Many investors want their portfolios to be diversified in order to minimize overall risk. In order to diversify, an investor may wish to invest in foreign markets. There is major growth potential in emerging markets. However, investing in foreign markets can be risky, so many investors choose to invest through mutual funds. American Depositary Receipts (ADRs) are another way in which investors can invest in foreign companies without having to worry about unfamiliar market practices, currency conversion, tax laws, and a general lack of company information.

According to the Securities and Exchange Commission (SEC), the stocks of most foreign companies that trade in the U.S. markets are traded as ADRs and are issued by U.S. depositary banks. Each ADR is essentially a receipt that represents one or more shares or fractions of shares of a foreign stock.

One advantage of ADRs is that an investor is still trading on the U.S. market. Therefore, all trade transactions are in U.S. dollars. The depositary bank will convert dividends and other payments into dollars for investors, and will also vote proxies if so instructed. Another advantage is that ADRs are able to access markets that are off-limits to individual foreign investors. Also, information about ADRs is more readily available than getting information about the actual foreign stocks. This is because most issuers of ADRs must comply with SEC standards.

One disadvantage of an ADR is that it may take longer to receive company information such as proxies, since it is passing through the depositary bank first. Another disadvantage is that depositary banks charge fees for their services, including converting foreign currency into U.S. dollars. These fees are passed on to the investor and are usually deducted from dividends.