The Investment Characteristics of American Depository Receipts

Abstract

This paper examines the investment characteristics of American Depository Receipts (ADRs) for 1983-1992. ADRs are found to have lower P/E multiples, higher dividend yields, and lower marketto-book ratios than international benchmarks, as measured by the Morgan Stanley Capital International Perspective ISCIP). In addition, significant differences in country and industry representations between the ADR sample and the world market portfolio are found. Further, ADRs provide a higher monthly return and a higher standard deviation than the MSCIP, while both the ADR sample and the MSCIP have lower betas than the S&P 500. Finally, ADRs offer greater return per unit of risk than does the MSCIP. Therefore, ADRs should receive a significant weighting in the portfolios of internationally diversified investors. INTRODUCTION As the world financial markets are becoming increasingly integrated, both individual and institutional investors are looking beyond the investment opportunity set available in the U.S. market. Many previous studies have documented the benefits associated with international diversification [see, for example, Solnick (1974) and Ibbotson, Carr, and Robinson (1982)]. Further evidence of the greater returns available from foreign stocks is documented by the performance of Morgan Stanley Capital International's EAFE (Europe, Australia, and Far East) benchmark index. Over the 23 years ended June 30, 1993, the EAFE returned 12.4% per annum in U.S. dollars in contrast to 9.4% for the Morgan Stanley Capital International U.S.A. index. There are several considerations that may induce an investor to look to foreign markets. First, many observers expect the foreign markets to continue to do well in the future. As noted by Simos and Triantis (1994) the economic growth potential of the newly industrialized and emerging economies appear to be far greater than that of the rather mature U.S. economy. Second, overseas stock markets constitute over 65% of total value of world equity markets and thus more than half of the world's investment opportunities today are outside the U.S. Third, although many individual foreign stock exchanges can be extremely volatile, these volatilities tend to balance each other out in the aggregate. Thus, including foreign securities in a portfolio can actually reduce the risk of a portfolio invested exclusively in U.S. stocks. Investors in overseas markets, however, need to consider two additional factors associated with foreign investments -- currency exchange risk as well as the potentially prohibitive cost of doing business abroad. American investors may encounter numerous difficulties when they trade and own foreign assets. These complications include: 1) myriad settlement procedures, 2) high rate of trade failures, 3) unreliable interest and dividend payments, 4) restrictions on foreign investment, 5) foreign withholding taxes, 6) capital controls, 7) differences in accounting rules and reporting requirements, and 8) poor information flow. These differences can make direct investing in foreign stocks both more confusing and more costly. As pointed out by Hawkins (1991), even U.S. pension funds have only 3% of their resources invested in international assets. American depository receipts, often called ADRs, represent one way of avoiding some of these pitfalls while at the same time achieving international diversification. This paper examines the investment characteristics and financial performance of ADRs for the 19831992 time period and compares these measures with the Morgan Stanley Capital International Perspective benchmark. ATTRIBUTES OF ADRS ADRs are negotiable certificates or financial instruments that provide American investors ownership rights to stocks or bonds in a foreign country. This instrument is created when a depository bank, that holds the underlying securities in the country of their origin, issues the negotiable certificate, called an ADR. …