A must-read for US stock investors: An in-depth analysis of the truth and pitfalls of ADR investing

What exactly is ADR? Explained in one sentence

Many US stock investors are both familiar and unfamiliar with ADR (American Depositary Receipt). In simple terms, an ADR is a certificate issued by a US depositary bank representing shares of a foreign listed company, allowing you to trade foreign company stocks directly on US stock exchanges.

Imagine: a Taiwanese company doesn’t want to relist in the US but wants to access the world’s largest capital market for financing. The solution is issuing ADR—foreign companies deposit their shares with a depositary bank, which then issues equivalent ADR certificates. The end result is that US and global investors can easily buy these foreign companies’ equity just like regular US stocks.

Companies like TSMC, Tencent, BYD, Alibaba—these well-known international giants are traded via ADR on US stock exchanges.

ADR Grading System: Risks and Opportunities Coexist

Not all ADRs are equal. According to the US Securities and Exchange Commission (SEC), ADRs are divided into three levels, with increasing regulatory requirements:

Level 1 ADR — The loosest option

• Only traded over-the-counter (OTC)
• Minimal disclosure, no need to submit full financial reports
• Least liquid, highest risk
• Suitable for patient investors seeking value opportunities

Level 2 ADR — A balanced choice

• Listed on NASDAQ or NYSE
• Must comply with SEC regulations, regularly disclose financials
• Balanced liquidity and regulation
• Most mainstream ADRs fall into this category

Level 3 ADR — The strictest standard

• Not only traded but also allows the company to raise capital in the US
• Most regulated, most transparent disclosures
• Best liquidity, lowest relative risk

Simple rule: if you want to avoid gambling, choose Level 3; if you’re willing to take risks for potential opportunities, Level 1 might surprise you.

Sponsored vs. Unsponsored ADRs: Understanding the Issuer’s True Intent

ADR also has another classification dimension: Sponsored ADRs and Unsponsored ADRs.

Sponsored ADRs involve active participation by the foreign company: the company signs an agreement with the bank, controls the issuance and management of ADRs, pays bank fees, and regularly submits financial information. These ADRs are more regulated, and investor risk is relatively controlled.

Unsponsored ADRs differ: the bank issues them on behalf of the foreign company, sometimes without the company’s knowledge. These ADRs can only be traded OTC, with lower transparency and higher risk. Tencent(TCEHY.US), BYD (BYDDY.US), Meituan (MPNGY.US) are typical examples of unsponsored ADRs.

The Secret of ADR Ratios: 1:1 Is Not the Standard

Many novice investors overlook this—the conversion ratio between ADR and the original foreign stock is not always 1:1.

For example, TSMC’s ratio is 1:5, meaning 5 shares of Taiwan TSMC stock(2330.TW) are equivalent to 1 ADR(TSM.US). Why? Companies usually set this ratio based on stock price, exchange rate, and liquidity needs. If the stock price is too high for retail investors, lowering the ratio makes the price more accessible.

Check these common Taiwan ADR ratios:

Taiwan Stock vs. Taiwan Stock ADR: Same Company, Different Investment Experience

Since the same company can be listed in Taiwan and also issue ADRs in the US, how should investors choose? The key differences are:

Nature: Taiwan stocks are the shares themselves; Taiwan ADRs are certificates representing those shares.

Trading Locations and Regulation: Buying Taiwan stocks involves the Taiwan Stock Exchange, under Taiwanese regulation; buying ADRs is on NYSE or NASDAQ, under US SEC regulation.

Different Tickers: Hon Hai in Taiwan is 2317; in US ADRs, it’s HNHAY—different codes, different systems, different feel.

Investor Base: Taiwan stocks mainly attract local Taiwanese investors; ADRs appeal to global investors.

Conversion Ratios: Buying one Taiwan stock equals one share; buying one ADR may represent 5 or 10 underlying shares.

Premiums and Discounts: Although their trends are similar, due to different exchanges, investor structures, and exchange rates, the prices of ADRs and Taiwan stocks often show discrepancies. In early 2023, TSMC ADRs and Taiwan stocks frequently diverged significantly—sometimes ADRs led the rally, other times Taiwan stocks did.

A-shares and A-shares ADRs: The Dual Track of Chinese Companies

Chinese companies also widely adopt ADR models. BYD, Great Wall Motors, and others listed in Hong Kong or A-shares also issue ADRs traded in the US.

The Practical Advantages of ADR Investment

Lower Taxes and Costs: Taiwanese investors trading ADRs face no income tax on profits under NT$1 million; overseas brokers often charge much lower fees than Taiwanese brokers, sometimes zero commission. For frequent traders, ADRs offer clear cost advantages.

Diversified Investment Opportunities: In US markets, you can buy not only US companies but also invest in top global firms via ADRs. Want to diversify between Tesla(TSLA) and NIO(NIO) in the EV race? ADR makes it possible.

Hidden Risks of ADR Investment

Liquidity Challenges: Many foreign companies are well-known domestically but have limited recognition in the US, resulting in fewer willing traders. For example, China Telecom(CHT.US) has an average monthly trading volume of about 145,000 shares, while Taiwan stocks of the same company trade around 12.24 million shares monthly—nearly a hundredfold difference. Poor liquidity means larger bid-ask spreads and higher risk of being stuck.

Exchange Rate Risks: Investing in ADR requires USD, introducing currency risk. Suppose you invest NT$30,000 in ADRs; at an exchange rate of 1:30, that’s $1,000 USD. If your investment gains 20%, it becomes $1,200. But if the exchange rate shifts to 1:25 when converting back, you only get NT$30,000—your apparent profit is wiped out by currency fluctuations.

Information Asymmetry: Especially for Level 1 ADRs, companies are not required to submit full financial reports to SEC. You need to seek financial info abroad yourself to make judgments. Many investors fall into traps due to lack of information.

Operational Costs for Non-US Investors: To trade ADRs, Taiwanese investors need to open overseas brokerage accounts, convert NT$ to USD, and fund the account before trading. Each step incurs costs and potential issues. Some choose to delegate to Taiwanese brokers for ADR procurement, but pay 1-2% handling fees—this adds up.

Decision Checklist Before Investing in ADRs

Before investing in ADRs, ask yourself:

1. Are the company’s fundamentals solid? Management, industry outlook, policy environment—like any stock, fundamentals determine long-term trends.

2. Is the ADR liquidity sufficient? Check monthly trading volume; if too low, think twice.

3. Can you accept exchange rate fluctuations? If currency swings bother you, ADR might not be suitable.

4. Is there a chance for premium or discount arbitrage? Some investors profit by selling at premiums and buying at discounts—only if you understand the phenomenon well.

5. Are operational costs worthwhile? Calculate total costs including currency exchange, account opening, and fees to ensure it’s worth it.

ADR is neither a flood nor a blessing—it’s a bridge connecting global capital markets. Used correctly, it allows low-cost investment in top global companies; misused, exchange rates and liquidity can eat into your returns. The key is understanding the mechanism, recognizing risks, and making decisions aligned with your situation.