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Jared Dillian
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The Liquidity Problem

Maudlin Economics Jared Dillian examines stock market liquidity.

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July 31, 2004

Ordinary vs. Extraordinary: ADR conversions amouse click away

By Ingrid Eisenstadter

Over on the buyside, Madison Gulley, executive vice president for global trading at Franklin Templeton, says his search for liquidity usually takes him to the foreign ordinaries. Creating or canceling ADRs usually costs five cents a share. With Franklin Templeton's global custody network, he does not need to incur the cost. (And, of course, many foreign companies have no ADR counterpart and the ordinaries are the only play.) But, for traders who do not have offices in 28 countries, as Gulley's firm does, to facilitate settlement, get the research, interpret local news or register as member firms on the local exchanges, buying the ADR to begin with is a simpler ride.

Almost two-thirds of money managers buying foreign securities prefer ADRs over ordinaries, according to a Thomson Financial buyside survey late last year. (Thomson Financial is an affiliate of Thomson Media, the publisher of Traders Magazine.) Listed ADRs are more transparent than foreign shares. It's not necessary to get up at 3:00 a.m. to trade. And you don't have to become familiar with the varying foreign surcharges.

The Fees

"Optically it can look like you're in the money," Mastrianni warns, "but you have to consider the fees." What's more, dividends come in dollars. Morgan vice president Bradley Katinas points out that another reason traders buy ADRs is that "portfolio managers, at some pension funds, for example, would like to diversify but cannot hold foreign securities due to ERISA regulations."

Nonetheless, sometimes even traders without a global network have little choice but to shop overseas in the hunt for liquidity. For example, consider Swedish Match (SWMAY, Nasdaq), a purveyor of tobacco products with a $3.3 billion market cap. The primary listing is in Sweden. Its average daily U.S. volume as an ADR is 1,000 shares. Often enough it's zero shares, accompanied by a bid/ask that you could drive a truck through.

Home Market

In its home market, however, SWMA trades from 2 to 5 million shares daily; the equivalent of 200,000 to 500,000 SWMAY ADRs. That's more than sufficient to keep a U.S. trader's accumulation away from prying eyes. And why would anyone want to own Swedish Match? Because it's up from the high $60s a year ago to more than $100 recently, and offers a dividend in excess of two percent.

But the hunger for foreign investments ensures that even very thinly-traded ADRs have institutional investors lurking behind them. For example, last June 24, London-based Hanson PLC, an international seller of building materials with an average U.S. volume of 8,000 shares (and a 6 percent dividend), announced a profit decrease in the first half of the year. Even though no retail news outlets ran the story that morning in the U.S., Hanson promptly tanked 9 percent on the opening bell. It climbed to a volume of 74,500 shares. The portion of the day's trading tracked by Thomson I-Watch confirmed it was almost all institutional action. (Thomson I-Watch is an affiliate of Thomson Media.)

Hanson's overseas shares moved in lock step with the U.S. price. Gulley says he looks at price parity when deciding if he wants to buy foreign ordinaries or ADRs. But, like most experienced global investors, he says arbitrage opportunities are usually too fleeting to take advantage of them.

Christopher Sturdy, managing director of BoNY's Depositary Receipt Division says, "Many arbitrage opportunities exist in theory in foreign exchange and time differences, and the ordinary price and ADR price, but they are typically ironed out very quickly - in seconds."

"There are people who do nothing else," he explains, "than take out any inefficiencies and tighten up the spreads." Sturdy is so enthusiastic about his business that he predicts, tongue-in-cheek, a market in IGDRs - intergalatic depositary receipts.