ABERDEEN Asset Management has bought Scottish Provident's fund management arm Prolific Financial Management in an all-share #55m deal.

It gives the vulnerable life insurer a 41% stake in AAM, which becomes Scotland's second-biggest independent fund manager with #11bn of funds, behind Baillie Gifford's #13bn.

AAM will issue 58 million new shares and sign an investment management contract with Scottish Provident with an #18m penalty for removal, halving to #9m after three years. Life funds will now make up half of its funds, but a quarter will be the more profitable unit trusts and will put a Scottish group into the UK's top 15 unit trust sellers for the first time.

The deal should add #5m to AAM's profits, expected to hit #6.5m this year, and enhance earnings straight away.

The ever-bullish Martin Gilbert, AAM's chief executive, said: ''It is a great deal for us, a good deal for Scottish Provident, and good for Scotland.'' He said Prolific's 30 or so fund managers would continue to be based in London, and stressed that drastic cost-cutting would not be needed to make the deal work.

Gavin Gemmell, senior partner at Baillie Gifford, commented: ''I can see that this gives Aberdeen pretty decent scale, providing you can make it work. The integration of Edinburgh and Dunedin was not without its problems.''

The City marked AAM up 13p to 108p, even though the deal has installed a friendly 41% shareholder and removed the prospect of a takeover by US-based Phoenix Home Life, which previously held 29.9% and will now have just under 20% of AAM.

Richard Andrews at Greig Middleton said: ''It looks a good deal for Aberdeen, it transforms the scale of it and broadens the spread with a full range of funds to manage geographically and by product type. A takeover by Phoenix is not now on the cards.''

Phoenix, which paid 136p for the second half of its stake in AAM and saw the price drop by a third, is to back the deal. It emerged yesterday that its senior management met Scottish Provident a year ago and that they mounted an unsuccessful joint bid recently for a Mexican insurance group.

Mr Gilbert said it gave the group the critical mass that Scottish fund managers have been looking for, and not always found.

''We have done this because the companies are very complementary. They have strengths in equity income, the US, technology, ours are in emerging markets, the Far East, corporate bond Peps.''

He said cash-rich AAM would have liked to have paid as much cash as possible, especially as Prolific has #8m of cash assets, but Scottish Provident wanted a strategic

holding.

Scottish Provident will have two directors on the AAM board.

One of the smallest of the surviving life insurers and widely touted as a bid target, Scottish Provident is seen as having deterred some potential predators with the move - but perhaps not others.

Bill Stewart, a director of Scottish Equitable, commented: ''I would have thought it made them less attractive.''

But Colin McLean at Scottish Value Management said: ''It would be quite easy to unscramble.''

David Woods, managing director of Scottish Provident, commented: ''If somebody was really after us for the amount of money it would take to do a deal like that, the fund management penalties are pretty small beer. It wasn't in our thoughts.''

Mr Woods said: ''It has been done for entirely strategic business reasons, and I think this is the sort of deal we are going to see more of.'' He said Scottish Provident had been among the first to separate out investment management and give it a separate identity, but it did not believe 100% ownership was sacrosanct.

''What is important is that we have a house asset manager with whom we can have a sensible relationship. Our core business is developing, designing and marketing retail financial products, and this sharpens the strategy.''

Scottish Provident said that the #61m it paid Danish insurer Hafnia four years ago for Prolific was the embedded value of its life business, which was not being sold. The asset management capability had effectively been acquired for nothing and its external business had been built up.

Mr Woods said: ''We are ensuring that our with-profits policyholders benefit from a sound investment.''

Colin McLean said the #6000m of Scottish Provident life funds might not be secure with Aberdeen in the long-term, as they were subject to performance review and the penalty for switching funds was halved after three years. But both Mr Gilbert and Mr Woods said the close relationship provided an incentive for the funds to stay where they were.

They both hoped that total funds would expand sufficiently to reduce the proportion of life funds in the total.

AAM has paid around three times Prolific's revenues, and Mr Gilbert said they hoped to achieve at least a 35% operating margin out of the business.

Prolific employs some 190 people in London, taking AAM's total staff to 320, and rationalisation of back office operations, particularly in unit trusts, is likely. Mr McLean said the EFM-Dunedin problems showed it could take time to nurture client relationships and build up performance records.

AAM has only recently changed its name from Aberdeen Trust, and given notice that all its investment trusts will be rebranded from Abtrust to Aberdeen. Now the fund management subsidiary will be renamed Aberdeen Prolific Asset Management, the unit trust companies Aberdeen Prolific Unit Trust Managers, and the unit trusts Aberdeen Prolific.

Prolific has #5600m of life funds, #1600m in unit trusts and unit-linked funds and #640m in offshore funds, investment trusts and institutional funds.

AAM has #1000m in unit trusts, #801m in investment trusts, #555m in institutional funds, #526m in life funds, and #200m in offshore funds and private client business.

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