It was 10:30 in the morning one day last spring when Chris Mitchell, a buyside trader at Harding, Loevner Management in New Jersey, decided to purchase 20,000 shares of Spain's Bankinter SA. The bank trades in its home country in euros and in U.S. dollars on the Pink Sheets. That's where the bank changes hands as an American Depositary Receipt (ADR) in the U.S. Although it was the ADRs that Mitchell wanted, he could not buy them because the bank has little liquidity on the Pink Sheets. But, no problem; the Bolsa de Madrid would be open for another hour. So, on his Bloomberg terminal, Mitchell logged onto G-Trade's trading platform, ADR Direct, and bought his shares directly on the Spanish stock exchange. There Bankinter trades around a quarter-million shares a day.
"I purchased the entire balance in three executions in the local market," Mitchell says. "The whole thing took about 45 seconds." His trade moved the Spanish market by just two cents. To complete his trip, Mitchell clicked on "Create ADR" and just seconds later he had his U.S. shares. The ADR Direct platform does this trick in 23 foreign markets, instantly calculating for each one the foreign exchange rate, ordinary-to-ADR ratio, local taxes and exchange fees. Sheesh!
Back in the 1920s, making a foreign investment meant negotiating on a foreign exchange, in a foreign currency, in a foreign language. Do your own research. Then in 1927, Morgan Bank, envisioning a new market that could capitalize on facilitating foreign investments, created the first ADR. This, for example, enabled Americans to buy shares in the British retailer Selfridge, just as they would purchase any U.S. equity. To accomplish this, Morgan bought the foreign ordinaries and resold them – packaged as shares that could be bought in dollars, which paid dividends in dollars.
Today, of course, it's commonplace to trade ADRs with a mouse click. But only in the last few months, through ADR Direct, has it also become possible to actually convert foreign ordinaries into ADRs – or the reverse trip – with the same ease. The platform, a brainchild of G-Trade, a division of the Bank of New York, has signed up 80 customers since July of 2003, according to Andrew Levine, a G-Trade managing director. At present, ADR Direct, with its straight-through processing all the way, is regarded as the most hot-wired response to investors' soaring demands to go global.
For traders who use the Bloomberg terminal, which provides the only access to ADR Direct, the platform is available at no extra cost. If you haven't got a Bloomberg, however, get out your checkbook. A workstation costs $1,700 a month.
An Alternative
"Instinet terminals are free," says Mike Plunkett, by way of comparison. He's North American president of the New York-based institutional brokerage. Instinet calls its global platform "Newport" (Get it? new port?). It provides access to 40 markets globally and "can do so many things that sometimes it's too much for people," Plunkett says. Thus, Instinet has brokers who are available to shop for the best price and execute trades for their clients who are not the do-it-yourself sort, like the ADR Direct traders.
Instinet brokers around the world will make real-time trades on behalf of clients who may be watching a baseball game on Sunday evening when the Japanese market opens, or who may be home snoozing when European markets are reacting to news at a time when it's still dark out in New York. And, Instinet is among the institutional brokers that provide research while G-Trade does not.
With the exception of G-Trade, converting an ADR to ordinaries or back again is manually-intensive at other firms, according to Levine. The manual steps include phone calls and e-mails. Now, advances in trading and technology are encouraging U.S. investors to trade more in ADRs.
In 1992, trading in ADRs accounted for 4.3 billion shares. Since then volume has grown every year, according to industry monitor IDC. At the end of 2003 volume had risen to 33.1 billion shares. For the first five months of this year, ADRs accounted for 19 billion shares. That puts 2004 on track for another record-breaking year.
While ADR dollar value did drop sharply along with U.S. equities during the recession – from $1.185 trillion in 2000 to $630 billion in 2003 – the ADRs are coming back faster. (ADRs and GDRs, the acronym for Global Depositary Receipts, are regarded as generic terms.) The Bank of New York, ranked as the biggest player in ADRs, notes that several of BoNY's indexes – the ADR composite, three international, a regional, and an emerging markets – all outpaced the S&P 500 comeback of last year.
Today, almost 12 percent of U.S. portfolios comprise foreign investments. The number of ADRs is down from its year 2001 high of 623 to 509 in 2003, but there's widespread agreement that the interest in investing globally is on the rise.
Over at Florida-based Empire Financial Group, Gerry Mastrianni, director of trading, agrees. "Demand is increasing," he says, "and most investors cannot deal in local overseas markets themselves."
The inexperienced investors buying into foreign companies on their own include, not just many portfolio managers, but some market makers and other traders. Mastrianni tells Traders Magazine, "There are firms doing business in ADRs that trade their ordinary shares through me."
"We use research from overseas trading partners," Mastrianni explains. "We have feet on the ground in all the foreign markets where we do business." Many trading firms do not have this background. These include many hedge funds that make up a big part of the ADR traffic. At Harding, Loevner, Mitchell points out that the firm manages $1 billion in overseas investments for nonprofit organizations, high net-worth individuals and retirement plans. Harding, Loevner traders do their own research.
But, for many traders, research is hard to find for both Pink Sheets ADRs and in overseas markets. With the exception of the more liquid, listed ADRs that do significant business internationally – ADRs such as Finnish Nokia, Japanese Sony and Swedish Ericsson – going global can be risky: Even when regional indexes show growth, individual country indexes may be shedding value. (Mastrianni notes that Swedish Ericsson trades more as an ADR than it does in its home country.)
Global Custody
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.