American Depository Receipts Provide Exposure to International Stocks

An American depository receipt (ADR) is a security that represents a non-U.S. company's publicly traded stock. The ADR is typically created when a U.S. bank purchases a foreign company's shares in its domestic market, and re-issues them in the United States. This is often done as a bundle of domestic shares because one ADR may equal more than one share.

While you can gain broad exposure to international markets through exchange-traded funds (ETFs) and mutual funds, there are only two ways to gain exposure to individual foreign equities:

1) buying the shares on a foreign exchange, or

2) buying an ADR.

If you are considering ADRs, there are several points to bear in mind:

• Withholding tax implications in an RRSP – From a tax perspective, ADRs are considered non-U.S. equities. This means you must pay withholding taxes on any dividends, even if you hold the ADRs within an RRSP.
• Liquidity – Because an ADR trades in a different market from its underlying foreign stock (and often in a different time zone), the price of the ADR can differ from the price of the underlying security. This is due to liquidity and investor activity within each market. Any difference is generally small; however, this kind of tracking error can be more pronounced for ADRs issued in smaller quantities.
• Benchmarking – ADR indices can vary significantly in composition from the various international equity benchmarks. While the ADR universe provides access to a large proportion of the international markets in terms of market capitalization, it covers a much smaller proportion of existing equity issues.
• Currency exposure – Although ADRs are denominated in U.S. dollars, they expose you to the currency of the foreign stock market, not to the U.S. dollar. The price of an ADR in U.S. dollars reflects the currency-adjusted appreciation or depreciation of the foreign stock in its own domestic market. From a Canadian perspective, the return generated from an ADR reflects the movement of the foreign stock in its domestic market and the value of the foreign currency relative to the Canadian dollar.