Factor Alpha & International Investing: Part 3 (of 4)
(This is the third in a series of four posts that examine the efficacy of factor-based investing in the International market.)
Access International Markets via ADRs
For many investors the only vehicle available to invest in foreign local shares is through a mutual fund. A viable alternative for investors to access international stocks is through American Depository Receipts or ADRs. ADRs are U.S.-listed foreign securities that enable U.S. investors to invest in non-U.S. companies while giving non-U.S. companies easier access to U.S. capital markets. Today, approximately 92% of the MSCI EAFE index can be accessed via the ADR market in the U.S. on a cap-weighted basis. Investing via ADRs provides a cost advantage relative to the local share market while providing a robust alpha opportunity.
Factor Alpha Efficacy and Cost: ADRs
Similar to our analysis on foreign local shares, we would like to evaluate the efficacy of a factor in the ADR space by comparing the return spread between the highest- and lowest-ranking decile.
Over the period from 1990 to 2015 when ADR data became available we see healthy return spreads for value and momentum among ADRs. While the spread for value is comparable at 18.6% versus 19.7% for local shares, momentum outperforms within the ADR universe by a slight margin. This data coupled with adequate coverage of the international market gives us confidence that research performed on the local share market is relevant in the ADR space.
Factor Alpha Spreads
While an inefficiently-priced market provides alpha opportunity for investors, it is not a cure all for achieving excess returns. A common concern about investing outside of the U.S. is related to cost. As ADRs trade on U.S. exchanges, the cost associated with trading these securities are no different from other U.S.-listed companies. The average ticket charge for trading a stock in the local share market from a developed country on the MSCI EAFE is approximately $22 compared to $6 for U.S. listed securities. This cost differential makes smaller account sizes more viable in the ADR market, since fees can significantly erode return.