美國信安金融集團 (PFG) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Principal Financial Group Second Quarter 2017 Financial Results Conference Call. (Operator Instructions)

I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.

Thank you, and good morning. Welcome to Principal Financial Group's second quarter conference call. As always, our materials related to today's call are available on our website at principal.com/investor.

Following a reading of the safe harbor provision, CEO, Dan Houston; and CFO, Deanna Strable, will deliver some prepared remarks, then we will open up the call for questions. Others available for the Q&A session include Nora Everett, Retirement and Income Solutions; Jim McCaughan, Principal Global Investors; Luis Valdés, Principal International; Tim Dunbar, our Chief Investment Officer; and Amy Friedrich, our new President of U.S. Insurance Solutions.

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-K 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.

Reconciliations of the non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures may also be found in our earnings release, financial supplement and slide presentation.

Before I turn the call over to Dan, I want to extend an invitation to our upcoming 2017 investor workshop in New York City on Thursday, December 7. This year's focus will be on our spread and risk businesses and our long-term capital deployment strategy. Dan?

Thanks, John, and welcome to everyone on the call. A special welcome to Amy Friedrich on her first earnings call. As communicated in our May announcement, Amy brings more than 20 years of business experience, including extensive leadership within our Specialty Benefits division and a strong background in strategy development.

This morning, I'll share some performance highlights and key accomplishments that position us for continued growth. Deanna will provide details on second quarter financial results and an update on capital deployment.

Building [upon] first quarter's momentum, we delivered a record $384 million of operating earnings in the second quarter that contributed to operating earnings of $754 million year-to-date. This is an increase of 21% compared to the first half of 2016, reflecting double-digit net revenue growth and strong expense discipline.

As I reflect on our performance in the first half of the year, we continue to deliver strong growth, execute our customer focused solutions-oriented strategy, balance investments in growth and expense control and be good stewards of shareholder capital. I'm particularly pleased with the trailing 12-month trends across our businesses for revenue, margins and pretax earnings. Our diversified, integrated business model continues to work for our customers and shareholders.

Compared to a year ago, we've increased assets under management, or AUM, 10% to a record $629 billion as of midyear. This increase provides a solid foundation for revenue and earnings growth for the remainder of 2017, and it reflects strong asset appreciation as well as $9 billion of positive net cash flows.

I do want to call out after 24 consecutive quarters of positive net cash flows, we had negative net cash flows during the second quarter. I don't view this as a systemic issue. There were a few primary contributors to this quarter's net cash flows. First and foremost, it reflects the volatility that's inherent in the global institutional asset management and retirement space as large deposits and withdrawals can occur unevenly over time. This negatively impacted flows in PGI, Principal International and the RIS-Fee business.

In the second quarter, we had 2 large mandates in PGI withdraw a total of $3.3 billion during a period that we did not have any new large mandates fund. One of the mandates left due to a rise in currency hedging costs; the other, the client took the investment management in-house. Importantly, these large withdrawals are not translating into significant revenue losses as we've had good success bringing in somewhat smaller higher revenue mandates.

As discussed last quarter, we continue to see negative net cash flows from Columbus Circle Investors. During the quarter, CCI had $900 million of negative net cash flows. We've made a number of changes at the boutique, and investment performance has improved year-to-date.

Additionally, the ongoing turmoil in the Chilean pension system continued to elevate withdrawals at Cuprum early in the second quarter, driving negative net cash flows of $400 million. Even with the outflows during the quarter, Chile reported record assets under management in local currency.

Lastly, despite some softness in sales during the quarter, we still delivered $700 million of positive net cash flows in Brazil and remained the market leader in net deposits.

Despite the pressure of this quarter, we continue to have multiple meaningful sources of positive net cash flow. Through 6 months, RIS-Fee, RIS-Spread and Principal International all delivered positive net cash flows, totaling $5 billion. We delivered at least $200 million each of positive net cash flows for 8 of our boutiques in PGI as sales of our niche institutional strategies remain solid.

Our U.S. retail funds business generated $0.5 billion of positive net cash flows, and our target date suite flows remained positive, including positive flows in second quarter with strong sales and contributions from retirement plan participants.

Our historical positive total company net cash flow was not an accident. It comes down to several key factors: strong long-term investment performance; expertise across asset classes and in asset allocation; a wide array of solutions that meet the needs of Retirement, retail and institutional investors; our breadth and diversity of asset-gathering businesses and leading positions and strong distribution networks in key asset management markets around the world. This all remains in place.

At midyear, more than 80% of Principal mutual funds, separate accounts and collective investment trust were above median for the 3- and 5-year performance periods. Additionally, 56% of our rated funds have a 4- or 5-star rating from Morningstar.

We again received multiple best funds awards during the quarter around the world. CPAM Malaysia was named fund house of the year by AsianInvestor during the quarter and our global high-yield fund won 9 Thomson Reuters Lipper fund awards.

For the second half of 2017, I'm cautiously optimistic about net cash flow as we expect improvement for PI in Brazil, Chile and Hong Kong; additional momentum for PGI across multiple platforms, including U.S. retail, Dublin and global SMA. There are a number of large mandates that we are working on in PGI that could fund by end of the year; growth opportunities within our spread business, particularly in the pension closeout business. That said, we also expect a handful of larger retirement plans to terminate an RIS-Fee over the next 2 to 3 quarters, totaling approximately $3 billion.

We continue to expect strong net cash flows in our core U.S. retirement plan market, small- to medium-sized businesses. Taken in total, we expect improvement in net cash flow for the second half of the year.

While net cash flow remains an important measure, what's more important is driving sustainable growth in revenue and operating earnings. To do so, we'll continue to capitalize on leading positions with our broad array of investment options with institutional and high net worth investors around the world and with retirement investors and long-term savers in the U.S., Latin America and Asia.

I'll focus my remaining comments on key execution highlights and the work we're doing to further strengthen our competitive positioning. In the second quarter, we continued to expand and enhance our solutions set with emphasis on outcomes-based funds with a particular focus on income solutions; alternative investments to enhance diversification and manage downside risk; our international retail platform to capitalize on opportunities in Latin America, Asia and Europe and our ETF, CIT and SMA platforms to provide lower-cost investment options to complement our more traditional strategies.

Product launches during the quarter included an emerging markets income fund on our UCITS platform, 2 new funds in Chile and an actively manage a yield-oriented equity ETF strategy on our U.S. platform.

Our ETFs are providing lower-cost ways to improve diversification for retail and high net worth investors. Two of our recent launches have received important recognition. Principal Active Global Dividend Income ETF is not only the largest 2017 launch to-date, it is the largest active equity ETF in the world. Principal U.S. Small Cap Index ETF was also recently recognized as 1 of the 5 most successful ETF launches of 2016.

Moving to distribution. We continue to advance our multichannel, multiproduct strategy. I'll highlight a few key developments. We continue to get our funds added to platforms' recommended list and model portfolios. Through midyear, we've earned 36 total placements, getting 22 different funds on 16 different third-party platforms with success across asset classes. CCB-Principal Asset Management was selected as 1 of 7 fund companies to offer their mutual funds on Alibaba's online financial portal.

We began the national rollout of Easy Elect, our patented technology designed to make it easier and more intuitive for people to make decisions and enroll in employer-sponsored benefits. Results remain strong with participation levels 10% to 15% higher than traditional enrollment methods.

Our term life insurance is now offered on a direct-to-consumer basis through AIG Direct.

Lastly, we continue to make progress on our digital advice and sales platform in the U.S., Latin America and Asia.

Before closing, a quick DOL update. The DOL fiduciary rule became applicable on June 9. We continue to work closely with our distribution partners around the implementation. This effort only strengthens our relationships with these key partners. While there is some uncertainty in the marketplace, we remain laser-focused on helping advisors deliver retirement, protection and income solutions to their customers.

In closing, we'll go forward from a position of strength with excellent fundamentals and the benefit of broad diversification. I'll look for us to continue to build momentum through 2017 and for that momentum to translate into long-term value for our shareholders. Deanna?

Thanks, Dan. Good morning to everyone on the call. I'll focus my comments on the key contributors to our financial performance during the quarter and provide an update on capital deployment.

In the second quarter, we generated a record $384 million of total company operating earnings and a record $1.31 of operating earnings per share, both a 14% increase over the year ago quarter. We had 2 significant variances during the second quarter that resulted in a net benefit to operating earnings.

Pretax impacts of these items included a $10 million benefit from higher-than-expected variable investment income; RIS-Spread benefited by $7 million and Individual Life benefited by $3 million; and $5 million of elevated quarterly expenses in Principal International, primarily in Mexico.

Net income available to Principal Financial Group was $310 million for second quarter 2017. This included net realized capital losses of $74 million, primarily driven by derivative marks. Credit-related losses were only $9 million and remained well below our pricing assumptions.

At quarter end, ROE, excluding AOCI, other than foreign currency translation adjustment, was 14.8% on a reported basis. Excluding the impact from the 2015 and 2016 actuarial reviews, ROE improved 230 basis points from a year ago to 15.3%, reflecting strong earnings growth, improvement in macroeconomic conditions and disciplined capital management. Keep in mind that over the long term, we expect to improve ROE by 30 to 60 basis points per year with fluctuations in any period.

Second quarter results were fueled by continued strong business fundamentals, underlying revenue growth and disciplined expense and capital management. Additionally, quarterly operating earnings benefited from strong U.S. equity market performance as the S&P 500 Index quarterly daily average increased more than 3% over first quarter and 15% over the prior year quarter.

As Dan indicated, total company AUM increased 10% from a year ago to a record $629 billion in second quarter 2017, providing us with a solid foundation for continued operating earnings growth. However, total company net cash flows for the quarter were a negative $2.9 billion. While the large withdrawals we experienced this quarter totaling over $5 billion were meaningful to net cash flows, the revenue impact is not significant.

To illustrate this point, the same client that terminated a $2 billion mandate during the quarter recently awarded us an emerging markets debt mandate. While the new mandate is only a small fraction of the assets they withdrew, it offsets nearly 60% of the annual revenue from the larger investment-grade mandate. While net cash flow is an indicator of future earnings, it doesn't always tell the whole story due to our wide array of product offerings with a broad range of fees.

Moving to business unit results. On a trailing 12-month basis and excluding the impact of the 2015 and 2016 actuarial assumption reviews, revenue growth and margin metrics were within or above our 2017 guidance ranges for all of our business units. RIS-Fee, RIS-Spread and PGI were above the guidance range for revenue growth while Principal International, Specialty Benefits and Individual Life were in line.

Additionally, RIS-Fee and RIS-Spread were above the guidance range for margins while PGI, Principal International, Specialty Benefits and Individual Life were in line. These strong results reflect the successful execution of our diversified and integrated business model with a constant focus on balancing growth and profitability.

Consistent with last quarter, my comments will exclude the impact of the significant variances I mentioned earlier. As always, reported business unit results and key drivers can be found in the slides, supplement and press release.

Principal Global Investors, Principal International, Specialty Benefits and Individual Life pretax operating earnings were in line with expectations in the second quarter. Each of these businesses continue to produce growth and margins that look very attractive relative to peers.

In addition, corporate pretax operating losses were in line with our expectations. We continue to anticipate full year 2017 corporate pretax operating losses to be at the favorable end of the previously announced range of $200 million to $225 million.

RIS-Fee and RIS-Spread results were higher than our expectations for the quarter, and I'll cover these in a little more detail. As shown on Slide 6, RIS-Fee's pretax operating earnings of $148 million increased 18% over the year ago quarter. The strong increase in earnings was driven by higher net revenue stemming from higher account values and disciplined expense management. Strong market performance relative to our assumptions continues to positively impact RIS-Fee's net revenue growth, margin, and thus, pretax operating earnings.

Turning to RIS-Spread on Slide 7. Pretax operating earnings were $89 million or 27% higher than the prior year quarter. Over the same time period, RIS-Spread account value grew 8% driven by strong sales in the pension risk transfer business and fixed annuities as well as opportunistic issuance in Investment Only. Similar to first quarter 2017, mortality and experience gains in our pension risk transfer business contributed to favorable operating earnings this quarter.

Moving to capital deployment on Slide 12. In second quarter, we deployed $166 million of capital, including $133 million in common stock dividends, $26 million in share repurchases and $7 million to increase ownership in a PGI boutique. Year-to-date, we've deployed $414 million of capital and remain on track to deploy $800 million to $1.1 billion for the full year.

5 years ago, we announced our intention to increase our payout ratio to 40% to better reflect our business mix. At that time, our payout ratio was approximately 30%. Last night, we announced a $0.47 common stock dividend payable in the third quarter, a 15% increase from the prior year period and approaching our targeted 40% dividend payout ratio. We'll continue to be strategic and disciplined in deploying capital. We have an active M&A pipeline and have created the financial flexibility to execute on attractive opportunities that enhance long-term shareholder value.

On a trailing 12-month basis, we have delivered a 5-year compounded annual growth rate of 13% in operating earnings, exceeding our 9% to 12% long-term target. I'm confident we'll continue to deliver above-market revenue growth and industry-leading margins and achieve our long-term targets in the future.

In closing, I have enjoyed the opportunity to meet with many of you in my new capacity this year. I look forward to future interactions in the coming months.

This concludes our prepared remarks. Operator, please open the call for questions.

(Operator Instructions) The first question will come from John Barnidge with Sandler O'Neill.

Two questions. The dividend was increased for a sixth consecutive quarter. Can you talk about ability to maybe keep that pace up? Should we anticipate maybe $0.01 every quarter? And then I'll ask other question later.

Yes. I wouldn't expect $0.01 every quarter. We, again, tried to provide you with the guidance that this 40% targeted payout ratio is really ideal from our perspective. It's taken a while to get there, and it's certainly our intention to be in and around that 40% unless something material was disruptive to the business.

And then premiums were up nicely across products in Specialty Benefits. Can you talk about that a little bit? Is it pricing power, maybe taking advantage of some of the disruption in the market or simply the U.S. economy is doing better? We had a decent print this morning for the second quarter.

Yes. Good question, John. Appreciate that. I'll have Amy go ahead answer that.

You're right, premiums look good. When we look at 8% premium growth rate, I'd say that's within our expectations. We've been seeing that for the last few years. And I do think we're benefiting from some pricing power. When we're in the small market with the type of reputation we have, consistently in there with good business processes, good products, good practices, we're seeing an ability to get off of a spread sheet and be a preferred provider, and we like that. I think one factor, though, you mentioned larger trends. I do think one factor going on in that premium growth is employment growth. So when I look at our business on a trailing 12-month basis, we're seeing employment growth of about 1.4% on our group products. And as we look back over the arc of the last 10 years, that's near a high for us. So that 1.4% is clearly helpful in driving our in-force premium. And it's indicative of employment growth going on, particularly in the small market. So again, with our over-indexing in the small market, that's a really helpful trend for us.

The next question will come from Humphrey Lee with Dowling & Partners.

Just a question on RIS-Fee. So in Dan's prepared remarks, you mentioned that there are some expected terminations in the second half of the year, roughly about $3 billion. So when you're factoring the pace of the net cash flows in the first half of the year and the expectation for the redemptions, is the normal kind of 1% to 2% RIS net cash flows [as being] AUM still a good expectation for the full year of 2017?

Yes. As you know, we don't provide updates on the guidance. But I would say that we still feel reasonably good about the range. It could be the -- to the low end of that. And we again try to help investors understand the patterns there by giving you some insights when we know through M&A and other sorts of related transactions where we know we have a large known out. What we don't know as well at this point in time, Humphrey, is what the ins look like. But again, our pipeline looks healthy, the business is very healthy and we're doing well in terms of competing out there. You could see that by the growth in the business. But maybe I can have Nora add a little bit more color for you on that question. Nora?

Sure. So the estimate that Dan gave of $3 billion, one thing to be aware of is we always have timing issues. So when we say 2 to 3 quarters, it could be this calendar year, some of that could slip into next calendar year, 1Q in particular. So again, just trying to give an approximation. Another important part of the $3 billion is the majority of that $3 billion represents one case. So one case is north of $1.5 billion, so again, that timing in that particular case, whether it falls on 4Q or 1Q at this point in time, we're not sure when that would occur. We don't see -- the balance of that $3 billion primarily reflects some M&A with a couple larger cases; and, in fact, in one case, a bankruptcy. So we don't see any systemic issue here. And back to Dan's earlier point, importantly, what we see with our core SMB segment, small to medium business segment, is continuing strong net cash flow. So whether it's 1% to 3% or not, it will depend on some timing here within the 1% to 3%. But probably more importantly, that core SMB segment still has strong net cash flow.

Got it. And then shifting to Principal International. So at least the media related to China, there's a lot of discussions about financial services reform, especially they had a meeting in -- couple weeks ago in July. And then there seems to be a lot of thoughts about there could be some announcements following the 19th National Congress meeting in the fall. So I was just wondering if you have any kind of additional insights in terms of the pension opportunities that you've mentioned in the past.

Sure. I'll take that, Humphrey, and then pass it off to Luis. Luis and I and other members of management were just there a couple of weeks ago, right on the heels of the financial forum that you mentioned. And what I would say is we had very healthy dialogue with our joint venture partner, China Construction Bank as well as with regulators. There seems to be a lot of advocacy and support on the part of state and [commerce] to support U.S. companies playing a more active role, working in partnership with Chinese companies. And so those trade discussions are very much alive and well. But we walked away feeling very good about the robustness of our conversations. The MOU is delivering what we had hoped it would be, which is a healthy exchange of ideas on how we can mutually work together to be successful. But maybe I'll have Luis add some additional color. Luis?

Yes, Humphrey. Yes, you're totally right. I mean, many reforms are coming, particularly if President Xi is going to be confirmed for the next 5 years. They're going to continue looking in the financial services industry. As you know, China is a policy-driven economy, so they're very much more focused on internal consumption and to continue developing that system. In particular, Humphrey, the pension reform in China is a big issue. And they are continually thinking how to switch their payroll system, Pillar 1, into a [contoured] system based on Pillar 2 and Pillar 3. So very encouraging discussions. In order to do that, they really need help. They need pension experts and global pension experts at Principal Financial Group. So we're very much more in those discussions, Humphrey.

The next question will come from Seth Weiss with Bank of America.

Want to focus on the RIS margins, maybe starting with fees. Obviously, you're running well ahead of the 29 to 33 margin guidance for the full year. The longer-term guidance suggests that those margins come down significantly. Could you just help us think about what actually drives that lower? Is it pricing pressure, higher expenses? Just trying to understand from a modeling perspective because it seems sort of steep to what your longer term suggests versus the current.

Yes. Seth, certainly appreciate the question. And you're right into ask those kinds of questions. But the first thing I would tell you is, you really have the benefit of strong domestic equity markets today that help really propel you to the high side of that. And that's certainly one of the very key components. The other is we had lighter expenses for the quarter, albeit sometimes you have timing issues. Those do get spread out over a period of time. But the management team, Nora, Greg Burrows and others are doing a really good job managing the efficiencies of the operations. And then, of course, we know that we've just got really strong investment performance for 3 and 5 year, which allows us still to manage a lot of the proprietary assets, which contributes to a successful franchise for Full Service Accumulation. But with that, I'm going to ask Nora to put some additional color on what the future might look like relative to those margins.

Yes, Seth. Dan said it, that you can't underestimate the power of equity market tailwinds. If you look at the daily average up 15.5% 2Q-over-2Q, and so just the ability to have -- for those equity markets to drive both top line and bottom line is significant. But probably as important, again, not overlooking a strong fundamental, strong sales up 25% year-to-date -- over year-to-date, strong recurring deposit. So the fundamental's very strong. But we certainly anticipate that the pricing pressure is going to continue. So that's why you see directionally the margins that we talk about. With that said, full year, we still expect to be at the high end of margin expectation and still expect to be at the high end of our earnings range. So we certainly are expecting continued good growth. But the margin discussion reflects both, on the positive side, the equity market lift and the fact that we expect pricing pressure to continue.

Did you have a follow-up, Seth?

Yes. A follow-up, Dan, on your comments on the timing around expenses, particularly for the back half of the year. It sounds like that could just tick up a bit from a timing perspective. Any granularity you could help us there, just to avoid surprises in the back half of the year?

Yes. It was not intended to be sort of a loaded question. But from one quarter to the next, there always is some lumpiness, the way expenses come in. When I think about not only the balance of this year, but as we think about 2018 and beyond, enhancing the customer experience is a big deal for me. We know that competition -- and I'm not talking about financial services, we're talking more broadly. The consumer has a higher expectation about what that feels like and looks like. We continue to invest in the brand, and we're getting really good traction there. It's being very well received. Technology used to be a lot about the back office and middle office, and we're seeing the need to make further investments on the very front end. So you'll see us making announcements around digital technology, machine learning, artificial intelligence to help us do a better job servicing customers and running the business. And then Jim mentioned, I know he's been on the road recently, about the expansion of some of our sales operations around the world. Again, we look at that as a good investment for today that pays off in the future. And then the last thing I would just draw your attention to is the shifting demands of the consumers away from 40 Act funds and even the CITs and a strong interest in exchange-traded funds, ETFs. In that franchise, Jim's adding resources, talent, platform and all things necessary. So it's that sort of pent-up views that I have on. Of course, we have to align our expenses with revenues. We want to be mindful of that. But those are the kinds of expenses I'm thinking about for the balance of the year and into '18.

The next question will come from Sean Dargan with Wells Fargo Securities.

Following up on Seth's question about RIS-Fee. The revenue growth in RIS-Spread is running far ahead of the guidance for the year. Should we expect that -- well, a, what's driving that? Is that pension risk transfer? And b, should we expect that to drop off over the back half of the year?

Nora?

Sure. So to Deanna's comments, certainly that pension risk transfer business is absolutely helping us drive both top line and bottom line. So we're seeing that strong operating earnings growth and margins through the first half of the year, driven by all of the underlying products in spread, but in particular that pension risk transfer business. So we're going to continue to -- and let me back up. We've called out -- with regard to variable investment income, as you can see from the slide, we called out $7 million pretax for 2Q. In addition to that, we've had -- in 2Q, we've had a mortality and experience gain at a similar amount, about $7 million pretax, as part of that pension risk transfer business. We don't necessarily expect that to repeat. So as you call those 2 things -- as you think about those 2 things separately and readjusting and back those out, we're still expecting to be at the top of our outlook ranges, both with regard to net revenue growth, 10% being the top end of that range, and with regard to margins. So attractive opportunities continuing in that opportunistic business of ours, pension risk transfer helping drive the top end of those ranges.

Does that help, Sean?

Yes. I mean, you're kind of far above the top end of those ranges now, but we'll see. And then I have a question for Amy about the quarterly spread of the Specialty Benefits business. In the past, Principal said that about 20% of the earnings come in the first quarter, 25% each in the second and third and 30% in the fourth quarter. Is that pattern going to hold true this year?

Amy?

I mean, there's lots of things that can happen with the business. And so when I think of 45% first half and 55% second half, I think that's a good representation of that seasonality that's in the business. That seasonality is going to come from our dental line and some sales-related expenses. So I think that's a good marker. If you're looking at kind of the ranges we've given, we are running towards kind of the mid- to upper half on those ranges for growth and margin and then the lower half on the loss ratio range, which is obviously a good combination.

Does that help, Sean?

Yes.

The next question will come from Ryan Krueger with KBW.

I had a question about Brazil. There was a slowdown, some in the quarter. I know, Dan, you talked about expecting a pickup back in the second half of the year. But just hoping for some more color on what you're seeing in that market?

Yes, sure, and I'll have Luis do that. Brazil is an interesting market because it has been so successful for so long in terms of dominating that local position with our joint venture partner, Banco do Brasil. And even, as I mentioned in my prepared comments, when you think about getting 37% of the flows, it tells you just how successful they've been. So I think what we're dealing with is a modest setback on still a very, very strong franchise. But Luis, you want to go ahead and build on that?

Yes, Ryan. Again, this is Luis. We have to put in perspective that in our pension business in Brazil, we delivered $1 billion in net customer cash flows in the second quarter. As Dan said and mentioned, that represents 37% of market share in that industry. We have had some slowdown in our deposit, nothing in our withdrawals that you could see in our supplement. And the reason is a simple one. Banco, our partner, they have been much more focused on their in-house banking products in the first part of the year rather than in other financial services product related, like pensions and insurance. So we are expecting that our partner is going to start shifting their attention in the later part of this year into other related financial products. But anyway, the $1 billion that we put together in the second quarter has also been a stellar performance for a pension company in Brazil. We do expect some improvements, but it is -- again, Brasilprev continues to be the leader in that industry.

That's helpful. And then for Jim. Your performance fees were fairly, I think, modest in the current quarter. What are you thinking for the, I guess, the back half of the year at this point?

Jim, go ahead.

On performance fees, we did indicate back when we did the guidance last December that this would be pretty lean year, not because of bad performance but because of incidents. Because remember, a large part of our performance fees are based on real estate funds with 3, 5, maybe even longer year periods and sometimes dependent on the time that the assets get realized. The outflow then leads to a performance fee. This year is a bit lean on that. We're expecting some pickup in 2018 but not much in the second half of the year. I am actually pretty pleased, though, that in the first half, we've seen revenues almost make up for what last year was a pretty good second quarter in performance fees. So -- and that's very sustainable. That's management fees, which in the end will also be sign that performance fees longer term could be positive. Just lastly, on performance fees for the remainder of the year. I think the main element there may well be the year-end performance fees on hedge funds and some of the other performance fee clients. I think that's very difficult to tell at the moment what that will look like. But there will be almost for sure a number there in the fourth quarter. You can see from the past, though, that it's fluctuated quite a lot.

The next question will come from Erik Bass with Autonomous Research.

I was hoping that you could provide more color on the PGI pipeline both new business opportunities but also potential at-risk cases. And also I was hoping you could quantify maybe the average fee rate differential between mandates that have been leaving as well as new business coming on in recent quarters.

Yes. The one comment I would make, Erik, and I think you just touched on it, which is a reminder to all of us, our franchise has passive, hybrid, active, alternatives and has hedge funds. And I think if you go back 5 and 10 years ago, you saw a strong correlation between AUMs and the corresponding revenues. That has now been effectively separated. There's no longer our -- it's highly correlated, especially when you think about all the different structures, ETFs, 40 Act funds, CITs. So we're going to have to be thinking about year-end and communicating to you as we provide you with better outlook and guidance on what we can expect because not every AUM today carries anywhere near the same revenue. It's so broad. And with that, I'll ask Jim to answer some of your specific questions.

Yes, Erik. Firstly, the range that Dan talks about, it goes from 3 basis points to 2 and 20. So there's a very wide range. Maybe 10 years ago, our range was a lot narrower than that. It didn't go as high because we didn't have so many alternatives. It didn't go so low because there were less in the more commoditized index products. Secondly, the 2 clients that took away the large mandates, I should emphasize, are still clients and are still buying added-value capabilities from us. But to give the specific numbers on the large mandates that were mentioned, the $3.3 billion and 2 large mandates that were lost in the second quarter was on 7 basis points. If I look at the average for the deposits in the second quarter of $4.5 billion, the average was 42 basis points. So in other words, those assets are much heavier in their impact on revenue than the ones we lost. And actually, if you'll trade $1 billion account for a $200 million higher added value one with the same client, the flows look terrible, but you're ahead in terms of the quality of the business. The pipeline is strong. We do regularly review the pipeline. And I would actually say just subjectively without a lot of numbers, it's probably the strongest it's been. And I think it demonstrates that with our capabilities in specialty strategies, in multi-asset strategies and the ability to add value, we are in a pretty good place to grow revenue. So if you like, I'm a lot more confident that we'll continue to produce above-industry revenue growth than I am about the flows in any given quarter. Lastly, on cases at risk. Yes, there's got to be cases at risk because things change, and the hedging has been a source of some difficulty both when we had dollar strength last year and then when we had increasing hedging costs on the Japanese yen this year. So there are cases that are at risk, not anything extraordinary though, not anything that makes the clients unhappy. And we're certainly confident that it won't be a matter of losing clients. It's more a matter of shifting balances on particular clients. So I'm really just trying to portray that we're managing this business more for revenue than for flows. But obviously, the flows is an indicator you need to look at.

That's very helpful color. And one follow-up, just on the investment performance and the 1-year numbers continue to face some pressure. I was just hoping for a little bit more color there on what's driving it, and as we move into the back half of the year, how you see that changing as kind of, I think, the second half of last year was a bit challenging.

Yes. You just hit on it, too, and Jim can elaborate. It was a rough third and fourth quarter a year ago.

Yes. And the annual number should look a bit better as those rough quarters that Dan mentioned roll off. Hopefully, we'll do better in the second half of this year. But it's -- also, there's a bit of noise around the performance numbers. And I'll give you a couple of statistics that may help here. If I look at our year-to-date results, how we're doing in 2017, 53% by number of our funds are above median. That doesn't sound great. That sounds almost random. But if I cut out the funds that are either indexed or predominantly indexed and remember this is a period when active management has paid off. Excluding those, we're 67% above median year-to-date. I think that shows that we're still on track with our very focused multi-boutique strategy, leading to very tightly focused investment teams that can outperform. So I remain confident that we've got plenty of good stuff for our salespeople to use versus clients. We mentioned 56% by number had 4- and 5-star in the U.S. mutual funds. It's actually 69% by assets, which I think really shows that our salespeople have a lot to work with. So that's kind of underlying my continuing confidence, which is, as I said, more on revenues than on flows.

The next question will come from Jimmy Bhullar with JPMorgan.

I had a question for Luis on just the Chilean business. Like what's really driving the outflows there? And do you see it more as being systemic? Or is it more of an aberration? And then relatedly, we've seen one of your competitors cut fees by a decent amount, MetLife subsidiary in Chile. Are you planning on any reductions in your fees in that market?

Thanks, Jimmy, for the question. Oftentimes, you reflect back on certain deals that you did and how you feel about the country in total. And as we go back and still interrogate our decisions around starting the voluntary business nearly 10 years ago and certainly the mandatory business within the last 5 years, we're reassured we're in the right markets. Some things challenge you from time to time on the political front. But I'll ask Luis to delve right into your questions related to the flows and what our outlook is. Luis?

Yes. Jimmy, thanks for your question. And probably you remember a couple of quarters ago that I mentioned to you that the main reasons for those outflows are 2. The first reason is more customers are anticipating their Retirement decisions, and Cuprum is an accumulator and, at the same time, we paid -- programmers [withdraw]. So that's a source of, I'd say, outflows. And the second reason for these outflows is about market aggressiveness. And we have been in a kind of an interesting environment. But if you're looking in our supplement, our deposits, we -- our [ability in order] to put deposits in remains intact. So my comments about that is that the discussions about pension reforms and movements in that market is making us -- our inflows a little bit choppy. But I like to go back with Cuprum and I will try to qualify my answer is, we are managing today more money in Cuprum than at any given point on its history. That's number one. Number two, Cuprum is still, in this kind of an environment, a very resilient company. And we are reporting, in a normalized way, more earnings and revenues. And they are slightly up in the trailing -- in the TTM and also in a quarter-over-quarter and in a sequential quarter. So even having those negative net customer cash flows, again, I'm saying that we are very pleased and -- with Cuprum. And Cuprum, as we improve, that is a very resilient organization and business. The discussion about the pension reform, which is driving all this kind of noise that you have mentioned, it is a very interesting one. But we remain very optimistic about the future of pension industry in Chile and in particular about Cuprum. The Chileans are not saving enough, and that's the main reason for the market adequacy that we do have there. So this is essentially where we're working, paying a lot of attention about asset retention, client retentions. We have seen improvements in May, June and July in our net customer cash flow, so we remain optimistic going forward.

And I had a follow-up just for Dan. As you're looking at your sort of global footprint in the international business and also just your capabilities on the asset management side, are you still interested in acquisitions, and if so, what specific markets or -- and asset classes? And how is the environment in those markets for deals?

Yes. Thanks. So I guess, a couple of points I would make. First from a geographical perspective, when you think about the countries we're in -- and we face those off against our projections for kind of 2025 and 2050 and where we think the emerging markets are going to grow and developing middle classes that would likely be candidates for buying these sorts of products and services, it is Chile, it is India, it is Brazil, it is India. It is in those markets where we planted seeds and have been there for a long time. So in terms of geography, I feel really, really good about where we are operating today. And again, a lot of credit goes to Barry and Larry over the years for making sure we got into the right markets. The second thing I would say as it relates to products and services, it's been amazing to me, Jimmy, how much they've evolved to look a lot the same around the world, both in terms of structures and asset classes. And I know both Jim and Luis have talked on many occasions that it's really local investing, regional investing and then global investing. I think what's changed to me is the pace of play. It's just evolving more quickly. So we do have to continue to be nimble. We have PI and PGI working very closely together to make sure that we're as efficient as we can be in building our products and solutions, investment solutions locally. Having said that, we'd still like to do more infrastructure. We think that that's an asset class that's very interesting. European real estate and more -- other markets where we can leverage our real estate capabilities from the United States would be good. And I think, again, you're witnessing the advantage of the boutique model with these uncorrelated investment results. CCI has struggled in some of their strategies, while we have other mid-, small and large cap capabilities in other boutiques that have performed quite well. But we have a shopping list. We have a very active pipeline. Tim Dunbar, Lou Flori and team just do a terrific job of sorting through it. But we feel good about the countries, we feel good about the shopping list relative to where we could add capabilities and, in some extreme instances, scale. Does that help, Jimmy?

Yes.

The next question will come from Suneet Kamath with Citi.

Just to follow up to Jimmy's line of questioning on the capital deployment. Just kind of given how the stock has had a nice move so far this year and where multiples are, is the thought that maybe capital deployment would skew a little bit more towards M&A over the next couple of quarters? Or do you think buybacks at this level are still attractive?

You just -- you phrased the question around -- line of questioning, it sounds more like a deposition. But I appreciate that, Suneet, and all kidding aside. So a couple of thoughts. The first where we want to focus is on organic growth. We think that that's good value for our shareholders and building scale, building capabilities. The spread business that you've seen nice growth in here in the last couple of years, we, again, think we're getting properly -- investors are being properly rewarded with good returns there. The targeted payout ratio was a high priority to get to that 40%. So you've seen us increase the dividend. There's been a lot of work in the last 12 months on the repositioning of the debt ladder to make sure that, that was in good order, so that we didn't experience something as we did back in 2008 and '09 when we had some debt maturing that was short term in nature. And then, of course, as I mentioned earlier, we feel good about our pipeline for M&A and again selectively purchasing our shares. But I have a lot of confidence that we'll hit that $800 million to $1.1 billion of capital deployment for the full year 2017. Does that help?

No, it does. Obviously, stock price is a good problem to have. Just on China, following up on Humphrey's question, could that be an opportunity for you guys to deploy capital going forward?

Yes. It absolutely does represent a good opportunity. It's a big market. If you look at CCB pension, they've already grown to be over $100 billion in a short period of time that they've been in business. They're adding a lot of scale and capability. It will take investment there to fully build out what's going to be necessary. But I would definitely say that as we think about gaining more momentum, more capabilities in Brazil, in Southeast Asia with our joint venture partner, CIMB as well as in China, there is -- there will be an ample opportunity to deploy capital quite wisely to help build on the prior success.

The final question is from John Nadel with Crédit Suisse.

I guess, a question on RIS-Spread. And I sort of talked about this, I think, last quarter, too. I'm looking at -- I know you've talked about a couple of adjustments that we should think about for the pretax operating there, mostly variable investment income but also some mortality gains. If I make those adjustments and I look at the growth on a year-to-date basis versus the first half of '17, account value growth is up, I think, about 11% year-over-year on average, but your core pretax operating income is up about 28% year-over-year. Can you help us understand a little bit better, is there a significant mix shift going on in the account values that's driving the margin higher here? Or is -- or was the first half of '16 just a lower-than-normal level of earnings, and thus, we're recovering? Just a little help there would be -- I'd like to hear some commentary there.

Yes. You're hitting on some good topics in there. Variable investment income certainly has been a nice tailwind to enjoy in prepays and those sorts of things, but I'll ask Nora to pile on here with some additional thoughts on what that might look like going forward. Nora?

So John, you hit on some of the delta. The higher -- obviously, higher VII, higher mortality, experience gains, lower expenses. But there -- to your point, there's also some higher core spread. And when you talk about product mix, it's as much about the opportunities we've had in those opportunistic businesses. So you think about the pension risk transfer business, you think about Investment Only. We certainly have gained around some of that core spread. But with that said, we still take you back to those outlook ranges, in the high end of those outlook ranges because as you move -- as you take out some of those items I've identified, yes, it brings you to the high end or slightly over the range. But there's a mix -- there's a product mix there, but it's a combination of those drivers. So we're just wanting you to take a balanced approach as you look through to what's driving this first half of the year relative to the second half.

It's been kind of interesting to me to see the demand for income and retirement, whether it's by individual or corporations trying to get out from underneath these liabilities associated with their defined benefit plan. And the places where we've played is -- it is relatively small end of that marketplace. And we're getting good pricing relative to what historically we would have thought we would have had. So again, we look at that as not only opportunistic but it's certainly been opportunistic in our favor within the last few years.

Well, that's, I guess, sort of the point that I'm trying to get at, right, is that this is -- I mean, you guys called the segment RIS-Spread, so spread-based earnings in a difficult spread environment. And you're -- even if I make those adjustments for higher variable investment income and other things, you're outpacing your account value growth. Earnings growth is outpacing account value growth by almost 3x in a tough spread environment. So it has to be mix shift, no?

Deanna, do you want to make a comment?

Yes. I think the other comment I would make, John, is we have shown very strong sales over the last few years in this segment. And it takes a while for those sales to actually translate into earnings. And so again, you did kind of a point-to-point account value growth, but obviously, some of the emergence of those earnings do take some time. And so I think it's important to look at the increase in earnings or, probably more importantly, to look at kind of what we're earning today and what we think that run rate is going forward, which I think if you normalize for the variable investment income and the mortality gain is really a good earnings to kind of build on going forward. And so I think that emergence of earnings relative to the growth is probably the other piece that's important to think about as well.

And we could follow up with you as well, John.

We have reached the end of our Q&A. Mr. Houston, your closing comments, please.

Yes. Just maybe 3 very quick comments. The first of which is from our vantage point, we believe the fundamentals of these businesses are very much intact. Secondly, we're going to continue to focus and find that delicate balance between growth and profitability. And the third is we're going to put a lot of emphasis on understanding the needs of our customers. That is our highest priority, to make sure that we remain relevant to our customers. And we all know that it's a very dynamic and shifting market. But we look forward to seeing you on the road. And again, thank you for taking the time today to participate in the call.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1 p.m. Eastern Time until end of day, August 4, 2017. 48354928 is the access code for the replay. The number to dial for the replay is (855) 859-2056, U.S. and Canadian callers; or (404) 537-3406 international callers.