Increased exchange-traded fund (ETF) ownership has been beneficial to American depositary receipts (ADRs). A study conducted by the University of Northern British Columbia found improved liquidity and information efficiency among ADRs owned by ETFs.

Researchers found ETF ownership reduced how much ADR prices move in reaction to a certain level of trading volume. The study’s authors looked at the Amihud ratio, which measures the price impact per unit of trading volume. Lower values imply a smaller price impact and thereby higher liquidity. ETF ownership is negatively correlated with the ADRs’ Amihud ratio, meaning it improved liquidity. Better liquidity reduces trading costs and makes it easier to buy and sell a security.

ETF ownership also improves the amount of an ADR’s earnings information that is priced in. The study’s authors believe this may be the case because “ETF investors’ trading on ADR firms are at least partly driven by country related information, and they help incorporate the country specific earnings into ADR firms’ returns.” As a result, the individual investor can get a clearer understanding of securities of a specific country and make a more educated decision.

The study’s authors believe this combination has helped to “improve the liquidity and pricing efficiency of less liquid and more opaque ADRs.”

Notably, ETF ownership does not have the same positive effects on U.S. stocks. “Stocks with more ETF ownership display higher volatility,” observe the study’s authors, conveying that ETFs may be associated with price uncertainty pertaining to individual stocks. ETFs can improve informational efficiency over the short term if there is a lacking informational environment, but “ETF ownership is associated with higher trading cost and lower informational efficiency” among U.S. stocks.

ETF ownership of ADRs increased from nearly 0% in 2001 to 3.6% in 2018. In comparison, ETF ownership of domestic stocks increased from 0% to 11% during the same time frame. Additionally, the average number of ETFs that a typical ADR is held by has risen from 6.2 to 17.6 over the observed period.

Source: “Do ETFs affect ADRs and U.S. domestic stocks differently?,” by Chengbo Fu, Qiping Huang and Hongfei Tang; SSRN, November 2021.

Related

First Cut ETFs

International Stock ETFs Outperforming Their Peers

Portfolio Strategies

International Diversification: Why It Still Makes Sense

AAII Stock Ideas

Building a Screen for Reasonably Priced ADRs