On my way to a breakfast meeting recently, I walked by the 'Opening Soon' Apple store in Vancouver's Pacific Centre Mall. I know how hot that store is going to be because I was shoehorned into the Toronto outlet the week before. But I thought to myself, I'm going to see a company that's even hotter - Sprott Inc.
Eric Sprott and his team have generated investment returns that are off the charts. They have nailed every key investment theme - long resources, short U.S. large-cap stocks (including financials) and a heavy emphasis on small-caps. When you go to sprott.com or read their literature, the investment returns wash over you like a warm wave and leave you feeling like "I've got to have some of that." Not surprisingly, assets under management have tripled in three years.
With Sprott Inc. selling shares to the public through a recently completed IPO (very hot) that began trading Thursday, we've been given a rare opportunity to look inside an asset manager. With a little controversy sprinkled in around its largest holding, Timminco, and some titter about Eric Sprott's art collection, it doesn't get any better than this for industry geeks like me.
But there's been lots written on Sprott already and I'm not here to weigh in on how the firm or stock is going to do. Rather, I'd like to use it to discuss the biggest challenge that all large managers have - dealing with size and rapid growth.
There is an adage in the industry that "the larger the assets, the lower the returns." There are lots of exceptions to this, but intuitively it makes sense that big firms have fewer securities available to them. Only large-cap stocks, where they can get a meaningful position, will have an impact on returns. Even then, I too often hear from portfolio managers that "it took me two months to get a full position in XYZ Corp."
At the meeting, I asked Eric Sprott how the growing asset base will affect the firm's ability to manage money. He responded by saying that they will take bigger positions in companies, be more aggressive in acquiring shares and start to use larger stocks to implement their top down strategies. They also want to focus their growth in new and unconstrained areas - for example, large-cap and foreign equities.
This is an important question because Sprott Inc. is already up to $7-billion under management and it invests almost exclusively in small and mid-cap stocks. Flows into the funds are strong and the performance gives the company a chance to launch an array of new hedge and mutual funds in the next few years. I'm willing to bet that Sprott's assets will be north of $10-billion by the end of next RRSP season.
Mr. Sprott said a few times, "we own 'em all," when referring to the fact that they've bought all the small caps available in industry sectors they really like. To date, "owning 'em all" has meant supercharged performance. With a larger asset base, however, it may soon mean the funds are just getting a decent position. Sprott Inc. provided liquidity to the small-cap resource market at the bottom, but it will be a big user of liquidity when it comes time to sell.
Generally, large Canadian managers have a number of "permanent" holdings in their portfolios - banks, insurers and other top 25 stocks. Perhaps a third to two-thirds of their portfolios never change. In high octane funds like Sprott, however, there are no entrenched, large-cap stocks to be seen. All holdings are subject to being sold.
For most managers, the changes that result from handling more money are evolutionary. They gradually become less bottom up and more top down. Stock pickers turn into strategists. This can mean that the firms get away from doing what they do best and migrate to strategies where they have no unique skill.
None of the answers to these size-related challenges is good for clients. As with other managers that have achieved significant heft, it is going to be harder for Sprott Inc. to deliver the kind of returns it has in the past (although I suspect most investors would be happy with half that amount). It has added a zero to the asset number in a very short time.
As much as the company's growth will be more diversified, Mr. Sprott's Canadian equity model, which makes up the company's biggest mutual fund and the long side of its hedge funds, will continue to garner a major portion of the new money. And with success comes an expanded product line, bigger team, increased marketing demands and public company responsibilities.
But Sprott Inc. has one big advantage relative to other firms. Making bold calls on big picture themes has always been part of the strategy and success. It doesn't need to change the game plan in that respect.
There are many people, including me, who wouldn't bet against Mr. Sprott. He's a rare money maker and his success has enabled him to bring in top people from other firms, including Peter Hodson and Alan Jacobs. He will deal with the expectations and growth challenges decisively and in his own way. It will be fun to watch.
© 2007 The Globe and Mail. All rights reserved.
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