Investing in Emerging Markets with U.S. Traded ADRs

By: Money_Morning

Larry D. Spears writes: For most of the past decade, the name of the game in worldwide equities has been investing in emerging markets.

If you don't believe me, just take a look at the performance of the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM).

It is an exchange-traded fund (ETF) that tracks MSCI's Index of major stocks in 21 emerging countries. Since its inception in April 2003, EEM is up 264.6%, not including the dividend.

By contrast, the S&P 500 gained just 55.7% over the same period.

That's a substantial difference in performance - one well worth pursuing for almost any investor.

But what's the best way to invest in emerging markets?

You might think the answer is just to buy EEM or a similar fund, like Vanguard's MSCI Emerging Markets ETF (NYSEArca: VWO).

However, there are some drawbacks.

One is a lack of focus. For instance, with an index fund you get the weak companies along with the strong. Another is the inability to target very specific industry groups or individual companies you think have the most potential.

Fortunately, there's an alternative to both emerging-market funds and direct foreign trading, which can be a tricky proposition for ordinary investors. It's called an American Depositary Receipt, or ADR, and there's been an explosion of them in recent years.

Investing in Emerging Markets with ADRs
ADR's are negotiable securities created when the stock of a foreign company is placed on deposit with a U.S. bank or other depositary institution. They are used as security for the issuance of shares either listed on U.S. stock exchanges or approved for trading on the American over-the-counter (OTC) market.

The shares are denominated in U.S. dollars, pay dividends in U.S. dollars and generally trade just like the stocks of U.S. companies.

Foreign companies typically create ADRs to tap the U.S. markets for operating or expansion capital unavailable in their home countries. Sometimes, though, the move is designed merely to increase their international exposure or enhance their credibility in the global business community.

The first ADR was created in 1927 and, for many years, most were large European or Japanese companies that sold products in America and wanted to give U.S. traders easier access to their shares.

Two prime examples are Dutch consumer-products giant Unilever N.V. (NYSE: UN) and Swiss pharmaceutical firm Novartis AG (NYSE: NVS).

Over the past few years, however, the ADR arena has seen a huge number of new entries from emerging-market nations - particularly China.

According to the DR Directory of BNY Mellon, one of the largest ADR depositories, the NASDAQ has listed 25 new ADRs over the past three years -19 of which are from China.

Similarly, the New York Stock Exchange has listed 67 new ADRs over the past 36 months, with only 10 from Europe, one from Japan and the rest scattered around the developing world.

The listing action has been even more frantic on the U.S. OTC market. In the past year alone, there have been 255 new ADR listings, including:

•18 from Thailand, representing 13 different industry groups.
•5 from the Philippines in five different business sectors.
•5 from South Africa, including three in the mining industry.
•17 from Indonesia, representing 11 different industry groups.
What that means for investors is that using just ADRs they can now easily create their own mini-portfolios of emerging-market stocks, focusing on a specific region, country, industry or even a particular sector within one of the larger developing nations.

For instance, BNY Mellon lists:

•117 companies with ADRs in the oil and gas production business, including major European and Asian corporations as well as those in emerging-market countries.
•108 companies in mining, including firms in resource-rich nations like South Africa, Australia and Russia.
•57 companies in mobile telecommunications, a particularly lucrative and fast-growing sector in the developing world.
Using ADRs to Build an Emerging Markets Portfolio
The explosion in ADRs also makes it much easier for American investors to exploit developing demographic trends in the Third World, such as growth in the middle class, expanding consumerism, alternative energy, infrastructure modernization and the like.

For example, ADRs are now traded for 37 companies in the leisure industry, 31 in the household goods and home construction sector, 58 in health care and medical services, 77 in the travel business and dozens more. If you want to play mankind's bad habits, there are even 32 ADRs for companies in the alcohol and other beverages sector as well as three for tobacco companies (though they're all from Europe).

In short, you can use ADRs to concentrate your emerging-market investments virtually any way you want.

You do, of course, need to exercise due diligence in your selections, just as you would with any U.S. stock. Plus, there are a couple of added risks.

Prime among them is liquidity, as trading volume is light in many of the newer or more obscure ADRs, particularly those on the OTC market.

It's also important to recognize "sovereign risk" related to the overall financial health of the ADR company's home country - e.g., a company from Pakistan (yes, there is one), Turkey or even Israel will naturally carry more risk than one from Japan or Europe (even from one of the weak sisters like Spain or Greece).

Be aware as well that, while the ADRs listed here must conform to U.S. accounting and reporting standards, the financial information from the company's foreign executives or accountants may be delayed or questionable in its accuracy.

Still, if you're eager to start investing in emerging-markets, but don't want the "homogenized" version offered by indexes, ETFs or closed-end mutual funds, ADRs could be just the ticket.

Ten ADRs to Start Your Search
With that in mind, here are 10 companies to review in starting your research. I've listed them by home country and industry group.

They include:

•Argentina - Mercadolibre Inc. (Nasdaq: MELI), recent price $94.70 - The market leader in e-commerce in most of Latin and South America.
•Brazil - Banco SantanderSA (NYSE: BSBR), recent price $8.07 -A Brazilian spinoff from a major Spanish bank.
•Chile - Lan Airlines S.A. (NYSE: LFL), recent price $27.96 - A passenger and cargo airline serving Chile, Peru, Argentina, Colombia and Ecuador, with routes around America, Europe and Oceania.
•China - VanceInfo Technologies Inc. (NYSE: VIT), recent price $12.70 - A technology outsourcer with IBM, HP and Microsoft on their customer list.
•Israel - Partner Communications Co. Ltd. (Nasdaq: PTNR), recent price $7.30 - A mobile phone network operator.
•Mexico - Homex Development Corp. (NYSE: HXM), recent price $17.25 - A home developer specializing in entry-level, middle-income and tourist housing in Mexico and Brazil.
•Peru - Cementos Pacasmayo (NYSE: CPAC), recent price $12.00 - A producer and distributor of construction materials, this company also operates several non-metals mines and quarries.
•South Korea - The LGL Group Inc. (Amex: LGL), recent price $7.43 - An information technology company.
•South Africa - Harmony Gold Mining Co. (NYSE: HMY), recent price $9.27 - A company that engages in underground and surface gold mining, exploration, processing and smelting.
•Turkey - Turkcell Iletisim Hizmetleri A.S. (NYSE: TKC), recent price $12.62 - A provider of mobile telecom and Internet services.

Source :http://moneymorning.com/2012/05/07/investing-in-emerging-markets-with-u-s-traded-adrs/

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