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For investors looking for a way to gain exposure to stocks listed on different exchanges across the globe without the expensive fees and complexities that go along with buying shares in foreign countries and the troubles associated with trading at different prices and currency values, ADR’S may be a reasonable option to gain exposure to foreign markets.

ADRs (American Deposit Receipts) are shares of foreign stock issued by a bank in the U.S. which purchases a bulk number of shares of the foreign company and then sells the shares in dollar denominations on U.S. exchanges.

There are several things to consider when using ADRs as a way to gain exposure to global companies that can be both benefits and concerns to U.S. investors. Some of the risks of purchasing ADRs that investors should consider are currency exchange risks where another country’s currency may fluctuate more than in the U.S. affecting the value of your investment, political stability and the country’s ability to handle inflationary pressures may also be potential problems that may arise when dealing with ADRs or any foreign stock in general.

Some benefits to investing abroad are the ability to diversify across multiple countries and economies to take advantage of emerging markets where growth opportunities are more abundant while at the same time spreading risk across multiple countries and economies to help avoid a huge economic swing or currency issue in one country. Another reason to consider ADRs is to take advantage of a comparative advantage in another country based on materials, labor or specific skills that make a company in another country more attractive than similar U.S. based companies. There will be times when the U.S. economy is less attractive than others and ADRs provide US investors the ability to participate in those economies and also as a hedge against complete exposure to the dollar without the high fees and confusing currency conversions of purchasing the local shares of the stock that is offered as an ADR.

Whether you are looking for ADRs or the locally traded global stocks AFG’s Economic Margin methodology and Valuation techniques provide investors a consistent method of valuing stocks all over the globe. It is always important to focus on companies that are expected to improve their economic profitability and are trading at a discount to their intrinsic value.

The companies listed below are from AFG’s ADR universe, and encompass characteristics that we look for when identifying stocks that are more likely to outperform. These companies are expected to improve their Economic Margins (what a company earns above or below its true cost of capital) in the next fiscal year and are currently trading at a discount to their intrinsic value. The backtest results shown below our list of companies will explain in detail the improved performance of portfolios when using these two criteria in concert within different countries and time periods.

We believe that the current macroeconomic uncertainty around the world may make most investment opportunities seem risky, but we believe that a portfolio built around stock selection adhering to these quantitative factors combined with international diversification should be well-positioned to outperform broader markets in the long run.

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The charts below highlight the performance of AFG’s EM and valuation variables used to identify the most attractive ADR'S. Within each country, there is a considerable spread between the top and bottom halves for each variable (Percent to Target and EM Momentum), and an even more significant spread is achieved when you combine both variables. When looking for attractive global investment opportunities, investors can use these variables as a great starting point. (More on these charts below)

The first table highlights the quantitative performance of Percent to Target (Top Half vs. Bottom Half), EM Momentum (Positive Momentum vs. Negative Momentum), and the combination of both.

Note that in a worldwide strategy, a multi-variable quantitative approach (with Percent to Target and EM Momentum) along with international diversification (across all countries) creates a long strategy that outperforms 81% of the time and a short strategy that underperforms 84% of the time. (Calculated as market months)

The next table highlights the annual performance: (12/31/91 – 7/30/2010).

Note that the combined strategy adds a significant amount of alpha over the individual variable strategies, and only led to one year of underperformance in 1999.

The final table highlights quarterly performance to take this to a little deeper level: (12/31/01 – 7/30/2010).

Note that with variable diversification and international diversification, this strategy has only seen 2 quarters of underperformance since 2002 Q1.

Disclosure: None