美國信安金融集團 (PFG) 2018 Q1 法說會逐字稿

Good morning, and welcome to the Principal Financial Group First Quarter 2018 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 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 January 1, 2018, the Edge Asset Management fixed income team joined Principal Global Fixed Income to better align capabilities and resources. As a result, approximately $11 billion 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 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; Amy Friedrich, 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-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 measure may be found on our earnings release, financial supplement and slide presentation.

Now I'd like to turn the call over 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 continue to deliver strong growth, execute our customer-focused solutions-oriented strategy, balance investments in our business with expense discipline and be good stewards of shareholder capital. At $409 million, we delivered record non-GAAP operating earnings, a 10% increase compared to first quarter 2017. This reflects good underlying growth across our businesses and the lower effective tax rate due to the U.S. tax law reform.

On a trailing 12-month basis, non-GAAP operating earnings exceeded $1.5 billion, 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 assets under management, or AUM, is up $54 billion or 9% to a record $674 billion. 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 billion or 50% to a record $144 billion. 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, it's 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 4- or 5-star rating. And as shown on Slide 5, 86% of Principal mutual funds; exchange-traded funds, or ETFs; separate accounts and collective investment trusts, or CITs, were above median for the 5-year performance, 72% above median for 3-year performance and 80% above median for 1-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 $2.3 billion of net cash flow, its 38th consecutive positive quarter, including record flows in Hong Kong and Southeast Asia. And RIS delivered $1 billion of positive net cash flow. RIS flow rebounded nicely from fourth quarter softness despite $1 billion of outflow 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 $1.5 billion 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 billion, representing different investment-grade credit mandates awarded to us over multiple time periods. And to be transparent, there's another $3 billion in the same investment-grade strategy at risk of leaving in the next year. That said, we continue to manage another $6 billion 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 $1.5 billion of positive flows over the last 3 years in 7 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 doubling 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 billion and $2 billion milestones in 2017, our ETF franchise surpassed $3 billion in the first quarter of 2018, placing us in 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 and driving retirement readiness. Our digital efforts are being recognized with the top 5 ranking on DALBAR's Mobile InSIGHT report in 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 in 2017 to offer mutual funds on the Ant Financial platform, Alibaba's payment affiliate. As of mid-April, we surpassed 2 key milestones: $6 billion of AUM and 3 million 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 0.5 billion platform users.

As one final distribution highlight, our recent acquisition of MetLife's Afore 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 million to investors through our share buybacks and common stock dividends, and we committed more than $80 million to M&A activities.

Before closing, a 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, Ethisphere Institute named Principal as one of the world's most ethical companies, 1 of just 5 companies in financial services to make the list. Forbes named Principal as one of America's Best Employers for Diversity, ranking sixth out of 250 companies recognized. Lastly, for the 17th time, the National Association of Female Executives named Principal one of the top companies for executive women. We're 1 of just 10 companies in its hall of fame, reflecting our longstanding 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?

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 million, an increase of 14% from the prior year quarter. Non-GAAP operating earnings were a record $409 million in first quarter or a record $1.40 per diluted share, an increase 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 21%, 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 2018 was $10 million pretax of lower-than-expected encaje performance in Principal International. As a reminder, first quarter 2017 significant variances included a total of $23 million 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&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 2016.

The U.S. 10-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 million 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 million. 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 remained compelling with a very robust sales pipeline.

As shown on Slide 6, RIS-Fees pretax operating earnings were $131 million, 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 million to $25 million 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 were 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 8. PGI's pretax operating earnings increased 10% from the prior year period to $110 million, reflecting an 8% growth in management fees and disciplined expense management, partially offset by investment in the business. At $42 million, 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 million to $210 million for the full year.

Our estimated risk-based capital ratio remains above our targeted range of 415 to 425 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 million of contingent capital funding arrangements, split between 10- and 30-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 & Poor's recently upgraded our senior unsecured debt ratings from BBB+ to A-. S&P noted increased access to unregulated dividends from changes in our legal structure.

As shown on Slide 12, we deployed $410 million of capital during the quarter, including $179 million in share repurchases and $147 million in common stock dividends. We also committed $84 million to 2 planned transactions during the quarter, to increase our ownership to 60% in our asset management joint ventures with CIMB 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 million to $8 million in the second quarter that will negatively impact PI's pretax margin and pretax operating earnings.

On April 16, we closed our acquisition of Internos, which expands our global real estate capabilities. Internos 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 million to $1.3 billion of capital in 2018. Importantly, we continue to deliver sustainable profitable growth. Excluding the impacts from actuarial reviews, over the last 5 years, we've delivered an 11% compounded annual growth rate and 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.

(Operator Instructions) Your first question comes from Jimmy Bhullar of JPMorgan.

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.

No, no, no. Please go ahead. Finish your second question, Jimmy.

So the other question was on share buybacks. 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?

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 Q. 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 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, the deployment of capital, good organic growth, nice acquisitions, all tuck-ins, so we feel like, again, we've got a really balanced approach to capital deployment. With that, I'll throw it to Jim to hit on your PGI fee income question.

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 27% 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 at all a disappointing first quarter, and it's well aligned with what we've said in the past in guidance.

Is that helpful, Jimmy?

Okay. Yes. 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 reform 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?

I think you might have squeezed in 3 and 4 questions there. But 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?

Yes. To your question 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, I will say. They always set a working group that has been 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 kind of the outcome that we might have. Only possible factor that might be raised, what will be the discussion is when the new bill is going to have 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 Cuprum, essentially, the result of our gains and productivity and efficiency that allows us to transfer that benefit to our customers. We continue keeping our value proposition there to our clients in customer service, financial advice and investment performance. So we're going to continue -- be in 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 -- that is a -- it's a very thoughtful fee adjustment in Chile.

And that was part of your guidance? It was part of your guidance, the fee adjustment?

Yes, sir. Yes, sir. We are expecting that this fee reduction is not going to impact our margins neither in Chile nor PI.

Your next question comes from Humphrey Lee of Dowling & Partners.

Just questions 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 million on a pretax basis. So you talked about, you have accelerated some of the digital investments in the fourth quarter and then there's going to be 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 on top of it, 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.

Yes. Humphrey, so thank you for that. I'm going to -- 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 with -- as you know, 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, let me throw it to Deanna.

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 the first quarter of '17, 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 first quarter of '17 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 '18 versus first quarter '17, our comp out there 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 did 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 outlook 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 RIS-Fee.

Yes. So Deanna's covered very well both RIS-Fee 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, really 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 a 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 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.

Thanks, Nora. Humphrey, did you have a follow-up?

Yes, I do. So kind of shifting gears 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 that have been 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 the inflows versus the outflows and kind of how we should think about the fee rates improvement as an underlying earnings driver as opposed to AUM growth in PGI.

Yes. Very much depends on those asset classes, and I think there's a good story there. Jim?

Yes. No, 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. I know what -- 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.

Your next question comes from Erik Bass with Autonomous Research.

I guess, to start, maybe just follow up on Humphrey's questions just on the revenue picture for PGI and, obviously, the fee pressures you've mentioned in institutional and the actions you're taking to deal with those. I mean, are those all contemplated in the kind of 4% to 8% revenue target for 2018 and the 5% to 8% long-term growth outlook? So do you think those targets are still achievable?

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 8%.

Yes. The industry's 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.

Got it. And then maybe moving to RIS-Fee. If you could just talk about the impact of equity markets on your margins there. 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?

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 or as -- on a daily basis, and we saw that was roughly up 5% -- well, 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?

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.

Did you have a follow-up?

No, that's helpful. So just sort of the midpoint is where that 8% would fall out?

Right, exactly.

Your next question comes from John Barnidge of Sandler O'Neill.

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?

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. 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 let me throw it to Amy for some additional comments.

Sure. 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 12-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.

Nora, some additional comments?

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 the positives happen with job and wage growth, we see it coming in through that fundamental growth in our business, which lifts all boats.

Jim, I think you have some perspective here.

Yes. John, just to comment from the economics point of view, we've been looking for the last 2 or 3 years at the aggregate data for our customers, our small, mid-sized business customers, and I would tell you very much aligned with your question. About a year or 2 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: rescaling, upscaling, labor shortage. I think it also shows a very good proved statement on the fundamental strengths of the small and mid-sized growing business segment.

Yes. And 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 nonqualified 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?

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?

Sure. Thank you so much. Nora?

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 billion to $25 billion of opportunity this year. And certainly, in our pipeline, we see that opportunity. So we're -- last year, we had record sales of $2.8 billion. 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 million to $500 million 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 lost policyholder. 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.

Your next question comes from Ryan Krueger of KBW.

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?

Yes. Jim, please?

Yes. The direct number is dominated by the point that Dan made about being 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 with institution. And as you know, we have very broad-ranged 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 are pinned to 0 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 really in the near term doesn't look like a big problem. But longer term, we have to be wary about our 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.

So Ryan, the comment in the -- my comments earlier were roughly $3 billion. And again, we don't think there's a lot outside of that and to a hedging strategy. Hopefully, that's helpful.

It is. And then other question was, can you give some more color on Southeast Asia flows that picked up materially and what's driving that?

It really did, and we're really excited about that. Luis, you want to provide some additional insights?

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 million in Thailand, in particular, 3 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 very consistent about what we have been planning in Southeast Asia and very consistent with our plans for 2018, in fact.

Your next question comes from John Nadel of UBS.

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 -- it is still kind of wide. So if I think about -- what are the external 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?

Sure. Happy to take the first shot at that and then throw it to Deanna. That $900 million to $1.3 billion 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 can 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, would it make 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. And 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?

Yes. I think Dan hinted on, I think the dividend piece is probably pretty easy for you to estimate. And the 2 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&A and share buyback. Obviously, share 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, first quarter is a great start relative to that, but those would be the 2 of the items that would tend to cause us to be at different places within that range.

John, do you have a follow-up?

Yes, I do. I'm curious, I was thinking about the group insurance business and going back to the days where tax reform was sort 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 it just a little bit too soon?

What's your take on that, Amy?

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 1-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, the other thing I would mention is there's obviously 2 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 are 2 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've got to make sure we're understanding both of those impacts not just the effective tax rate change.

Your next question comes from Suneet Kamath of Citi.

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 2?

Yes, it's a good question. Nora, you got those specifics?

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?

It was the comparison of the new business versus before and that we could follow up if you don't have that information.

Sure. Yes, we can follow up with specifics. But directionally, because of their 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 option. So we'll get you the specifics on that.

Yes. Suneet, just as a franchise, if we look at, for example, as a representative, a sampling 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 these CITs that are being manufactured by PGI have become sort of 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&P 500 simply being available on the platform because those target date strategies are going to capture anywhere from 1/3 to 1/2 of those flows into the plans in the first place. So hopefully, that's helpful.

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 401(k) at different employer sizes. And when I look across at some of your competitors, there seems to be a blend of 401(k), 457, 403(b). 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?

Real good question. Nora, you want to take that one?

Yes. Actually, Suneet, we are quite active in the 403(b) 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 that is not part of our strategy. But we certainly -- if you think about our Total Retirement Suite, both with the DB and the nonqual as well, for a tax-exempt organization, we bring the entire suite to them. So we are a meaningful player in you can call it the 403(b) space. But it's actually the tax-exempt market where we bring 403(b) as one of the tools, but in addition to that, bring the DB, the nonqual, et cetera. As far as the 457 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.

Just a couple -- just a quick pile on there for just a couple of moments. The 457 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 other 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, retain talent with really state-of-the-art solutions. And that may not be quite as recognized by the buyers in the 457. And that 403(b) 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?

No, that's fine.

Your final question comes from Tom Gallagher of Evercore.

First one for Jim. Just on flows for PGI, I know you've highlighted the $3 billion 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 billion 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, do you think -- how do you see that looking over the next few quarters?

Please go ahead, Jim.

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, if you think longer term, some of them with promote structures are multiyear carriers, which definitely builds up the value of the business for the longer term. So in 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 40 Act, ETFs, CITs, UCITS and SMA and others had a very substantial, very sturdy $4 billion unchanged last year of inflows and remained 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 hedged markets, we have things like real estate debt, we have high yields, we have REITs, we have income buyer 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.

Tom, did you have a follow-up?

Yes. So I guess, my follow-up is for Nora. Can you talk a bit about fee compression in 401(k)? I guess, your revenue yield was down a little bit this quarter. But how do you see -- I think every 1Q, you see a little bit of that, and I presume maybe that's just simple repricing. And I know -- I think there's a fewer -- 1 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?

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 -- of repricing 1/1 around our investment portfolio, so that sequential drop was fewer days but also some repricing. But to your broader question, and we talked about this before, we certainly -- and this is industry, not just Principal, but there's been a longstanding 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'll be more. Sometimes it'll 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 is 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 of the business, 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, et cetera, that is extremely strong and that is what's going to drive the growth of this business.

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

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 and integrated and diversified approach to serving the needs of the customer 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 you.

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, May 4, 2018. 4782916 is the access code for the replay. The number to dial in for the replay is (855) 859-2056 for U.S. and Canadian callers or (404) 537-3406 for international callers. This concludes today's conference call. You may now disconnect.