Check-in Brazil ADRS vs Local Shares

One of the noteworthy developments here in Q4 has been the renewed interest in capital controls by countries trying to manage the flood of portfolio capital. Brazil's 2% tax on purchases of Brazilian stocks and bonds is among the most significant examples.

A number of ADRs on Brazilian companies trade in the United States and often with very good liquidity. When we initially compared the price of the local shares for Petrobras and the ADR, we found the ADR pricing did not account for the 2% tax on the local shares.

Subsequently Brazil has announced a 1.5% tax on new ADR issuance. We thought it timely look again at the ADR/local share performance.

First, returning to Petrobras. The ADRs still are trading in line with the local shares and the 2% tax on foreign purchases of real for local shares is not reflected in the price of the ADR.

Second, we looked at Vale, one of the the country's key commodity producers. The ADR has been trading at what appears to be a small premium to the local shares, but not 2%.

Third, we looked at the Gerdau, the steel company. The premium of ADRs to the local shares appears near 2%.

This exercise suggests that for investors indifferent to owning the ADR or local shares that decisions need to be made on a case-by--case basis. Academic work suggests that the ADRs will likely price in the tax over time and that the arbitrage opportunities may close.