Alpha & Beta

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As the overall market swings, basic skills such as picking stocks become less important.

Beta is traditionally defined as market volatility that every stock has some exposure to, whereas alpha is individual stock-specific risk and reward.

Over the last 10 years, the overall market has shifted from a market where people trade on alpha-based bets to a market where a significant amount of trading is aimed at capturing beta inefficiencies.

 

In common English, this means bad news in Italy immediately translates into bad news for Brazilian equity pricing. The whole world has become so connected and focused on the short term that individual stock picking has become almost irrelevant.

Even when trying to capture beta, we think it is important to buy companies you like and to develop taste for a good story versus an average story. In the long term, we hope alpha generated from focusing on individual names will still deliver value for investors.

Junior mining companies clearly are impacted by global news. When the banks faltered in 2008, a large number of juniors were forced to significantly dilute or go out of business. However, junior mining is one sector where individual-name alpha still has significant influence.

When we research projects and companies, we study four things:

General market (beta)

You can buy general market exposure cheaply via indexes and individual equities. We would not recommend buying junior mining companies for general market exposure, as it is expensive.

Commodity focus (alpha)

Commodity focus can be bought by purchasing physical commodities, futures, major equities with a commodity focus, or junior mining companies. The reason we like junior mining companies for commodity exposure is because they’re highly leveraged versus other options, and the leverage is cheap to maintain.

Project quality (alpha)

Project quality is important and can only be captured by buying individual names. Good projects sell for a premium but are hard to come by. Focus on finding good projects within a commodity sector, and don’t just buy projects because you like the commodity. If you cannot find a good junior project, buy the major.

Management quality (alpha)

Call up management, shake their hands, and have drinks with them. If you don’t like them, don’t buy into the company. Bad management is easy to avoid with a bit of due diligence. Is the CEO someone you want on your side? Keep in mind that nice guys finish last, and you want a management team that will kill for the company while being honest with shareholders.

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