1. ADR Basics: Introduction
  2. ADR Basics: What Is An ADR?
  3. ADR Basics: Determining Price
  4. ADR Basics: Risks
  5. ADR Basics: Conclusion

Several factors determine the value of an ADR beyond the performance of the company: Analyzing these foreign companies involves looking at more than just the fundamentals. Here are some risks that investors should consider before trading an ADR:

Political Risk. Research if the government (and economy) in the home country of the ADR is stable, and if any sanctions are on the horizon that could change the company’s financial outlook. A foreign bank ADR, for example, may have an uncertain future if new sanctions from its home country would cut the bank’s indirect access to international capital markets. Keep in mind, sanctions from the U.S. could also affect foreign companies.

Exchange Rate Risk. Is the currency of the home country stable? Remember the ADR shares track the shares in the home country. If a country's currency is devalued, it will trickle down to your ADR. This can result in a big loss, even if the company had been performing well.

As Thornburg Investment Management explained in a blog post, “A common misperception is that American Depositary Receipts, which bundle ordinary shares of an overseas-listed company to a U.S.-traded security, don’t carry currency risk. Driving the confusion is the fact that ADRs, as they are commonly known, are traded in U.S. dollars. While ADRs effectively spare U.S. investors the administrative expense and foreign tax assessments associated with trading in foreign-listed stocks, they don’t nullify the impact of currency exchange rate fluctuations.” 

Inflation Risk. This is an extension of the exchange rate risk. Inflation is the rate at which the general level of prices for goods and services is rising and, subsequently, purchasing power is falling. Inflation can be a big blow to business because the currency of a country with high inflation becomes less and less valuable each day.

Tax Treatment of ADRs

The tax treatment of ADRs can get a little tricky. If you’re not prepared, you could end up with some surprises at tax time. As far as the IRS is concerned, ADRs are generally treated the same as domestic investments, and investors are subject to the same capital gains and dividend taxes at the same rates. What happens in the foreign country is where tax treatment can differ.

Many countries withhold taxes on dividend payments – typically 15% to 20%, but it can be higher, depending on the country. You’ll have to pay U.S. income tax on the net dividend, and claim a deduction for the amount of the foreign tax to avoid double taxation. Keep in mind, the amount you can reclaim depends on the double taxation agreement in place between the U.S. and the foreign country. In some cases, you won’t be able to reclaim the entire withholding amount. It’s recommended that you consult with your broker and/or tax adviser for more information and any applicable U.S. tax forms. 

 


ADR Basics: Conclusion
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