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Market Up or Down, You Still Win

November 28, 2018

One of the many great books by author Tom Wolfe is the 1987 The Bonfire of the Vanities, which was later made into a 1990 film starring Tom Hanks as the protagonist, Sherman McCoy.

The scene that is of particular interest for you is when Sherman, a Wall Street bond trader (my own stock in trade years ago), is asked by his daughter about what he does for a living. His wife explains that Daddy is like someone that cuts a cake and passes the slices on to others, collecting the crumbs that fall along the way. Sherman then interrupts and says that some of those crumbs can be pretty big and that he can put them together to make a pretty nice cake for himself.

“Collecting the crumbs” is one of my favorite analogies when looking at one of the behind-the-scenes industries of the financial markets. Asset management companies pull in customers and their cash to build up their assets under management (AUM). Then, in turn, they actively or passively manage those assets and collect fee income as well as other streams of revenues.

And unlike hedge funds, whereby the major source of income is performance fees, general asset management companies get paid on how much AUM they have, quarter after quarter, whether they are great managers or just mediocre.

Great outlier returns are excellent to attract and maintain more AUM, but middling returns that keep up with median results for sectors are actually all that is necessary for a good-performing asset management company. The key is to be able to have good marketing and sales bringing in more assets and good relationship management to keep the assets that fee income comes from.

AllianceBernstein Holding LP (AB) is a global asset management company with 200 mutual funds as well as managed accounts, pension funds and some performance-fee hedge funds for customers around the world. It is a stand-alone company that is also a subsidiary of the Paris-based insurance company AXA SA (AXAHY), which works to channel customers into the fund management company, helping to increase its AUM.

I knew AllianceBernstein for many years during my career in trading and asset management. But I really got to understand its underlying strengths thanks to my recommendations and investments years ago in some of its closed-end funds, including the AllianceBernstein National Municipal Income Fund (AFB) and the AllianceBernstein Global High Income Fund (AWF).

I watched the holdings and the management during various ups and downs in the markets, including during times of stress, and was impressed with how the company worked.

And while the company, like others in the asset management business, has gone through some changes and transformations, the key has been building up its AUM, particularly over the past seven years, to a current level of over half a trillion dollars.

This build-up of AUM means that it keeps piling on fee income for its shareholders. And that continues to show up in nice revenue growth—the latest numbers may not sound big, with recent year-over-year gains of 4.70%, but that is on top of the nice pile of revenue that keeps coming from the mountain of AUM.

That efficiency brings great operating margins. For the most recent quarter, they are running at 25.10%, up some 7.20% over last year. That really shows how more AUM with the same business makes for greater overall fee income and better margins.

And with greater AUM and more efficiencies that it brings to margins, the return on shareholder equity is also impressive at 17.78%.

The company is set up as a limited partnership (LP) with AXA and other fund managers in the know owning millions of shares, along with management and the board, who know what’s so good about the company and the fee income coming from its AUM.

Being an LP, it is a form of a passthrough. This means that it is tax-advantaged for investors in that it avoids paying corporate income taxes while also passing through some tax deductions through to shareholders along with their dividends. And the dividend is nice at 69 cents a quarter, up some 35.21% over the past year for a yield of 9.18%.

This combination of a big and rising dividend and good performance at building and maintaining AUM continues to gain more notice in the market. AllianceBernstein has run rings around the S&P 500 over the last 12 months. The overall return is 33.11% compared to the price gain in the S&P 500 of only 5.42%.

And there is more to like. Right now, the stock is valued at less than 2 times its book value. And with AUM on the rise, as discussed above, there should be further gains. And if not, the ample dividends should be more than enough to deliver for your portfolio through thick and thin.