are over 2,000 ADRs from more than 70 countries listed in the US, it’s going to be difficult for any stock brokerage to offer us similar access to that many countries. Furthermore, certain companies only list their ADRs, and do not have a home-country listing for their underlying shares.
By investing in ADRs, we can start investing in both the largest US companies AND the largest global companies with access to just the US stock market. For example, if we are using a low-cost online brokerage like Futu SG (moomoo), we can easily buy and sell securities in the US market. In addition, we can also use Futu SG (moomoo) to buy and sell stocks listed in Singapore and Hong Kong.
Source: Screenshot from moomoo app
As more people converge in the US market to trade both US and non-US companies, the liquidity of our ADR investments is also boosted. If we could only invest in the individual stock markets, liquidity may suffer.
When investing in ADRs, Singapore investors only need to worry about trading in one other foreign currency – the USD. If we wanted to invest in ADRs such as Taiwan Semiconductor Manufacturing Co (TSMC), SAP, Unilever, Infosys and UBS, we can invest in all of them in USD. The alternative, to buy their underlying shares in their home country, is gain access to their local stock markets and use the New Taiwan Dollar (for TSMC), Euro (for SAP), British Pounds (for Unilever), Indian Rupees (for Infosys) and Swiss Francs (for UBS) for our investments.
Constantly having to incur exchange rate spreads eats into our investment returns too. On top of the spread, certain brokers may also charge a foreign currency conversion fee. Fortunately, many online stock brokerages such as Futu SG (moomoo) do not charge any fees on top of the exchange rate spread. With ADRs, we can use our USD for many more investments.
Certain traditional stock brokerages that provide US markets may automatically convert our USD proceeds into SGD before crediting it into our bank account. Futu SG (moomoo) actually allows us to store our USD when we sell our investments. This way we can simply re-use our USD whenever we make another investment in the future, without incurring another round of currency conversion spread.
Source: Screenshot from moomoo app
One con we need to consider is a potential double taxation on dividends from ADRs. For Singapore investors, we are already subjected to a 30% withholding tax on dividends from US-listed securities. If we invest in an ADR that also incurs a withholding tax when transferring dividend payments to the US, there is a chance we incur withholding tax twice, from the local country and US.
We also incur a periodic ADR fee ranging from about US$0.02 to US$0.05 per share when we invest in ADRs. This is to compensate the banks for providing custodial services. The exact amount will be depicted in the respective ADR’s prospectus. These fees will likely be broken into smaller amounts each year. For ADRs that pay a dividend, this fee will be automatically deducted. Otherwise, you may see it appear as a small fee on your monthly statement.
As explained above, certain unsponsored ADRs also do not comply with SEC regulations. Nevertheless, for investors buying ADRs via stock brokerages, such as Futu SG (moomoo), this isn’t a major issue, as we would only be able to invest in listed ADRs – which comply with SEC regulations.
$0 Commission For Your US Stock Investments Forever
Whenever we invest, regardless of whether it is in US stocks or other exchanges, we also have to factor in the stock brokerage commission fees. This can be relatively hefty if we do not use a low-cost stock brokerage account.
Singapore investors can now enjoy $0 commission on our US stock investments forever when we deposit $2,700 with Futu SG (moomoo). When investing with Futu SG (moomoo), we also won’t suddenly see any hidden stock brokerage charges, as Futu SG (moomoo) has also stated that its platform fees AND its Data fees will both be $0. This optimises our investment returns, whether we are regularly dollar-cost averaging into the markets or trading US stocks frequently.
In addition, Futu SG (moomoo) does not charge any custodian fees for holding our ADRs and other investments on our behalf. This is another form of hidden fee that we may incur on a regular basis when using other stock brokerages.
Finally, if we are still deciding to open an online stock brokerage account, moomoo will give us a chance to spin and win a free* US-listed security when we deposit a minimum of $2,700. The Tesla share being the highest valued and the NIO ADR the lowest prize on offer.
Disclaimer: *T&Cs apply. Read full terms on Futu SG (moomoo). This article has not been reviewed by the Monetary Authority of Singapore.