Wealth Managers, Direct Indexing and ADRs

Wealth managers can add international exposure to their U.S.-based clients’ portfolios in several ways. One way is via direct indexing of an international index, such as the MSCI EAFE Index. Another is to invest in American depository receipts (ADRs). ADRs are issued by U.S.-based banks or brokers and represent shares of a foreign company. They are priced and settled in USD. Each of these represents an option that may facilitate the operational complexity of a multi-currency portfolio and the associated exchange rates.

A third option is to create personalized portfolios using the prescreened liquid and investable constituents (370 ADRs) of the MSCI EAFE Expanded ADR Index. As of March 2022, when the universe was expanded to include level 1 ADR issuers, the index covered approximately 70% of the market capitalization of its parent index, the MSCI EAFE Index.

Has the MSCI EAFE Expanded ADR Index provided similar coverage and exposures as the MSCI EAFE Index?

Our analysis shows that the country allocation of the MSCI Expanded EAFE ADR Index has approximated that of the MSCI EAFE Index, since its inception on March 27, 2022. On average, each country’s coverage was 43% of its investable securities.

Likewise, the MSCI FaCS^™ exposures of the MSCI Expanded EAFE ADR Index have been close to those of the MSCI EAFE Index. The main difference has been the MSCI EAFE Expanded ADR Index’s greater exposure to large-cap stocks because ADRs have been typically issued by companies with larger market capitalizations.

Managers who consider complementing their clients’ domestic allocations with international allocations via direct indexing may wish to examine how market capitalization and sector exposures are aligned with the clients’ investment preferences.