1997-09-08 04:00:00 PDT San Francisco — Mutual funds aren’t the only way to own a piece of a foreign company.

Many do-it-yourself investors are adding international flavor to their portfolios with American Depository Receipts (ADRs).

ADRs are certificates issued by U.S. commercial banks that represent shares of a foreign company. The certificates resemble domestic stocks.

ADRs trade like any other U.S. security in the over-the-counter market or on a national exchange, and are priced and pay dividends in dollars.

ADRs are typically bought and sold through brokers, but many can now be bought from banks with recently introduced direct purchase options. Most also offer dividend reinvestment plans.

An estimated 98 percent of the ADRs are sold by the Bank of New York, J.P. Morgan, and Citibank.

Although the first ADR was introduced by J.P. Morgan in 1927, the investments started taking off about seven years ago.

Today about 1,700 ADRs from companies in more than 60 countries are available to investors, and more are being added.

Some of the more well-known foreign companies offering ADRs include Sony Corp. Telefonos de Mexico. Barclays Bank Plc and Quantas Airways.

Since 1990 ADRs have enjoyed an an-

nual compounded return of 30 percent, while ADR trading has increased 22 percent, according to the Bank of New York.

The value of depository receipts traded in 1996 was $337 billion, a 22 percent jump from the previous year, the bank said.

For the first half of 1997, the value of depository receipts reached $221 billion, up 27 percent over the same period last year, the bank said.

ADRs have grown in popularity as investors learn more about the importance of diversification, said Anita Emard. Citibank’s director of product management for depository receipts.

Diversification — creating a portfolio mix of stocks, bonds, cash and international securities — is especially important given the volatility of the U.S. stock market.

The idea is that if one investment drops, such as U.S. stocks, others like international securities can help cushion the blow by either holding steady or increasing in value.

With the expanding global economy, ADRs are a natural way to go, Emard said. They’re also easy. They’re traded in U.S. dollar terms and don’t require any kind of foreign exchange.

ADRs are primarily used by large institutional investors or individual investors who enjoy picking individual stocks, said Mill Valley financial planner Stefan Williams.

They’re a good way to get foreign exposure if you know what you’re doing, he said, adding that ADRs can complement mutual funds by targeting specific countries or industries.

RAISING CAPITAL

Foreign companies usually offer ADRs to raise capital after exhausting all possibilities in their home market.

Many of these foreign companies also hope to broaden their shareholder base, and expand globally.

The U.S. is key to developing a market or a brand identity, said Emard.

ADRs are either sponsored — where foreign companies work with a depository bank and actively manage the program — or unsponsored — created and offered without a foreign company’s active participation.

About 78 percent of all ADRs are sponsored, according to Citibank.

There are five types of ADRs: Level I, Level II, Level III, Rule 144A ADRs and Global Depository Receipts (GDRs).

Level I ADRs are only traded over-the-counter. Level II and Level III ADRs are listed on U.S. exchanges or quoted on Nasdaq.

Listed ADRs are more popular because retail investors can follow the prices every day in the paper, said Edward Van Raay. a vice president at J.P. Morgan.

Only qualified institutional buyers with at least $100 million in assets, or non-U.S. residents, can buy Rule 144A ADRs. GDRs are for non-U.S. residents only.

TAX ADVANTAGES

ADRs have some potential tax advantages and cost efficiencies over international mutual funds, said Williams.

Unlike mutual funds, there’s no management fee for holding ADRs. And depending on how often they’re traded, they can be more tax efficient than mutual funds.

With mutual funds, for instance, you may be socked with short-term capital gains every year if the fund manager changes the portfolio’s mix.

By contrast, you can control the sale of ADRs to take capital gains or losses.

Most ADRs are purchased by institutional investors. Last year, the top ADR buyers were Fidelity Management & Research, Capital Research & Management, and Putnam Investment Management Inc.. according to J.P. Morgan.

When choosing from among the hundreds of ADRs on the market, you have to evaluate the foreign company’s fundamentals, just as you would with a U.S. stock.

This involves looking at the economy of the country the company is based in, and whether it’s in a high-growth industry.

Researching foreign companies can be problematic because you have to contend with different languages, exchange rates and accounting standards.

All ADR transactions are in dollars. And Level II and Level III ADRs must comply with generally accepted accounting principals (GAAP), which means you’ll have little trouble obtaining and reading the foreign company’s financial statements or annual reports.

DIRECT PURCHASE

The latest development in the world of ADRs is the introduction of direct purchase options.

With direct purchase options, you can save money by buying ADRs directly from banks. They’re similar to plans that let you purchase U.S. stocks directly from domestic companies.

Most ADRs also offer dividend reinvestment plans, which let you build up your account quickly by automatically reinvesting your dividends to buy more ADRs.

J.P. Morgan last year was the first bank to roll out a direct purchase option. Today, 60 ADRs can be purchased with this plan.

J.P. Morgan’s Shareholder Services Program requires an initial minimum investment of $250, and a one-time enrollment fee of $15. The purchase or sale of an ADR costs $5 per transaction, plus 12 cents per share. The charge for dividend reinvestments is 5 percent of the dividend up to $2.50 per dividend payment.

The Bank of New York’s Global BuyDIRECT program offers 110 ADRs, requires a minimum initial investment of $200, and charges a one-time enrollment fee of $10. The purchase or sale of an ADR costs $5 per transaction, plus 10 cents per share. The charge for dividend reinvestments is 5 percent of the dividend up to $5 per dividend payment, and another 10 cents per ADR purchased.

Citibank is rolling out its own direct purchase option later this month. It’s called the International Direct Investment Program and will offer up to 40 ADRs this year.

The Citibank program requires an initial minimum investment of $250, and a one-time $10 enrollment fee. The purchase of an ADR costs $5 per transaction, plus 10 cents per share. The sale of an ADR costs $10 per transaction, plus 10 cents per share. The charge for dividend reinvestments is 10 cents per share.

In order to attract and retain investors, non-U.S. companies need to offer the same type and range of services that U.S. companies offer, said Vince Fitzpatrick, vice president in charge of broker/institutional marketing for the Bank of New York.

ADR RESOURCES

— Bank of New York: For information on ADRs go to the Web site at www.bankofny.com/adr/index.htm. For information about the bank’s Global BuyDIRECT program, call (800) 345-1612

— Citibank: ADR information will be available beginning later this month on the bank’s Web site at www.citibank.com /. So will information about the bank’s International Direct Investment Program at (800) 808-8010.

— J.P. Morgan: For information about the bank’s Shareholder Services Program, call (800) 749-1687. The Web site at www.jpmorgan.com / doesn’t have any ADR information. Source: Chronicle research