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Ring In 2017 With A 7.5 Percent Yield Stock (AB)

You know it’s December when you begin hearing long sets of holiday classics on the radio, when you start seeing gift-wrapped cars with huge bows on TV, and when you simply cannot escape reading about the Santa Claus rally in the financial press.

In keeping with some of these traditions, I present to you an idea that seems both timely and appropriate for the next year: a position in an asset management company.

Why do I like asset managers, particularly right now? The idea might seem controversial — but I think it allows us to make use of several market trends and expectations.

Global asset manager AllianceBernstein Holding LP (AB) is a good place to turn, allowing us to take advantage of the stock market’s strength while providing a built-in hedge of fixed income. And because the company is a publicly traded master limited partnership (MLP), it takes advantage of the absence of double taxation by paying out its pass-through income to its unitholders.

This elimination of double taxation allows more income to flow to the unitholders. Of course, the income is taxable for individual unitholders, and there are other features of investing in MLPs that are important to understand (please ask your broker to explain these differences to you).

But the MLP structure or a high dividend yield in and of themselves do not necessarily make for a good investment. So what does?

It may seem obvious, but first and foremost is the MLP’s ability to sell its products and to make money consistently.

In this sense, AllianceBernstein seems well-positioned for 2017 and beyond. The business of this company, in a nutshell, is to help people invest; in return, it takes a fee for the services. The size of the fee directly depends on the amount of money the company manages, i.e. assets under management (AUM). And because AB’s business is exposed to both equity and fixed income markets, the company seems well-situated for the current market environment, where surprises seem especially likely.

However, the market seems to view AB primarily as a fixed income shop. Thus, worries about future assets and profit growth — both related to the unraveling of the bond bull market — have been holding back AB’s share price.

True, a significant portion of AUM is related to the fixed-income market. At the end of the third quarter (September 30), AB had $490 billion in assets under management. Of this, equity accounted for $160 billion (or nearly 33%), and the rest was classified as fixed income ($280 billion, or almost 57%) and “other,” such as multi-asset and alternative asset investments ($51 billion, or 10%).

But this is where the competitiveness of the services — and the quality of management — comes into play. As I discussed with my premium Daily Paycheck readers in mid-October, even as higher interest rates put pressure on fixed income investments, funds will begin incorporating new issues with higher coupons, resulting in higher yields over time.

As a result, active management, which provides more flexibility, is likely to be more appealing than passive management.

Alliance’s strength is in its active management, which can be measured by the performance of company-managed funds and accounts. The relative outperformance of AB fixed income funds suggests that its competitiveness is indeed strong: On a three- and five-year basis, 90% of its fixed income offerings outperform more than half of peers; on a one-year basis, the number is a bit lower, but a still respectable 83%.

AB is also competitive when it comes to equities, although in this asset class, there is room for improvement: 43% of invested assets have outperformed on a one-year basis, with 63% and 64% outperforming on a three- and five-year basis, respectively.

Further, when it comes to the target markets served, the company is well diversified. AllianceBernstein is in the financial research and investment business, and it offers investment management services to institutional, retail, and high-net-worth individuals. Moreover, AB is also well-positioned for the long term, as it can continue to benefit from the growth in the retirement market and 401(k)s.

No business can rely only on its existing clients; this is especially true for a highly competitive asset management business. This is where the strength of the product (discussed above) counts — and also the strength of the company’s sales force. Alliance has that strength in spades, with sales of new products replacing accounts lost to competition, market forces or both. In the latest quarter, for instance, gross sales increased 43% on a year-over-year basis, helping replenish AUM and replace outflows.

The risk of competition, and the company-specific risk of concentrating more in fixed-income assets than in equities, seem to be reflected in the unit’s current valuation: Units of AB sell at about 12 times estimated future earnings — an attractive valuation.

On a final note, while AB pays most of its free cash to its unitholders, these payments tend to fluctuate. Over time, though, its current yield of 7.5% has the potential for growth if the company executes according to its growth plan.

This yield, combined with the fact that AllianceBernstein is trading at a relatively low multiple, makes it well-positioned to capitalize on the strength in the equity market while providing some fixed-income protection as well.

AB is just one of many picks I’ve recommended to my The Daily Paycheck subscribers. As 2017’s forecast comes into focus, I’ll be supplying my subscribers with more promising income opportunities. If you’d like to be the first to get this advice, along with my most recent picks, click here.

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