Coincidentally, I was talking to the portfolio manager of our index funds today and part of the conversation was surrounding tracking error and the use of ADRs and GDRs. In a post from last week I had mentioned how using ADRs and GDRs could be a source of tracking error, but there is more to that conversation lest you think you should always avoid depositary receipts.
One reason is political risk. For example, our global and emerging markets index funds try to hold the direct stocks on their foreign exchanges as much as possible, but for the case of Russian stocks there is enough concern that getting your money out of the Russian stock exchange might not always be feasible that using ADRs is preferable.
Another reason to consider using ADRs (or GDRs) is that you can avoid paying Stamp Duties. Stamp Duties are levied by certain countries for buying and/or selling stocks – it is simply a tax. In the UK, the stamp duty is 0.5% of the value of the transaction, and to give you an idea as to how much revenue is generated from stamp duties it was as high as 4.5 billion pounds in 2001 (so it likely isn’t going anywhere anytime soon).
By buying an ADR instead, you would avoid the stamp duty. So as long as you monitor the premium or discount to NAV of the ADR and deem it to be liquid enough it may very well be a superior option than buying the direct stock and incurring an instant tracking error of 0.5% off the hop.
