Domestic equity managers are looking abroad to boost their performance, bulking up their portfolios with ADRs.
Money managers say they are increasing holdings of ADRs (which are receipts for shares of a foreign company held by a U.S. bank, representing equity ownership in the company) for three key reasons. They gain access to more companies, lower their exposure to a potential recession in the U.S. and get greater exposure to certain sectors and industries such as mining and clean energy firms where there are simply not very many U.S.-based companies.
Brett Meyer, a senior vice president for Callan Associates independent adviser group, which provides research to financial intermediaries and independent consulting firms, said roughly 20% to 25% of U.S. institutional money managers have asked their clients to allow them to increase their exposure to ADRs. Other U.S. managers are already allowed to increase that exposure, he said.
In response to managers requests, staff of The Teachers Retirement System of Illinois, Springfield, last year loosened the reins on domestic equity managers and allowed them more discretion to invest in ADRs.
Greg Turk, director of investments, told trustees of the $42 billion fund at a Dec. 6 investment committee meeting that some of the plans managers were finding better investment opportunities outside of the U.S. Mr. Turk said managers wanted more exposure to overseas markets like China, India and some South American countries because those markets were outperforming the U.S. Mr. Turk said staff were allowing managers more discretion to invest in ADRs and that the results were favorable, without providing specific performance details.
Mr. Turk declined to be interviewed. Eva Goltermann, public information officer, said she was unable to provide specifics on which TRS managers now invest in ADRs or the amount theyve invested through these securities.
Three of four domestic equity managers for the Ohio Police & Fire Pension Fund, Columbus, already are allowed to use ADRs. The remaining manager did ask officials at the $12.5 billion fund to buy up to 5% in foreign stocks that are listed in the U.S. exchanges. The fund then discussed including those stocks in an ADR framework, said David Graham, a spokesman for the fund.
Executives at other pension funds contacted for this story said they either already allow their managers to invest in ADRs or their managers have not asked for permission to increase the amount of ADRs they can hold in the portfolio.
ADRs were particularly attractive last year as international stocks generally outperformed domestic stocks.
According to data from Birinyi Associates Inc., Westport Connecticut, the top performing ADRs in 2007 were: China Finance Online Co. Ltd., which jumped 392% to close the year at $21.90; China Eastern Airlines Corp. Ltd., up 348% to $97.66; DryShips Inc., 329% to $77.40; Mechel, 281% to $97.14; TBS International Ltd., up 278% to $33.06; and Baidu.com Inc., which increased 246% to $390.39.
In some cases, ADRs are attractive because theyre not tied to the strength or demise of the U.S. economy, said Eric Teal, chief investment officer for First Citizens Capital Management Group, a Raleigh, N.C.-based manager with $7 billion in assets.
He said his firm has between 5% and 7% of its U.S. large-cap core portfolio invested in ADRs. That portion was at 1% a few years ago and has slowly moved up.
Weve found them to be attractive, particularly in the energy and basic material sectors, Mr. Teal said. He named BHP Billiton Ltd. and Total SA as particularly attractive ADRs.
Arvind Sachdeva, chief investment officer of large-cap value at Victory Capital Management Inc., Cleveland, also named BHP Billiton as an attractive ADR.
ADRs comprised roughly 10% of his $1.85 billion large-cap value portfolio last year, up from 2% to 3% a few years back. That percentage has dropped recently because the valuations of some of those names became more full, he said.
But ADRs are generally attractive because they give a portfolio manager full exposure to various sectors, Mr. Sachdeva said. He used mining as an example. It is hard, if not impossible, to find U.S. companies that mine every type of mineral. But a company like BHP mines everything.
It allows the domestic managers, to the extent that they have global capabilities to still invest in attractive industries and companies and reduce exposure to a weak U.S. dollar, added Neil Rue, managing director of Pension Consulting Alliance Inc., Portland, Ore.
Consultants and investment staff overseeing pension funds have generally been fine with their domestic managers increasing the number of ADRs in their portfolio as long as it does not go too far.
Its another way to access emerging market names, said Josh Emanuel, head of manager research for Wilshire Associates Inc., Santa Monica, Calif.
Some clients want to take more risk in non-U.S. equity markets. It shouldnt become the primary source of (the domestic managers) outperformance or risk in their portfolio.
Typically, Id be nervous if the U.S. equity manager is investing more than 10% of their its portfolio in ADRs, Mr. Emanuel added.
Other consultants, such as Mr. Meyer, said they are comfortable with U.S. stock managers having anywhere from 10% to 20% of the portfolio made up of ADRs.
At the end of the day a lot of large-cap, U.S.-based securities are getting a lot of revenue globally. Whats the difference in investing in an overseas company that gets a lot of revenue from the U.S., Mr. Meyer said. That argument holds some credence.
Christine Williamson contributed to this story.