A coffee with leading fixed income investor Scott Colburne of Sprott Asset Management

Geoff Cook - CFP, CHAIP

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Sprott Asset Management has a history of outperformance, and cutivating leading investment managers.

I had the privilege last week to sit at our boardroom table in Toronto over a coffee with Scott Colburne and Ben Chim of Sprott Asset Management. Scott and Ben along with Michael Craig are a key part of the fixed income team at Spott, managing four funds.

This team became part of the Sprott family in 2010. Prior to being at Sprott the team managed Fixed Income portfolios at TD Asset Management.
Scott is an award winning bond fund manager. In the past, Scott managed TD's Global Bond and Canadian Core Plus Fund responsible for overseeing $30 billion in fixed income.

The team left TD in an effort to be able to do things differently. They wanted to be able to run unconstrained funds and were restricted by a mandate at TD.
The fixed income landscape today is very difficult. With interest rates at all time lows it is tough to generate returns with bonds in a traditional manner.
This team has come to Sprott because they have the freedom and flexibility to do what they need to do to generate returns independent of what the overall markets are doing.

Here are a few points I took away from chatting with Scott and Ben;

- Currencies are incredibly inefficient and very liquid. 35% of their returns come from currency.
- There is concern in the fixed income markets with extremely low interest rates. We need to use different methods to generate returns. We don't want to be measured versus a benchmark, but measured on absolute return in any market.
- They use options in their funds to hedge risk and gauge profit vs. loss.
- Their portfolios are unconstrained and they can to short up to 20% in their fund(s).
- Their portfolios are designed for institutional investors but open to retail investors.
- Their funds have higher yields with less sensitivity to interest rate risk. (Yield is 5.3% vs. the Dex at 2.3%) (Duration is 3.9 years vs. the DEX at 7 years)
- "We are not sure we will have inflation in the near term, but it is inevitable."
- "Quantitative Easing (QE) is a suppression of nominal interest rates, and represses returns."
- "Buy and Hold will not work in this environment."
- "The profitability in Fixed Income has changed forever since 2008."
- They do not need interest rates to rally to make money.
- They aim to produce returns of 6% - 10% primarily in capital gains.

They describe the typical bond fund vs. what they are doing.

The typical bond fund is...

- Category Focused

- Limited Investment Set

- Domestic Focus

- Relative Returns

Theirs approach is...

- Flexible
- Opportunistic

- Global

- Absolute Returns

The biggest eye opener for me was how Scott presented about the risk in bonds today. He presented some breakeven calculations to show how much of a rate increase we would need to wipe out the yield of some commonly used bonds. (Remember interest rates and bond prices are negatively correlated)

Interest Rate Increase Necessary for a 0% Annual Return;

DEX Universe Bond Index = +0.31%
DEX Universe Corporate A Bond Index = +0.44%
Goverment of Canada 10 yr Bonds = +0.20%
Bank of America Merrill Lynch High Yield Index = +1.62%

Because when interest rates rise, Bond prices fall you can see this is a very tough environment to generate returns in the Fixed Income space. I can see why Scott and his team decided to start funds where they could use alternative strategies to generate returns.

- To read Scott and his teams Market Insights click here
- To learn more about this Fixed Income team click here
- To watch a recent interview with Scott on BNN click here

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