On the surface, Eric Sprott embodies everything that conventional wisdom says the smart fund buyer should avoid. He swings for the fences. His flagship Sprott Canadian Equity Fund charges a large management fee. And he stakes the success of his portfolio on the soundness of controversial, unproven theories.

These are not the characteristics that typically lead to consistent, long-run outperformance. Except that in Sprott’s case, it all works. That’s why he is Investment Executive’s 2007 Mutual Fund Manager of the Year.

WhenIE selects its Fund Manager of the Year, we look at the fund’s performance, absolute and relative, over a 10-year period, consistency of performance, costs and correlation to the S&P/TSX composite total return index. (See page 4 for methodology.)

Typically, the funds and their managers that rank well in our methodology are steady, consistent performers that add a little bit of alpha around the edges each year. Over time, that compounds into a solid performance advantage over average funds and managers. High-ranking funds also typically have low MERs, which is another advantage that accumulates over time.

This year’s honouree, Sprott Canadian Equity Fund, offered by Toronto-based Sprott Asset Management Inc. and co-managed by Eric Sprott, is none of those things. Instead, Sprott is a manager who aims to shoot the lights out each and every day — and the fund has seemingly managed to do so over the past 10 years. It has had one down year in the past 10, and that was its first full year of operation, when it lost 16%. Since then, its worst calendar year was a 13% gain in 2005. Its best year was 1998, when it had a 53.4% gain.

The Sprott fund has consistently blown away its benchmarks. It is outperforming both the S&P/TSX composite and the S&P 500 index for one, three, five and 10-year periods ended Oct. 31. Its 10-year average annual compound return is 27.5% — compared with a 9.8% return for the S&P/TSX and 5.4% for the S&P 500 for the same time period.

The Sprott fund makes big bets — and it wins far more than it loses. It has experienced 79 months with positive returns over its lifetime, vs 43 months with negative returns. Its best 12-month period over the past 10 years was a gain in excess of 100%. And, since inception, in late 1997, the fund’s cumulative return is 1,166%.

Given the magnitude and consistency of the fund’s returns, the fact that it charges a hefty 2.5% management fee still seems like a bargain compared with funds that are cheaper but deliver much less bang for the buck. (In 2004, the Sprott fund began offering F-class units, with a management fee of 1.5%; and I-class units, for which the fee is negotiable). The fund also pays a performance fee of 10% for returns in excess of the benchmark, putting its total MER at a lofty 4.3%, according to Morningstar Canada data.

Apart from fees, another characteristic that sets the fund apart is that it enjoys more investment freedom than your average mutual fund, as it has regulatory approval to short stocks and to invest up to 20% of its assets in gold and silver.

Not at all the profile of the typical mutual fund MVP. In fact, the shoot-the-lights-out performance record, fee structure and portfolio all make the fund look a bit like a hedge fund in mutual fund’s clothing.

But there’s no denying that the fund’s atypical methods are working. The eponymous Sprott serves as portfolio co-manager on the fund, as well as chairman and CEO of the firm that bears his name. Joining Sprott on the fund is co-manager Anne Spork, vice president and senior portfolio manager; in 2001, senior portfolio manager Jean-François Tardif was added to the team.

Sprott suggests that the secret to the fund’s success is two-pronged: the firm’s analysts and portfolio managers do a good job of identifying macro trends, and seizing on them; and within those overarching themes, they seek companies that they believe can deliver outsized returns (typically smaller, unknown plays) and then make large bets on them.

“We’re always going for the home run,” Sprott says. “How do you make 27.5% returns by buying stocks that are going to go up 20%? You have to be looking at stocks that can go up by 50s and 100s and multi-hundreds — which is what we do.”

@page_break@Ordinarily, home-run hitters strike out a lot. And Sprott concedes that his fund has had its share of strikeouts. But what has saved it, he suggests, is getting the theme right in the first place. “Normally, the secular theme carries you part of the way,” he says, “and then the individual company gets you the outsized return.”

So, if you get the macro theme right — for example, that gold or oil prices are going higher — then almost any company in the sector is going to give you some return. In this context, the only real way to strike out — if you are betting on oil, for example — is to buy the one company that comes up completely empty when drilling. With that floor in place, the big gains come to the fund manager who is able to ferret out the unplucked gems — and that’s what Sprott has been able to do better than most.

The challenge of investing in line with a big-picture theme is that even when you’re right, the market can be wrong for a long time. The key is sticking to your guns, Sprott says, if you have a theme you truly believe in, and trusting that eventually the market will come around. In the meantime, there’s always something that’s working, he says — so, diversification is a necessity for home-run hitters, too.

This emphasis on getting the theme right, and sticking with it, leads Sprott to some controversial stances. He calls himself a “secular bear” — insisting that we are currently in a bear market and have been since 2000, when the U.S. tech bubble finally burst. Notwithstanding the fact that indices in both Canada and the U.S. have recently been hitting new highs, Sprott maintains that the market fallout we’re currently seeing represents the culmination of a trend that began in 2000. But that the pain had been delayed by the emergence of a housing bubble in the U.S. and the swelling of global liquidity — all of which is now, finally, proving unsustainable.

Moreover, Sprott embraces the Peak Oil Theory — the idea that global oil production has topped out, or will soon top out, and as a result, oil prices must rise, perhaps precipitously. Buying into that theory has led the Sprott fund not only to energy stocks but also to great gains in uranium miners and to plays in alternative energy and coal.

“The Peak Oil thesis looks like it’s really holding together,” Sprott says. “And there are lots of things you can do around Peak Oil that can generate outsized returns.”

For example, he estimates that uranium stocks went up by about 1,000% in three years.

Looking ahead, Sprott sees other positive themes playing out — even in the context of a bear market — such as agriculture and water plays.

This reliance on themes, and the flow of investment ideas that they spawn, has pushed Sprott to close the fund to new money from time to time. Sprott most recently reopened the fund in January 2006. He says that the fund was shuttered in early 2005 due to the fact that its inflows were outstripping its supply of investible ideas. Now, the idea flow is strong enough that the fund can handle more money, and he imagines that will be the case for the time being.

While the supply of ideas may be limited, there’s no magic to coming up with them, Sprott insists. “I believe that a little bit of hard work and keeping your eyes and ears open can make you a successful investor,” he says. “There are things to see and notice — they’re quite readily available — you just have to be receptive. You have to read between the lines a little to see what’s happening.”

In theory, markets are efficient. But, in practice, Sprott has found that there are plenty of opportunities to exploit untapped ideas.

It’s the challenge of deciphering these signals and distilling them into investment ideas that keeps things fresh for Sprott after almost 40 years in the business. “It’s fun. It’s a bit like kids in a candy store, trying to find the next winner,” he says, adding that, in some ways, the losses are just as interesting — trying to determine where the management team went wrong on a particular stock, and how to avoid that same mistake in the future.

While Sprott admits to hobbies such as travel, golf and collecting art, his real passion remains investing. And Sprott Canadian Equity Fund’s outstanding performance record suggests that such ardour can be richly rewarding — for managers and investors. IE