Engineering a turnaround

Sprott will remain true to its roots as a resources investment specialist, Grosskopf says, and it’s just a matter of time before the commodity cycle turns upward again. That, he adds, will breathe life into the significantly undervalued resources holdings and precious-metals bullion funds that dominate Sprott’s product line.

“The pendulum has swung way too far, and many resources companies are dramatically undervalued,” Grosskopf says. “There is potential for a huge revaluation. We are not giving up on the resources industry at all, and we believe it’s an opportune time to reload.”

The past couple of years have been tough. Sprott’s profits plunged as investment performance stumbled, redemptions increased and revenue from management fees dwindled. The most recent results show net income for the nine months ended Sept. 30, 2013, of $8.9 million, or 5¢ a share – a fraction of the $28.7 million (17¢ a share) earned in the corresponding period a year earlier.

Sprott’s stock currently is trading in the $2.60 range, a long way from its issue price of $10 a share in 2008, before the global financial crisis. AUM was $7.3 billion on Sept. 30, 2013, down by 29% from $10.3 billion a year earlier.

“It’s been somewhat painful,” Grosskopf says of watching Sprott’s AUM wither away while the stock-market party roars ahead in the U.S. “We’re laying the groundwork for the next resources boom, but there’s a lot to be said for a diversified platform.”

A key belief at Sprott – that rampant global government stimulus measures will lead ultimately to devaluation of paper currencies and boost the value of hard assets such as precious metals – remains. Although there has been talk of tapering monetary stimulus in the U.S., those at Sprott believe that any such reductions will be hampered by the fact that a massively indebted government cannot afford the consequences of higher interest rates.

Sprott’s heavy concentration in the energy and precious metals sectors fuelled growth when commodity prices were rising, says Dan Hallett, vice president and principal with HighView Financial Group of Oakville, Ont., but has turned into a vulnerability for Sprott in the past couple of years as commodity prices wilted.

“The company’s positioning in commodities helped it build a big business on the strength of one mandate, with outstanding performance for several years,” Hallett says. “But Sprott has come off its much stronger position of a few years ago. While they may have once scoffed at the idea of offering income and balanced funds, they have been undergoing a forced transition to include mainstream products.”

In addition to the resources industry doldrums, Sprott is dealing with changes in the management suite and a shrinking role for company founder Eric Sprott, who owns 35% of the company’s issued stock. Earlier this year, Sprott named two senior portfolio managers, John Wilson and Scott Colbourne, as co-chief investment officers (CIO) of a key subsidiary, Sprott Asset Management LP, which manages the parent company’s family of mutual funds, hedge funds and discretionary managed accounts.

The two new co-CIOs replace Eric Sprott, who has given up his role as CIO but remains chairman of Sprott Inc. Eric Sprott, 68, has been gradually relinquishing day-to-day corporate management and investment responsibilities. Other Sprott managers, such as Allan Jacobs, senior portfolio manager and director of small cap investments, and Peter Imhof, investment strategist, are taking on bigger roles at some of the funds formerly headed up by Eric Sprott, including the flagship Sprott Canadian Equity Fund.

“There’s been change in the way we are managing our portfolios, and a greater focus on teamwork and risk management,” Grosskopf says. “Eric’s day-to-day responsibilities have changed and he is no longer as responsible for managing the team or for securities selection. He remains involved with overall investment strategy, and continues to steer the firm as chairman and major shareholder.”

In the executive suite, Kevin Bambrough, former president of Sprott Inc. and former president and CEO of Sprott Resource Corp., recently took his leave after more than a decade with the organization. He has been replaced at Sprott Resource Corp., which specializes in private-equity deals in the resources and agricultural arenas, by Steve Yuzpe, previously chief financial officer. Grosskopf describes Bambrough’s departure as a “separation of interests… We saw the future differently. He will pursue his interests and we will pursue ours.”

Grosskopf plans to capitalize on Sprott Inc.’s global reputation for resources expertise and is keen to diversify the firm’s sources of income by developing relationships with international partners and tapping a worldwide pool of investors. Sprott recently launched a global hedge fund for institutional investors – Sprott Macro Managers Fund – and has launched an offshore global mining investment fund in partnership with Zijin Mining Group Co. Ltd., one of the largest mining firms in China. The latter fund will be available to the massive market of Chinese investors.

In addition, South Korea’s National Pension Service recently named Sprott as co-manager of a 10-year US$375-million private-equity fund, along with Woori Asset Management Co. Ltd. of Korea. That fund will invest in global natural resources and power-generation opportunities.

On the lookout for acquistions

Yet another prong of Sprott’s diversification strategy is acquisition. Sprott has invested in sales, compliance, legal and back-office staff, Grosskopf says, and although the company wants to remain a “scrappy independent,” the hurdle is rising regarding assets needed to operate profitably and compete against the investment industry giants. Sprott is on the lookout to acquire another fund-management firm, Grosskopf says, and will be adding selectively to its lineup of funds and portfolio managers in 2014.

“We’re an independent, niche firm finding ways to add value,” Grosskopf says. “We don’t want to be a supermarket with 70 funds. But we can’t afford to sit idle and wait passively for a rebound in the resources business.”

About half of Sprott’s $7.3 billion in AUM is held in closed-end physical bullion funds holding silver, gold, platinum and palladium, and these funds generate lower fees than Sprott’s more actively managed hedge funds and mutual funds. Many of Sprott’s older equities-based mutual funds and hedge funds also tilt toward precious metals and resources stocks.

In the past couple of years, Sprott has augmented its lineup with new fixed-income and balanced funds, as well as diversified equity and balanced funds under the “Enhanced” banner managed by Wilson. Since Wilson came on board in early 2012 from Cumberland Private Wealth Management Inc. of Toronto, the Enhanced line of funds have garnered about $350 million in AUM.

These funds employ defensive strategies using put and call options to provide downside protection in dropping markets, but won’t completely capture bull market moves. Wilson also has taken over Sprott Opportunities RSP Fund and Sprott Opportunities Hedge LP.

“[Wilson] is a bright spot at Sprott, and the Enhanced funds have been gathering assets through new sales,” says Scott Chan, analyst with Toronto-based Canaccord Genuity Corp. “The funds have a different style than Sprott’s other equity funds and are doing better.”

On the fixed-income side, Sprott’s offerings include Sprott Diversified Yield Fund, Sprott Short-Term Bond Fund and Sprott Absolute Return Income Fund. Heading up Sprott’s fixed-income portfolios is co-CIO Colbourne, who was hired in 2010 to beef up Sprott’s fixed-income shelf, now standing at $400 million in AUM.

“All in all, we are pleased with the growth of fixed-income,” Grosskopf says. “Clients were asking for it; we needed to have it.”

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