A Must-Read for New Investors in U.S. Stocks | Understand the Reference Value of ADRs and Easily Allocate Overseas Assets

What exactly is ADR? A one-sentence explanation to make it instantly clear

ADR (American Depositary Receipt) is a special certificate issued by a U.S. depositary bank representing shares of a foreign company. Simply put, when a foreign company wants to raise funds in the U.S. capital market, the most direct way is to issue ADRs, allowing U.S. investors to buy foreign company stocks as conveniently as U.S. stocks.

For example, well-known companies like Taiwan Semiconductor Manufacturing Company (TSM.US), BYD (BYDDY.US), Tencent (TCEHY.US), etc., all trade on U.S. stock markets through ADRs. Foreign companies deposit their shares with U.S. depositary banks, which then issue corresponding ADR certificates, enabling trading on NASDAQ, NYSE, or OTC markets.

Why issue ADRs? Benefits for companies and investors

Benefits for companies

For foreign companies already listed in their home country, listing again in the U.S. is complicated and costly. Issuing ADRs simplifies the process, allowing access to the world’s largest capital market and raising funds, while maintaining their domestic listing status—multiple benefits in one move.

Benefits for investors

Without ADRs, investors wanting to buy foreign company stocks must:

• Open securities accounts in the relevant country
• Convert funds into local currency
• Bear exchange rate risks and complex transaction procedures

With ADRs, investors only need to operate in USD on U.S. stock platforms, making everything easier and more straightforward. This is why ADRs are so attractive to global investors.

Core considerations for ADR investing

Investing in ADRs seems simple, but there are many aspects to pay attention to.

1. Liquidity issues

Most foreign companies have limited recognition in overseas markets, and investors understanding and trading their ADRs are relatively few. For example, Taiwan Mobile (CHT.US) has an average monthly trading volume of about 145,000 shares on U.S. markets, far below the 12.24 million shares traded in Taiwan during the same period. Poor liquidity means higher difficulty in buying/selling, wider spreads, and directly impacts your entry and exit costs.

2. Company fundamentals analysis

Like investing in regular stocks, ADRs’ price movements are affected by operational performance, industry outlook, policy support, etc. Importantly, many Level 1 ADRs in the U.S. do not require detailed financial disclosures, so investors must review the financial reports published by the company in its home market. For example, TSMC’s ADR surged 32% in early 2023, mainly driven by reopening after COVID-19, strong financials, and bright industry prospects.

3. Exchange rate risk cannot be ignored

ADRs are traded in USD, so fluctuations in exchange rates can directly erode investment returns. Suppose you invest 30,000 TWD to buy ADRs, with USD/TWD at 1:30 (equivalent to $1,000). If the ADR earns a 20% profit ($1,200), but the exchange rate shifts to 1:25 when converting back, you only get 30,000 TWD—your gains are wiped out by currency conversion costs.

Additionally, if the foreign company’s local currency fluctuates sharply against USD, ADRs will also fluctuate accordingly. This is an important risk factor investors must consider.

Classification and levels of ADRs, from low to high risk

Two main issuance types

Sponsored ADRs: Issued by a bank on behalf of the foreign company, with a formal agreement. The foreign company retains control and pays fees, while the bank facilitates trading. These ADRs comply with SEC regulations, regularly disclose financial info, and have the highest regulatory standards.

Unsponsored ADRs: Sometimes even without the foreign company’s involvement, issued solely by depositary banks. These can only be traded OTC, with incomplete information disclosure, and higher risk. Tencent, BYD, Meituan’s ADRs are examples of this type.

Three levels of ADRs

Based on the depth of market access in the U.S., ADRs are divided into three levels, with increasing regulatory requirements:

Level 1 ADRs carry the highest risk because of minimal disclosure and poor liquidity; investors should be extra cautious.

ADR ratios: the secret behind non-1:1 ratios

This is a common oversight for beginners—ADR ratios do not directly match the foreign company’s local shares 1:1.

For example, TSMC’s ADR ratio is 1:5, meaning 5 shares of Taiwan TSMC stock equal 1 ADR. Similarly, Hon Hai (Foxconn) is 1:5, but Chunghwa Telecom’s ratio is 1:10.

Companies set ratios based on stock prices and exchange rates. If the stock price is too high for easy trading, they increase the ratio to make each ADR cheaper. Here are some Taiwan major companies’ ADR ratios for reference:

Taiwan stocks vs Taiwan ADRs, which one to choose?

Why does the same company list both in Taiwan and the U.S.? What are the key differences?

Fundamental distinction: Taiwan stocks are directly issued by the company; Taiwan ADRs are just certificates representing those stocks—they are not the actual stocks.

Trading scenarios differ completely: TSMC trades on the Taiwan Stock Exchange under Taiwan regulations; its ADRs trade on NYSE under SEC rules. Trading hours, rules, costs vary greatly.

Codes, currencies, investors are entirely different:

• Taiwan stock code 2330 vs ADR code TSM
• Local currency TWD vs USD settlement
• Domestic Taiwanese investors vs global U.S. investors
• Buying 1 share = 1 share vs buying 1 ADR representing 5 shares

The most overlooked aspect is the premium/discount phenomenon. Although the stock price trends of Taiwan stocks and ADRs are generally aligned, their daily price movements often differ. For example, in early 2023, TSMC’s stock prices in Taiwan and the U.S. showed noticeable divergence, sometimes ADRs performed better, sometimes worse. Smart investors leverage this premium/discount mechanism for arbitrage.

A-shares and A-share ADRs: investment logic

Similar to Taiwan stocks, A-shares also enter the U.S. via ADRs. Companies like BYD (BYDDY.US), Great Wall Motors (GWLLY.US), etc., have U.S. ADRs.

The logic is identical:

• Nature: A-shares are stocks; A-share ADRs are certificates
• Regulation: CSRC (China Securities Regulatory Commission) vs SEC (U.S. Securities and Exchange Commission)
• Exchanges: Shenzhen, Shanghai vs NYSE, NASDAQ, OTC
• Investors: Mainly Chinese investors vs overseas investors

For those wanting exposure to Chinese companies but trading in USD, A-share ADRs provide a convenient channel.

Practical advantages of investing in ADRs

Lower tax costs

For Taiwanese investors, profits from ADR trading under NT$1 million are tax-free. In contrast, trading in Taiwan stocks involves transaction tax, stamp duty, and other costs, while U.S. ADR trading costs are very low or even zero commissions. High-frequency traders will find ADRs’ cost advantages especially significant.

More diversified asset allocation

Investing solely in U.S. stocks limits exposure to U.S. companies. ADRs open the door to global investments. Want to invest in electric vehicle sector? You can choose U.S. Tesla (TSLA.US) or Chinese NIO (NIO.US), greatly enhancing portfolio diversification.

Practical obstacles to ADR investing

Complex operation process

Non-U.S. investors must go through multiple steps: open overseas brokerage account → exchange currency to USD → deposit funds → trade. This process is time-consuming, and currency exchange and transfer fees add up.

Some investors use Taiwanese brokers to purchase ADRs on their behalf, but they pay high handling fees of 1%-2%, which is a significant cost.

Double exchange rate risks

Besides the stock’s own price fluctuations, you also face USD exchange rate risks. If the foreign company deals with a third currency (like RMB, JPY), you face multiple exchange risks, greatly reducing investment certainty.

Decision framework for ADR investment

To evaluate ADRs effectively, investors should establish a clear decision-making framework:

1. Assess liquidity: Is trading volume sufficient? Are spreads too wide?
2. Deeply understand the company: Especially Level 1 ADRs, review local financial reports
3. Monitor exchange rate trends: Buying when USD appreciates is more advantageous
4. Watch for premium/discount opportunities: Use price differences between local stocks and ADRs for arbitrage
5. Confirm transaction costs: Including currency exchange, fees, taxes, and other costs

ADRs bring convenience to global investors but also involve additional complexity. Only by understanding their mechanisms and risks can you truly leverage ADRs for global asset allocation.