These two banks are a great entrée into participating in the ADR markets.
Bank of Nova Scotia (BNS) and State Street Corporation (STT)
From Global Investing
There are several ways you can buy individual foreign stocks with a US brokerage account. The easiest way is using the American Depositary Receipt mechanism, or ADR, which some foreign companies create in order to make it easier for US and other non-local investors to buy their shares. This is because some foreign companies have US employees who want to benefit from stock options, or because they have US customers whose loyalty they want to increase.
The first ADRs were created way back in the 1920s by JP Morgan for Selfridges, a London department store popular with US visitors. It was listed on the “curb” exchange, which eventually became the American Stock Exchange. Today the major exchange, the NYSE, primarily offers ADRs of the biggest and best-regulated foreign companies. Many more are listed on NASDAQ, which attracts tech stocks.
But most non-US shares that trade in the US are over-the-counter stocks. There are two kinds of OTC ADRs, sponsored and unsponsored. A sponsored ADR is created by the company and it usually pays all the ADR fees. An unsponsored ADR is created by a brokerage or depositary bank, usually because there is demand for the share or because there will be demand as a result of, for example, a convertible bond or stock issue. When it converts, there will be sellers and to protect the foreign company, it is easier to buy in the US stock markets. Fees are taken out of dividends when they are imposed, and are hard to recoup from foreign stocks without a dividend.
As a general rule, because of the perception that risks are higher and because foreigners are less likely to own stocks (directly or indirectly) than Americans, the dividend payout from ADRs tends to be much higher than that for standard red-white-and blue shares. The added risk is currency movement, which can work in your favor or against it. You are ultimately buying in euros or sterling or yen, however easy it is to get a dollar quote.
Depending on your broker, you can also trade on respectable foreign markets. This is easiest in Canada where there are several dual-listed major companies on the NYSE, which formally do not count as ADRs. Moreover, many Canadian shares for startups and speculation can be bought directly in Canadian markets by US investors. Be careful of any stock which is not listed on the main Canada market of Toronto, as regulation in Vancouver is lax.
Apart from Canada, the brokerage fees for dealing directly in a foreign market are very variable, with each trade costing as much as $60-65 with some brokers (like Charles Schwab) or banks (like HSBC.) So you have to buy a large lot of shares to make the deal worthwhile, and you have to sell the lot rather than taking half of your profits off the table unless the share has risen phenomenally. Other brokers are cheaper, like E-trade, Fidelity, and Interactive Brokers. But almost all of them only cover some major stocks in some major markets and are cutting back on what they offer.
You can also buy funds that invest in a particular region or country, either closed-end or exchange-traded funds that you buy through a regular broker in return for a simple commission—rather than an open-end fund which is marketed directly. Funds aim to match or beat the country or regional index. ETFs set out to match an index. CEFs are quixotic and do whatever their managers think will pay off.
The easiest foreign market for US fund managers to operate in is England, which has lots of household name companies (although Selfridges no longer is listed in London.) Despite this, a British fund managing brokerage has determined that US ETFs investing in Britain collectively fail to match the FTSE index, the leading UK market gauge, by 21%--either doing better or worse by that amount.
If Britain is that hard to track, any more exotic and more foreign market is going to be harder, with foreign languages and foreign reporting requirements. The auditors will be less well known. There will be great lumps of stock not available to trade because of family control or foreign government stakes. So, rather than being off by 21%, the index-trackers will be off by more. Hence the ETFs, in particular, are prone to simply trade the index itself. Rather than buying every single share which exists in the region or country they cover, or even the best known ones, they simply buy the index or a derivative of it. That avoids considerable costs for trading in and out of single stocks.
The creator of many of these derivatives on UK and European stock indexes is Canada’s Bank of Nova Scotia (BNS) which is NYSE- and Toronto-listed. Another is State Street Corporation (STT), also NYSE-listed. These companies are a quick way to benefit from the globalization of markets. They create hedges which balance each other out, one for bears and one for bulls on the individual or grouped foreign market. They are also moving into derivatives on global sectoral markets. STT yields 1.57% and BNS 3.84%, because it also is a major player in global banking for individuals and companies, notably in Latin America and the Caribbean. Both are largely owned by institutional investors rather than retail investors.
With both US and European banks facing serious new regulations and taxes in 2018, there is an argument to be made for banks specializing in derivatives like BNS and STT for retail accounts. Don’t buy the derivatives (which are usually illegal for US individuals to do under SEC regulations). Buy the bank creating them.
Vivian Lewis, Global Investing, www.global-investing.com, 212-758-9480, January 8, 2018