Considerations in Constructing ex-US Factor Portfolios Using ADRs

This article examines the feasibility of constructing factor-based direct indexing (DI) portfolios using only American Depository Receipts (ADRs) in the ex-US universe. With the increasing popularity of personalized indexing, where investors can own individual securities in a managed, customized portfolio, there is a need to explore the potential of ADR-only DI portfolios. The study begins with an analysis of the ADR universe compared to a benchmark index, highlighting the differences in market capitalization, sector, and country weightings. It then investigates the performance of ADR portfolios using well-known equity factors, such as value and profitability. The results show that market-value-weighted ADR portfolios underperform the benchmark index, but there is evidence of both a value and profitability effect in the ADR universe. Factor-based ADR portfolios can be a viable investment strategy, offering active return in the ex-US universe. However, careful consideration should be given not only to factor selecting and weighting schemes, but also to the resulting tracking error, turnover, risk, and the necessary account minimums.