Walter Scott & Partners’ top executives tell Ian Fraser why being owned by Mellon Financial will bring better balance to the boutique
Walter Scott & Partners, the global equities house set up by former nuclear physicist Walter Scott and two fellow refugees from Ivory & Sime in 1983, has ‘carpe diem’ as its company motto.
It is an appropriate choice. Earlier this month Mr Scott “seized the day” when he accepted a cash-and-shares offer valuing his firm at an estimated £360 million – or 2.5% its $27 billion (£14.4bn) under management — from Pittsburgh-based Mellon Financial. The deal, expected to close in September, will be sweetened should Walter Scott & Partners exceed certain profit hurdles laid down by Mellon over the next four years.
Mr Scott, who learned about investment from Jimmy Gammell at Ivory & Sime in the 1970s, says the US firm first started “cosying up” to his company in late 2003. However, he says that Mellon’s asset management chief Ron O’Hanley only came up with a “sensible proposal” in the spring, after investment consultants Buck had produced a thorough evaluation of the Edinburgh firm.
Mr Scott was prompted to sell was because, given he is 59 years old and the firm’s majority owner, ownership could have started to become an issue. He owns 70% of the equity, with managing director Alan McFarlane owning 20% and co-founder Marilyn Harrison 10%.
The Edinburgh-based business has since the 1990s had a policy of hiring talented graduates from a diverse range of backgrounds and Mr Scott wanted to ensure these younger colleagues were not left in the lurch. Also, without what he describes as Mellon’s “broad shoulders”, he concedes that his company may have struggled to cope with the increasingly complex demands of regulation, compliance and IT.
“With this step we are preparing Walter Scott & Partners to be a strong firm for another 25 years,” says Mr Scott, who distinguishes himself by wearing a kilt to meetings with prospective clients and regularly pilots the company jet to meetings in North America. He says he was particularly impressed by the degree of autonomy that Mellon allows the boutique investment firms within its stable.
“Within their multi-boutique model, this firm will have considerable autonomy. I remain chairman, Alan remains managing director, we retain control over the business, and we also retain control over hiring and firing, salaries and bonuses.”
Furthermore the defined benefit pension arena where Walter Scott has traditionally played has today entered a period of terminal decline and Mr Scott believes that being part of Mellon should boost his chances of winning mandates from the up and coming defined-contribution sector, where Mellon has key distribution strengths. “The deal should enable us to create a better balanced business and one with genuine upside potential for the young people,” he says.
Ever since he founded the business with Ian Clark and Marilyn Harrison, both of whom are also remaining with the firm, Mr Scott has made managing equities on a truly global basis his “niche”. He has combined this with the “buy and hold” investment approach that he learned at Ivory & Sime.
The approach, the antithesis of index tracking, means that before choosing to invest in, say, GlaxoSmithKline, Walter Scott & Partners will have a thorough look at other global drugs firm such as Pfizer, Novartis and Hoffman-La Roche. Once a pharmaceuticals firm has made the grade, Walter Scott & Partners will stick with it for a very long time. The company only invests in a stock if all 25 of its investment staff unanimously agree it is a good idea.
Mr Scott sums up the approach as “classical, fundamental and long-term”. He also describes it as akin to “planting a garden for the long term”. Instead of filling this imaginary garden with annual flowers – “that’s what you get if you use sellside research – they may look stunning but tend to be killed off by the first frost” – he prefers to build a garden with “temporal depth and seasonality”.
Over the years Walter Scott & Partners has consistently held the shares of Australia-based Woodside Petroleum, China Light & Power, Hong Kong & China Gas and Japanese machine tools company Fanuc. “We like to own things for a long time. It’s a far more reliable way to make people money than trading.” Churning is less than 10 per cent. McFarlane says that one of Mr Scott’s greatest achievements has been to consistently resist the temptation to “cosy up to the index”.
Mr Scott admits that it took time for the approach to catch on with pension funds and other institutional clients. “It’s only in the past five or six years that people have been appointing for pure global mandates.”
After the dotcom crash of 2000, the company’s assets under management stood at just $2.7bn. They have since soared to in excess of $27bn. Insiders attribute much of this dramatic growth to the arrival of the former Global Asset Management executive Alan McFarlane. He joined as director in September 2001 and was appointed managing director in 2003.
Under Mr McFarlane’s leadership the company has formalized its investment process and started to market itself more aggressively to institutional clients outside the US. Over the past four years a reinvigorated team under McFarlane has built a sizeable client base in Canada, Europe, the Middle East and Australia, as well as winning significant additional mandates from US clients.
“A crucial element was that in 2001 Walter Scott & Partners was too small, and it hadn’t engaged with all the initiative it could have done with some of the enquiries that came its way,” explains McFarlane.
According to Companies House figures he company more than doubled its profits to £18m in the year to April 5 2005, up from £7.9m the previous year. That was on a turnover of £33m with administrative expenses of £15m. Turnover in the current year is expected to come in at between £50m and £60m. Mellon’s recently appointed CEO, Bob Kelly, expects the acquisition will generate an internal rate of return in the high teens, and said the purchase will add to earnings per share starting this year.
Mr Scott puts the recent growth spurt down to a range of factors, including the fact the firm was perceived as having “earned its spurs” after turning 20 three years ago. “At each notch – $5bn, $10bn, $15bn – we found ourselves attractive to larger funds.” The company also found US-based consultants such as Cambridge Associates, Rocaton, Summit Strategies and Ennis Knupp & Associates increasingly willing to recommend it to non-US clients.
So what now for Mr Scott? He seems determined to remain with Walter Scott & Partners, which is now installed at Ivory & Sime’s old offices at 1-3 Charlotte Square, even after the four year earn-out period expires. However having grossed an estimated £250m from the sale, Scott intends to follow the footsteps of other successful Scots such as Andrew Carnegie, who immigrated to Pittsburgh at the age of 12 in 1848 — and continue to make generous and targeted donations to universities, colleges, the arts and sport.
He will also continue with his personal mission to see Edinburgh’s Charlotte Square restored to its original Georgian splendour.
This article on the sale of Walter Scott & Partners to Pittsburgh based Mellon Financial was published in the Financial Times FTfm section on 29 May 2006. For more on the asset management industry in Scotland see Still thriving as a centre of excellence