Hedge fund manager Eric Sprott.Darren Calabrese/The Globe and Mail
Surfing the Internet in his home office one day more than a decade ago, Sheldon Meingarten came across an unusual investment fund.
It had been a tough time for investors to make money: The bursting of the tech bubble, 9/11 and a moderate recession in the U.S. had conspired to send stock markets on a downward spiral. But one portfolio manager, Eric Sprott, seemed like a wizard, generating annual returns of roughly 30 per cent since 1997.
Mr. Meingarten invested a chunk of his wife's RRSP into the Sprott Canadian Equity Fund. Soon after, he added his own money, spreading the investments across several funds. In all, he put in a "healthy six figures."
For years he felt like a genius. At one point his return on the investment had climbed to about 250 per cent, so he didn't pay much attention to Mr. Sprott's world view that hard assets such as gold and silver would thrive in a world awash in debt, and that producers of these precious metals would soar when the financial system collapsed. "I was riding that rocket," Mr. Meingarten said.
The rocket has now crashed. Falling prices for commodities and resource stocks have badly hurt the performance of Sprott Asset Management, and Mr. Sprott has lost more than a little of his reputation as the man with the Midas touch. Investors in that Canadian fund have lost nearly half their money over the past five years, but the returns have been just as bad on many Sprott funds. Through March, three of the firm's hedge funds had lost at least 33 per cent of their value in the preceding 12 months – and that was before last week's sharp decline in gold and silver prices.
Investors have pulled their money in response; the firm's mutual, offshore and hedge funds suffered redemptions totalling $539-million last year.
Money managers earn fees as a percentage of the value of their assets under management, so less money to be managed means less revenue earned. That pessimism has seeped into the stock price of the public company that owns the asset management business, Sprott Inc. Since going public in 2008 at $10 a share, the asset manager has only once traded at that value again. It closed on Friday at $2.73, a loss of 73 per cent since its debut.
All this red ink raises some critical questions. How long will Mr. Sprott remain wedded to the theories that tie him to junior resource plays? And how long will his colleagues stand behind them?
The Globe and Mail spent the past few weeks talking to the company's senior management, including Mr. Sprott himself, power players in Bay Street's asset management circles, analysts and former Sprott employees. Many of those interviewed believe the company will struggle until Mr. Sprott, who is 68, retires, but a vocal minority believe the asset manager can turn things around by diversifying into the income and yield-oriented securities that investors now crave, even if the founder lingers.
An attempt to diversify
Eric Sprott's prestigious art collection – a Van Gogh, a Monet – still hang on the walls of Sprott Inc.'s offices in Toronto's Royal Bank Plaza, but the man himself is often abroad.
Since stepping back from day-to-day management of the company and handing the reins in 2010 to Peter Grosskopf, a former Cormark Securities executive, he now spends about one-quarter of his time in Scottsdale, Ariz., where he bought a house for $7.2-million (U.S.) in 2008.
However, he still vigorously manages several flagship funds, and remains the firm's public face. When gold markets plummeted last week – the most in 30 years – it wasn't Mr. Grosskopf who spoke on a conference call the next day. Mr. Sprott took the microphone and made sure everyone knew his company was still committed to precious metals.
Multiple people who've left Sprott Inc. told the Globe that Mr. Sprott's unwavering belief in investing in gold and silver led the founder to butt heads with those inside the firm who questioned this stance. These sources claim that if staff argued for diversifying the funds in the past, Mr. Sprott had sometimes accused them of not being team players.
That's a misconception, the current managers say. "I think people still are fearful that Eric will disapprove if they take a contrary view," Mr. Grosskopf said. Yes, Eric Sprott can "roar," the CEO said, "but he's also incredibly supportive of people that are successful running franchises for their own clients and for their own strategies."
"You will get people who come from this firm who say, 'Oh, Eric didn't approve of what I was doing,' but those were people that generally weren't strong enough to survive in their own businesses."
Mr. Grosskopf uses his own story as an example of what can be accomplished. "When I first got to the firm, we had the opportunity to take all our resources and put them in that precious metals area, and just become the world's biggest precious metals firm … And we said, 'We shouldn't do that.'"
To branch out, he hired Scott Colbourne, a fixed-income manager from TD Asset Management, and later brought on John Wilson to focus on equities across all industries. They were named co-chief investment officers in 2012.
He's also pursued adding a global macro fund as well as a partnership with Chinese gold and copper giant Zijin Mining Group Co. Ltd., which put up $100-million to start a new fund with Sprott's managers, who contributed $10-million.
Outside the fund business, Mr. Grosskopf is beefing up several business lines, including Sprott Resource Lending Corp., which lends to resource companies, and a private equity arm that invests in smaller explorers that aren't publicly traded. Both generated the bulk of Sprott's special performance fees in 2012.
Yet Mr. Grosskopf continues to double down on resources, too. In 2011, the company paid $90-million in stock to acquire three U.S. investment funds run by Rick Rule – who, like Mr. Sprott, is a gold bug. And he has emphasized selling Sprott's physical gold and silver trusts, which offer investors the ability to directly own the precious metals. Since 2010, these trusts have raised a hefty $3.4-billion.
These funds have brought in new assets at a time when Sprott's mutual funds and hedge funds face contraction . During the bull market in commodities, stellar returns kept the money pouring in, but those days are gone. Despite its push into fixed-income, the company has raised only $500-million in this asset class, amounting to about 5 per cent of Sprott's $10-billion in assets under management.
Unwavering belief
Despite the troubles, Mr. Sprott will not be shaken from his belief that precious metals are one of the few ways for investors to protect themselves from an inevitable spike in global inflation, caused by central bank policies that increase the money supply in an effort to create growth.
Even in the face of tepid inflation, a resurgent U.S. stock market and the prospect that the U.S. Federal Reserve will curtail its quantitative easing program, Mr. Sprott can still find evidence to back up his investment thesis. For example, he points to the Japanese central bank's recent decision to ramp up its own money-creation efforts in order to stimulate its economy and to devalue the yen.
"People who realize the insanity of the financial policies should get involved in the safe assets, and that safe asset should not be a paper asset," he said in an interview.
He's not alone in that view. "Certainly governments are still overspending; debt levels are high; the amount of printing that's going on globally is astounding," said Chris Beer, senior portfolio manager of commodities and precious metals at RBC Global Asset Management. In the past few years "we had a tiny increase in the gold supply, but we've had a monumental increase in the monetary supply."
One of the riddles of Sprott's performance is that many of the things its founder predicted did come to pass – an abundance of debt led to the collapse of a major Wall Street institution (Lehman Brothers) and five euro zone countries were bailed out – yet the funds have still struggled. "It's like you've got all the answers right, and the teacher gives you a C+," a former employee said.
There is also an unanswered question in Mr. Sprott's theory. Hard assets have value because there is a fixed supply of them, but it isn't clear why Sprott favours junior resource companies as the best way to play that market. These companies typically explore for metals, and developing any of their projects would require either bank lending or raising money in the capital markets. Financing has been a struggle for juniors in recent months, and rampant delays and rising costs haven't improved matters.
"Nobody's going to put a penny in any exploration project right now, which obviously hurts Eric," said Canaccord Genuity analyst Scott Chan.
Some wonder if psychology is at play. For any investor, it is hard to sell a stock at a loss. Former employees and other asset managers believe the same thing could be playing out with Mr. Sprott. He has been so public with his beliefs that abandoning them now would be all but impossible.
Then, of course, there's Mr. Sprott's disposition. Speaking at an event for students at Carleton University, his alma mater, in December 2011, he said: "I'm not a believer in diversification, I just do not believe in it. I never have, I never will."
Some funds have lost so much money that the only way to earn performance fees – which are charged when returns beat certain thresholds – would be with another high-risk, high-reward bet. Yield-producing stocks such as real estate trusts are hot right now, but they aren't going to offer the 100-per-cent returns that Mr. Chan calculates would be needed on many funds to earn such fees again.
Growing pains
Big-name asset managers are prone to certain pitfalls. As they grow, they gather assets – sometimes quickly, as in Sprott Inc.'s case – and can become unwieldy and difficult to manage.
"As firms get bigger, some of the tools that they used to become successful get taken away from them," said Tom Bradley, the founder of Steadyhand Investment Funds, who once ran Vancouver-based money manager Phillips, Hager & North Investment Management Ltd. Sprott made its name investing in junior resource companies, but there are only so many good, small opportunities.
Sprott has also had trouble selling the stocks of smaller resources companies; it simply can't find buyers for such large positions. Mr. Grosskopf admitted this has been a problem, but argues the worst is behind them. "A lot of those positions have fallen so much in value now … that they're individually insignificant in the context of the fund."
Other missteps have hurt investor confidence. Last year Sprott acquired small asset manager Flatiron Investment Management, but within six months the firm blew up and Sprott wrote off $5-million. Mr. Grosskopf did not shy away from the mistake, noting that Sprott was built with an entrepreneurial spirit, which can lead to the occasional wrong call. But he asks investors still in his funds to stick with him.
"It's an unusually violent cyclical downturn … the worst thing you can do is react to it in a panic and sell at the wrong point," he said.
Sprott is not the only firm suffering. AGF Management Ltd. is in pain. Even IGM Financial Inc., one of the steadiest companies in the Canadian fund management business, is experiencing net redemptions. The industry's structure is also changing, with banks becoming fearsome competitors and exchange-traded funds swelling in popularity.
But the big question now is whether investors are willing to wait it out at Sprott. Redemptions will likely continue to be a problem this year, according to analysts, although the management team has said they believe anyone who wanted to redeem probably already has.
For Mr. Meingarten, the time to throw in the towel came in January when he pulled the last of his money. In total, he came away with a compound annual gain of about 7.5 per cent since his initial investment in 2002. But he still can't wrap his head around how it all fell apart so fast. And he doesn't have the luxury of staying invested while he figures it out.
"Maybe five, 10 years from now, [Eric] will be dead right. But in the meantime, I'm too close to retirement to hang in there," he said, adding that 30-per-cent losses are just too tough to stomach at his age. "I can't absorb that any more."
With files from Pav Jordan.
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As Sprott's equity funds lose money, some investors have begun pulling their cash out. That has forced the company to sell physical bullion funds to attract new clients. It has been successful in doing so – but these funds pay smaller fees than traditional mutual funds and hedge funds. (All in 2012 figures.)
$506-million
Dollar value of mutual-fund assets that Sprott lost in 2012, through redemptions and market declines. That was 20 per cent of mutual fund assets.
$307-million
Dollar value of hedge-fund assets the company lost last year, excluding offshore funds.
$1.9-billion
The amount Sprott raised by selling new bullion funds.
$5,168
The value today of a $10,000 investment made five years ago in the Sprott Canadian Equity Fund.
Tim Kiladze