What Is an American Depositary Share (ADS)?

An American depositary share (ADS) is an equity share of a non-U.S. company that is held by a U.S. depositary bank and is available for purchase by U.S. investors.

The entire issuance of shares by a foreign company is called an American Depositary Receipt (ADR), while the individual shares are referred to as ADSs. But the terms American Depositary Shares and American Depositary Receipts are often used interchangeably.

Understanding American Depositary Shares

An ADR is a negotiable certificate issued by a U.S. bank, under agreement with the foreign company, and is evidence of ownership of ADSs, much the same way a stock certificate denotes ownership of equity shares.

ADSs are meant to facilitate trading of the shares. They can trade over-the-counter (OTC) or on a major exchange such as the New York Stock Exchange (NYSE) or the Nasdaq (Nasdaq), depending on how much the foreign company is willing to comply with U.S. regulations. Listing on a major exchange generally requires the same level of reporting as that done by domestic companies, as well as adherence to Generally Accepted Accounting Principles (GAAP).

The Benefits of ADSs

Foreign companies that choose to offer shares on U.S. exchanges gain the advantage of a wider investor base, which can also lower costs of future capital. For U.S. investors, ADSs offer the opportunity to invest in foreign companies without dealing with currency conversions and other cross-border administrative hoops.

The Downside of ADSs

There is some currency risk involved in holding ADSs. Fluctuations in the exchange rate between the U.S. dollar and the foreign currency will have some effect on the price of shares as well as on any income payments, which must be converted into U.S. dollars.

Tax treatment of dividends from ADSs is also different. Most countries apply a withholding amount on dividends issued for ADRs. This withholding amount can vary. For example, Chile and Switzerland withhold 35% while France can withhold as much as 75% of the tax on dividends, in the case of non-cooperative countries within the EU. The withholding tax is in addition to the dividend tax already levied by U.S. authorities. The dividend tax can be avoided by ADR investors by filling out Form 1116 for foreign tax credit.

Real World Examples of ADSs

A single ADS often represents more than one share of common stock. Further, ADSs can “gap” up or down outside of U.S. trading hours, when trading is happening in the company’s home country and U.S. markets are closed.

For example, South Korea’s Woori Bank, a subsidiary of Woori Financial Group, has ADSs that are traded in the U.S. The bank’s ADS gapped up by $0.03 on July 20, 2016. A technical analysis of the price action on this ADS shows that for the past decade, its price continued higher two-thirds of the time after a gap up.

What Is the Average Annual Return (AAR)?

The average annual return (AAR) is a percentage used when reporting the historical return, such as the three-, five-, and 10-year average returns of a mutual fund. The average annual return is stated net of a fund’s operating expense ratio. Additionally, it does not include sales charges, if applicable, or portfolio transaction brokerage commissions.

In its simplest terms, the average annual return (AAR) measures the money made or lost by a mutual fund over a given period. Investors considering a mutual fund investment will often review the AAR and compare it with other similar mutual funds as part of their mutual fund investment strategy.

Understanding the Average Annual Return (AAR)

When you are selecting a mutual fund, the average annual return is a helpful guide for measuring a fund’s long-term performance. However, investors should also look at a fund’s yearly performance to fully appreciate the consistency of its annual total returns.

For example, a five-year average annual return of 10% looks attractive. However, if the yearly returns (those that produced the average annual return) were +40%, +30%, -10%, +5% and -15% (50 / 5 = 10%), performance over the past three years warrants examination of the fund’s management and investment strategy.

Components of an Average Annual Return (AAR)

There are three components that contribute to the average annual return (AAR) of an equity mutual fund: share price appreciation, capital gains, and dividends.

Share Price Appreciation

Share price appreciation results from unrealized gains or losses in the underlying stocks held in a portfolio. As the share price of a stock fluctuates over a year, it proportionately contributes to or detracts from the AAR of the fund that maintains a holding in the issue.

For example, the American Funds AMCAP Fund’s top holding is Netflix (NFLX), which represents 3.7% of the portfolio’s net assets as of Feb. 29, 2020. Netflix is one of 199 equities in the AMCAP fund. Fund managers can add or subtract assets from the fund or change the proportions of each holding as needed to meet the fund’s performance objectives. The fund’s combined assets have contributed to the portfolio’s 10-year AAR of 11.58% through Feb. 29, 2020.

Capital Gains Distributions

Capital gains distributions paid from a mutual fund result from the generation of income or sale of stocks from which a manager realizes a profit in a growth portfolio. Shareholders can opt to receive the distributions in cash or reinvest them in the fund. Capital gains are the realized portion of AAR. The distribution, which reduces share price by the dollar amount paid out, represents a taxable gain for shareholders.

A fund can have a negative AAR and still make taxable distributions. The Wells Fargo Discovery Fund paid a capital gain of $2.59 on Dec. 11, 2015, despite the fund having an AAR of negative 1.48%.

Dividends

Quarterly dividends paid from company earnings contribute to a mutual fund’s AAR and also reduce the value of a portfolio’s net asset value (NAV). Like capital gains, dividend income received from the portfolio can be reinvested or taken in cash.

Large-cap stock funds with positive earnings typically pay dividends to individual and institutional shareholders. These quarterly distributions comprise the dividend yield component of a mutual fund’s AAR. The T. Rowe Price Dividend Growth Fund has a trailing 12-month yield of 1.36%, a contributing factor to the fund’s three-year AAR of 15.65% through Feb. 29, 2020.

Special Considerations

Calculating an average annual return is much simpler than the average annual rate of return, which uses a geometric average instead of a regular mean. The formula is: [(1+r₁) x (1+r₂) x (1+r₃) x … x (1+r_i)] ^(1/n) – 1, where r is the annual rate of return and n is the number of years in the period.

The average annual return is sometimes considered less useful for giving a picture of the performance of a fund because returns compound rather than combine. Investors must pay attention when looking at mutual funds to compare the same types of returns for each fund.