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Fund Manager Focus - December 2014

Scott Investment Partners, Henley, England

Founded in 2013, Scott Investment Partners is a global equity investment management firm founded by Dr. Walter Scott, Marilyn Harrison and Matthew Scott. The new Scott Investment Partners LLP manages monies for two institutional clients worth an estimated $250 million. They are long term investors running concentrated portfolios. They look for companies that have unique competitive advantages, strong business and financial models, low or no debt, a good long-term vision, good control of their operating environment and generating strong returns for their equity owners.

Dr. Scott is the eponymous founder of Walter Scott & Partners, Edinburgh (with AUM of $75 billion) which he sold to BNY Mellon in 2006.

Why Henley - not London or Edinburgh?

"We like to be away from major centres and for most of the time (when I was at Walter Scott & Partners) our office was Millburn Tower in the country - in 26 acres - it was a Georgian style castle. The office should reflect the uniqueness of the firm. It should be a little idiosyncratic, off the beaten track and conveniently located. Henley is near enough to London to tick that box and yet provides the inspirational tranquillity of the River Thames."

Is the history of SIP a family office?

"The firm began managing family funds. In so doing we recognised the poverty of service available to similar family offices. Then we were approached by a number of other family offices. In parallel we were approached by an American institutional client. It was the combination of the two that crystallised our decision to create the new firm. By coincidence we stumbled upon the perfect office for a specialist investment management firm here at The Old Rectory in Henley."

What differentiates you from other investment management start ups?

"We don't sell a product. We provide a service for each client which is unique to each client. We don't think the investment needs of any individual or institution are the same or have the same time frame so we try to match the service with client needs. The way we run the firm is to have an upper limit to the number of partners - 10. And an upper limit to number clients of 6 per partner - so 60 clients maximum."

Target for AUM?

"We are not asset gatherers. The limit is 60 clients. There is no asset limit. We intend to do a good job for each of our clients rather than adding lots of clients."

Stocks in portfolio currently and why?

"That's the stuff our clients pay us for! We seek to generate a real rate of return of 5 - 7% per annum above liability inflation experienced by the client. Our average holding period is 10 years. Many names in the portfolio can expect to be present for 20 years."

What is your investment style?

"The research we conduct aims to identify businesses that we expect to own forever. A sale is the result of a breakdown in one or more of the 'buy' criteria. The research is initially based on official publications of the companies themselves - so the annual report. We do a detailed financial analysis based on a spreadsheet proprietary to the firm that we designed and that is conducted manually. We think that's important as rather like a good car mechanic seldom has clean hands, a good financial analyst gets his hands dirty with the numbers. And you get a better feel for the numbers and how they relate to one another. That analysis allows us to develop 7 key variables relative to the company.

  • A systemic pattern of growth - a driving growth vector
  • A proprietary level of profitability - a clear indication of added value
  • The response to competitive pressures
  • The control of input costs and output prices - the determinants of profitability
  • The absolute level of profitability
  • The financial model - a debt-free cash-generative balance sheet over the whole investment cycle
  • Management - how this year's predictions and plans translate into next year's results
We believe that wealth creation for our clients does not come from us but from the discipline that we bring to identifying the businesses that are creating wealth."

Do you use screens? For example, recently you chose to meet FedEx and ADP.

"FedEx is a sensational company, we've known it for years, they are absolutely attached to the pulse of the world economy and therefore if we have the opportunity to hear what they have to say it is of immense value. And it's a great company.

I've known ADP since I was just out of short trousers! I have an immense respect for it. I also know Paychex and like it. If I have the opportunity to meet ADP management again I want to understand the changes that have taken place in their business model, where they have diverged from their competitors.

Companies and company management are what make the return for our customers. They are the lifeblood of what we do. We can narrow the list of who we want to talk to by financial analysis but at the end of the day when we buy the shares in a company for a client we are delegating that part of a portfolio to that management team and it beholds us to know them."

How important is it for you to meet management?

"In the first instance, if we get to see the IR people, that's nice. Hopefully, if we make an investment we'll get the opportunity to see senior management on a regular basis - much as our clients want to see us on a regular basis. I regard meeting management as a major privilege that is conferred on us by virtue of our representing active shareholders."

Market cap cut off for US holdings?

"No limitations as we don't run funds and our clients have different needs."

Which benchmark do you use?

"Each client has got some benchmark that they regard as important to them. We don't use benchmarks so are 'benchmark agnostic'. More importantly, in the long run we find that what we do results in a return stream that is not co- variant with any particular index and is generally superior."

Does a stock have to be profitable?

"Yes: the businesses that we invest in are all profitable."

What about companies with very high valuations?

"We have a valuation discipline. The higher the valuation, the greater the expectation that the company can deliver and therefore the higher the risk. If 25 xs earnings is an ordinarily expensive share then the probability of us buying something at 40 xs earnings is very low indeed. From time to time events transpire to bring valuations down that have nothing to do with the company. In 1987 and 1997, the market provided the opportunity to buy what had been highly priced companies but which had experienced no business setbacks."

Do you vote your proxy?

"Yes. In general we have a standing instruction with our custodian to vote proxies with the management. If we object to something, we would in general sell the shares. We take the discipline of actually voting."

Are SRI/ESG issues a consideration? eg tobacco, defense etc.

"We invest in companies that are profitable. If a client has a particular thing about tobacco or contraception for example then we are happy to accommodate that in their portfolio. We make sure that the client who is asking for those limitations makes similar limitations for their expectations. My father worked in the tobacco industry all his life. Just before dying in 1978 he said 'the tobacco industry is finished, this whole tobacco kills is going to destroy the industry. Take my advice and don't own any tobacco stocks in your portfolio'. From that moment until the present time, Phillip Morris is probably one of the best performing companies in the world! By taking the moral high ground a customer can limit their opportunities but that is their prerogative."

What's your geographical exposure?

"Our greatest exposure is in developed markets, we don't pay much attention to benchmarks but it has mostly to do with valuations. Currently we are neutral in the US, underweight in continental Europe and the balance is in the UK and Asia. We only have ~ 40 stocks in the portfolio as we run quite concentrated portfolios."

What about Canadian stocks? Can you own them and do you?

"We own one company in Canada but it's a significant position."

Who do you like to meet at a company?

Dr. Scott "the CEO or CFO. What we want to get is the person who 'feels' the company, the person who embodies what it is doing, its ambitions and dreams. I want to understand what makes a company's heart beat. But I don't want to fall in love with management."

Matthew replies "as I don't have 40 years of investment experience, IR is fantastic for me for a company I know nothing about. We regard meeting management as a privilege and understand that we are delegating that part of our portfolio to management."

Has the FCA change in corporate access in the UK changed how you meet companies?

"We are delighted you are here and delighted to be on your list of companies. I have never yet written a 'dear Mr X we own shares in your company, can we come and see you' letter and had a No. I've never proactively used a broker to organise a meeting. We go directly to the CFO or CEO. We regard the company broker as doing a job for the company not for us. Our portfolio has an average holding period of 10 years so we aim to develop a long-term relationship."

How much attention to you pay to sell-side research?

"For completeness, after doing our own research we'll scan broker research which we can easily access to see if anyone is saying anything which we don't already know. But an awful lot of the research that comes out of brokerage houses is targeted to effect a transaction so it is, by its very nature, short term. If a company is going to miss its guidance for the next quarter, who the hell cares? The analysis is short term."

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