Principal Financial Group Inc

NASDAQ:PFG

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, and welcome to the Principal Financial Group Second Quarter 2018 Financial Results Conference Call. [Operator Instructions]. I would now like to turn the conference over to John Egan, Vice President of Investor Relations.

[John Egan, VP, IR]

Thank you, and good morning. Welcome to Principal Financial Group's second quarter conference call. As always, 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; Amy Friedrich, U.S. Insurance Solutions; and Dennis Menken, our Chief Investment Officer for Principal Life Insurance Company.

Some of the comments made during the 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. Reconciliation of the non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures may 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 two upcoming events. We're hosting an investor event in Tokyo, Japan, the morning of Friday, September 28, highlighting our global asset management and retirement strategies and opportunities for growth in Asia. Our 2018 Investor Day will be held on Thursday, November 15 in New York City. Our leadership team will discuss future opportunities in our businesses as well as details on our accelerated investments in digital and the expected impacts to our businesses. Additional details to follow. Dan?

[Daniel Houston, Chairman, CEO & President]

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 up with details on our financial results and capital deployment.

In the second quarter, we delivered $391 million of non-GAAP operating earnings, bringing non-GAAP operating earnings to $800 million through 6 months. This was an increase of 6% compared to the first half of 2017. While we're benefiting from the underlying growth of our businesses and U.S. tax reform, growth year-to-date has been muted by several items, including lower variable investment income, our accelerated investment in digital business strategies, unfavorable macroeconomic conditions and transaction and integration costs associated with our recent acquisitions.

As I reflect on the first half of the year and overall, we continue to demonstrate strong business fundamentals, balanced investments in our businesses with expense discipline and be good stewards of shareholder capital. Most importantly, we continue to execute our customer-focused solutions-oriented strategy to help people achieve financial security and success. On a trailing 12-month basis, non-GAAP operating earnings exceeded $1.5 billion, demonstrating our continued strength and leadership in retirement and long-term savings, group benefits and protection in the U.S., 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 $37 billion or 6% to $667 billion. The effect of foreign exchange rates reduced AUM by $10 billion during the period, primarily driven by weakening of the Brazilian real against the U.S. dollar. AUM growth has also been dampened by recent market performance. In addition, we've increased AUM in our joint venture in China, which is not included in the reported AUM, by $59 billion or 61% over the trailing 12 months to a record $155 billion. This strong growth underscores the magnitude of the opportunity in China and the value of our long-term relationship with China Construction Bank.

Our AUM provides a solid foundation for future revenue and earnings growth, and it highlights the diversification of our asset management franchise by investor type, asset class and geography and strong integration across our businesses. We again received the multiple best fund awards during the quarter, including recognition in China, Hong Kong, India, Indonesia and Malaysia. And CCB-Principal Asset Management was recognized by Ant Financial, winning their best investor education content award.

We also continue to deliver very strong investment performance. At midyear, for the Morningstar-rated funds, 63% of the fund-level AUM had a 4- or 5-star rating. And as shown on Slide 5, 86% of the Principal actively managed mutual funds, exchange-traded funds, separate accounts and collective investment trusts were above median for the 5-year performance, 70% above the median for the three-year performance and 83% above median for the one-year performance.

Moving to total company net cash flows at $2.3 billion in the second quarter, we were pleased with the sequential rebound. RIS delivered $2.2 billion of positive net cash flow in the second quarter on strong sales and retention for both fee and spread, bringing 6 months flows to $3.2 billion for the segment.

PI delivered $1.4 billion of net cash flow in the second quarter, its 39th consecutive positive quarter and $3.7 billion through 6 months despite relative softness in Brazil. As context, pension deposits in Brazil were down nearly 30% across the industry through May, reflecting meaningful changes to Brazil's investment landscape as well as current political and economic uncertainty. We anticipate continued pressure on flows. But long term, we remain optimistic about the pension and savings market in Brazil and confident in our joint venture's ongoing ability to capture leading market share.

Flows from our joint venture in China, which are not in the reported net cash flow, continued to be strong at $12 billion in the second quarter and $27 billion through six months.

In terms of assets sourced by Principal Global Investors, however, we had negative net cash flow of $1.4 billion in the second quarter. This result does not include the $3 billion investment-grade credit strategies that we described to be at risk during the first quarter call. Consistent with the industry, PGI's net cash flow has now been under pressure for several quarters. In recent quarters, we've seen demand for lower-cost investment options become even more pronounced. That said, we'll continue to see strong interest in our active investment capabilities as we help institutional and retail clients diversify, build wealth, generate income, protect against downside risk and address inflation. From an institutional perspective, these mandates tend to be smaller in terms of assets but with higher revenue rates. In response to growing demand, distribution and product development remain 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; further, the build-out of our ETF and CIT platforms, creating lower cost investments to compete with pure passive options and complement our active mutual fund strategies.

I'll now share some key execution highlights, starting with our investment platform. In the second quarter, we launched 8 new funds in Asia and Latin America, responding to increasing retail and institutional demand for multi-asset and income-generating solutions. 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. We also launched the Principal Investment Grade Corporate Active ETF during the quarter, adding to our suite of income-oriented solutions on our U.S. platform. At $3.4 billion of AUM at midyear, we now rank 24th on the ETF League Tables.

During the quarter, we entered into a partnership with MUFG Union Bank to launch a lending platform focused on originating loans and securitizing them in CMBS deals, with Principal acting as a primary loan servicer and MUFG providing warehouse line funding.

Turning to our recent acquisitions in mid-April. We closed acquisition of Internos, also known today as Principal Real Estate Europe, adding significant European real estate investment capabilities. This will allow us to offer investment solutions across key European jurisdictions and expand our leadership in the key asset class. This transaction has been favorably received by both the consultant and client communities. Principal now manages or sub-advises more than $80 billion of real estate assets globally.

In late May, we closed on a transaction for our Southeast Asia joint ventures with CIMB that increased our ownership to 60%. Also, at the end of May, we announced plans to acquire a majority stake in RobustWealth, and the acquisition closed in early July. The transaction is the culmination of an 18-month relationship and a major development expanding and enhancing our digital capabilities. RobustWealth brings a suite of solutions for investment advisors, including a digital advice platform, goal-based investment tools and efficient client onboarding.

In addition to serving advisors, we plan to leverage the RobustWealth platform in a number of ways to better serve existing and former retirement plan participants needing innovative IRA rollover solutions to enhance our managed account offering with a more technology-enabled and personalized solution as an additional avenue for investment product and asset allocation model delivery and to advance digital sales across the suite of Principal investment and protection products.

We look forward to sharing more details as we continue to enhance our digital solutions that reduce barriers to action and eliminate pain points for our customers and advisors.

Moving to distribution. We continue to advance our multichannel, multiproduct approach. We earned two dozen total placements during the quarter, getting more than a dozen different funds on 14 different third-party platforms with success across asset classes. As you may recall, in June of 2017, CCB-Principal Asset Management, our joint venture with China Construction Bank, was selected to offer mutual funds on the Ant Financial platform. As of midyear, we had more than $6 billion in AUM and 3 million investors on this platform. As another important platform development in China, CCB-Principal Asset Management was selected to offer mutual funds on the Tencent platform this quarter. While the revenue and the operating earnings impact from these platforms is currently modest, we expect them to become more meaningful over time. Importantly, combined, these platforms provide our joint venture exposure to millions of users.

While Deanna will cover this in more detail, I also want to say how pleased I am with our capital deployment through midyear. In addition to our ongoing investment in organic growth and our accelerated investment in digital business solutions, we returned $671 million to investors through share buybacks and common stock dividends and committed $130 million to acquisitions.

Before closing, I'll share 2 pieces of recognition for the quarter. In May, Forbes Magazine named Principal as one of America's best employers, ranking us fourth out of 500 large companies recognized. And earlier this week, we earned the top spot on the Forbes first-ever list of America's Best Employers for Women, reflecting our commitment to equality, flexibility and women's advancement. Along with first quarter recognition for our commitment to diversity, inclusion and ethical behavior, this speaks volumes about our culture and why we'll be successful long term.

Second quarter was a period of continued progress, helping customers and clients achieve financial success. Despite some macroeconomic pressures, I look for us to continue to build on the momentum in the second half of 2018 and for that momentum to translate into long-term value for our shareholders and each of our stakeholders. Deanna?

[Deanna Strable, EVP & CFO]

Thanks, Dan. Good morning, and thanks for participating on our call. Today, I'll discuss key contributors to our second quarter financial results, and I'll provide an update on capital deployment. Net income attributable to Principal was $457 million for second quarter 2018. This included net realized capital gains of $65 million, reflecting $100 million after-tax gains from the sale of a minority stake in a benefits administration technology provider. We had an opportunity to monetize our investment as the company was looking to expand and recapitalize.

Non-GAAP operating earnings were $391 million in the second quarter or $1.35 per diluted share, a 3% increase over the prior year quarter. Year-over-year earnings growth was suppressed by volatile macroeconomic conditions and our accelerated investment in digital but benefited from strong underlying business fundamentals and tax reform.

Our non-GAAP operating earnings effective tax rate was 19.4% for the second quarter, and we continue to expect the full year to be within our previously guided range of 18% to 21%.

ROE, excluding AOCI other than foreign currency translation adjustment, was 13.9% on a reported basis for the second quarter. Excluding the impact from the 2017 actuarial review, ROE was 14.3%, in line with the first quarter.

We had 3 significant variances during second quarter that negatively impacted reported non-GAAP pretax operating earnings by a total of $23 million. Impacts included $13 million of lower-than-expected variable investment income. Lower prepayment fees and real estate returns were partially offset by higher returns from alternatives. Impacts to the business units included $6 million in RIS-Fee, $4 million in RIS-Spread and $3 million in Specialty Benefits. Principal International had $6 million of lower-than-expected encaje performance and $4 million of integration costs from the Mexico Afore acquisition. This was lower than the $6 million to $8 million range we communicated on our first quarter call.

Excluding significant variances in both periods, total company non-GAAP operating earnings increased 4% on a pretax basis and nearly 8% on an after-tax basis over the year ago quarter.

Our accelerated investments in digital business strategy remains on track and in line with the impact communicated at last year's outlook call. We plan to provide additional details on our digital investments at our upcoming Investor Day on November 15.

Macroeconomic conditions were mixed but created a net headwind during second quarter 2018, with volatile equity market performance, including a 1% decline in the S&P 500 daily average. This negatively impacted our U.S. fee-based businesses despite a point-to-point increase in the S&P 500 during the quarter. And a weakening of certain currencies against the U.S. dollar, primarily in Brazil, negatively impacted Principal International by about $4 million compared to first quarter 2018.

When we made the strategic decision to expand into emerging markets over 20 years ago, we knew that attractive growth came with additional volatility. Fluctuations in foreign currency, global equity markets, inflation and interest rates as well as political uncertainty can cause volatility quarter-to-quarter. We'll continue to execute our strategy, and we remain confident in our growth prospects in these countries.

Despite the macroeconomic noise during the quarter, our businesses continued to demonstrate strong fundamentals. In RIS-Fee, recurring deposits increased 11% from the prior year period and 7% on a trailing 12-month basis, very strong results reflecting employment growth, increased deferral rates and double-digit growth in employer matches.

In group benefits, on a trailing 12-month basis, in group growth, or lives covered and existing cases, increased a record 1.8%. This has a positive impact on both premiums and pretax operating earnings. And this metric is even stronger when we look at it for our target market of small- to medium-sized businesses. We provide products to help business owners protect their business, transition ownership and save for retirement. Our Individual Life business market sales increased from a year ago and represented 65% of total sales in the quarter, another reflection of the increasing strength and confidence of small- to medium-sized business owners. Positive employment and participant trends are contributing to strong underlying growth across our U.S. businesses.

Turning to the key drivers for the businesses. On a trailing 12-month basis and excluding the impacts of the annual assumption review, the revenue growth and margins for PGI, Specialty Benefits and Individual Life are all within the 2018 guided ranges. It's important to note that the significant variances caused by variable investment income were $86 million lower in second quarter 2018 on a trailing 12-month basis compared to the year ago quarter. We don't typically exclude variable investment income when looking at trailing 12-month metrics as it tends to even out over longer periods of time. However, this variance is certainly impacting the current trailing 12-month revenue and pretax operating earnings growth rates in RIS and U.S. Insurance Solutions.

While margins in both RIS-Fee and RIS-Spread were within our guided ranges, net revenue growth in both businesses was below the guided ranges. This is due to lower variable investment income as well as spread compression in RIS-Spread.

Excluding the impacts of the annual assumption review and encaje performance, Principal International's pretax return on combined net revenue was below our guided range, primarily due to headwinds from macroeconomic factors. PI's net revenue growth remains within our guided range.

In my following comments on business unit results for the quarter, I'll exclude the significant variances we've called out in both periods in my comparisons. Pretax operating earnings for RIS-Fee, Principal Global Investors, Specialty Benefits, Individual Life and Corporate were all in line with or exceeded our expectations for second quarter. Principal International's pretax operating earnings were also in line, excluding the impact of foreign currency translation.

As shown on Slide 7, RIS-Spread pretax operating earnings of $85 million were slightly below our expectations. While we had $1.5 billion of fixed annuity sales in the quarter, pension risk transfer sales and MTN issuance have been light in the first half of the year. We continue to view these businesses as opportunistic and remain disciplined in our pricing. Lower-than-expected variable investment income as well as the timing and level of sales throughout the year is anticipated to cause RIS-Spread full year 2018 net revenue growth to be at/or below the low end of our guided range. That said, we expect an increase in pension risk transfer sales in the second half of the year and believe full year sales will meet or exceed 2017 sales of $2.8 billion.

Moving to capital deployment on Slide 12. We deployed $391 million of capital during the second quarter, including $196 million in share repurchases, $149 million in common stock dividends, $46 million on announced M&A and increased ownership in a PGI boutique. This brings our year-to-date capital deployment to $801 million. We expect full year deployment will be at the high end of our $900 million to $1.3 billion range.

As we evaluate our capital deployment options, we currently find share repurchases to be a compelling opportunity. The $375 million we deployed through share repurchases in the first half of the year was almost twice as much as all of 2017. Last night, we announced a $0.53 common stock dividend payable in the third quarter, the 10th consecutive increase in our dividend. This is a $0.01 increase from the second quarter 2018 dividend and a 13% increase from the prior year period. We continue to target a 40% dividend payout ratio. And going forward, our dividend growth will be more aligned with the rate of net income growth.

M&A is important in supplementing organic growth and has contributed to our above-industry earnings growth over the long term. We recently closed on 4 acquisitions. The Mexico Afore acquisition integration is complete and going better than expected. We estimate $0.02 of additional EPS for the full year 2018. Our increased stake in Southeast Asia through our joint venture with CIMB is also expected to produce immediate returns, contributing $0.01 to $0.02 of EPS accretion in 2018. And Principal Real Estate Europe, formerly Internos, is also expected to be accretive to earnings in the second half of 2018. RobustWealth, our most recent acquisition, is expected to be slightly dilutive for the next several quarters as we continue to expand our investment in the business. Given the benefits across the entire organization, RobustWealth will be reported in corporate. Even with this impact, we expect corporate operating losses will be within the previously guided range of $190 million to $210 million for 2018.

Our estimated risk-based capital ratio remains well above our targeted range of 415% to 425%, which puts us in a very strong position to absorb the NAIC's change to the RBC formula to reflect tax reform. We continue to estimate a negative 40 to 50 percentage point impact to our ratio from this change.

As we start the second half of 2018, our capital and liquidity position is the strongest it's ever been. We ended the second quarter with over $1 billion at the holding company, nearly $450 million of capital in excess of a 420% RBC ratio and more than $350 million of available cash in our subsidiaries. In addition, a low leverage ratio and no debt maturities until 2022 gives us financial flexibility.

We are excited about our prospects as we enter the second half of 2018 and remain confident that our diversified business model and ongoing investments position us well for the future.

Operator, please open the call for questions.

[Operator]

[Operator Instructions]. The first question will come from Alex Scott with Goldman Sachs.

[Taylor Scott, Goldman Sachs Group]

First question I have is just on the digital investment. When I think about the RobustWealth acquisition, I mean, how much of it is related to sort of synergies with investment that you are planning to make? And should we think about that sort of reducing the amount of acceleration in the investment? Or is there still a lot of investment to kind of do on the back of making that acquisition?

[Daniel Houston, Chairman, CEO & President]

Yes. Thanks, Alex. This is Dan. I'll take that. The bottom line is we consider this acquisition separate and apart from our previously discussed digital investment. This really is about acquiring an entity that not only brings a nice professional staff of technologists, but they come with an investment background. That's their orientation. And there's a lot of work to be done on this digital platform for digital advice. There's also a lot of upside -- we work with a lot of independent advisors to look for these kinds of solutions to be their back office, so in other words, white labeling an asset allocation solution for them. So it's really quite additive to the other six initiatives that we've talked about relative to our investment in digital. Is that helpful?

[Taylor Scott, Goldman Sachs Group]

Yes, it is. And then another question, it's a bit unrelated. I guess, just this retirement bill that's being considered in Congress that could make some changes to, I guess, tax incentives and 401(k) as well as, I think, motivate group annuities. I mean, is there any color you can provide on what you're seeing and hearing there and how you think that would sort of impact your business?

[Daniel Houston, Chairman, CEO & President]

Yes, the Retirement Enhancement Security Act and better known as RESA. I have had an opportunity to spend a fair amount of time on Capitol Hill talking about this. You can forget how frequent we actually do have legislation that tries to promote retirement savings. I would say for the most part, we find this one to be a comprehensive bill that is additive and net positive for the industry. And with that, let me ask Nora to go ahead and add some additional detail.

[Nora Everett, President, Retirement & Income Solutions]

Sure. So there's a couple of things happening. You probably also heard about tax 2.0 that the House Ways and Means Committee Chair Brady released, I think, within the last couple of days, yes, on July 24. So in combination -- and what Brady is -- there's a speculation that Brady will actually take RESA, that bill, and potentially attack the 2 together. We are certainly proponents of RESA. You're talking about open MEPs that would help address coverage gaps. You're talking about a safe harbor for in-plan annuity options, to your point. There's a lot of opportunity with that particular piece of legislation to both address some of the coverage gap but obviously also positive to our business and our business model, so very much in favor of moving that piece of legislation forward. Tax 2.0 is interesting. So what Brady is outlining, and it's just an outline at this point, is a new savings vehicle called universal savings account. And that would be an individual account with after-tax dollars potentially up to $5,500 investment tax-free with less restriction around withdrawals. And the interesting thing about that account is, from our perspective, we want to make sure if this legislation moves forward, that there's a good balance between continuing to incent long-term savings and obviously addressing some of the, what I call, a rainy day fund issue. So we are absolutely in favor of anything that's going to enhance that long-term savings piece of the equation and certainly a proponent for addressing the coverage gap.

[Operator]

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

[Humphrey Lee, Dowling & Partners Securities]

A question for Deanna. You talked about on the capital deployment side you expect to be towards the high end of your guided range. If I think about the $800 million year-to-date, plus probably another $300 million of dividends in the second half, that would put you at $1.1 billion. So for that remaining $200 million, how should we think about the balance between share repurchases and potential additional M&A opportunities?

[Daniel Houston, Chairman, CEO & President]

Deanna, please?

[Deanna Strable, EVP & CFO]

Yes. Thanks, Humphrey, for the question. Obviously, I think we'll continue to have a very balanced and disciplined approach from capital deployment. And you pointed out, we've done that thus far this year, with the added amount really going to share buyback, really, given the attractive, compelling opportunity there with the current stock price. The first thing I would say is that $1.3 billion is not a hard cap. As we've -- if you go back over last 5 to 7 years, you've seen times we've been within our guided range and other times where we've been above that guided range. And so we'll continue to look at opportunities, evaluate them relative to each other. We do sit in here today have a $200 million board authorization remaining. So share buyback will be part of what we'll consider as we go forward, in addition to those M&A pipeline as well. As we've specifically think about share buyback, really we look at that opportunistically. It's based on valuation of the stock. It's based on our capital position at the time. And it's also, as mentioned, very much dependent on other deployment opportunities. And so all of those are somewhat hard to predict for the remainder of the year. But again, we feel good that we'll be at/or above the high end of that range, and we'll continue to be very balanced and disciplined in our approach.

[Daniel Houston, Chairman, CEO & President]

Humphrey, do you have a follow-up?

[Humphrey Lee, Dowling & Partners Securities]

Yes. So in terms of RIS-Fee, I think in your prepared remarks, the recurring deposit is definitely a good story there. You talked about there's greater deferral and then also greater matching. But I was just wondering if you can share that a little more, can you talk about some of the dynamics that's happening within the recurring deposits in RIS-Fee?

[Daniel Houston, Chairman, CEO & President]

Yes, I'd be happy to do that. Just at a very high level, you're right, this 11%, 12% increase in reoccurring deposits is really helping. I think it gives you an indication just how strong the overall economy is. This is pay increases. This is larger bonuses, profit sharing. So American workers are certainly benefiting from the economy growing, which is very positive for our business. But Nora do you want to add some additional color?

[Nora Everett, President, Retirement & Income Solutions]

Sure. So to your question, there are multiple factors that are feeding in, and Dan's identified some of them. Certainly, a big factor is we continue to grow the number of plans we work with. We continue to grow the number of participants we work with, the number of participants with account values. So you've got the macro piece and you also have the fundamental business piece where we continue to grow the business. I would focus on the trailing 12-month as well because quarter-to-quarter, you're going to see some noise, whether that's ESOP, whether that's defined benefit. But even that trailing 12-month growth number at 7% is a really healthy trailing 12 months over trailing 12 months. So we look forward, we see these accelerants with regard to the number of plans, the number of participants, the economics around both wage growth and the fact that folks are increasing their deferrals and their employees are increasing their match, so a lot of positive momentum with those underlying fundamentals.

[Daniel Houston, Chairman, CEO & President]

Just one other thing I'll add there, Humphrey. If look back at kind of the low point of what the average deferral, it was kind of in the mid-6%. Now it's north of 8%. And that percentage difference is quite significant when you think about just overall deposits coming into these plans. So I think the message around increasing your savings commitment to retirement is important and it's out there, and we're seeing it in our stats. So thanks for your questions.

[Operator]

The next question will come from John Barnidge with Sandler O'Neill.

[John Barnidge, Sandler O'Neill + Partners]

I know you've talked quite a lot about -- at length about how outflows seen in PGI were lower fee generating and some of the flows coming in were higher fee generating. And then fees as a percent of AUM in 2Q '18 was its highest level since 4Q '16, so it seems like that's happening. Can you expound a little bit more about what you're seeing from the fee level side from new assets in PGI and maybe a little bit on your outlook for flows?

[Daniel Houston, Chairman, CEO & President]

Yes. So it's a great question. I'll just look to Jim to respond accordingly, John.

[James McCaughan]

Yes. Thank you, John. In terms of the pipeline, we see a lot of assets in the specialties we've talked about in the past, whether it's real estate; high yield; small cap; emerging markets, both debt and equity, although those are out of favor at the moment but still in the pipeline because institutions will often buy out-of-favor assets. So in other words, our pipeline is very much added-value products, which our clients seek for higher return. And that's really the explanation of your point about our basis points fees creeping up over time. We're seeing in the industry what I'd describe it as a decoupling between flows and revenues. Firms that have very big inflows maybe doing it for almost nothing, and therefore, not so much growing revenues. We're at the other end of it.

And so our flows may have suffered, but the revenues continue to grow. A year ago, at the equivalent call, I said I was much more confident for the near future about revenue growth than I was about flows. It has worked out that way. Having said all that, I think there are signs that we're maybe on a bit of a better patch here. First point -- first number I would point to is global institutional distribution, where our sales in the first half were $8.2 billion, which is up 35% on the year before. That reflects the build we've made and the enhancements we've made in global institutional distribution. And I think that's well aligned with the strong performing and specialty capabilities we have. So in institutional, I feel pretty positive around the sales. Of course, as you know, there were reasons for outflows over the last 12 months.

There were funds that were started for a fixed term. There were the performance issues two years ago at Columbus Circle. And there was the increased cost of hedging that was causing, particularly Japanese and European clients, at the margin to withdraw. You still see the first and last of those to some extent, but I do expect that we'll be in a much better position since the worst appears to be over in those sort of high level impacts on our flows. Columbus Circle, I spent some time there earlier this week, and I'm hopeful we'll be growing by 2019. The performance has come around very strongly. So if I add it all up, I'm pretty confident that the institutional flows can improve. On retail, something we did, which I think was only important as a good fiduciary, is a soft close on our very well-recognized mid-cap and SMid income strategies. We did that bringing on stream some other attractive products where our retail flows have been low. I have to say on the second quarter, we had an outflow on the 40 Act funds of about $850 million. That was a result of those attractive products picking up a bit slower than we wanted. And the soft close obviously is to conserve capacity and continue doing a good job for our existing customers. So the answer really is to try and sum it up, we're confident in the pipeline we're seeing. We think the strong performances of most of our strategies give us a lot to work with. But there are factors somewhat beyond our control that could make the flows a bit lumpy. But I do believe that this quarter was pretty representative of some good efforts by the team.

[Daniel Houston, Chairman, CEO & President]

John, do you have a follow-up?

[John Barnidge, Sandler O'Neill + Partners]

I've taken enough time with that question.

[Operator]

The next question will come from Jimmy Bhullar with JPMorgan.

[Jamminder Bhullar, JPMorgan Chase & Co.]

First, just had a question for Jim on PGI flows. And if you could give us any mandates -- any update on the Japan mandates that you think might be at risk and what the assets associated with those mandates are?

[Daniel Houston, Chairman, CEO & President]

Sure. Jim, please?

[James McCaughan]

Yes. On the Japan mandate we talked about at the last quarter's call as being at risk, it's at risk because of increased hedging costs. The hedging cost has gone from perhaps 50 basis points when the mandate started to well over 200 basis points. And when you're an investment grade, that's not enough to cover the spread. That mandate has not gone. It remains at risk for economic reasons, though the client relationship is very strong. We're working with that client and other Japanese clients on different ways to manage money. I wouldn't want to make a judgment as to whether our next flows in Japan will be positive or negative, but there is still a risk from the heightened cost of hedging.

[Jamminder Bhullar, JPMorgan Chase & Co.]

And what's the amount associated with that? I think you had mentioned maybe $3 billion to $4 billion or something in that range before?

[James McCaughan]

Yes. The remaining investment-grade hedge piece is $3 billion.

[Jamminder Bhullar, JPMorgan Chase & Co.]

Okay. And then if Luis is there, if he could talk about just the environment in Brazil. It seems like the entire sort of pension industry is troubling there. And what needs to happen for that to improve?

[Daniel Houston, Chairman, CEO & President]

Just a quick comment before Luis gets into that, Jimmy. I mentioned in my prepared comments -- we've had a lot of conversations around Europe for a long time. We identify emerging markets as a place that you want to do business. You have to accept a lot of the conditions that are in place, one of which, of course, is typically more politically volatile, although I say that somewhat hesitantly with the backdrop here in the U.S. and some of our policies. Secondly and perhaps more importantly, it's just the volatility in the local economic markets, whether you're measuring currency, you're measure economic output. But I think Luis and his team have just done an outstanding job identifying the right markets for us to be in. Brazil certainly falls under that category. I couldn't feel more confident about that management team's ability to manage their way through this rough patch in Brazil. But with that, I'll turn it over to Luis to answer your question very specifically.

[Luis Valdés, President, Principal International, Inc.]

Okay. Thanks, Dan. Jimmy, let me first start saying that we certainly remain optimistic on Brazil and its economic recovery. And also, the second quarter slowed down or a speed bump that we have, we think that is effectively behind us today. With that, let me say that because of the economic downturn that Brazil has had, the entire industry -- the pension industry has seen a 30% decrease in their deposit year-to-date. Despite of that, Brasilprev has generated net customer cash flows of $4.6 billion in a TTM basis, which is a very commendable 7% over beginning of a period AUM. So we continue performing extremely well. You have to remember that probably 3 years ago, we have 50% of the total net customer cash flows of that industry. Certainly, we were first mover. We were very aggressive. And we have plenty of conveyors there, so we do have today more than 20% of that market share, which is very commendable as well. I will say that if you're looking at our net customer cash flows and its evolution in Page #18 of our supplement, you will see that our withdrawals, they really performed very stable. It's pretty much more the softness in new deposits that's driving down a little bit our net customer cash flows, even having -- so that's $300 million positive for the second quarter, having that sort of a hiccup in the economy in Brazil is very commendable. So a very strong business, a very resilient strategy, and certainly, we do have a great company there.

[Jamminder Bhullar, JPMorgan Chase & Co.]

Just a question on the group benefits business. Your results have been consistently better than expected there and, I think, overall, generally better than competitors' results as well. So what is that you feel is helping you, especially on the margin side? And then also, is your outlook now for the business a little more upbeat than it would have been maybe 6 months or a year ago?

[Daniel Houston, Chairman, CEO & President]

I suspect Amy might say it's all about leadership. But we'll see what her actual answer is. Amy?

[Amy Friedrich, President, United States Insurance Solutions]

Sure, thanks for the question. I think the way you kind of asked the question is that the results have been better than expected. And I guess, what I'd just give you some insight into is when we really made the commitment years ago to dig deep into the small- to medium-sized business market, we expected results like this. So our technology investments that we've been making, the investments that we've -- and tools we've put in the hands of the brokers and advisors who serve this market and then the great products that we're building behind it, things like the great dental network, sitting with great dental and vision products, have really started to pay off. And again, when we do business in one piece of business or 100 pieces of business that are employer who have 40 lives or 50 lives or 60 lives of people that they provide these benefits to, you sometimes don't make the headlines. But what I would say is we feel very strongly this is the right market to be in. Small business owners need and value our help. They reward you with loyalty. And it means that some of the things that you run into in the larger case market with price pressures simply aren't present in the small case marketplace. So we feel very good about our competitive position in that marketplace, and we feel good that our outlook, to the extent we've given you outlook on this business, is still appropriate. We certainly revisit that on an annual basis, and so you'll hear more from us on that.

[Operator]

The next question is from Erik Bass with Autonomous Research.

[Erik Bass, Autonomous Research]

I was actually hoping Luis might be able to speak a little bit more broadly about the international business outside of just Brazil. And just as we see some of the macro and political noise, where are you seeing or which markets are most exposed to kind of disruption in emerging markets? And how are you seeing the underlying growth dynamics in other countries?

[Daniel Houston, Chairman, CEO & President]

It's a good question, Erik, and I appreciate that. Just a quick comment. I was actually in China just last week visiting with a lot of senior government officials and, of course, our very close friends at China Construction Bank, of which we, as you know, have an open MOU as we continue to explore expanding that relationship. And I would tell you that in spite of a lot of the rhetoric that we're hearing about in terms of trade, and it is a topic of discussion, I don't believe that those issues are standing in our way of advancing our relationships in Southeast Asia or Latin America for that matter. But with that, I'll turn it over to Luis.

[Luis Valdés, President, Principal International, Inc.]

Okay. Thanks, Erik, for your question. And let me start giving you a fact that probably is going to help you in order to have a better picture about our countries in emerging markets. If you're putting Brazil aside and its currency, and if you're looking what has been the volatility for all our currencies, the relationship and correlation with the euro is almost 1. So the volatility, in particular, for FX is a global thing and theme. It's not just related to the emerging market. Even if you're looking at the correlation with the Malaysian ringgit or the Chilean peso, it's almost 1. So it's very, very correlated. So that's number one. Number two, certainly, we have had some additional volatility and some kind of global and geopolitical issues that are under discussion. But if you're looking at our portfolio and how our portfolio has evolved in the last 3 to 4 years, we're in much better shape than we were three years ago.

So we're less exposed to countries like Brazil, and we have a much more balanced portfolio than we used to have. If you're looking at our portfolio in terms of net customer cash flows, we have generated TTM, in the last 12 months, $8.3 billion in net customer cash flows from $6.7 billion a year ago. So that is a 24% increase in our net customer cash flows TTM in the last period. And if you're looking to the supplement, a very important part of that net customer cash flows are coming from our subsidiaries in Asia. So having said that, I would say that in terms of volatility, we're very much more well prepared in order to weather any particular situation going forward. Our portfolio is much more well diversified. Our production is much more well diversified and operating earnings. In particular, the country that is being the outlier has been Brazil. But as I said before, we remain confident. We're going to have some volatility going forward. We are facing presidential elections on October 7. August is going to be a very interesting month to pay attention to because the presidential candidates are going to be defined. So more to come, Erik.

[Daniel Houston, Chairman, CEO & President]

Erik, did you have a follow-up?

[Erik Bass, Autonomous Research]

Yes. Just a follow-up for Jim on the institutional pipeline. And some comments we've heard from other asset managers is that there's been a slowdown in the funding of some institutional mandates given moves in interest rates and spreads, particularly around things like core fixed income or high yield. Just curious if that's a dynamic that you're seeing at all.

[Daniel Houston, Chairman, CEO & President]

You have some color, Jim?

[James McCaughan]

Yes. Not really, Erik. If you look at institutional mandates, there are always some of them were they say, great news, you've got the fund, and the money funds 12 months later. That can happen. But I don't see that really changed a lot. That may be a function of some of the specialty asset classes we're in. So that's an excuse I wouldn't make.

[Operator]

The next question will come from Ryan Krueger with KBW.

[Ryan Krueger, KBW]

Maybe a follow-up, Dan. You've made a comment about progress on the China MOU. I guess, what are your thoughts on potential timing of that happening? And then how should we think about, if that does happen, I guess, the capital that you'd potentially put into that new structure?

[Daniel Houston, Chairman, CEO & President]

Yes. So good question. The first thing I would say is these things, as you know, are very difficult to predict. There's a lot of people that have to make decisions, including regulators, when you have a foreign buyer coming in to take a minority share. We have had a very healthy dialogue with the appropriate government officials who would ultimately have to approve our purchasing a piece of an existing retirement company that is owned by China Construction Bank. We've had very healthy dialogues at the most senior levels of the bank. We've also had those same conversations within the subsidiary company that manage these assets.

The MOU, as you know, is already underway in terms of already exploring the use of our technology, the capabilities and expertise that we can bring to the table. But I'd like to think that sometime in the next sort of 6 to 9 months, we can bring resolution. In terms of capital, that's an item that has not been completely quantified at this point in time. It's a manageable number. We would have a minority stake. And as those details become more clear, we'll be sure and share those with you. But again, I don't look at it as a -- in a magnitude of our balance sheet as being a disruptive sort of number to gain access to the retirement market. In terms of its impact, once we do buy in, it's a little bit like all these other businesses that Luis and Jim have built over the years, which is it doesn't happen the first couple of years, but you find that will -- flying as time goes on and generating strong profits down the road. So again, we want to be there. We can see the economic upside of doing so and feel good about our chances of getting there.

[Ryan Krueger, KBW]

That's great. And then on the RBC ratio, once the tax reform impact comes due, do you anticipate changing your 415% to 425% target?

[Daniel Houston, Chairman, CEO & President]

Yes. Let me ask Deanna to make a quick comment there.

[Deanna Strable, EVP & CFO]

Yes. Ryan, good question. That's something we're going to probably continue to evaluate. What I would say here, and I've mentioned it before, we feel in a really strong position relative to our ability to absorb that change and still have a risk-based capital that is at a level that we feel very good about. So we're sitting here today above our targeted range. We've estimated the impact to be about 45 percentage points. And when you put those 2 together, I'm confident we will still have a risk-based capital range that will be at/or just slightly below our current target. And then what we'll do is continue to watch the industry, watch our competitors and obviously react to rating agency reaction and evaluate whether that 415% to 425% remains a good target going forward.

[Operator]

The next question will come from John Nadel with UBS.

[John Nadel, UBS Investment Bank]

I guess, I didn't quite realize that variable investment income on a trailing 12-month basis was that much below your target. I think you had mentioned $86 million. Although that may just be $86 million lower than the prior trailing 12 months, which I don't know if that was elevated. So can you just give us a sense, how do things compare to a normalized level? Like what is that normalized level? It does appear that it's affecting revenue comps.

[Daniel Houston, Chairman, CEO & President]

Yes. Thanks, John. Deanna?

[Deanna Strable, EVP & CFO]

Yes. The $86 million that I referred to on my prepared remarks or what you heard earlier today is not the shortfall in the current trailing month period. It's really comparing the fact that we had pretty positive impacts that we called out in the prior trailing 12. And so the delta between the 2 is $86 million. How we go about that is going into a year, obviously, we've embedded into our guidance a certain amount of variable investment income. And a portion -- and some of that is just hard to predict. And so what we'll call out in a given quarter, some of it is hard to predict, some of it is lumpy quarter-to-quarter, and we'll be consistent both on the plus end and the negative end, calling out when the current quarter is different than what we've expected. I'd say that the positives that we saw in the trailing 12-month period, we saw some good prepays during that period. We also saw some good benefits from real estate. I'd say if you look at the more recent quarters, prepays have become much more difficult and real estate has just been lumpy quarter-to-quarter. And so again, hopefully, that gives you a little bit of color on that. If you want to go into more detail, we can do that offline. But it does, as you mentioned, have some impacts on the OE -- reported OE and revenue growth quarter-to-quarter.

[John Nadel, UBS Investment Bank]

Okay, that's very helpful. And then just a follow-up to Jim on the fee rate in Principal Global. Was there any impact in this current quarter, 2Q, from performance fees? Because I'm with John Barnidge on the -- it really did jump. And I recognize what you've been saying for a while is coming through in terms of the shift, the sort of barbell approach year, but it seems pretty significant in a single period of time.

[Daniel Houston, Chairman, CEO & President]

Yes. Yes, please, Jim, go ahead.

[James McCaughan]

To quantify that, John, performance fees in the second quarter totaled $6.8 million. Typically, 1/3 to 1/2 of performance fees come through to profits. So there was a boost but not a very large one. The comment I'd make on performance fees is, as you know, 2017 and the first half of 2018 have been much lower than the previous 2 years in performance fees. We had some really good harvesting of performance fees on real estate in the earlier couple of years, in 2015, 2016. I think long term, the average of performance fees will be somewhere between the heightened experience of the previous two years and the rather meager experience of the last 1.5 years. The reason I say it'll be a little lower is absolute return prospects and investments are going to be constrained by relatively low interest rates. But as you know, having said that, hope you -- I hope it's helpful to give you the exact quantification of performance fees. And I think that long term, they're going to be a material contributor even if not in every quarter to the way we show our results.

[Operator]

The final question is from Suneet Kamath with Citi.

[Suneet Kamath, Citigroup]

Just want to ask on the competitive environment. I mean, when we look at the RIS-Fee business and we calculate the fee rate, it looks like that continues to come down. And I know there's different ways to calculate it, and your internal view may be different than what we're seeing externally. So I was just wondering if you could comment a little bit on what you're seeing in terms of competition on the fee side. And has there been any progress or momentum on the side of your charging fees based on headcount as opposed to AUM in the small case market?

[Daniel Houston, Chairman, CEO & President]

Sure, and I'll let Nora jump right into this. But if I could, just kind of at a macro level, Suneet, something to think about here is the fact that this has always been a competitive space for as long as I can remember. We actually are a bit unique in that we've got quite a different mix between small, medium and large, all of which generate different revenue flows. We've also been fortunate over the years to have a disproportionate larger percentage of the assets go to proprietary investment options. And as we migrate towards more open architecture, there is pressure there. But having said all of that, the sales organization and Nora and her team have done a really good job meeting the needs of the marketplace, while at the same time, maintaining really good margins, and at the same time, making huge investments in the business. So Nora, do you want to go and add to that, please?

[Nora Everett, President, Retirement & Income Solutions]

Sure. So Suneet, we've talked about this before. And this quarter, it actually was masked a little bit by the lower net investment income. But if you look even quarter-over-quarter, our fee revenue growth is up 4%, up $12.7 million. And that is actually as expected, and we've talked about this before. We look at -- and this is an industry trend as well, as you look at that average account value going up and relate that to revenue growth, you're going to see, we all are going to see that gap. It's a longstanding industry trend.

We tend to see it between 4% and 8%, the gap between average account value growth and revenue growth. Sometimes it's going to be more. Sometimes it's going to be less. It's noisy quarter-over-quarter, so we take a longer-term view. But certainly, all the things you mentioned are captured in that gap. There is -- and to Dan's point, it has been competitive for many, many years. And within that gap, not only you're going to see competitive pricing, but you're going to see product mix changes, you're going to see investment lineup changes. So all of that is captured.

So certainly, no new news here. What I like to refocus on is just how important that makes that underlying fundamental growth around plan growth, participant growth, account value growth, winning our fair share and oftentimes more with regard to this very, very successful retirement investment platform that we have, especially in that target date suite, just very significant success there in our ability as we move through that suite. Today, our CIT hybrid, that combination of active and passive is still very successful. So that combination of the work that Jim and his team are doing from an asset management perspective and my team is doing from a distribution and service perspective continues to resonate in the market, and we continue to win more than our fair share.

[Daniel Houston, Chairman, CEO & President]

Thanks, Nora. Suneet, did you have a real quick follow-up?

[Suneet Kamath, Citigroup]

Yes. Just wanted to quickly follow up on PRT. We have been hearing from some other companies that maybe pricing there is getting more competitive. Just want to get a sense of what you're seeing. It sounds like you're optimistic about growth on the back half of the year.

[Daniel Houston, Chairman, CEO & President]

Yes. It is a good question. And maybe just because we're out of time here, I'll take this one real quickly. And the fact of the matter is this has been a sweet spot for us for a long time. We tend to play at the smaller to medium-sized end of the spectrum. We view the business as being very optimistic. We're very disciplined at how we go about the pension risk transfer business. Although the first half of the year was a little bit light here, we anticipate making it up in the second half of the year. We like it. It's core to our strategy. And again, of all things I worry about, that's frankly just not one of them. So thank you for the questions, Suneet.

[Operator]

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

[Daniel Houston, Chairman, CEO & President]

Yes. Just to be very brief here, my quick observations are the following, and that is it was a -- from our perspective, a good quarter and a very good half to the first start of the year. We have taken a very balanced approach with capital deployment. You heard Deanna specifically frame the acquisitions that we have made and that they are accretive, which we feel good about. Also, I want to reemphasize, we're going to continue to invest in this business. For long-term shareholder value, we must continue to make those investments. And the fact that -- and I thought Luis and Jim did a really nice job here covering the emerging markets. By their very nature, they're going to be volatile. But we need to be there, where there's a lot of upside growth for shareholders.

Just as a reminder to what John had shared at the beginning of the conversation, we are going to have an investor meeting in Tokyo on September 28. We'd love to have you join us and also again in November 15 in New York City. So again, thank you for your interest in the company, and look forward to seeing you on the road here in the next few months. Thank you.

[Operator]

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 3, 2018. 8249939 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. You may now disconnect.