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By Scott Burns | 03-03-2010 11:37 AM

What to Know When Investing in ADRs

Morningstar's Scott Burns and Bank of New York Mellon's Julio Lugo tackle frequently asked ADR questions about dividends, financial filings, and currency risk.

Scott Burns: What to know when investing in ADRs. Hi there, I'm Scott Burns with Morningstar. Joining me today is Julio Lugo, who's the Vice-President of Index Products for the Bank of New York Mellon Group. Julio, thanks for being here.

Julio Lugo: Thanks for having me, Scott.

Burns: So ADRs are a rapidly growing area in the financial world right now. What are some tips for investors? What do they need to understand when they're using an ADR? Because they are a little different than just your more vanilla U.S.-listed, U.S.-based security.

Lugo: That's true. Sometimes what I see and what I mostly hear, is that the ADR may be illliquid, and that's not the case. The ADR itself is as liquid as the underlying share in the local market.

So like an ETF, you have the creation and redemption process. As an ADR holder, you're entitled to all the rights and entitlements as if you were the underlying shareholder. So all the dividends, the information, all flow through us, the Bank of New York Mellon, as a depositary, and reaches the end investor.

Burns: If I own an ADR, what should I know about the dividend policy? What should my expectations really be?

Lugo: Actually, there's greater efficiency holding the ADR and receiving the dividend, because we, as the depositary, we're custodizing the local shares in that market. When the dividend is paid, the dividend is actually paid to us and then we'll convert into the U.S. currency, announce a record date here in the United States, and a payable.

Most of the dividends are qualified dividends, and because the local governments recognize us as the depositary, you get the net dividend paid to you, which there's no need to do a reclaim process.

Burns: OK, and that reclaim process, that's where things get complicated.

Lugo: And can be quite lengthy.

Burns: Right. People say, "Oh, it was a three percent yield, and at the end of the day I only pulled home 50 basis points of yield, after I paid taxes here and paid taxes there."

Lugo: That is correct.

Burns: That's very efficient. I think another question a lot of folks have is about the filings, because now, an international company, even if you're holding it in the U.S., is not filing always on the quarterly annual system that we have in the U.S. They're not even using a lot of the same forms that we're used to seeing, like 10-Ks and 10-Qs and things like that. How's that process work? What should people understand there?

Lugo: There are 365 listed ADR programs, those that trade on the New York Stock Exchange, the New York Stock Exchange Arca, as well as NASDAQ. They file what's called a 20-F, which is equivalent to the 10-K.

They make all the reps and warranties just like U.S. companies would, and it keeps them on a level playing field with other U.S. companies on those exchanges. So the information is transparent and available to all the U.S. investors.

Burns: I think one last thing, a lot of investors think, OK, I bought an ADR and I purchased it in dollars and the share price was listed in dollars, so I don't have to worry about currency. True or false, is currency and issue with ADRs?

Lugo: Currency is an issue. You are investing in a foreign company overseas; you have political risk. You are not insulated to any foreign currency. We saw that back in the Mexican peso crisis in the mid-'80s.

Burns: All right. Julio, thanks for joining me. I'm Scott Burns with Morningstar. For this and other ADR research and coverage, please check out Morningstar.com.

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