Investors around the world are always looking to diversify their portfolio by investing in international securities. At the same time, companies around the world are always looking to tap international markets and increase their global presence. It is important for companies to raise capital abroad as well as at home.

The American Depository Receipt, or ADR, offers globally conscious investors a convenient avenue to add foreign investments to their portfolios. JP Morgan created the first ADR in 1927 to help investors put their money into Selfridge's, a British retailer. Since that time, JP Morgan has been the leader in offering ADRs to the American investor. Over the course of time, the ADR has developed into an efficient vehicle for foreign companies to trade their shares on U.S. markets.

Types of ADRs
Foreign companies seeking the benefits of ADRs generally go after what are commonly known as sponsored ADR programs. The companies themselves initiate the process and then work with a depositary bank, which actively manages the ADR program.

The company benefits by making a strategic foray into the U.S. market, controlling its image and reputation in the capital markets. Generally, only sponsored ADRs can be listed on major stock exchanges or quoted under the NASDAQ system. While most ADR programs are sponsored, many un-sponsored programs (in which the ADRs are created and offered to investors without a company's involvement) still exist.

Level I
A level I ADR is the most basic form of the ADR program. It is used when companies are not initially seeking to raise capital in U.S. markets (or do not wish to or cannot). These ADRs cannot be listed on an exchange or on NASDAQ. A Level I ADR program offers an easy and inexpensive way for a company to see what kind of interest the U.S. market has for its securities, and if the company would be able to build a presence. Since they cannot be traded on exchanges, Level I ADRs are typically traded on the over-the-counter (OTC) market.

Level II
With Level II ADRs, companies are typically listed on major stock exchanges and quoted on the NASDAQ. This offers foreign companies larger visibility in the U.S. market, and therefore also offers more active trading and greater liquidity. Investors can find such ADRs listed on the New York Stock Exchange or the American Stock Exchange, and can check Level II ADR quotes on the NASDAQ.

Level III
Level III ADRs are the most high profile. Foreign companies decide to actively pursue the U.S. market and they fund a public offering of their ADRs. These ADR IPOs are immediately offered on major stock exchanges or NASDAQ. The benefits of these ADRs for foreign companies are substantial, as the companies can immediately begin raising capital to fund their U.S. operations. There is also much greater visibility for a company willing to take this course.

Rule 144A
Many companies seek to raise capital in the U.S. markets privately by issuing restricted securities under Rule 144A. This rule gives foreign companies a way to sell securities which do not require SEC review. Rule 144A facilitates the trading of privately placed securities by institutional investors, also known as qualified institutional buyers. These buyers must own or manage at least $100 million in securities.

Performance
There are several high-performing ADRs that trade on U.S. markets. For the purposes of this discussion, the focus will be on telecommunications giants with multiple international holdings. The charts below focuses on Finnish cell-phone giant Nokia and French telecom Vodafone.

As one can see on the above chart, the year-to-date performance of Nokia is comparable to the NASDAQ composite. If traded as an American company, Nokia would undoubtedly be a strong component of the NASDAQ.

In examining the data on the Vodafone chart, we see very similar results to the Nokia chart. The results are indicative of the severe weakness in the telecommunications sector. Vodafone, a leading global telecommunications company, underscores that weakness in telecommunications is not a U.S. problem but an international epidemic.

The Bottom Line
Investors are always looking for new avenues in which to diversify their portfolios. For those interested in global diversification, ADRs are attractive and easy. Equity markets have become local institutions with global presence. The tides of politics and economics can often make foreign companies a more attractive investment option than domestic companies.

Damir Fonovich, Market Analyst, Econoday