I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.
Thank you. 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 1st, 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. 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. Risk 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 measure may be found in our earnings release, financial supplement, and slide presentation. 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 continued 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 a 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, 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 four or five-star rating. As shown on slide five, 86% of Principal mutual funds, exchange traded funds, or ETFs, separate accounts, and Collective Investment Trusts, or CITs, were above median for the five-year performance, 72% above median for three-year performance, and 80% above median for one-year performance.
Moving to net cash flows, we were pleased with the first quarter results for Principal International and Retirement and Income Solutions. PI delivered $2.3 billion of net cash flow, its 38th consecutive positive quarter, including record flows in Hong Kong and Southeast Asia. RIS delivered $1 billion of positive net cash flow. RIS flows rebounded nicely from fourth quarter softness despite $1 billion of outflows from the loss of a single client, as we discussed on the fourth quarter call. Despite these positive results, total company net cash flow was a negative $1.5 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. 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 in 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.
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 three years in seven of our boutiques. We continue to see strong interest in our specialty solution and alternative investment capabilities as we help clients diversify, build wealth, generate income, protect against downside risk, and address inflation. Assets in these mandates tend to be smaller, but with higher fees.
Consistent with previous discussions, the divergence between asset growth and revenue growth is increasing. A 2017 Boston Consulting Group report projects that passive AUM will grow faster than any other product type through 2021. They also project that 90% of industry revenue growth over this period will come from alternatives, active specialties and solutions. This is where we compete and excel. Distribution and product development remains heavily focused on income and other outcomes-based solutions, real estate and other alternative investments, and our international retail platform to capitalize on emerging markets experiencing strong wealth creation. The build-out of our ETF and CIT platforms is providing lower-cost investment options to compete with pure passive options and complement our more traditional active mutual fund strategies.
As communicated last quarter, PGI is gaining traction with its Dublin platform, as well as its SMA, CIT, and ETF platforms, helping to offset some of the institutional pressure. I'll now share some key execution highlights, starting with our investment platform. In the 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 in driving retirement readiness.
Our digital efforts are being recognized with a top five 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. We continue to advance our multi-channel, multi-product 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 mid-year in 2017 to offer mutual funds on the Ant Financial platform, Alibaba's payment affiliate. As of mid-April, we surpassed two key milestones, $6 billion of AUM and three million customers.
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 half-billion platform users. 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%. 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. A quick update on the DOL Fiduciary Rule.
You know, on March 15th, 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 named Principal as one of the world's most ethical companies, one of just five companies in financial services to make the list. Forbes named Principal as one of America's Best Employers for Diversity, ranking sixth out of 250 companies recognized. Lastly, for the 17th time, the National Association for Female Executives named Principal one of the top companies for executive women. We're one of just 10 companies in its Hall of Fame, reflecting our 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%-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 pre-tax 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 prospective, 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 pre-tax. 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.
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 pre-tax operating earnings were in line with our expectations for the quarter. RIS Spread and Specialty Benefits pre-tax operating earnings were also in line with our expectations after taking into account the favorable mortality and morbidity experience. For RIS Spread, opportunities in the pension risk transfer business remain compelling with a very robust sales pipeline. As shown on slide six, RIS Fee's pre-tax 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 are up 9%, recurring deposits grew 7%, defined contribution plan count increased 2.5%, or almost 900 plans, and participant count increased 4% with over 190,000 new participants. Moving to Slide 8, PGI's pre-tax 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 pre-tax 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-$210 million for the full year. Our estimated risk-based capital ratio remains above our targeted range of 415-425 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-year 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 pre-tax 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 two plan 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 20th, 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-$8 million in the second quarter that will negatively impact PI's pre-tax margin and pre-tax operating earnings. On April 16th, 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 five years, we've delivered an 11% compounded annual growth rate in non-GAAP operating earnings, well within our long-term target of 9%-12%. This concludes our prepared remarks. Operator, please open the call for questions.
At this time, I would like to remind everyone that to ask a question, press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Jamminder Bhullar of JPMorgan.
Hi. Good morning. 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. Just wanted to see if you had any comments on that. Secondly Go ahead, actually.
No, please go ahead and finish your second question, Jimmy.
The other question was on share buybacks. I think you ended up buying back more stock this quarter than you have on a quarterly basis in the last several years. 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? 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?
Let me pick up on your second question first, I'll throw it to Jim to weigh in on the PGI fee income. Like you would expect, Jimmy, we always look at all the options on how we go about deploying our capital and where we stand with potential acquisitions in the queue. 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. There's still some remaining for the second and third quarter, obviously, that we have to complete that. 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.
Again, the dividend having increased, good deployment of capital, good organic growth, nice acquisitions, all tuck-ins. 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 income question. Jim?
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%-23% of the year comes in the first quarter, and 27%-28% comes in the fourth quarter. 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.
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, you didn't go into that. If anyone wants me to, I can. 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. Yeah, maybe one more. I'm not sure if Luis is on the call. It seems like the environment in the Chilean business has gotten a little bit better with the election and talk of drastic pension reform subsiding. Is that your view as well? 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 that you gave us?
I think you might have squeezed in three and four questions there.
Yeah.
Luis is here. They're relevant questions, and certainly prepared to respond. As you point out, Chile is rebounding, and we remain optimistic, Luis?
Yes. Good morning, Jimmy. A few questions about Chile and the pension reform, which is pending. Since March 11, we have a new administration there. We value the birth and the death of its new cabinet. Good names, very professional, very technical. The discussion is heading in the right direction, I would say. They already set a working group that is being created with very good names as well. Very, I would say, professional people, very dedicated. Good intentions in this discussion. We are very optimistic about the kind of outcome that we might have. Only possible factor that might derail a little bit this discussion is when the new bill is going to have the Congress. The current administration doesn't have majority in both chambers, probably a kind of negotiation might happen there. We have to pay a lot of attention.
Extremely involved in that process, Jimmy. We're paying a lot of attention about that. As you have said, a positive and better environment in order to have this discussion in Chile. About the fee reduction in Cuprum, essentially is the result of our gains in productivity and efficiency that allows us to transfer that benefit to our customers. We continue keeping our value proposition there to our clients and customer service, financial advice, and investment performance. We're going to continue being a very competitive fee there. As you said, this new fee rate is going to be in place in July 1st. Certainly, you can take that bet it's a very thoughtful fee adjustment in Chile.
Thanks for your question, Jimmy.
That was part of your guidance? The fee adjustment?
Yes, sir.
Okay.
We are expecting that this fee reduction is not going to impact our margins, neither in Chile nor for PI.
Thank you.
Very good. Thank you.
Your next question comes from Humphrey Lee of Dowling & Partners.
Good morning, and thank you for taking my questions. Just a question related to expenses, especially in RIS fees. I understand the digital initiative is supposed to pose a 2% earnings impact in 2018 on a pre-tax reform basis. I would assume that's probably closer to $50 million on a pre-tax basis. You talked about you have accelerated some of the digital investments in the fourth quarter, then there's some ongoing expenses in the first quarter. I was just trying to figure out where do you stand in terms of these investments in RIS fees? On top of it, there seems to be some moving pieces in the expenses line in this quarter. I was just wondering if you can provide some additional color in terms of where do you think the expenses will be for the rest of the year?
Yeah, Humphrey. Thank you for that. The broad comment I'm going to make before throwing it to Deanna is that we're actually incredibly enthusiastic about these investments in digital. We're getting some traction. We're seeing it materialize here. We started in the fourth quarter, we're well into it in the first quarter here, we're starting to see progress made, I'm frankly very excited about that. 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, then Nora could add a few comments specifically to RIS Fee. 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 and expenses to our growth in revenue. 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.
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 2017, we did state that expenses were light in that quarter, primarily due to timing. This quarter, as you mentioned, our total expenses do include the impact of those digital investments. Given that, you would have expected this quarter to see a slightly higher increase in expenses, again, due to low in first quarter of 2017 and the additional investments this quarter. I tend to look at growth and expenses and revenue over a longer time period. Even if you just look at first quarter 2018 versus first quarter 2017, our comp and other was up 4.9%.
That's in line with our net revenue growth on a reported basis. 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 pre-tax operating earnings growth about 2%. 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.
I think bottom line, it feels like our expenses in the first quarter align with what we've talked about in the past. I'll pivot to Nora to see if she has any additional comments specific to RIS Fee.
Deanna's covered very well, both RIS Fee and at the PFG level, so I won't repeat that. 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. 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. Really excited about that for the long haul. In addition to that, we've really lifted our game around our marketing and marketing spend. Those things are investments back in the business.
They give us the confidence that we're going to continue to have a leading franchise here with regard to both top line and bottom line growth.
Thanks, Nora. Humphrey, did you have a follow-up?
Yeah, I do. Shifting gear to PGI a little bit. When I'm actually looking at the management fee less pass through, looking at the year-over-year basis, it's definitely showing some improvement as well as on a quarter-over-quarter basis. I suspect that's because some of the mix shifts going on within PGI. 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 how we should think about the fee rate improvement as an underlying earnings driver as opposed to AUM growth in PGI.
Yeah. Very much depends on those asset classes, and I think there's a good story there, Jim.
Yeah. No, thank you, Humphrey. 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, they are seeing declining revenue. That's really being hit very hard by the demand for lower pricing. As you know, that's not the area we're primarily in. We're in active specialties, alternatives, and multi-asset class solutions, those are where we feel confident about revenue growth. It's interesting, I know it's in the back of people's minds, 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. 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. 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. 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.
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.
Humphrey, thanks for your questions.
Your next question comes from Erik Bass of Autonomous Research.
Hi, thank you. I guess to start, maybe just follow up on Humphrey's question, just on the revenue picture for PGI, and obviously the fee pressures you've mentioned at institutional and the actions you're taking to deal with those. I mean, are those all contemplated in the kind of 4%-8% revenue target for 2018 and the 5%-8% long-term growth outlook? Do you think those targets are still achievable?
We actually do.
Yeah.
We think they're still well within those range. We don't reaffirm, I would say that we anticipate these things in advance and feel comfortable with that 4%-8%.
Yeah. 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. Thank you. Maybe moving to RIS, if you could just talk about the impact of equity markets on your margins there, I know you commented specifically on the DAC, I think, in the prepared remarks. Should we think about the midpoint of the 30%-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. This was kind of a wild quarter because of the ride to think that, again, the way we get compensated on the revenues are as on a daily basis, and we saw that was roughly up 5%. While if you looked at the point to point, it was a -1%, which does have an impact on the DAC line. I think the assumptions that you're using are spot on. Nora, would you like to add to that at all?
Yeah. If you look at our fee revenue line, the vast majority of that fee is based on account value, clearly, given our portfolio, we're going to lift and fall based on the equity markets. 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. Just sort of the midpoint is where that 8% would fall out.
Right. Exactly.
Okay. Perfect. Thank you.
Thank you.
Your next question comes from John Barnidge of Sandler O'Neill.
Thank you. There had 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?
Yeah. Maybe I'll have both Amy and Nora weigh in on that. 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. What I would say is I, again, think we start from a very credible place from a wage base. We've always tried to maintain that positioning, and it's true with our benefits, it's true with our wages, and it's true in trying to create the right environment. What's probably changed the most for us is the need to go out and recruit talent that tends to be at the higher end of the spectrum. More hiring of people with data scientist backgrounds, and some of our digital efforts will come with talent that has a higher wage.
If that's impacting Principal, I have to believe other firms are running into that same sort of situation. With that, let me throw it to Amy for some additional comments.
Sure. Hi, John. Let me give you a couple perspectives on this. First perspective is, I think we have said before, we're still seeing it happen, there's employment growth that is particularly pronounced and positive in the small market. 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. Very healthy metric, 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, we see small employers asking us about interesting new benefits more than they have even in the past. 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. 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. Certainly, we're benefiting from those, from the job and the wage growth in RESB 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. 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 a comment from the economics point of view. We've been looking for the last two or three years at the aggregate data for our customers, our small mid-size business customers. I would tell you, very much aligned with your question, about a year or two ago, we saw the wage rates in that area going up faster than the economy as a whole. I think that shows partly the phenomenon you're talking about reskilling, upskilling, labor shortage. I think it also shows a very good proof statement on the fundamental strength of the small and mid-size growing business segment.
Yeah. Last comment, John, before, see if you have a follow-up. When I think about Amy's business around the Business Owner Executive Solutions and non-qualified deferred compensation, again, an area where it was disrupted by tax reform. It actually has been disrupted in a positive way, and we're seeing nice growth there, too. 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? Thank you very much for your answers.
Thank you so much. Nora?
Sure. 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-$25 billion of opportunity this year. Certainly in our pipeline, we see that opportunity. 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-$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 policy holders. From that perspective, we'll continue to monitor expectations, from that perspective, we're highly confident that we have both the reserve in place and the process in place.
Thanks, Nora.
Great. Thank you.
Our next question comes from Ryan Krueger of KBW.
Hi. Thanks. Good morning. First question was, can you give a sense for how much AUM you have in these currency-affected fixed income strategies with lower basis point yields at this point?
Yeah. Jim, please.
Yeah. The direct number is dominated by the point that Dan made about having a few billion still with the client that we lost money for in the first quarter. I think that's in terms of what we really know just about the extent of it. What you don't know is how attitudes to currency hedging can evolve at institutions. As you know, we have very broad range clients in 85 countries. Some of those countries will definitely see rising or indeed falling hedging costs. The problem has been that yen and euro interest rates are pinned to zero at the same time as the U.S. rate is rising. That's really the differential that determines the hedging cost.
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 of that where foreign investors 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. I think there are natural tensions that will stop the interest rates getting massively out of line. I don't feel particularly concerned about that beyond the large client that Dan referred to in the script.
Ryan, yeah. The comment in my comments earlier were roughly $3 billion. Again, we don't think there's a lot outside of that peg to a hedging strategy. Hopefully, that's helpful.
It is. Thanks. Other question was, can you give some more color on Southeast Asia flows that picked up materially and what's driving that?
That 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, three different mandates. We're very pleased about that. Certainly, a very strong activity in Malaysia. That is 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.
Thank you, Ryan.
Great. Thanks.
Your next question comes from John Nadel of UBS.
Hey, good morning, everybody. I have a couple of questions. The first one, Dan or Deanna- The total capital deployment range for this year, I know it's not really that different from prior years, but the range is still kind of wide. If I think about it, 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 Strable. That $900 million-$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. Again, in that pension risk transfer business, you can use up additional capital.
I would say that in the area of acquisitions, again, when it makes sense and it's accretive and we can be opportunistic around capabilities and scale, we want to go after that. That's probably the largest variable here. Of course, as we all know, the one way we can fill in at the end is relative to share buyback if the opportunity is there and it really fits with our internal model. I think it's purposely a bit wide to give us a bit more flexibility for making good decisions. Deanna Strable, additional thoughts?
Yeah, I think Dan Houston hit it on. I think, the dividend piece is probably pretty easy for you to estimate. The two that would tend to be more volatile, and could end up different than maybe what we thought at the beginning of the year, would be around M&A and share buyback. Obviously, share buyback is going to be dependent, as we've said, on other deployment opportunities as well as valuation. 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. Those would be the two of the items that would tend to cause us to be at different places within that range.
John, do you have a follow-up?
Yeah, I do. Thank you for the answers to that. I'm curious, thinking about the group insurance business and going back to the days where tax reform was sort of first discussed or floated, I think Principal was probably one of the first to actually say pretty specifically, that there was an expectation that that would pass 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?
Yeah, it's a little bit too soon.
Yeah.
Really why I think I'm so comfortable kind of talking about this unique to Principal is because when you look at our group benefits business, so much of the business we have is on a one-year rate guarantee. 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. I think their answers can be accurate, but again, it's given their own block. A little bit early, but again, we have a high percentage of our block that is annually renewable.
Deanna.
John, the other thing I would mention is there's obviously two impacts on pricing relative to tax reform. I think the one that you're focused on is obviously the lowering of the effective tax rate and group benefits and PGI are likely our two businesses within the complex that benefited the most from that. 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. Really, as we think about pricing, we need to take into account both of those. I still agree with Amy's comment that for group benefits, this is probably likely a net positive. We got to make sure we're understanding both of those impacts, not just the effective tax rate change.
Thanks for your question, John.
Yeah, very much appreciate that. Thank you.
Very good.
Your next question comes from Suneet Kamath of Citi.
Thanks. Good morning. Just on RIS, can you give us a sense of what % of the account value is in passive options at this point, and then how that compares to kind of the new deposits that you're getting? Is there a big difference between those two?
Yeah, it's a good question. Nora, do you have those specifics?
Yeah. I don't have the specifics. Generally, we have a meaningful portion of that portfolio that has always been in passive. As we have flows into our CIT hybrid, the percentage of passive will go up on a relative basis. What was your second question, Suneet?
It was the comparison of the new business versus the old-
New business
We can follow up if you don't have that information.
Sure. Yeah, we can follow up with specifics, 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 options. We'll get you the specifics on that.
Yes, Suneet, just as a franchise, if we were to look at, for example, as a representative sampling of Principal Global Investors, about 85% of the assets under management are active, 15% are passive. If you looked at the revenues, it's 97% of the revenues coming from the active, 3% coming from the passive. I think maybe to reorient your question just a little bit, and Nora touched on 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. As you know from our performance numbers, they're very competitive in the marketplace.
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 a third to half of those flows into the plans in the first place. Hopefully that's helpful.
Yeah, no, it is. Then I guess my second question might be a little bit strategic. As I think about your RISP business, it's I think almost entirely 401 at different employer sizes. When I look across at some of your competitors, there seems to be a blend of 401, 457, 403. 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?
Yeah. Actually, Suneet, we are quite active in the 403 market, the tax-exempt market. It's a priority for us from a strategic perspective. We play in that space, in particular in the employer-sponsored plans, versus the legacy chassis around an individual annuity model. That is not part of our strategy. We certainly, if you think about our total retirement suite, both with a DB and a non-qual as well, for a tax-exempt organization, we bring the entire suite to them. We are a meaningful player, and you can call it the 403 space, but it's actually the tax-exempt market where we bring 403 as one of the tools, but in addition to that, bring the DB, the non-qual, 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.
For sure, we're in the tax-exempt market in a meaningful way.
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 low bid gets the deal. I'm not talking about investment options there. I'm talking about all the other record-keeping services. If you think about how we've oriented our investments around digital, the customer experience, it's to really try to help employers attract and retain talent with really state-of-the-art solutions. That may not be quite as recognized by the buyers in the 457. That 403 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 all right. Thanks.
Thank you.
Your final question comes from Thomas Gallagher of Evercore.
Good morning. First one for Jim, just on flows for PGI. I know you've highlighted the $3 billion currency overlay mandate being at risk. 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 just because we haven't really seen that level of net outflows at PGI before. Do you think we've hit a high water mark there? I realize some of those are low fee, but just from an absolute standpoint, how do you see that looking over the next few quarters?
Please go ahead, Jim.
Yeah. 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. Incidentally, if you think longer term, some of them with promote structures or multi-year carries, which definitely builds up the value of the business for the longer term. On that piece, I feel really confident. I think we're positioned very effectively. I think that the performance should make us confident on our retail platforms. Our retail platforms last year, between 40 Act ETFs, CITs, UCITS, and SMA and others, had a very substantial, very steady, $4 billion and change last year of inflows, and remained positive in the first quarter. That's sort of building up business by gradual flows, and I feel very good about that.
I don't want to 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. I take some comfort from the fact that even in those hedged markets, we have things like real estate debt, we have high yield, we have REITs. We have income-biased strategies which have a high enough expected return to absorb the current hedging costs or even any likely hedging costs. I feel cautiously optimistic, but I don't want to promise you that this is going to be our only bad quarter for flows.
Okay.
Tom, do you have a follow-up?
Thanks, Dan. I guess my follow-up's 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. I think every 1Q, you see a little bit of that, and I presume maybe that's just simple repricing. I think that's one less fee day in the quarter. 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. 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. That's number 1. Number 2, to your point on the sequential, we definitely saw the impact of some repricing 1/1 around our investment portfolio. That sequential drop was fewer days, but also some repricing. To your broader question, we've talked about this before, we certainly, and this is industry, not just Principal, but there's been a long-standing trend where we expect to see this gap between account value growth and revenue growth, we've generally talked 4%-8%. Sometimes it'll be more, sometimes it'll be less. Quarter-to-quarter can be noisy because of revenue timing.
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. There are no surprises here to us with regard to the results. The underlying growth of the business, extremely strong. 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.
Okay, thanks.
Thanks, Tom. Thank you. Appreciate your question.
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, an integrated and diversified approach to this, serving the needs of the customer, is still the right model. Strong investment performance. We're frankly in the asset classes that are going to be in high demand. 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. We'll continue to differentiate for our customers in delivering long shareholder value, and look forward to seeing many of you on the road here in the next few months. Thank you.