Principal Financial Group - Earnings Call - Q1 2018
April 27, 2018
Transcript
Speaker 0
I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.
Speaker 1
Thank you, and good morning. Welcome to Principal Financial Group's first quarter conference call. As always, materials related to today's call are available on our website at principal.com/investor. I'll start by mentioning a change to our first quarter financial supplement in the PGI AUM by boutique table on the top of Page 16. Effective 01/01/2018, the Edge Asset Management fixed income team joined Principal Global Fixed Income to better align capabilities and resources.
As a result, approximately $11,000,000,000 of AUM moved from Edge to the Principal Global Fixed Income boutique. Following the reading of the Safe Harbor provision, CEO, Dan Houston and CFO, Deanna Strehbel will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q and A session include Nora Everett, Retirement Income Solutions Jim McCoggan, Principal Global Investors Luis Valdez, Principal International Amy Fredrick, U. S.
Insurance Solutions and Tim Dunbar, our Chief Investment Officer. Some of the comments made during this conference call may contain forward looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10 ks filed by the company with the U. S.
Securities and Exchange Commission. Additionally, some of the comments made during this conference call may refer to non GAAP measures. Reconciliation of the non GAAP financial measures to the most directly comparable U. S. GAAP financial measure may be found in our earnings release, financial supplement and slide presentation.
Now I'd like to turn the call over
Speaker 2
to Dan. Thanks, John, and welcome to everyone on the call. This morning, I'll share some performance highlights and accomplishments that position us for continued growth. Deanna will follow with details on our financial results and capital deployment. First quarter was a good start to the year for Principal.
We continued to deliver strong growth, execute our customer focused solutions oriented strategy, balanced investments in our business with expense discipline and be good stewards of shareholder capital. At $4.00 $9,000,000 we delivered record non GAAP operating earnings, a 10% increase compared to first quarter twenty seventeen. This reflects good underlying growth across our businesses and lower effective tax rate due to The U. S. Tax law reform.
On a trailing twelve month basis, non GAAP operating earnings exceeded $1,500,000,000 demonstrating our strength and leadership in The U. S. Retirement and long term savings group benefits and protection markets, retirement and long term savings in Latin America and Asia and global asset management. Compared to a year ago, reported rate assets under management or AUM is up $54,000,000,000 or 9% to a record $674,000,000,000 Over the same period, we also increased AUM in our joint venture in China. That is not included in the report of AUM by $48,000,000,000 or 50% to a record $144,000,000,000 This provides a solid foundation for revenue and earnings growth.
And it underscores not only the diversification of our asset management franchise by investor type, asset class and geography, but also strong integration across business units. As I reflect on the strong recent traction in China specifically, is a great reminder of the benefit of continuously making investments to drive long term growth. As additional color on our asset management franchise, we again received some noteworthy third party recognition during the quarter. Principal funds ranked eighth on Barron's list of best fund families in 2017. Additionally, we received best fund awards in more than 10 countries from organizations including Bloomberg, Morningstar and Lipper.
Our investment performance remains very strong at quarter end for our Morningstar rated funds. 69% of fund level AUM had a four or five star rating. And as shown on Slide 86% of principal mutual funds, exchange traded funds or ETFs, separate accounts and collective investment trust or CITs were above median for the five year performance, 72% above median for three year performance and 80% above median for one year performance. Moving to net cash flows. We were pleased with the first quarter results for Principal International and Retirement and Income Solutions.
PI delivered $2,300,000,000 of net cash flow, its thirty eighth consecutive positive quarter, including record flows in Hong Kong and Southeast Asia. And RIS delivered $1,000,000,000 of positive net cash flow. RIS flows rebounded nicely from fourth quarter softness despite $1,000,000,000 of outflows from the loss of a single client as we discussed on the fourth quarter call. Despite these positive results, total company net cash flow was a negative $1,500,000,000 for the quarter, primarily reflecting elevated institutional withdrawals in Principal Global Investors as well as lower deposits resulting from some delayed fundings due to market volatility. A single client accounted for over half of PGI's total net outflows for the quarter.
Due to rising currency hedging costs, the client withdrew over $3,000,000,000 representing different investment grade credit mandates awarded to us over multiple time periods. And to be transparent, there's another $3,000,000,000 in the same investment grade strategy at risk of leaving in the next year. That said, we continue to manage another $6,000,000,000 of assets for the same client and other strategies where the cost of hedging can be more easily absorbed. And they awarded us a new mandate during the quarter. While the new mandate is less than 10% of the assets they withdrew, it offsets more than 40% of the annual revenue from the larger investment grade mandate.
Quarterly volatility and currency hedging costs aside, PGI institutional flows have been under pressure for several quarters now. As such, I'll provide some color on what we're seeing and what we're doing to improve future flows and continue revenue growth as well as our outlook going forward. We've seen demand for lower cost investment options become even more pronounced in the institutional space in recent quarters. This has impacted withdrawals and made deposit growth challenging. We expect this trend to continue, but real opportunities remain for managers that can consistently deliver strong investment performance and demonstrate value to the marketplace.
We're doing both. We delivered at least $1,500,000,000 of positive flows over the last three years in seven of our boutiques. We continue to see strong interest in our specialty solution and alternative investment capabilities as we help clients diversify, build wealth, generate income, protect against downside risk and address inflation. Assets in these mandates tend to be smaller, but with higher fees. Consistent with previous discussions, the divergence between asset growth and revenue growth is increasing.
A 2017 Boston Consulting Group report projects that passive AUM will grow faster than any other product type through 2021. However, they also project that 90% of industry revenue growth over this period will come from alternatives, active specialties and solutions. This is where we compete and excel. Distribution and product development remains heavily focused on income and other outcomes based solutions, real estate and other alternative investments and our international retail platform to capitalize on emerging markets experiencing strong wealth creation. The build out of our ETF and CIT platforms is providing lower cost investment options to compete with pure passive options and complement our more traditional active mutual fund strategies.
As communicated last quarter, PGI is gaining traction with its Dublin platform as well as its SMA, CIT and ETF platforms helping to offset some of the institutional pressure. I'll now share some key execution highlights starting with our investment platform. In first quarter, we launched more than a dozen new funds in total across Southeast Asia, China and Latin America responding to increasing local retail and institutional demand for multi asset and income generating solutions. Importantly, we continue to make progress leveraging our mutual fund and ETF platforms across borders, delivering our global investment capabilities to meet the needs of local clients. In April, we launched the principal investment grade corporate active ETF, adding to our suite of income oriented solutions on our U.
S. Platform. After surpassing the 1,000,000,000 and $2,000,000,000 milestones in 2017, our ETF franchise surpassed $3,000,000,000 in the 2018, placing us on the top 25 on the ETF league tables at quarter end. In the bank loan market, we priced our first collateralized loan obligation at Post Advisory Group in April. This marks the beginning of a product build that provides an efficient way for investors to have access to an attractive asset class.
We also made additional progress towards the quarter on the digital front. We launched enhanced digital experience to help guide customers through their retirement savings options when they change jobs or retire. Additionally, we launched a first of its kind ESOP website to address the needs for succession planning among U. S. Business owners and help advisors discuss the potential benefits of ESOPs to business owners and their employees in driving retirement readiness.
Our digital efforts are being recognized with the top five ranking on DowBar's Mobile Insight Report and the Life and Annuity Industry and Outstanding MPF Mobile App Award in Hong Kong in the Wealth and Investment Management category. More to come as we drive towards digital solutions that reduce barriers to action and eliminate pain points for customers and advisors. Moving to distribution, we continue to advance our multichannel, multiproduct approach. We earned more than 20 total placements during the quarter getting more than a dozen different funds on 15 different third party platforms with success across the asset classes. CCB Principal Asset Management, our joint venture with China Construction Bank was selected midyear twenty seventeen to offer mutual funds on the Ant Financial platform, Alibaba's payment affiliate.
As of mid April, we surpassed two key milestones, dollars 6,000,000,000 of AUM and 3,000,000 customers. While the revenue and earnings impact is currently modest, we expect both to become more meaningful over time. Clearly, a key benefit today is brand exposure to Ant's 5,000,000,000 platform users. As one final distribution highlight, our recent acquisition of MetLife's foray business in Mexico increases our sales force competing in the private retirement market by more than 75%. While Deanna will cover this in more detail, I want to comment on our balanced approach to capital deployment.
In addition to our ongoing investment in organic growth and our accelerated investments in digital business strategies, we returned more than $325,000,000 to investors through our share buybacks and common stock dividends and we committed more than $80,000,000 to M and A activities. Before closing, quick update on the DOL Fiduciary Rule. As you know, on March 15, the Fifth Circuit Court of Appeals delivered a ruling invalidating all elements of the DOL Fiduciary Rule, including the broadened definition of the Fiduciary Investment Advice and Best Interest Contract Exemption. Until the Fifth Circuit Court enters its order as final, which we expect could happen as early as May, the Fiduciary Rule remains in effect and we will continue to operate in accordance. The U.
S. Securities and Exchange Commission and the National Association of Insurance Commissioners continue to work on the best interest standard proposals for their respective areas of jurisdiction. We and the industry in general believe a workable uniform best interest standard is beneficial and should be pursued. I'll also share some additional recognition for the quarter. For the eighth time, Atthosphere Institute named Principal as one of the world's most ethical companies, one of just five companies in financial services to make the list.
Forbes named Principal as one of America's best employers for diversity, ranking sixth out of two fifty companies recognized. Lastly, for the seventeenth time, the National Association of Female Executives named Principal one of the top companies for executive women. We're one of just 10 companies in its Hall of Fame, reflecting our long standing commitment to women's advancement into leadership positions. These speak volumes about who we are as a company and why we'll be successful long term. In closing, again, first quarter was a very good start to the year for Principal.
It was a period of continued progress, helping customers and clients achieve financial success. I look for us to continue to build on that momentum throughout 2018 and for that momentum to translate into long term value for shareholders and each of our stakeholders. Deanna?
Speaker 3
Thanks, Dan. Good morning, and thank you for participating in our call. Today, I'll discuss key contributors to our first quarter financial results, and I'll provide an update on capital deployment. The first quarter was a strong start to 2018 with net income attributable to Principal of $397,000,000 an increase of 14% from the prior year quarter. Non GAAP operating earnings were a record $4.00 $9,000,000 in first quarter or a record $1.4 per diluted share and increased 10% over the prior year quarter.
Reflecting the benefits of U. S. Tax reform, our non GAAP operating earnings effective tax rate was 17.7% for the first quarter. This was at the lower end of our 2018 guided range of 18% to twenty one percent, primarily due to the impact of stock based compensation and state income tax treatment. While there may be some volatility in the effective tax rate quarter to quarter, we still expect to be within the guided range for the full year.
ROE excluding AOCI other than foreign currency translation adjustment was 13.9% on a reported basis for the first quarter. Excluding the impact from the 2017 actuarial review, ROE was 14.3% and improved 20 basis points from year end. The only significant variance in first quarter twenty eighteen was $10,000,000 pretax of lower than expected encaje performance in Principal International. As a reminder, first quarter twenty seventeen significant variances included a total of $23,000,000 from higher than expected variable investment income and higher than expected encaje performance, partially offset by an assessment associated with the Penn Treaty liquidation. Excluding these significant variances, total company non GAAP operating earnings increased 17% over the year ago quarter.
This reflects underlying growth and some favorable experience in our spread and risk businesses, which I'll discuss shortly. Looking at macroeconomic factors, market volatility returned in the first quarter. While the S and P 500 daily average increased 5% during the quarter, the open to close decreased 1%. As perspective, this is the first quarterly decline for the index since first quarter twenty sixteen. The U.
S. Ten year treasury yield increased 34 basis points during the quarter, a positive development. However, it takes some time for the higher rates to have a noticeable impact on portfolio yields and thus financial results. Additionally, positive impacts from foreign currency exchange rates during the quarter were offset by the negative impact of significantly lower interest rates in Brazil and lower inflation in Latin America. Favorable mortality and morbidity contributed to strong first quarter results in RIS Spread and Specialty Benefits, benefiting each business by approximately $10,000,000 pretax.
Specific to specialty benefits, an extremely low and unsustainable loss ratio for individual disability benefited first quarter results. As a reminder, group life claims were elevated in the year ago quarter, negatively impacting results by nearly $10,000,000 The Specialty Benefits business is a key growth driver for Principal as our focus on small to medium sized businesses continues to differentiate us in the marketplace. In Individual Life, mortality experience was within our expectations during the quarter. Total company operating expenses returned to expected levels in the first quarter from an elevated fourth quarter. Our accelerated investment in digital business strategies is on track.
Total company operating expenses returned to expected levels in the first quarter from an elevated fourth quarter. Our accelerated investment in digital business strategies is on track. As previously discussed, these digital investments will impact business unit margins throughout the year with benefits beginning to emerge in 2019. In my following comments on business unit results, I will exclude the significant variances from both periods in my comparisons. Individual Life and Principal International pretax operating earnings were in line with our expectations for the quarter.
RIS Spread and Specialty Benefits pretax operating earnings were also in line with our expectations after taking into account the favorable mortality and morbidity experience. For RIS Spread, opportunities in the pension risk transfer business remain compelling with a very robust sales pipeline. As shown on Slide six, RIS Fee's pretax operating earnings were $131,000,000 down 5% from the prior year quarter. Net revenue increased 4% on a 6% increase in fee revenue, offset by higher operating expenses, including investment in the business and higher DAC amortization. In 2018, we expect a DAC amortization run rate of 20,000,000 to $25,000,000 per quarter in RIS Fee.
This is higher than our previous run rate due to the adoption of revenue recognition guidance and impacts from the third quarter actuarial review. Importantly, RIS Fee's underlying business fundamentals remain strong. Compared to a year ago, sales are up 9%, recurring deposits grew 7%, defined contribution plan count increased 2.5% or almost 900 plans, and participant count increased 4% with over 190,000 new participants. Moving to Slide eight. PGI's pretax operating earnings increased 10% from the prior year period to $110,000,000 reflecting an 8% growth in management fees and disciplined expense management partially offset by investment in the business.
At $42,000,000 corporate pretax operating losses were lower than our expected run rate. Corporate losses can be volatile in any given quarter and we expect to be within our guided range of 190,000,000 to $210,000,000 for the full year. Our estimated risk based capital ratio remains above our targeted range of $415,000,000 to $425,000,000 and is slightly higher than our RBC ratio at year end. We intend to keep our ratio elevated until the NAIC provides guidance on changes to the RBC formula to reflect U. S.
Tax reform. We are currently estimating a negative 40 to 50 percentage point impact to our ratio from this change. During the quarter, we entered into $750,000,000 of contingent capital funding arrangements, split between ten and thirty year tranches. These provide us financial flexibility and access to funds regardless of the economic environment and will not impact our leverage ratio unless drawn upon. The initial and ongoing financing costs are reflected in corporate and were included in our 2018 guidance for corporate pretax operating losses.
Additionally, Standard and Poor's recently upgraded our senior unsecured debt ratings from BBB plus to A-. S and P noted increased access to unregulated dividends from changes in our legal structure. As shown on Slide 12, we deployed $410,000,000 of capital during the quarter, including $179,000,000 in share repurchases and $147,000,000 in common stock dividends. We also committed $84,000,000 to two planned transactions during the quarter to increase our ownership to 60% in our asset management joint ventures with CINB in Southeast Asia and to take full ownership of the Principal Punjab National Bank asset management company in India. Both transactions are slated to close in the coming months.
On February 20, we closed our acquisition of MetLife's Afore business. This transaction makes Principal the fifth largest Afore in Mexico in terms of AUM. Integration is on track and progressing as planned. The acquisition will be accretive to earnings in 2018. That said, we are anticipating integration expenses of approximately 6,000,000 to $8,000,000 in the second quarter that will negatively impact PI's pretax margin and pretax operating earnings.
On April 16, we closed our acquisition of Internas, which expands our global real estate capabilities. InterNAS has been renamed Principal Real Estate Europe and will benefit from Principal's resources and scale. Last night, we announced a $0.52 common stock dividend payable in the second quarter, a 13% increase from a year ago as we continue to target a 40% dividend payout ratio. This is our ninth consecutive quarterly dividend increase, reflecting our strong financial position and commitment to increasing long term shareholder value. We remain confident in our ability to deploy 900,000,000 to $1,300,000,000 of capital in 2018.
Importantly, we continue to deliver sustainable profitable growth. Excluding the impacts from actuarial reviews, over the last five years, we've delivered an 11% compounded annual growth rate in non GAAP operating earnings, well within our long term target of 9% to 12%. This concludes our prepared remarks. Operator, please open the call for questions.
Speaker 0
Your first question comes from Jimmy Bhullar of JPMorgan.
Speaker 4
Hi, good morning. So I had a few questions. First on the PGI business. It seemed like your fee income and overall earnings were weaker than we would have assumed. I think fees were flat sequentially.
They were up on a year over year basis, but less than the increase in the market or asset growth would have suggested. So I just wanted to see if you had any comments on that. And then secondly go ahead actually.
Speaker 2
No, no, no. Please go ahead and finish your second question, Jimmy.
Speaker 4
So the other question was on share buyback. So I think you ended up buying back more stock this quarter than you have on a quarterly basis in the last several years. So not sure if you did that because last quarter you didn't buy back anything or was it because the stock price declined and you wanted to be more proactive? And if that is the reason then should we assume that if the price stays beaten down you'd be more active with buybacks than you've been in recent years?
Speaker 2
So let me pick up on your second question first, and then I'll throw it to Jim to weigh in on the PGI fee income. Like you would expect, Jimmy, we always look at all the options on how we go about deploying our capital and where we stand with potential acquisitions in the queue. And I would say that, again, on a very deliberate basis, looking at all of our options, we felt because we had the authorization for the share buyback, it was a good opportunity for us to do so as you might expect. That's still there's still some remaining for the second and third quarter obviously that we have to complete that. And we've got a Board meeting coming up here in May, which we'll have continued conversations with the Board on next steps relative to share buybacks.
But again, the dividend having increased, good deployment capital, good organic growth, nice acquisitions, all tuck ins. So we feel like, again, we've had a really balanced approach to capital deployment. With that, I'll throw it to Jim to hit on your PGI fee income question. Jim?
Speaker 5
Thank you for the question, Jimmy. Just as context, the first thing to point out is there is quite a lot of seasonality in our quarter to quarter numbers. As a guideline for profitability, typically 22% to 23% of the year comes in the first quarter and twenty seven percent to 28% comes in the fourth quarter. And one of the reasons for this is seasonality on revenues, partly driven by The U. S.
Tax year, driven also by accounting years and decision making processes. The first quarter tends to be a bit low on transaction fees. It tends to be very low on incentive fees, which tend to be clustered in the fourth quarter. So I would argue that the 10% or 10.4% increase in profits, over 8% increase in management fees, from the year ago quarter is a better measure, a more appropriate measure of the progress we've made because that takes out the effect of seasonal adjustment. The other thing, of course, is that the expenses are seasonal, but you didn't go into that.
But if anyone wants me to, I can. But I don't think that this was a taller disappointing first quarter and it's well aligned with what we've said in the past in guidance.
Speaker 6
Is that helpful, Jimmy? Okay.
Speaker 4
Yeah. And then maybe one more. I'm not sure if Luis is on the call, but it seems like the environment in the Chilean business has gotten a little bit better with the election and talk of sort of drastic pension reforms subsiding. So is that your view as well? And then what you reduced fees in the business.
I think they're going into effect in 3Q. How should we expect that to impact your results in the second half versus your guidance?
Speaker 2
You might have squeezed in three and four questions there. Luis is here and they're really relevant questions and certainly prepared to respond. But as you point out, Chile is rebounding and it's we remain optimistic. But Luis?
Speaker 7
Yes. Good morning, Jimmy. A few questions about Chile and the pension reform, which is pending. Since March 11, we have a new administration there. We value the birth and the death of its new cabinet.
Good names, very professional, very technical. So the discussion is heading in the right direction. Would say they always set a working group that is being created with very good names as well. Very, I would say, professional people, very dedicated. Good intentions in this discussion.
So we are very optimistic about the kind of the outcome that we might have. Only possible, you know, factor that might derail a little bit the discussion is when new bill is going to head the Congress. The current administration doesn't have majority in both chambers. So probably sort of a kind of negotiation might happen there. So we have to pay a lot of attention.
Extremely involved in that process, Jimmy. So we're paying a lot of attention about that. But as you have said, a positive and better environment in order to have this discussion in Chile. About the fee reduction in Cubroom, essentially the result of our gains in productivity and efficiency that allows us to transfer that benefit to our customers. We continue keeping our value proposition there to our clients and customer service, financial advice, investment performance.
So we're going to continue being a very competitive fee there. And as you said, this new fee rate is going to be in place in July 1. And certainly, you can take that, but it's a very thoughtful fee adjustment in Chile.
Speaker 2
Thanks for your question.
Speaker 4
And that was part of your guidance? That was part of your guidance, the fee adjustment?
Speaker 7
Yes sir. Yes sir. Okay. We are expecting that this fee reduction is not going to impact our margins neither in Chile nor for PI.
Speaker 4
Thank you.
Speaker 2
Very good. Thank you.
Speaker 0
Your next question comes from Humphrey Lee of Dowling and Partners.
Speaker 8
Good morning and thank you for taking my questions. Just a question is related to expenses, especially in RIS fees. So I understand the digital initiative is supposed to pose a kind of 2% earnings impact in 2018 on a pretax reform basis. So I would assume that's probably closer to $50,000,000 on a pretax basis. So you talked about you have accelerated some of the digital investments in the fourth quarter and then there's some ongoing expenses in the first quarter.
But I was just trying to figure out like where do you stand in terms of these investments in RIS fees? And then and on top of that, there seems to be some moving pieces in the expenses line in this quarter. And I was just wondering if you can provide some additional color in terms of where do you think the expenses will be kind of for the rest of the year?
Speaker 2
Yes, Humphrey, so thank you for that. I'm the broad comment I'm going to make before throwing it to Deanna is that we're actually incredibly enthusiastic about these investments in digital. We're getting some traction. We're seeing it materialize here. We started in the fourth quarter.
We're well into it in the first quarter here and we're starting to see progress made. And I'm frankly very excited about that. But with regards to the specifics, me throw it to Deanna.
Speaker 3
Thanks, Humphrey. I think what would work best is if I talk about our expenses in total for the company and then Nora could add a few comments specifically to RIS Fee. And so the first thing I would say is when I have dug into our first quarter expenses for the company in total, they were not significantly different than what we expected. We've always talked about a goal to align the growth in expenses to our growth in revenue. But as we've also discussed, it's very critical that we balance that with investments in the business because those investments have served us well up to this point and will continue to serve us well in driving long term growth.
I think it's also important to recognize that there is seasonality to expenses. Some of that Jim just talked about, fourth quarter is always our highest expense quarter, and first quarter tends to be our second highest quarter due to items such as PGI, payroll taxes, and overall variable compensation tends to be a little bit higher in the first quarter as well. If you go back to 2017, we did state that expenses were light in that quarter, primarily due to timing. And this quarter, as you mentioned, we did include our total expenses does include the impact of those digital investments. And so given that, you would have expected this quarter to see a slightly higher increase in expenses, again, due to low in 2017 and the additional investments this quarter.
I tend to look at kind of growth in expenses and revenue over a longer time period. But even if you just look at first quarter twenty eighteen versus first quarter twenty seventeen, our comp in other was up 4.9%. That's in line with our net revenue growth on a reported basis. But if you actually adjust net revenue for encaje and VII, that compares to an 8% increase in net revenue. Specific to digital, we did have some digital in fourth quarter, but much more significant in the first quarter.
As you mentioned, we said on the outlook call that would impact our pretax operating earnings growth about 2%. And you get a very accurate calculation to get to a dollar amount of expenses that we might expect in 2018. Our first quarter spend was very aligned with that. And we don't expect anything different for the full year, different than what we told you on that outlet call. The spend is spread throughout all of the segments, and benefits will begin to emerge in 2019.
So I think bottom line, it feels like our expenses in the first quarter align with what we've talked about in the past. And I'll pivot to Nora to see if she has any additional comments specific to
Speaker 9
RIS Fee. Yes. So Deanna has covered very well both RIS Fee and at the PFG level, so I won't repeat that. But just to give you a little flavor for the investments that we're making and to Deanna's point, excited about in RIS Fee. We're not just talking about technology, but we're also talking about customer experience.
And that's at the plan sponsor employer level, that's at the plan participant level, that's the digital experience that we want to have with our advisors. So we're really looking at this when we say digital or we say technology, we have a number of really critical audiences that we are investing in building that digital experience around. So really excited about that for the long haul. And in addition to that, we've really lifted our game around our marketing and marketing spend. So those things are investments back in the business.
They give us the confidence that we're going to continue to lead have a leading franchise here with regard to both top line and bottom line growth.
Speaker 2
Thanks, Nora. Humphrey, did you have a follow-up?
Speaker 8
Yes, I do. So kind of shifting gear to PGI a little bit. So when I'm actually looking at the management fee less pass through, kind of looking at the kind of year over year basis, it's definitely showing some improvement as well as on a quarter over quarter basis. I suspect that's because some of the mix shifts going on within PGI. But I was just wondering if Jim can talk about a little bit more the fees that you're getting from outflows from the inflows versus the outflows and kind of how we should think about the fee rate improvement as an underlying earnings driver as opposed to AUM growth in PGI?
Speaker 2
Yes, very much depends on those asset classes. And I think there's a good story there, Jim.
Speaker 5
Yes. Thank you, Humphrey. And this links back to some of the comments Dan made in his prepared remarks about us being well aligned with the places where revenue growth is happening. If you look at the asset management industry, there's a lot of money flowing into passive and active core players, but they are seeing declining revenue. That's really being hit very hard by the demand for lower pricing.
And as you know, that's not the area we're primarily in. We're in Active Specialties, Alternatives and Multi Asset Class solutions. And those are where we feel confident about revenue growth. It's interesting, know it's in the back of people's mind, how bad can this hedging effect get. I would point back to the second quarter of last year, when we had a similar outflow because of hedging costs.
In that case, it was both euro and yen hedging costs. And I did remark in that call that I felt much more confident about revenues than I did about future flows at that point. I still feel that way because we are in areas where the average basis points can go up because of the change of mix. And this is things like real estate, like high yield, like small cap and emerging markets. Those are areas where we are really quite strong and have actually even in a fairly tough first quarter had decent flows.
So, yes, Jimmy, I think the main sorry, Humphrey, I think the main point here I'd make is that we are well placed to continue that revenue growth, almost well, not quite regardless of the flows. The flows will turn positive again. I have little doubt about that given our execution and our performance. But having said that, I think the mix is a very important attribute that we have to be a growing revenue earner in the Asset Management business.
Speaker 2
Humphrey, thanks for your questions.
Speaker 0
Your next question comes from Erik Bass of Autonomous Research.
Speaker 10
Hi, thank you. I guess to start maybe just follow-up on Humphrey's question just on the revenue picture for PGI and obviously the fee pressures you've mentioned at Institutional and the actions you're taking to deal with those. I mean are those all contemplated in the kind of 4% revenue target for 2018 and the 5% to 8% long term growth outlook? So do you think those targets are still achievable?
Speaker 2
We actually do. We think they're still well within those range. We don't reaffirm, but I would say that we anticipate these things in advance and feel comfortable with that 4% to
Speaker 5
eight Yes. The industry is seeing very heavy disruption. The very difficult environment for passive and active core players is playing out almost exactly as we expected. So no need to change the guidance for that.
Speaker 10
Got it. Thank you. And then maybe moving to RIS Fee. And if you could just talk about the impact of equity markets on your margins there. And I know you commented specifically on the DAC, I think, in the prepared remarks.
But should we think about the midpoint of the 30% to 34% guidance range for the year being based on the 8% equity market return assumption? Or is this too simplistic?
Speaker 2
No, I don't think that's overly simplistic. And this was kind of a wild quarter because of the ride to think that, again, the way we get compensated on the revenues are as on a daily basis, and we saw the that was roughly up 5%. While if you looked at the point to point, it was a minus 1%, which does have an impact on the DAC line. But I think the assumptions that you're using are spot on. Nora, would you like to add to that at all?
Speaker 9
Yes. And so if you look at our fee revenue line, the vast majority of that fee is based on account value. And clearly, given our portfolio, we're going to lift and fall based on the equity markets. But with the assumption baked in, we're absolutely confident with regard to that margin guidance.
Speaker 2
Did you have a follow-up?
Speaker 10
No, that's helpful. So just right sort of the midpoint is where that 8% would fall out?
Speaker 2
Right, exactly.
Speaker 10
Okay, perfect. Thank you.
Speaker 2
Thank you.
Speaker 0
Your next question comes from John Barnett of Sandler O'Neill.
Speaker 11
Thank you. There have been a thought that post tax reform there'd be a wave of wage inflation and some benefits inflation in The U. S. Employment force. Given your small to middle market positioning, the thought that you could benefit, it seems like the defined contribution number of plans has ticked up, specialty benefits sales are strong.
Can you possibly talk about how you're seeing that in your various different businesses so far this year?
Speaker 2
Yes. So maybe I'll have both Amy and Nora weigh in on that. But to your point, there's also a second element to that, and that is what's the impact on principal itself from wage inflation and the impact it might have on our expenses. And what I would say is I again think we have we start from a very credible place from wage base. We've always tried to maintain that positioning.
And it's true with our benefits. It's true with our wages. And it's true in trying to create the right environment. What's probably changed the most for us is the need to go out and recruit talent that tends to be at the higher end of the spectrum. So more hiring of people with data scientist backgrounds and some of our digital efforts will come with talent that has a higher wage.
And if that's impacting Principal, I have to believe other firms are running into that same sort of situation. But with that, let me throw it to Amy for some additional comments.
Speaker 12
Sure. Hi, John. Let me give you a couple perspectives on this. First perspective is, I think we have said before and we're still seeing it happen, there's employment growth that is particularly pronounced and positive in the small market. So when we isolate out those cases that are in that smaller market for us, maybe employers who employ less than 200 people, we're seeing a trailing twelve month kind of employment number go up to about 2.3% in terms of that in group growth.
So very healthy metric and that has stayed healthy even post tax reform. One of the interesting things we're seeing in the marketplace post tax reform is that we're a market that is near kind of full employment. And so we see small employers asking us about interesting new benefits more than they have even in the past. So leaning into those ancillary benefits, so the secondary benefits, asking questions about short term disability and long term disability when they previously maybe hadn't looked at some of those coverages before. Certainly there's also interest in accident and critical illness.
In the other pieces of the portfolio that can be a really interesting add on that can attract a workforce. So Dan talked about that workforce piece. That's really what we're seeing as well, is they're trying to get an attractive benefits package out there for that extended workforce that is really competitive right now.
Speaker 2
Nora, some additional comments?
Speaker 9
Yes. So certainly, we're benefiting from those from the job and the wage growth in RIS Fee and our full service retirement business in particular, which is why you see those strong recurring deposit growth up 7% quarter over quarter, why you see this growth not just in participants up 4%, but also participants with account value. We see employers lifting their match, both including the match for the first time and lifting the match. So you see as that as the positives happen with job and wage growth, we see it coming in through that fundamental growth in our business, which lifts all boats.
Speaker 2
Jim, I think you have some Yes, perspective
Speaker 5
John, just a comment from the economics point of view. We've been looking for the last two or three years that the aggregate data for our customers, small midsize business customers. And I would tell you very much aligned with your question. About a year or two ago, we saw the wage rates in that area going up faster than the economy as a whole. I think that shows partly the phenomenon you're talking about reskilling, upskilling, labor shortage.
I think it also shows a very good proof statement on the fundamental strength of the small and midsize growing business segment.
Speaker 2
Yes. Last comment, John, before I see if you have a follow-up. When I think about Amy's business around the business owner executive solutions and non qualified deferred compensation, again, an area where it was disrupted by tax reform. It actually has been disrupted in a positive way, and we're seeing nice growth there too. So any follow-up questions, John?
Speaker 11
Sure. That'd be great. Could you talk about the pipeline and market environment for PRT transactions in the last several months since the MetLife material weakness charge? And what you're hearing or seeing from a regulatory perspective as well in that market? Thank you very much for your answers.
Speaker 1
You so much. Nora?
Speaker 9
Sure. So in our pension risk transfer business, 1Q was a little light on sales, but we are extremely confident with regard to the pipeline that we see both in the industry. I mean, the industry, as you probably know, is expecting close to 20,000,000,000 to $25,000,000,000 of opportunity this year. And certainly, in our pipeline, we see that opportunity. So we're last year, had record sales of $2,800,000,000 We would expect to be looking at that same type of number this year even with a little softer first quarter because of that industry volume.
And in particular, our opportunities within that $5,000,000 to $500,000,000 space. With regard you asked about from a regulatory perspective, we don't have concerns from that perspective. We talked about that on the last call. We're confident that we're reserved appropriately reserved. And certainly, we have significant processes and oversight around loss policyholders.
So from that perspective, we'll continue to monitor expectations. But from that perspective, we're highly confident that we have both the reserve in place and the process in place.
Speaker 2
Thanks, Samara.
Speaker 11
Great. Thank you.
Speaker 0
Your next question comes from Ryan Krueger of KBW.
Speaker 6
Hi, thanks. Good morning. First question was, can you give a sense for how much AUM you have in these currency affected fixed income strategies with lower basis point yields at this point?
Speaker 2
Yeah, Jim, please.
Speaker 5
Yeah, the direct number is dominated by the point that Dan made about having a few billion still with the client that we lost money for in the first quarter. I think that's in terms of what we really know just about the extent of it. What you don't know is how attitudes to currency hedging can evolve at institutions. As you know, we have very broad range clients in 85 countries. Some of those countries will definitely see rising or indeed falling hedging costs.
The problem has been that yen and euro interest rates have pinned to zero at the same time as The U. S. Rate is rising. That's really the differential that determines the hedging cost. So, what I would say is, it's really in the near term doesn't look like a big problem.
But longer term, we have to be wary of that for foreign investors that are investing in U. S. Securities and choose to hedge it. There comes a time when either for their economics or for their accounting, it begins to look less advantageous to buy U. S.
Securities. But I think there are natural tensions that will stop the interest rates getting massively out of line. So I don't feel particularly concerned about that beyond the large client that Dan referred to in the script.
Speaker 2
So Ryan, comment in this in my comments earlier, we're roughly $3,000,000,000 And again, we don't think there's a lot outside of that pegged to a hedging strategy. Hopefully that's helpful.
Speaker 6
It is. Thanks. And then other question was, can you give some more color on Southeast Asia flows that picked up materially and what's driving that?
Speaker 2
It really did and we're really excited about that. Luis, you want to provide some additional insights?
Speaker 7
Yes. Thanks Ryan for your question. Certainly our activity in Asia is doing much, much better and we're very pleased about that. Flows in Southeast Asia, 800,000,000 in Thailand in particular, three different mandates. So we're very pleased about that.
And certainly a very strong activity in Malaysia. So that's the reason why. That is a very consistent about what we have been planning in Southeast Asia and very consistent with our plans for 2018 in fact.
Speaker 2
Thank you, Ryan.
Speaker 13
Great. Thanks.
Speaker 0
Your next question comes from John Nadel of UBS.
Speaker 14
Hey, good morning, everybody. I have a couple of questions. The first one, Dan or Deanna, the total capital deployment range for this year, I know it's not really that different from prior years, but the range is still kind of wide. So if I think about what external are factors or maybe even internal factors that you see are most critical that would move you from the lower end of that deployment range to the upper end?
Speaker 2
Sure. Happy to take the first shot at that and then throw it to Deanna. That 900,000,000 to $1.3 is again, when you start off at the beginning of the year, you want to leave yourself a bit of a wide berth. We've been on the record to say that the 40% payout of net income, which we know has some variability, would certainly impact the funding level and have an impact on where it hits within that range. I think the organic growth, we get pretty close on that one in terms of how we're going to deploy the capital there.
But again, in that pension risk transfer business, you can use up additional capital. I would say that in the area of acquisitions, again, it makes sense and it's accretive and we can be opportunistic around capabilities and scale, we want to go after that. That's probably the largest variable here. Of course, as we all know, the one way we can fill in at the end is relative to share buyback if the opportunity is there and it really fits with our internal model. So I think it's purposely a bit wide to give us a bit more flexibility for making good decisions.
But Deanna, additional thoughts?
Speaker 3
Yes. I think Dan hit it on. I think the dividend piece is probably pretty easy for you to estimate. And the two that would tend to be more volatile and could end up different than maybe what we thought at the beginning of the year would be around M and A and share buyback. Obviously, buyback is going to be dependent, as we've said, on other deployment opportunities as well as valuation.
But I think we have a long history of being within or above really what we've stated going into the year. Obviously, quarter is a great start relative to that. But those would be the two the items that would tend to cause us to be at different places within that range.
Speaker 2
John, do have a follow-up?
Speaker 14
Yes, I do. Thank you for the answers to that. I'm curious, thinking about the group insurance business. And going back to the days where tax reform was sort of first discussed or floated, I think principal was probably one of the first to actually say pretty specifically that there is an expectation that that would pass through to the through sales and premium rates pretty quickly such that after tax margins before reform and after reform would probably look pretty similar. I guess I'm curious given the beginning of the year is such a critical part for sales in the group insurance business, whether you're already seeing that come through or is
Speaker 6
it just a little bit too soon?
Speaker 2
What's your take on that, Jamie?
Speaker 12
Yes. It's a little bit too soon. And really why I think I'm so comfortable kind of talking about this unique to Principal is because when you look at our group benefits business, so much of the business we have is on a one year rate guarantee. So compared to a lot of our competitors, when we're really actively repricing every single year and looking at the health of our business and doing the appropriate studies every quarter and every year, we tend to really move things into our block, maybe even a bit more quickly than some of our peer competitors. So I think their answers can be accurate, but again it's given their own block.
So a little bit early, but again, we have a high percentage of our block that is annually renewable. John,
Speaker 3
the other thing I would mention is there's obviously two impacts on pricing relative to tax reform. I think the one that you're focused on is obviously the lowering of the effective tax rate and Group Benefits and PGI are likely our two businesses within the complex that benefited the most from that. But the other thing you can't ignore is that our NAIC is contemplating a change in capital requirements that would increase the capital that is needed to back our businesses. And so really, as we think about pricing, we need to take into account both of those. I still agree with Amy's comments that for group benefits, this is probably likely a net positive.
But we got to make sure we're understanding both of those impacts, not just the effective tax rate change.
Speaker 2
Thanks for your questions, Yes,
Speaker 14
very much appreciate that. Thank you.
Speaker 0
Your next question comes from Suneet Kamath of Citi.
Speaker 13
Thanks. Good morning. Just on RIS Fee, can you give us a sense of what percentage of the account value is in passive options at this point? And then how that compares to kind of the new deposits that you're getting? Is there a big difference between those two?
Yes.
Speaker 2
It's a good question, Nora. Do have those specifics?
Speaker 9
Yes. And I don't have the specifics, but generally, we have a meaningful portion of that portfolio that has been has always been in passive. And as we have flows into our CIT hybrid, the percentage of passive will go up on a relative basis. And what was your second question, Suneet?
Speaker 13
It was the comparison of the new business versus Salesforce, but if we could follow-up if you don't have that information.
Speaker 9
Sure. Yes, we can follow-up with specifics. But directionally, because of the really strong flows into our target date suite and extremely strong flows into the hybrid product within the target date suite, we will see an increase in the underlying account value with regard to passive options. So we'll get you the specifics on that.
Speaker 2
Yes. Smedes, just as franchise, if we were to look at, for example, as a representative sample of Principal Global Investors, about 85% of the assets under management are active, 15% are passive. If you look at the revenues, it's 97% of the revenues coming from the active, 3% coming from the passive. And I think maybe to reorient your question just a little bit, and Nora touched on it, it isn't necessarily a pure passive target date strategy that they're looking for. They're looking for a lower cost strategy.
And that's where the CITs that are being manufactured by PGI have become sort the primary vehicle for providing active management at a lower cost. And as you know from our performance numbers, they're very competitive in the marketplace. So that's really become our workhorse as opposed to a passive option like an S and P 500 simply being available on the platform because those target date strategies are going to capture anywhere from a third to half of those flows into the plans in the first place. So hopefully that's helpful.
Speaker 13
Yes. No, it is. And then I guess my second question might be a little bit strategic. But as I think about your RIS Fee business, it's I think almost entirely four zero one at different employer sizes. And when I look across at some of your competitors, there seems to be a blend of four zero one, four fifty seven, four zero three.
And I guess I'm just curious, why is it that you guys haven't participated in some of those tax exempt markets, where I think the returns might be a little higher on an ROE basis? Is it that you're just not set up that way? Or is there some reason why you haven't taken advantage of that part of the market?
Speaker 2
Grow, good question. Nora, you want to take that one?
Speaker 9
Yes. Actually, Suneet, we are quite active in the four zero three market, the tax exempt market. It's a priority for us from a strategic perspective. But we play in that space, in particular, in the employer sponsored plans versus the legacy chassis around an individual annuity model. So we that is not part of our strategy.
But we certainly if you think about our total retirement suite, both with the DB and a non qual as well, for a tax exempt organization, we bring the entire suite to them. So we are a meaningful player and you can call it the four zero three space, but it's actually the tax exempt market where we bring four zero three as one of the tools, but in addition to that, bring the DB, the non qual, etcetera. As far as the four fifty seven market, that's a pretty unique market, and that is not a focus for us under our current strategy. But for sure, we're in the tax exempt market in a meaningful way.
Speaker 2
Just a couple just a quick pile on there for just a couple of moments. The $457,000,000 also tends to be quite large. These are generally municipalities always out to bid, if you will, the kind of low bid gets the deal. And I'm not talking about investment options there. I'm talking about all the record keeping services.
And if you think about how we've oriented our investments around digital, the customer experience, it's to really try to help employers attract and retain talent with really state of the art solutions. And that may not be quite as recognized by the buyers in the April. And that 04/2003 market that Nora was describing, it's based upon individual annuities. That sometimes can come with a little bit higher price. Some of that is driven by the fact that a lot of those assets tend to get driven into a guaranteed account, which speaks to the higher revenue rates that you were referring to in your comments.
Did you have a follow-up?
Speaker 13
No, that's all right. Thanks.
Speaker 2
Thank you.
Speaker 0
Your final question comes from Tom Gallagher of Evercore.
Speaker 15
Good morning. First one for Jim, just on flows for PGI. I know you've highlighted the $3,000,000,000 currency overlay mandate being at risk. But can you comment, I guess, just a little more broadly how you see things playing out for the next couple of quarters here? The $6,000,000,000 of outflows was kind of startling from just because we haven't really seen that level of net outflows at PGI before.
Do you think we've hit a high watermark there? And I realize some of those are low fee, but just from an absolute standpoint,
Speaker 6
do you
Speaker 15
think how do you see that looking over the next few quarters?
Speaker 2
Please go ahead, Jim.
Speaker 5
Yes. First, thanks for the question, Tom. First thing to say is that we do see a pretty strong pipeline. And it's a pipeline including some quite good rich revenue mandates. Also incidentally, you think longer term, some of them with promote structures or multi year carries, which definitely builds up the value of the business for the longer term.
So on that piece, I feel really confident. I think we're positioned very effectively. I think that the performance should make us confident on our retail platforms. Our retail platforms last year between 48 ETFs, CITs, USIPS and SMA and others had a very substantial, very steady £4,000,000,000 and change last year of inflows and remain positive in the first quarter. So that's sort of building up business by gradual flows and I feel very good about that.
I don't want to go come down and make a very tight prediction about what happens as a result of currency hedging, particularly in the developed world. I think that there is still risk in that as there is for all large asset managers. But I take some comfort from the fact that even in those hedge markets, have things like real estate debt, we have high yield, we have REITs, we have income bias strategies, which have a high enough expected return to absorb the current hedging cost or even any likely hedging cost. So I feel cautiously optimistic, but I don't want to promise you that this is going to be our only bad quarter for flows.
Speaker 10
And do have
Speaker 2
a follow-up?
Speaker 15
Yes. Thanks, Dan. So I guess my follow-up is for Nora. Can you talk a bit about fee compression in 04/2001? I guess your revenue yield was down a little bit this quarter.
But how do you see and I think every 1Q you see a little bit of that I presume maybe that's just simple repricing and I know I think there's a fewer one less fee day in the quarter. But can you talk more broadly about what's going on there? I think you mentioned the vast majority of your fees are based on AUM. Can you quantify at all how much are actually based on non AUM factors like per participant? And is that changing at all?
Speaker 9
Sure. So Tom, we've got the vast majority of our full service business is tied to account value, a very small amount, which would not be tied to account value. So that's number one. Number two, to your point on the sequential, we definitely saw the impact of some repricing oneone around our investment portfolio. So that sequential drop was fewer days, but also some repricing.
But to your broader question, and we've talked about this before, we certainly and this is industry, not just principal, but there's been a long standing trend where we expect to see this gap between account value growth and revenue growth. And we've generally talked 4% to 8%, sometimes it will be more, sometimes it will be less. Quarter to quarter can be noisy because of revenue timing. But if you look at overall product mix, if you look at overall asset mix, if you look at competitive pricing, that was certainly impacting this gap, which is the discussion we've been having. So there are no surprises here to us with regard to the results.
The underlying growth extremely strong. So what you see there, when you see that lift in recurring deposits, when you see the lift that we've talked about, plan count, participant count, etcetera, that is extremely strong and that is what's going to drive the growth of this business.
Speaker 13
Thanks. Thank
Speaker 2
you. Appreciate your question.
Speaker 0
We have reached the end of our Q and A. Mr. Houston, your closing comments please.
Speaker 2
Thank you. Appreciate your questions very much today. Our focus really does remain on delivering value to our customers and shareholders. I have a lot of confidence that the business model that we have, an integrated and diversified approach to this serving the needs of the customers, is still the right model, strong investment performance, and we're frankly in the asset classes that are going to be in high demand. And the other thing I love about the business model, it's a global business model.
Much of what we're selling here, we're leveraging in and around the rest of the world. So we'll continue to differentiate for our customers and delivering long shareholder value and look forward to seeing many of you on the road here in the next few months. Thank