Sprott Inc. has abruptly shuttered one of its hedge funds after it was hammered by the Swiss National Bank's shocking mid-January decision to drop its currency peg to the euro.
The Sprott Absolute Return Income Fund, launched in Aug. 31, 2010, had $21-million in assets under management and a stated investment objective to "maximize absolute total returns on investments with low volatility" primarily by investing in fixed income securities, currencies and derivatives. It had just enjoyed a solid 2014, generating an 11.6-per-cent return – well in excess of the main hedge fund indexes – when disaster struck on Jan. 15.
On that day the Swiss National Bank unexpectedly abandoned its decision to maintain a minimum exchange rate of 1.20 Swiss francs to the euro, after repeatedly affirming its commitment to hold the exchange rate floor of one of the world's safe-haven currencies.
That wreaked havoc on the currency markets and spelled disaster for the Sprott fund. Its managers had staked 10 per cent of the fund's assets selling a Euro-Swiss franc put, an option that would generate value for the fund as long as the Swiss central bank held to the currency peg. Anything that prompted the Swiss franc to spike in value could force the fund managers to cover the position at a massive loss, eating into the fund's capital.
That's what happened after the unexpected move by the Swiss bank prompted the country's currency to spike by 15 per cent in value. "It was one of the largest single-day currency movements in the history of foreign exchange…the whole foreign exchange market was caught off guard," said Sprott spokesman Glen Williams. "The one-day move and change in the volatility of the option damaged the value."
"Obviously the Swiss National Bank decision had a negative impact on the fund," Mr. Williams said. "The currency volatility made for a very difficult environment for foreign exchange funds. A lot of other funds were hit by this."
Sprott closed out the position at a huge loss: by the end of January, the fund's assets under management had fallen by 17.8 per cent over the month, almost entirely due to the euro-Swiss franc put bet gone bad. By contrast, the index which tracks similar hedge funds, the HFRX Absolute Return Index, posted a 0.6 per cent gain.
Another Canadian hedge fund manager likened the chain of events to "selling fire insurance in the middle of a rain forest and then seeing a big blaze and paying someone a massive amount of money to tear up the policy."
As a result of the Swiss currency hit, Sprott told outside unitholders it had closed the absolute return fund on Jan. 30 and would return their remaining capital. Mr. Williams said the fallout for individual investors was limited, as Sprott had contributed three-quarters of the funds assets under management. In addition, one of the fund's portfolio managers, Michael Craig, is no longer with the company, he said.
A second Sprott fund, the Sprott Strategic Fixed Income Fund, was also hurt by the Swiss move, but its euro-Swiss Franc position has been closed "and the fund remains very liquid,"
Sprott has about $750-million in hedge fund assets under management