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How clarity over intended risk sources helps investors target superior outcomes through portfolio construction. It is commonly understood that there is no return without risk, but risk is often not well understood. In this foundational paper, the RBC Global Equity team explores some of the important differences between the two main groups of equity risk – stock-specific and common – and shows how stock-specific has the potential of greatest risk-adjusted returns for the skilled investor. Although risk sources are often poorly defined, making accessing pure stock-specific risk problematic, the paper proposes an approach whereby investors who are clear about their intended risk sources can use diversification to manage residual exposures to unintended risk sources. For the true stock picker, the returns from the resulting portfolio should be driven by alpha. For the asset owner, the uniqueness of alpha generated returns offers useful diversification opportunities within a broader asset mix.
