For most investors in this world, American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) are either the sole, or preferred avenues, for investment in global stocks while trading in their own domestic market. That is, an American resident can buy shares of German companies trading in Germany. However, if he wants to trade in German stocks denominated in US Dollars, then the only option is via ADRs.

ADRs are receipts issued by a depository bank that are backed by a specified number of foreign securities. Similar securities in other financial markets are referred to as Global Depository Receipts (GDRs). In the EU they are termed as EDRs, that is, Euro Depository Receipts.

Global securities
An average American retail investor tends to trust ADRs, because they are issued by players like JP Morgan, or Bank of New York, institutions that provide reassurance to them. Thus, the feeling that a certain due diligence has been done by an American financial institution, encourages such investors to invest in ADRs. Also, ADRs are traded in dollars and pay dividends in dollars. This protects US investors from exchange rate risk, a factor that many of them are uncomfortable with.

Some US institutional investors are allowed to invest in foreign companies only using the ADR route. Thus, this is the only avenue available to such entities, if they wish to invest in foreign companies.

Price discovery
From an issuers’ angle, certain markets are considered to be specialists in certain industries, and consequently companies feel that better price discovery will take place if their securities are listed in such markets. For instance, Canada has a large and well-developed mining industry. Hence, many foreign mining companies have issued depository receipts listed on the Toronto stock exchange.

For good companies based in developing countries, the process of ADR issuance makes them more transparent, by forcing them to adhere to US GAAP and SEC, NYSE and NASDAQ guidelines. Greater disclosure benefits not only the potential foreign investors, but the current and future domestic investors. For such companies, such listing improves their acceptance in the global financial markets, similar to the case of NRI bridegrooms in India prior to liberalisation. For instance, a software company seeking a loan in London, will be taken more seriously if it is NYSE listed as opposed to just NSE listed.

Indian investors can invest in ADRs and GDRs, sitting in India. This facilitates investments in top global companies which are not currently listed on the BSE and NSE. By using a platform such as Global Invest in ICICI Direct, an Indian investor can trade in ADRs on European, Japanese, and other foreign companies.

For most Indian investors, there are two sources of return from such investments. First, they get capital appreciation in the US market. Second, the US dollar steadily appreciates with respect to the Indian Rupee. Consequently, both dividend payouts, and capital gains, tend to get magnified when converted to Indian currency.

The writer is CEO, Tarheel Consultancy Services