Diversification with American Depository Receipts
By Saghir Aslam
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the Ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
Because international markets follow different financial cycles than the U.S. market, international investments can make gains while domestic markets are flat or declining. That’s why global diversification, a strategy of allocating investment dollars among U.S. and international markets, can potentially help investors reduce risk and optimize returns.
Although past performance does not guarantee future results, studies have shown that diversifying a portion of your total equity assets into international investments has historically raised overall returns, while reducing the volatility of a portfolio. Even though this would have not been the case in recent years. Our market has not been traditional. We have had a very unique market with only certain stocks going up.
Spanning the Globe to Maximize Returns
World financial markets have undergone profound changes in recent years. For example, the U.S. today accounts for a little than one third of the world’s stock market capitalization-down from more than two thirds just decades ago. While U.S. companies continue to offer substantial investment potential for investors, investment opportunities may also reside in the securities of foreign companies.
One of the most convenient ways for you to take advantage of these opportunities is through American Depository Receipts, or ADRs. ADRs are negotiable certificates that represent ownership of a given number of shares in a foreign company.
Benefits of ADRs
U.S. investors generally prefer ADRs to actual foreign shares for the following reasons:
- Convenience. ADRs are issued by U.S. banks in the United States and can be bought and sold just like the stocks of U.S. companies. Their prices are quoted and their dividends are paid in U.S. dollars. Many are listed on U.S. stock exchanges, with their prices appearing regularly in financial newspapers.
- Speed. ADR trades clear and settle just as easily as U.S. stock trades, usually within three business days. Investors tend to encounter fewer operational snags when exchanging ADRs than they might with outright foreign share purchases.
- No Foreign Exchange Concerns. ADRs allow investors to avoid the potential costs and inconvenience associated with foreign exchange transactions. However, fluctuation in the value of the dollar, relative to other currencies, can affect ADRs investment results. Although investors are spared having to translate foreign currencies into U.S. dollars to determine the value of your investment, ADR prices are directly affected by currency fluctuations, as well as other economic and/or political risks specific to the issuing country. Thus, ADRs may perform better or worse than the underlying shares in the home-country market.
- The ADR Market has Grown. While ADRs have been in existence since the 1920’s, they have experienced rapid growth and increased popularity in recent years. Investors have sought to participate in the integration of the European Community, the transition of Eastern bloc countries to market economies, the privatization of world-class companies and rapid growth in the Pacific Rim and Latin America-all through the ADR market.
- Greater Interest. At the same time, foreign companies have shown greater interest in participating in the ADR market because it has enabled them to increase their visibility and global presence, raise capital, broaden and diversify their shareholders base, generate support for their products and services in the U.S., and enhance employee benefit and stock option plans. Today, more than 1,400 ADRs are available in the U.S.
- Special Considerations. Please keep in mind that investing abroad carries special risks. Many foreign markets are not as liquid as the U. S. markets, and political risk and currency risk must be considered. Although ADRs are traded in U.S. dollars, their prices are indirectly influenced by currency fluctuations.
- In general, the weaker the performance of the U.S. dollar versus the currency of the ADRs home country, the better the net investment results (and vice versa). International investing should not be considered a complete investment program.
As markets worldwide continue to develop, foreign stocks-particularly in the form of ADRs-are likely to play an increasingly important role in investment portfolios. ADRs may help suitable investors capitalize on the opportunities presented by a changing global marketplace. As always, please remember that the stock market, whether here or abroad, is very risky and only the money that can afford to be lost should be invested.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, nor does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr Aslam does not have anything for sale.)