For tax reasons, I switched a position I had in the HSBC London GBP listing into the USD ADR. The ADR represents 5 shares of the GBP listing. My understanding was that since at all times 1 ADR = 5 UK stock, when holding the ADR, your underlying currency risk is still GBP which is what I wanted. So I sold my UK position to by 1/5 in the ADR, hoping that I could revert the position at some stage in the future at no cost since at all times I retained the same exposure. For some reason I don't understand, 1 year down the road, if I simulate a converstion of my position back in the UK stock, I love about 25 % when the original stock has lost only 9 %. As if had been exposed to USD/GBP risk. I understand that the price of the ADR is a function of the price of the UK stock and the UK/USD exchange rate, but if the ADR drops in price due to UK/USD, I should be able to compensate that as I will need less USD to buy back the GBP, so this factor should be offset. Can anyone understand where is the problem ? For me if at all times 1 ADR in USD = 5 UK stock, I could at all times switch from one to the other retaining the same exposure, but in practice does not seem to be the case !
I went through historical data, and computed the daily P&L of the strategy, and correlation with GBPUSD is perfect, so the strategy is indeed affected by currency risk, even if at all times, 5 UK stock = 1 ADR
Now I still need to understand why, because my expectation was to remain at all time with a position equivalent to the one I had with the UK stock...