American Depositary Receipt Basics

Today’s investors have access to a wide range of investment products, including stocks, bonds, mutual funds and ETFs. Part of what makes these “usual suspects” attractive is that they are familiar and easy to trade – just call your broker or place the order yourself online. When several of these investments are used together, they can form the basis for a strong portfolio.

Most investment professionals would agree that diversification – mixing a wide variety of investments within a single portfolio – helps lower risk and increase returns. And it’s not just different types of investments that are important to constructing a well-diversified portfolio: Your securities should also vary by risk and by industry.

Take stocks, for example. It’s recommended that you have 10-12 stocks in your portfolio to help lower risk. But that doesn’t mean you should buy 10 tech stocks or 10 energy stocks or 10 blue-chip stocks. Instead, you should aim to buy stocks of different sizes and across multiple industries to spread out risk. A lesser-known type of stock – and one that can add a new dimension to your portfolio – is the American Depositary Receipt (ADR). (For more on diversification, see: Risk and Diversification.)

An ADR is a security that represents shares of a non-U.S. company that is held by a U.S. depositary bank outside the United States. According to the Securities and Exchange Commission (SEC), there are more than 2,000 ADRs available today, which represent shares of companies in more than 70 countries worldwide. ADRs allow investors in the U.S. to invest in companies on a more global basis, and they provide an opportunity for non-U.S. companies to access to the U.S. capital markets. (For more, read: How to Trade Foreign Stocks.)

ADRs are a popular way to trade foreign stocks. The world’s largest IPO, Chinese Internet giant Alibaba Group Holding Limited (BABA), for example, is a foreign company that trades in the U.S. as an ADR on the New York Stock Exchange. [L2] Even though you may be less familiar with ADRs than regular stocks, they trade the same way – on major stock exchanges and over-the-counter (OTC) markets. And like regular stocks, ADRs can be a good addition to your portfolio – especially if you’re interested in investing in foreign-based companies. Read on to learn the basics and decide if ADRs might be right for you.