Impact of Currency Moves On An ADR

One of the stocks recommended in prior years’ and currently held in Portfolio 2 is Diageo, the UK spirits company.  Since the portfolios that I run for my nephews and nieces only purchase and hold stocks on US exchanges (for simplicity reasons), in order to get international exposure to companies like Diageo they are purchased as an ADR, or “American Depository Receipt”.    Here is a decent definition of an ADR, from wikipedia:

An American Depositary Receipt (abbreviated ADR) represents ownership in the shares of a non-U.S. company that trades in U.S. financial markets. The stock of many non-US companies trade on US stock exchanges through the use of ADRs. ADRs enable U.S. investors to buy shares in foreign companies without the hazards or inconveniences of cross-border & cross-currency transactions. ADRs carry prices in US dollars, pay dividends in US dollars, and can be traded like the shares of US-based companies.

Each ADR is issued by a U.S. depositary bank and can represent a fraction of a share, a single share, or multiple shares of the foreign stock. An owner of an ADR has the right to obtain the foreign stock it represents, but US investors usually find it more convenient simply to own the ADR. The price of an ADR often tracks the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares.

Thus for practical purposes the ADR is issued in US markets which enable US investors to easily hold and trade the stock and receive dividends.

Our shares of Diageo (the ADR is on the NYSE,  while the “main” stock is issued on the London Stock Exchanges or LSE) were purchased in late September, 2007 at a price of $88.75.  The current price of the ADR as of mid June 2010 is $66.42, calculated as (88.75-66.42/88.75) a LOSS of 25% of its value, as traded on the NYSE as an ADR.

The “main” stock on the LSE, however, traded for about 1074p in September, 2007 and is now worth 1,115p as of mid June 2010, for a (1115-1074/1074) GAIN of 4%.

Leaving aside the issue of tracking error on in the US ADR which is not likely to be significant, the gap in performance of 29% between our loss and their gain is measured by the performance of the US dollar vs. the British Pound.  In September, 2007 the British Pound was trading for roughly $2 against the dollar.  It is currently trading at approximately $1.46 against the dollar, for a  (2 – 1.46/2) LOSS OF  27%.

Thus the difference in performance between the two stocks was 29% and the fall in the British Pound vs. the US dollar was about 27%, so you can see that this delta is almost totally caused by the change in currency value during this time.

For years this currency effect has worked in FAVOR of US investors putting money in overseas stocks because the dollar was declining against other major currencies (the pound, the Euro).  However, now the US Dollar is strengthening against foreign currencies so the impact is reversed, and if you have significant overseas exposures in most currencies you are now seeing losses when they are translated into US Dollar terms.

Since I track a lot of items on the custom spreadsheets that I make for each portfolio I will start tracking the currency impact on ADR’s as distinguishable from the performance on the underlying exchange.  This will highlight the DIRECT portion due to changes in currency costs.

A couple of minor items:

– for my portfolios where I don’t usually owe taxes one minor annoyance is that taxes are withheld for overseas dividends.  If you pay foreign taxes you can net them against your US obligations (at a simplistic level) but since my portfolios don’t generally pay taxes due to their low level of gains and losses I don’t get this back.  Here is a company site explaining how a Finnish company withholds taxes on dividends which is useful.  For my purposes in the portfolio I only show the “net” proceeds; on my yield calculation I may start to show it “net” of withholding since I don’t get it back

– of course currency issues are far more complicated than this in that the company may earn in USD or in British Pounds; for example Diageo earns a lot of its income on US sales so it may book gains or losses anyways on currency but these are already “embedded” in the income statement.  The ADR price between the LSE and NYSE is due to the  “currency change” impact, but changes in currency rates may also impact the price of Diageo on the LSE itself

1 Comment

  1. The roiling currency markets have been a boon to some companies and a huge bust for others, depending on which side of the pond you are on. The euro has had a bang up week against the dollar this week (for whatever reason).


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s