Investing In Adrs: A Guide For Indians

American Depository Receipts (ADRs) are financial instruments that are similar to shares but are traded on US exchanges. They are issued by US-based depository banks and represent a fixed number of shares of a foreign company. ADRs are denominated in US dollars and allow US investors to purchase stock in foreign companies that would otherwise be unavailable. They also enable foreign companies to expand their international footprint and gain access to investors in a different market.

For Indian investors, ADRs offer two sources of return: capital appreciation in the US market and the appreciation of the US dollar against the Indian rupee. They also eliminate the hassle of understanding the Indian markets and dealing with foreign currency transactions.

Some of the top Indian ADRs by market capitalization include HDFC Bank Limited, Dr. Reddy's Laboratories Limited, Infosys Limited, ICICI Bank Limited, and Wipro Limited.

Understanding the basics of ADRs

American Depository Receipts (ADRs) are financial instruments similar to shares but traded on US exchanges. ADRs are denominated in US dollars and allow investors to buy stocks of companies that are listed outside the US. They are issued by US-based depository banks and represent a fixed number of shares of a foreign company.

ADRs are a convenient way for US investors to purchase stock in foreign companies that would otherwise be unavailable. They also allow foreign companies to expand their international footprint and gain access to investors in a different market. For Indian investors, ADRs offer two sources of return: capital appreciation in the US market and the appreciation of the US dollar against the Indian rupee.

There are two types of ADRs: sponsored and unsponsored. Sponsored ADRs are issued in cooperation with the foreign company, which bears the costs of issuing the ADR and handles all aspects of transactions with investors. Unsponsored ADRs are issued by a US bank without the approval of the foreign company, which has no involvement or participation in the ADR.

There are also three levels of ADRs: Level 1, Level 2, and Level 3. Level 1 ADRs are the most basic type and are not listed on an exchange, while Level 2 ADRs are used to establish a trading presence on a stock exchange. Level 3 ADRs have the highest level of compliance and are considered the gold standard.

When investing in ADRs, it is important to remember that they function differently from traditional stocks in terms of fees and taxes. While they are subject to US capital gains and dividend taxation rules, the taxation laws of the foreign country where the company is based may also apply.

Overall, ADRs provide a valuable opportunity for investors to diversify their portfolios and invest in foreign companies, while also offering benefits such as increased transparency and compliance with US market regulations.

Benefits of investing in ADRs

Investing in American Depository Receipts (ADRs) offers several benefits to investors. Here are some key advantages:

Ease of Use

ADRs eliminate the complexities associated with investing in foreign companies. Without ADRs, investors would need to open a brokerage account in the company's home country, deal with currency conversions, and hold securities in a foreign account. ADRs allow investors to purchase foreign stocks through U.S. brokers, using U.S. dollars, making the process more accessible and convenient.

Greater Transparency

ADRs trade in compliance with U.S. market regulations, providing greater transparency. ADR holders receive immediate notifications in English regarding any corporate actions, ensuring they stay informed about their investments.

Equity Exposure to International Companies

ADRs enable U.S.-based investors to gain equity exposure to companies from various countries, including India, Japan, and South Korea. This diversification allows investors to access international markets and potentially increase their investment opportunities.

Enhanced Returns for Indian Investors

Indian investors can benefit from two sources of return through ADRs: capital appreciation in the U.S. market and appreciation of the U.S. dollar against the Indian rupee. As a result, both dividend payouts and capital gains can be augmented when converted to INR.

Voting Rights and Dividend Entitlements

ADRs provide investors with the same voting rights and dividend entitlements as common stockholders. This ensures that ADR holders have a say in company decisions and are entitled to their fair share of dividend distributions.

How to initiate the process of investing in ADRs

To initiate the process of investing in ADRs, it is important to first understand what they are and how they work. ADR stands for American Depository Receipt, which is a type of financial instrument or certificate that represents a fixed number of shares of a foreign company. ADRs are traded on US stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ, allowing non-US companies to trade on these exchanges. This provides an opportunity for US investors to purchase stock in foreign companies that would otherwise be unavailable.

• Understand the Basics: Familiarize yourself with the concept of ADRs, how they work, and the potential benefits and risks involved. ADRs are denominated in US dollars and function as depository receipts, not outright shares. They offer benefits such as ease of use, greater transparency, and exposure to international companies. However, it's important to note that fees, taxes, and regulatory requirements may differ from traditional stocks.
• Choose a Broker: Select a broker who has experience in handling ADR investments. The broker will play a crucial role in facilitating the purchase of ADRs and ensuring compliance with regulatory requirements.
• Identify the Underlying Stock: Decide on the Indian company whose ADRs you want to invest in. Examples of Indian companies with ADRs include HDFC Bank, Dr. Reddy's Laboratories, Infosys, ICICI Bank, and Wipro. Research the company's financial health, performance, and growth prospects before making a decision.
• Understand the Ratio: When investing in ADRs, it's important to understand the ratio of ordinary share value to ADRs. For example, if the ratio is 3:1, it means that three shares of the underlying stock are equivalent to one ADR. This ratio helps determine if the ADR is priced at fair market value.
• Purchase the ADRs: Once you have selected the company and understood the pricing, you can purchase the ADRs through your broker. These receipts can be bought and sold on US stock exchanges just like regular stocks.
• Monitor Performance: After purchasing ADRs, it's important to regularly monitor the performance of the underlying company and the ADRs themselves. Stay updated with financial reports, news, and market trends that may impact the value of your investment.
• Understand Voting and Dividend Rights: As an ADR holder, you have the same voting rights and dividend entitlements as common stockholders. Familiarize yourself with these rights and the processes for exercising them.
• Be Aware of Different Types of ADRs: There are two main types of ADRs: sponsored and unsponsored. Sponsored ADRs involve an agreement between the bank and the foreign company, with the company bearing the costs of issuing the ADR. Unsponsored ADRs are issued by a US bank without the approval of the foreign company. Additionally, there are three levels of ADRs (Level 1, Level 2, and Level 3) which differ in terms of compliance and listing requirements.
• Consult with Experts: Consider consulting tax experts who have knowledge of multiple financial markets and tax laws of different countries. This is especially important since ADRs may be subject to different taxation rules and regulations.
• Diversify Your Portfolio: Investing in ADRs can be a great way to diversify your portfolio internationally. Consider including ADRs from various countries and industries to spread your risk and maximize potential returns.

By following these steps, you can initiate the process of investing in ADRs and gain exposure to Indian companies listed on US stock exchanges. Remember to always conduct thorough research and due diligence before making any investment decisions.

Taxation and fees associated with ADRs

Taxation and fees are important considerations when investing in American Depositary Receipts (ADRs) from India. Here are some key details to keep in mind:

Taxation:

• Double Taxation: ADRs may expose investors to double taxation, as they are subject to both local and foreign taxes. In the US, ADRs follow the same capital gains and dividend taxation rules as traditional stocks. However, the dividend payouts of ADRs are net of currency conversion expenses and foreign taxes. Investors may need to seek a tax credit or refund to avoid double taxation on capital gains.
• Withholding Taxes: Some countries automatically withhold taxes on dividends paid by companies within their borders. This means that a portion of the dividend will be withheld by the broker and deposited with the foreign government, based on their taxation rules and rates.
• Tax Treaties: The US has tax treaties with many countries, which can impact the taxation rates for US investors. It is essential to consult tax experts familiar with the financial markets and tax laws of different countries.

Fees:

• Custody Fee: The depositary bank that holds the underlying stock may charge a custody fee to cover the costs of creating and issuing an ADR. This fee is typically outlined in the ADR prospectus and can range from one to three cents per share. It may be deducted from dividends or passed on to the investor's brokerage firm.
• Pass-Through Fee: ADRs may also incur periodic pass-through fees, which compensate the agent or depositary bank for providing custodial services. These fees typically range from $0.01 to $0.05 per ADR per dividend but can also be assessed in the absence of dividend payments.
• Currency Conversion Fees: While ADRs are denominated in US dollars, investors may incur currency conversion fees when investing in foreign securities. These fees are necessary to directly link the foreign security with the one traded on the domestic market.

Risks and challenges of investing in ADRs

While investing in ADRs can be a great way to gain exposure to foreign markets and diversify your portfolio, there are some risks and challenges that you should be aware of before investing. Here are some of the key risks and challenges of investing in ADRs:

Exchange Rate Risk

ADRs are traded in US dollars, but the underlying shares are typically denominated in the local currency of the company's home country. This means that there is an inherent exchange rate risk associated with ADRs. If the value of the US dollar fluctuates significantly against the local currency, it can impact the value of your investment.

Double Taxation

Investing in ADRs may also expose you to the risk of double taxation. Dividends paid on ADRs are typically subject to withholding taxes in the company's home country. As an investor, you may need to file a special form with the Internal Revenue Service (IRS) to avoid being taxed twice on the same income.

Limited Selection of Companies

Compared to the vast array of domestic companies listed on US stock exchanges, there are relatively fewer foreign companies that offer ADRs. This limited selection may restrict your investment options and could impact your portfolio diversification strategy.

Unsponsored ADRs and Lack of Voting Rights

Unsponsored ADRs are issued without the involvement or approval of the foreign company. These ADRs may not comply with regulations set by the Securities and Exchange Commission (SEC) and do not come with voting rights for shareholders. Unsponsored ADRs are also more likely to have varying dividend offers, as multiple banks can issue them for the same company.

Costs and Fees

ADRs can be more expensive to invest in compared to domestic stocks due to additional costs such as depository fees, administrative expenses, and currency conversion costs. These fees are usually deducted from dividends or passed on to the investor's brokerage firm.

Delisting and Geopolitical Risk

There is always a risk that an ADR may be delisted from a stock exchange. This could be due to various factors, including economic or geopolitical events in the company's home country. If an ADR is delisted, investors might lose access to their investment, as seen in the case of Russian ADRs following the Ukraine invasion.

Frequently asked questions