On Sponsored and OTC ADR’s

In the accounts I attempt to offer a mix of US stocks and foreign stocks, under the theory that most of the world’s economy is outside the USA and for beneficiaries with a long time horizon, it is important to go where the growth of the future will reside.  In addition, this gives us some upside (and downside) if the US dollar rises or declines because foreign currencies do not always move consistently with our dollar.

Generally I have offered as stock selections ADR’s sponsored on one of the major US exchanges, either NYSE or NASDAQ.  These sponsored ADR’s must conform with US accounting rules (called GAAP) and other requirements, such as Sarbanes Oxley, which add additional auditing and compliance costs and supposedly provide offsetting assurances that the financial statements are correct and free from some sorts of defects.

From the perspective of the issuer, the foreign company listing in the USA, this provides additional avenues to reach potential stock holders outside of their local market.  ADR’s are easy for US citizens to purchase because they trade just like US stocks and do not cost extra to purchase, and don’t have any “direct” currency risk because it is always quoted in US dollars (although there is implied currency risk since as the host country’s currency moves against the US dollar, this affects the price).

However, not all firms find it worthwhile to issue ADR’s to reach US stockholders, and many do not want to pay the additional costs to comply with US accounting and regulatory rules.  Thus you cannot purchase many popular stocks, such as BMW, via an ADR that is traded on a major US exchange (NYSE or NASDAQ), because it does not exist.

Another alternative is to buy an “unsponsored” ADR, meaning one that trades on the over-the-counter (or OTC) market, which is also called the “pink sheets”.  OTC stocks can be seen because they have different ticker symbols, usually ending with a “Y”.  The OTC markets have traditionally had a bad reputation because they don’t have the same listing requirements as NASDAQ or NYSE and have been areas of “penny stock scams” and the like for years.

There is nothing inherently wrong with being in the OTC markets, however, and recently one of our ADR’s, Siemens, de-listed from the “sponsored” markets and became an OTC or pink sheet stock.  It received a new ticker symbol SIEGY.  The old stock symbol ticker was SI.  The volume transitioned over seamlessly.  This article, from the Siemens company website, describes the delisting process rationale and how it impacts US stockholders.

1) What is the impact of the delisting of Siemens ADRs from the New York Stock
Exchange (NYSE) on ADR holders?
Until May 15, 2014, Siemens American Depositary Receipt (ADR) facility was a so called
“sponsored Level II ADR program” which meant that Siemens ADRs were traded on the NYSE and
that Siemens was subject to periodic reporting obligations with the U.S. Securities and Exchange
Commission (SEC). Since May 16, 2014, i.e., after delisting from the NYSE, Siemens ADRs are no
longer traded on the NYSE or any other stock exchange in the U.S. This does not mean, however,
that Siemens ADR facility was closed down. To the contrary: Siemens converted its “sponsored
Level II ADR program” into a so-called “sponsored Level I ADR program”. This means that investors
are still able to purchase, sell and trade ADRs, although trading is no longer on-exchange, but solely
off-exchange (over-the-counter).
On May 16, 2014, Siemens filed a Form 15F to deregister its securities with the SEC. As a result,
Siemens reporting obligations were suspended with immediate effect (e.g., Siemens will no longer
be required to submit reports on Form 6-K or annual reports on Form 20-F to the SEC) Siemens
expects that its reporting obligations with the SEC will finally terminate in mid-August. Irrespective of
the delisting, high standards of transparency in financial reporting and first class corporate
governance will continue to be top priority at Siemens.
2) What was the reason for delisting from the New York Stock Exchange (NYSE)?
The goal of the delisting and planned deregistration was to address the change in the behavior of
our investors. The trading of Siemens shares is nowadays conducted predominantly in Germany
and via electronic trading platforms or over-the-counter. Trading volume of Siemens shares in the
USA was low, amounting to significantly less than 5% of its global trading volume in the year 2013.
As a consequence processes of financial reporting are simplified and efficiency is improved.

Thus from Siemens’ perspective, it cost extra money to do US based accounting reports but there was only 5% of its trading volume in the US.  Since the German accounting rules are likely as useful to investors as the US accounting rules, there is little additional risk in a stock such as Siemens moving to the OTC market from the “sponsored” ADR market.

This doesn’t mean that OTC markets aren’t riskier or less regulated than Sponsored markets (like NYSE and NASDAQ) – they are and the instruments that trade there are generally riskier, as well.  In the case of Siemens, however, it likely makes little to no difference.

Depending on your brokerage firm, however, OTC stocks can cost more to buy than listed stocks.  You need to look at the fine print in your statement.  It may involve extra charges or a higher cost / trade.  I am not planning on buying “new” non-sponsored ADR’s as of now but I am interested in seeing how this ADR trades on the OTC markets and what sort of extra fees (if any) that I might encounter when selling it.

Another option is to buy directly in foreign markets.  For instance, my brokerage firm probably would allow me to buy BMW in Euros on the German exchange.  To do this my statement would become more complicated because I would have currency gains and losses and instruments quoted in multiple currencies, the US dollar and Euro (and then this would get more complicated as I added currencies of other countries, such as the British Pound, the Australian Dollar, etc…).  For now I am not doing this but I will watch it and as the costs get further reduced at some point this will be a likely option.

I always learn a great deal by going through brokerage statements and details and noticed the ticker symbol changing on Siemens and then investigating “why”.  I also learned a lot about currency withholding on foreign ADR’s.  I can also see the explicit fees that my brokerage accounting is assessing.  This information has made me a better and more informed investor and I hope to pass these insights on to the beneficiaries of these trust funds.



Currency Rates and Japan

Japanese Market and Currency Swings

The Japanese stock market has been rallying, although recent losses have been in the headlines. Lets use this rally to provide us a stark example of the impact of currency rates on your portfolio.

As part of a policy from the Japanese government to spur growth, their currency has been allowed to depreciate 25% over the last 6 months. If you go to any typical financial site on the web you can see the ratio of the US Dollar to the Japanese Yen or follow the ticker “JPY” which is the ratio of the Yen / Dollar. The Japanese Yen was .013 per USD in October, 2012 and is now at a ratio of .0098 per USD as of May, 2013.

Now let’s look at the gain in stock prices. The Japanese Nikkei 225 index, which peaked at 38,916 in January of 1990, was around 10,000 in January 2011. The index reached 14,000 recently, for a gain of approximately 40% in local currency terms.

Anyone would want to participate in a 40% stock market rally, right?

Well, results can vary. EWJ, an iShares ETF covering the Japanese market, is “unhedged”. Thus if you invest you get the local market appreciation (the 40% gain) but this is offset by any currency moves, which means that you lose 25% when you put it back into US dollars. Let’s do a (very simplified) math problem here:

– $100 worth of US investment gains 40% in local currency terms = $140
– Take that $140 and multiply it by 75% (to reflect the 25% loss in currency) and you now get $105 USD
– Thus your gain in USD terms, after the currency change is 5% ($105-$100 / $100)

Due to a number of factors the math doesn’t work that simply so let’s show some real world examples.

Performance of Unhedged (EWF) and Hedged (DXJ) ETF’s

EWF is the “unhedged” ETF for the Japanese market, and DXJ is the “hedged” ETF for the Japanese market (meaning that they buy enough USD derivative offsets to adjust performance against currency moves in the US dollar).

Over the last year the DXJ returned around 50% while EWJ returned 20%. This article describes the battle for market share between the two funds, which DXJ (the hedged one) seems to be winning in the near term.

For many years the Japanese Yen APPRECIATED against the US dollar, so this is a reversal of long term trends. If you’d have used the hedged ETF all those years ago you would have had the opposite results. Hedging is great when the US dollar is appreciating, but goes the opposite when the dollar is falling. Note too that in the long term hedging an ETF is more costly than leaving it in an unhedged state, although this premium is not that large.

Simpler Example – A Single Stock

Let’s look at a simpler story – Nidec, a Japanese manufacturer, has been a stock we selected for Portfolio Two and held it for several years. The ADR for this stock is NJ, and its “underlying” stock on the Tokyo Stock Exchange has the symbol 6594. The two stocks should trade very close to lock step, and the only significant difference in value should be caused by currency swings. Over the last six months

– 6594 on the Japanese exchange (denominated in Yen) has had a positive return of 29%
– NJ, an ADR on NYSE (denominated in dollars) has had a positive return of 10%

Overseas Dividends and Taxation

I go through all of the portfolios individually and track all the transactions in order to create the spreadsheets that you can see on the sidebar.  One of the items I noted a while back is that if you receive a dividend on an ADR from an overseas company, your broker will withhold taxes and you won’t receive your entire dividend in cash.

A little background – an ADR is an instrument that trades on a US stock exchange that moves along with the underlying stock on a foreign exchange.  These ADR’s allow you to get stock exposure to overseas markets on an individual stock basis without having to purchase them through an international exchange, which brings additional procedural and processing headaches.  Generally only very large and liquid overseas stocks have US based ADR’s.

For instance Portfolio One, our longest tenured portfolio at over ten years, has the following ADR’s:

– Statoil (STO) – Norway
– CNOOC (CEO) – China
– China Petroleum (SNP) – China
– Taiwan Semiconductor Manufacturing (TSM) – Taiwan
– Toyota (TM) – Japan
– Canon (CAJ) – Japan

The determination of whether or not there is tax with-holding depends on the country.  The rate also depends on the unique circumstances of the country.

This article has a list of countries that do not withhold taxes at all and the rates that they use for US citizens. Below are some of the rates of countries for which my portfolios either have stocks or may consider to have ADR’s in the future –

No Withholding:
Columbia – 0%
India – 0%
Singapore – 0%
South Africa – 0%
UK – 0%

Taxes Withheld for US Citizens:
Australia – 30%
Brazil – 15%
Canada – 15%
China – 10%
Finland – 28%
France – 25%
Germany – 26.4%
Israel – 20%
Italy – 27%
Japan – 10%
Mexico – 10%
Netherlands – 15%
Norway – 25%
South Korea – 27.5%
Spain – 19%
Sweden – 30%
Switzerland – 35%
Taiwan – 20%
Turkey – 15%

As an investor, you can deduct the tax that you pay to foreign countries on your US tax form. This is a tax “credit” so it reduces your tax liability dollar-for-dollar, the best type of deduction. There is a publication called 514 “Foreign tax Credit for individuals” that explains this in more detail. Like everything else related to taxes, ask a professional for advice or read the form yourself. Here is a layman’s summary:

– If you only have passive income (dividends or income) such as is found on a 1099-DIV or 1099-INT
– You claim less than $300 in foreign tax credits (or $600 if married filing jointly)

If the above 2 items occur, then you can just put the amount of foreign taxes paid on your return and you don’t have to file a form 1116 which also ultimately puts limits on the amount of foreign taxes that you can deduct on your US return and is more complicated, as a result.

Thus you may want to select ADR’s from countries with favorable tax treaties with the US and with low withholding of dividends. For instance, China at 10% (and UK at 0%) are better than Switzerland at 35%. This won’t generally matter at the level of dividend income that my portfolios create each year – for instance portfolio 1 had about $500 of dividends in 2011 – so if all of it was (worst case) withheld at 35%, this would be ($500 * .35%) = $175. You need to own a pretty large portfolio to cross $300 in foreign with-holdings… for instance if you had $50,000 in foreign stocks which returned 4% in dividends at 15% foreign withholding that would mean that $50,000 * 4% * 15% = $300.

Note that whether or not the foreign taxes were withheld, you still owe US taxes. Since the recipients of my portfolios aren’t working full-time they have low (or no) income levels and they have low tax rates, anyways. They also benefit (like all investors) from the dividends received rule which limits dividends to 15% tax rates, and their capital gains are also lower because they are in low income brackets.

I hope this is helpful. I always learn something when I take apart the detail of my brokerage statement and try to recalculate everything (now I can recalculate the withheld taxes on dividends!). I recommend that over time you try to do the same, as well. Financial literacy is your friend.

Like every tax rule, there are exceptions and complications, so do your own research.

Currency Impact on ADR’s

In a previous post I calculated the impact of currency change on a specific ADR, Diageo, the UK spirits company. To do this, I looked at the price in US dollars on the US exchange (in this case the NYSE) and the price of the “underlying” stock on its resident exchange, in this case in Pounds on the London Stock Exchange (LSE). In the case of this stock, the ADR (which we own in the US) decreased in US dollar terms (what we really care about) by 25%, while the “underlying” stock on the LSE increased in value by 4%, for a “performance gap” of about 29%. The UK Pound dropped by about 27% during this period against the US dollar, which accounts for this difference.

Due to the large impact of currency moves on ADR’s, I am going to attempt to track this going forward on the spreadsheets that I use for each portfolio. For each ADR I buy I will do the following:

– track the price of the ADR on the US exchange at the time I bought it (already doing this)
– track the price of the ADR on its “home” exchange at the same date (this is new)
– track the ratio of US Dollars to the relevant foreign currency (in the case of Diageo, it is dollar vs. Pound relationship) on that same date
– then for each update I will track how the performance of the “underlying” stock is on its home exchange (in the case of Diageo, up 4%)
– I will track the performance of the US dollar vs. the foreign currency
– Then I will determine the portion of the gap tied to foreign currency moves, which will likely be the total performance difference between the ADR and the underlying value on the home exchange

In this post, I describe the process that I use to track stock performance and overall portfolio performance on each of my accounts (up to 5 now). The process of tracking performance is MUCH more complicated and tedious than you might think, since I am trying to track a lot of items that your brokerage statement either doesn’t want you to know or hasn’t thought through the process of giving it to you in a useful format. For 99% of the population out there (maybe even a higher percentage) taking apart the brokerage statement in detail and looking at the component pieces of return will teach you something that you don’t know. While the quality of the analytics provided by outside vendors is increasing, it is still not simple to track performance, pull out expenses, the portion of return due to dividends, etc… And I would be willing to bet that the average investor doesn’t know the portion of their portfolio’s return due to currency moves between the parent and the underlying exchange for ADR’s, for instance.

For those that are expert investors there are other impacts of currency moves WITHIN the stock price that aren’t simple to show like the Diageo example, above. For instance, if a company produces goods in a country with a strong currency and sells them in a country with a weak currency, that company’s profit will be impacted negatively, which will show up in their profit and loss statement, and impact the stock value. To avoid this impact many companies try to “source” production in the same country where it is sold, if that is possible. Companies can also “hedge” by purchasing contracts which, for the cost of the contract, will make the currency impact go away, and to make it more complex many companies only partially hedge. For the purpose of this analysis I am simplifying this away because it is already captured within the existing stock price valuation and future prospects.

I will add this analysis to the stocks that are ADR’s in the portfolio and get this for the update needed for “stock selection season”, which is coming up in late August before the kids / now some are adults go back to school / college for the year.

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