According to Citigroup, new tax laws in the US are set to boost American investor interest in Asian ADRs.
The reason is that ADRs will be given equal tax treatment to domestic stocks in respect to dividend payments – on which the tax rate has been lowered to a maximum of 15%. Given Asian stocks tend to pay higher dividends than US stocks this could lead to a surge in interest in dividend-paying Asian ADRs.
This matters because US investors currently own $1.2 trillion worth of foreign stocks. ADRs now represent 35% of that figure.
"The recent US Tax Bill enacted into law on May 28," says a Citigroup report, "has made equity ownership, including ownership of non-US equity, more attractive for US investors, so we expect the trends of increasing US investor capital committed to non-US corporations to continue."
The change could drive more money into Asian ADRs, and could also lead to behavioural changes among US investors that sees them favour ADRs to an even greater extent.
The tax benefit on dividends will only be applied to foreign companies listed in the US, which means primarily ADRs. Thus if a well off American individual had to decide whether they would buy one of two Asian stocks with a dividend yield of 5%, but one was an ADR and one was simply listed in its local market, the tax advantage would naturally make (all other things being equal) the ADR look more favourable. The individual will pay a maximum tax rate of 15% on the dividend income from the ADR but 38.6% for the other non-US listed stock.
Citigroup points out that over a 10 year horizon, for a company with a dividend yield of 5% and a 6% growth rate that the US shareholder will make a present value gain of 10% thanks to the tax cut and this will be significant.
And as Citi also points out: "In the two weeks following the passing of the act, ADRs as a universe outperformed companies in the MSCI World Ex-USA index by 3.3% (and the S&P 500 by 2.3%). As dividends of most companies in the index also benefit from the reduction in tax rates for US investors, we believe the higher percentage of US investor ownership in the companies with ADRs as well as the relative ease of capital investment through ADRs for US investors explains some of the differential in performance."