Investors fume at Sprott’s shakeup of Flatiron funds

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Just six months after Sprott Inc. bought Flatiron Capital Management, the asset manager is shutting one of the acquired funds and replacing the managers of the others after assets under management plummeted by 45 per cent.

The news blindsided investors and many lashed out on a conference call on Monday.

When Sprott announced the acquisition of the hedge fund manager in June, chief executive officer Peter Grosskopf said the deal would add about $260-million of assets under management and help his company diversify away from the volatility that comes from investing in junior resource companies. On Monday, Sprott said the situation is so bleak that assets in the acquired funds have dropped to about $140-million, and the Flatiron Strategic Yield Fund lost 32 per cent in November alone.

Executives from Sprott and Front Street, which contracted out management of its troubled Strategic Yield Fund to Flatiron, were contrite on the conference call. "This has been a most unfortunate and most undesired situation for everyone," said Gary Selke, Front Street's chief executive officer. "There are no winners here, just people who have suffered."

Sprott has shut the Flatiron Market Neutral LP, and Flatiron's portfolio managers, Steve Duenkler and Parm Kaliarai, have been relieved of their duties. They will remain with the firm in advisory roles. A roster of portfolio managers from Sprott and Front Street Investment Management, made up of Frank Mersch and Eric Dzuba from Front Street and John Wilson, Scott Colbourne and Michael Craig from Sprott, will assume their positions and try to restore investor confidence.

Mr. Selke attributed much of the sudden drop in fund values to a bet on warrants that went awry. Warrants are highly volatile securities that allow their holders to buy shares in a company at a specified price on a future date. The warrants that Flatiron's managers bought turned out to be very bad bets and the bulk of the losses came from positions in just a dozen securities.

To get its house back in order, Sprott decided to shut the Flatiron Market Neutral fund, winding it up effective Nov. 30. Redemptions have also been halted, meaning investors can't get their money out, so that the income portfolio managers have some time to breathe while they assess the damage.

The purchase price for Flatiron was $10.7-million. Peter Grosskopf, Sprott's chief executive officer, said payments to Mr. Duenkler and Mr. Kaliarai were dependent on performance and asset retention "and they will suffer from the outcome here." However, he added that "we take small solace in that," given how much investors have lost. Units of the Front Street Strategic Yield Fund, which trades publicly, are down 47 per cent since Aug. 13.

Despite the losses, both Mr. Grosskopf and Mr. Selke said they still believe in the overall strategy of Flatiron funds, which is centred on convertible bonds, and both firms have managers who are well-versed in these securities. On the conference call, Sprott noted that while they could have created their own convertible arbitrage fund, they figured it was best to acquired Mr. Duenkler and Mr. Kailirai because they posted average annual returns of 9.54 per cent after fees – a key marketing point to investors.

The decision to dramatically shuffle oversight of the Flatiron funds comes a few weeks after Sprott cancelled its offering of the Sprott Flatiron Convertible Strategies Trust for failing to raise more than $20-million.