ADRs are tradeable assets that mirror shares in companies issued outside of the US. They are usually issued by banks and let US investors trade in overseas companies using the US dollar and legal system.
For example, investors in the US can buy ADRs in Royal Dutch Shell - the famous oil company. Shell is traded on the London Stock Exchange in pounds but ADRs let US investors buy them in dollars.
Another benefit of ADRs is that they mean any dividends a US investor receives from an overseas company will be paid in dollars.
How does an ADR work?
ADRs are usually issued by banks. These banks will buy actual shares in overseas companies and then issue corresponding ADRs.
If we go back to our Shell example, a US bank might buy 1000 shares in Shell. They’ll then be able to issue ADRs equivalent to 1000 shares in the oil company.
One ADR doesn’t have to be equal to exactly one stock. It could be worth one share or a thousand shares. Some banks even allow investors to buy ADRs that are equivalent to fractions of a share.
Owning an ADR means that you are entitled to ownership in the share(s) that it represents.
That means an ADR representing 1000 shares in Shell could be exchanged for 1000 real shares in the oil company.
Most ADR owners will not bother doing this because the main purpose of an ADR is to keep things in US dollars and under the US legal system. Actually owning the shares in an overseas company would remove these benefits.
Why is this beneficial?
In our overwhelmingly interconnected world, it can be easy to forget that our planet is still made up of different nation-states that have their own laws, currencies and taxes.
That means it’s often easier to buy stuff from people or companies based in the same country as you are. Investing is not immune to this process.
Investing in stocks and shares comes with its own set of tax laws and financial regulations. Currencies are also an issue. US-issued stocks are traded in dollars, so if you are in the UK, you’ll have to convert your pounds before you can invest.
That’s why ADRs exist. They effectively pass on all the bureaucracy involved in overseas investments, whether its currency transactions or tax issues, to the banks that issue them.