ADRE: Using ADRs To Invest In Emerging Market Stocks

Summary

• International markets are divided into three segments: Developed, Emerging, and Frontier, the smallest.
• With the spread of COVID-19 and the slow rollout of the vaccine in Emerging Market countries, investors are rightly concerned about the economic impact.
• This article includes expert outlooks for Emerging Market investing going into 2021 and beyond along with exploring ADRE.
• Believing that Emerging Markets will survive COVID-19, I am Bullish on ADRE for those looking for exposure to this equity segment.

Source: Wikiwand

Introduction

Invesco BLDRS Emerging Markets 50 ADR Index Fund (NASDAQ:ADRE) is a unique ETF as it doesn't invest directly in Emerging Market stocks. It limits itself to the 50 stocks that comprise the S&P/BNY Mellon Emerging 50 ADR Index. This index only includes ADRs, American Depositary Receipts.

Investopedia.com defines ADRs as:

An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. depositary bank representing a specified number of shares-often one share-of a foreign company's stock. The ADR trades on U.S. stock markets as any domestic shares would.

ADRs offer U.S. investors a way to purchase stock in overseas companies that would not be available otherwise. Foreign firms also benefit, as ADRs enable them to attract American investors and capital without the hassle and expense of listing on U.S. stock exchanges.

Source: investopedia.com

Of course, this means savvy investors can use ADRE's holdings to easily compile a list of Emerging Market ADRs and then pick their own subset based on countries and/sectors they think will perform the best. Keep in mind, ADRs focus on the largest companies. That focus on large, established companies is why I am Bullish on ADRE.

Expert views on the current and future outlook for Emerging Market stocks

Lazard Asset Management summarized their view as:

• The recovery in emerging markets equities that began in late March 2020 picked up steam in the fourth quarter thanks to COVID-19 vaccine breakthroughs and the US election outcome. The MSCI Emerging Markets Index outperformed global developed markets equities in 2020.
• We expect that emerging markets economies will benefit further as the vaccine is distributed in developed markets during the first half of 2021 and in emerging markets later in 2021 and 2022; value companies, in particular, are poised to benefit from higher global growth.

Source: lazardassetmanagement.com

They also provided the following chart showing the inverse relationship to MSCI EM Index returns and the value of the USD against world currencies.

Everything else being equal, the currently shrinking US dollar should underpin EM stocks until we hear the President or FED say they want a stronger dollar.

Ben Carlson in 2018 posted an article showing the best time to buy EM stocks is after they had a 20% correction.

Source: awealthofcommonsense.com

Since his data ended in July 2018, I used PortfolioVisualizer to see how EM, INTL Developed, and US stocks have performed since the beginning of 2018.

Source: portfoliovisualizer.com

Since the start of 2018, EM stocks have bettered International Development market stocks, lagged US stocks, and showed a small gain themselves. Since the September 2015 date mentioned, EM stocks have rallied and now show a 10.6% CAGR. Based on Mr. Carlson's premise, this might not be the best time to buy EM stocks. A later chart shows EM stocks might be starting a pullback also.

Of course, any analysis of Emerging Markets requires an understanding of Asia, and specifically China.

Source: matthewsasia.com

Asia and mainly China dominate most EM indices and thus the ETFs that follow those indices. There are ETFs that exclude China so investors can escape or adjust their EM China exposure. One such ETF will be mentioned later.

Source: gordcollins.com

This chart implies about a 10% annual growth in GNP thru 2025. Personally, I take any data flowing from China with a "grain of salt". While they are the most populated country, some forecasters believe their economy will stale due to a lack of workers as a result of their "one-child" policy of the 1970s and 80s. That should have less effect on the stocks owned by ADRE compared to the broader indices used by other ETFs.

Lyn Alden, who also writes as a Seeking Alpha Contributor, in her How to Invest in Emerging Markets: Guide for 2021 (lynalden.com) article, highlighted important data points EM investors need to investigate, presented here with some thoughts added by me.

• Growth rates: Countries with growing populations are more likely to have growing GNPs. While larger EM companies sell overseas, smaller ones are more country/region dependent for their growth.
• Debt levels: This can be seen as an indication of the health of the country plus their need to use debt to spur their economy. Compare this to the growing debt level here at home.
• Trade & Current Balances: People differ on what these mean and Lyn goes into depth on the topic so I point readers to her more-expert analysis.
• Foreign Reserves: Large foreign reserves help a country defend its currency. A country can use these reserves to aid in setting its currency's value on world markets.
• Stock Valuations: How does each country, along with each company, compare the standard equity valuation ratios like P/E, P/B, etc.

William Blair recently posted a Bullish on Emerging Markets Equities article on Seeking Alpha that adds to the points already mentioned. Along with those, he provides a chart showing EM valuations at one of their largest discounts to Developed markets as of the end of 2020.

I will end this section with the opinion expressed by J.P. Morgan Asset Management on Emerging Market investing:

Overall we see ample room for the emerging market economies to continue the process of catch up and to play an increasing role in driving global growth. Emerging markets now account for 40% of global nominal GDP but only 12% of the MSCI All-Country World index.

Emerging market stocks will likely remain a more volatile section of the global stock market. Those that have a strong preference for assets whose prices slowly and steadily grind higher may not appreciate the additional volatility that emerging markets bring to a portfolio. If, however, investors have a long time horizon and can stomach the volatility, then emerging markets would be expected to pay returns close to 8%, compared to 5% in developed market equities.

Source: am.jpmorgan.com

Examining Invesco BLDRS Emerging Markets 50 ADR Index Fund

Seeking Alpha describes ADRE as:

The fund invests in public equity markets of global emerging region. The fund invests in stocks of companies operating across diversified sectors. It invests in growth and value stocks of companies across diversified market capitalization. It seeks to track the performance of the S&P/BNY Mellon Emerging 50 ADR Index. ADRE started in 2002.

Source: seekingalpha.com

ADRE has $230m in AUM with Invesco charging 30bps in fees. Yield is currently under 1%. As the name implies, it holds roughly 50 ADRs.

ADRE is based on the following index, which S&P describes as:

The S&P/BNY Mellon Emerging 50 ADR Index seeks to track all American depositary receipts trading on the NYSE, NYSE American, and NASDAQ that represent shares in the largest 50 companies from emerging markets.

Source: spglobal.com

Source: invesco.com

Not surprising, China is almost 50% of the market weight of the Index, with three of the next four countries also being from Asia, one of which is South Korea. I mention that as not all index providers still consider South Korea as Emerging, some include them in their Developed Market indices.

The Top 10 ADRs held by ADRE are:

Source: invesco.com

With almost 40% in two holdings, here is Seeking Alpha's description of both and their current ratings and factor grades:

Taiwan Semiconductor Manufacturing Company Limited manufactures and sells integrated circuits and semiconductors. It also offers customer service, account management, and engineering services. The company serves customers in computer, communications, consumer, and industrial and standard segments in North America, Europe, Japan, China, and South Korea. Taiwan Semiconductor Manufacturing Company Limited was founded in 1987 and is headquartered in Hsinchu, Taiwan.

Source: seekingalpha.com

Alibaba Group Holding Limited, through its subsidiaries, provides online and mobile commerce businesses in the People's Republic of China and internationally. It operates through four segments: Core Commerce, Cloud Computing, Digital Media and Entertainment, and Innovation Initiatives and Others.

Source: seekingalpha.com

For more information on ADRE, visit the Invesco website.

Portfolio Strategy

Source: ProSolution

There are probably over 100 Emerging Market funds to pick from. I decided to compare four others to ADRE to help readers decide if ADRE's use of ADRs only is what they are looking for to gain Emerging Markets exposure. I tried to pick a good cross-section of popular funds.

Source: Fidelity and EMF site, compiled by Author

A common feature, even for the ETF that avoids China, is the overwhelming weight the Asian countries have. Except for DEM that focuses on dividend payers, yields are all under 2%. EMF has two advantages over the others: Being a CEF, it currently sells at an 8% discount to NAV and it's the only one not tied to an index. This would allow it to reposition its holdings faster if trouble is spotted in a particular region, country, or company. Index ETFs have the risk/benefit of the index provider redesigning its rules, the most recent one was most providers have now started to add China "A" shares to their indices.

Data by YCharts

My Bullish rating on ADRE is for long-term investors. I like the ADR focus as it forces the ETF to only hold large companies. One quirk of assigning stocks to an index based on their home country is that it doesn't indicate where their revenue or profits come from. These companies, especially large ones like Taiwan Semiconductors, depend on the strength of their export markets. That fact allows investors to focus on the companies themselves, not the home country's economic projections.

Market timers might want to wait to see if the recent correction will continue. For investors looking at an ETF with lots of holdings, meaning a smaller average market-cap, more vaccines being released should aid Emerging Market countries exiting from any economic restrictions they have which would support local growth. As indicated, smaller companies should be more positively impacted by that superior growth the experts are forecasting for Emerging Market countries.

Being a believer in being truly diversified across all asset classes, all investors need to at least consider owning Emerging Market stocks. Many of these EM countries have an ETF focused on their single country, allowing great flexibility in setting your exposure weights.

Analyst’s Disclosure: I am/we are long EMF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[thumb.ai]

@Retired Investor Why do you want the largest companies?

You mentioned the word "established" which implies reduced chance of a company going bankrupt. But I wasn't sure.

[Retired Investor]

@thumbsoup There’s that but main thought is these companies sell mostly to Developed countries whose economies will recover faster than EM where the smaller ones are more dependent, IMO.