closer look

A Deeper Look: Principal Financial Group

closer look

Despite a recent rise in popularity of passive investing, active management continues to hold the largest share of U.S. mutual fund assets. But a common saying in the industry is that such investments are sold rather than bought, a sad acknowledgement that too often sales hype trumps an evidence-based approach to analyzing fund performance. 

As part of IFA's ongoing series breaking down how active managers at major fund complexes are actually doing compared to their indexes, we've put through our microscope Principal Financial Group. 

The publicly traded provider of retirement savings as well as investment and insurance products is based in Des Moines, Iowa. As of the latest reported quarter, it had nearly $674 billion in assets under management and approximately 20 million customers. It employs about 10,000 in the U.S. and operates in four business segments: Retirement and Income Solutions; Principal Global Investors; Principal International and United States Insurance Solutions. The company receives maximum revenue in the form of premiums. 

Many investors are familiar with Principal through their company sponsored retirement plans. They are ranked as the ninth-largest recordkeeper of defined contribution assets in the U.S. and provide a variety of third-party administration, investment management and fiduciary related services to a wide range of different sized plans.

Principal, however, has recently been caught up in litigation involving complaints by participants in two workplace retirement plans. A trio of investors are charging that target-date funds from Principal Global used by 401(k) plans offered through Starkey Laboratories and Fleetcor Technologies feature underperforming and overpriced investments.

As Bloomberg news reports, this isn't the first time a Principal unit has been taken to court by plan investors. The Principal Financial Life Insurance Co. agreed in 2015 to a multimillion dollar payment to settle claims that it "breached fiduciary duties by exclusively investing in proprietary products and causing its retirement plan to pay excessive fees for those investments," according to the news agency.

Aside from concerns raised by participants surrounding the retirement plan side of the business, we are also going to examine some of the issues involving Principal's investment products sold in other distribution channels.

As mentioned above, we've taken a deeper look at the performance of several other mutual fund companies in the past. One universal conclusion: they have failed to deliver on the value proposition they profess, which is to reliably outperform a risk comparable benchmark.

You can review our past analysis by clicking any of the links below:

Fees & Expenses

Let's first examine the costs associated with Principal's surviving 69 strategies. It should go without saying that if investors are paying a premium for investment "expertise," then they should be receiving above average results consistently over time. The alternative would be to simply accept a market's return, less a significantly lower fee, via an index fund.

The costs we examine include expense ratios, front end (A), level (B) and deferred (C) loads, as well as 12b-1 fees. These are considered the "hard" costs that investors incur. Prospectuses, however, do not reflect the trading costs associated with mutual funds.

Commissions and market impact costs are real expenses associated with implementing a particular investment strategy and can vary depending on the frequency and size of the trades executed by portfolio managers.

We can estimate the costs associated with an investment strategy by looking at its annual turnover ratio. For example, a turnover ratio of 100% means that the portfolio manager turns over the entire portfolio in one year. This is considered an active approach and investors holding these funds in taxable accounts will likely incur a higher exposure to tax liabilities such as short- and long-term capital gains distributions than those incurred by passively managed funds.

The table below details the hard costs as well as the turnover ratio for all 69 surviving active funds offered by Principal that have at least three years of complete performance history. You can search this page for a symbol or name by using Control F in Windows or Command F on a Mac. Then click the link to see the Alpha Chart. Also, remember that this is what is considered an in-sample test; the next level of analysis is to do an out-of-sample test (for more information see here).

 

Name Ticker Turnover Ratio % Prospectus Net Expense Ratio 12b-1 Fee Deferred Load Max Front Load Global Broad Category Group
Principal Blue Chip Institutional PBCKX 27.1 0.69       Equity
Principal California Municipal A SRCMX 39.8 0.77 0.25   3.75 Tax Preferred
Principal Capital Appreciation A CMNWX 20.1 0.82 0.25   5.5 Equity
Principal Capital Securities S PCSFX 8.4 0.01       Fixed Income
Principal Core Plus Bond R5 PBMPX 128.3 0.71       Fixed Income
Principal Diversified Intl R5 PINPX 46.7 1.09       Equity
Principal Diversified Real Asset Instl PDRDX 65.1 0.86       Allocation
Principal Dynamic Fltng Rt Hi Inc Instl PDYIX 104 0.77       Fixed Income
Principal Equity Income A PQIAX 23.3 0.89 0.25   5.5 Equity
Principal Global Div Inc Instl PGDIX 120.1 0.75       Allocation
Principal Global Multi-Strategy Instl PSMIX 317.6 1.63       Alternative
Principal Global Opportunities Instl PGOIX 117.1 0.85       Equity
Principal Global Real Estate Sec Instl POSIX 67.3 0.94       Equity
Principal Government & High Qual Bd A CMPGX 22.6 0.88 0.25   2.25 Fixed Income
Principal High Yield A CPHYX 51.2 0.92 0.25   3.75 Fixed Income
Principal High Yield Fund I Inst PYHIX 104.8 0.67       Fixed Income
Principal Income A CMPIX 12.5 0.87 0.25   2.25 Fixed Income
Principal Inflation Protection J PIPJX 60.9 1.07 0.15 1   Fixed Income
Principal International I Inst PINIX 66.6 1       Equity
Principal International Small Company A PICAX 58.8 1.61 0.25   5.5 Equity
Principal Intl Emerging Markets R5 PEPSX 97.4 1.5       Equity
Principal Large Cap Growth R5 PDPPX 80 0.91       Equity
Principal Large Cap Value III Inst PLVIX 33.4 0.72       Equity
Principal LargeCap Growth I Instl PLGIX 38.5 0.64       Equity
Principal LargeCap Value R5 PLVPX 112.1 0.68       Equity
Principal LifeTime 2010 Institutional PTTIX 13 0.65       Allocation
Principal LifeTime 2015 Institutional LTINX 19.8 0.67       Allocation
Principal LifeTime 2020 Institutional PLWIX 14.2 0.7       Allocation
Principal LifeTime 2025 Institutional LTSTX 22 0.71       Allocation
Principal LifeTime 2030 Institutional PMTIX 20.9 0.72       Allocation
Principal LifeTime 2035 Institutional LTIUX 30.6 0.67       Allocation
Principal LifeTime 2040 Institutional PTDIX 26.6 0.69       Allocation
Principal LifeTime 2045 Institutional LTRIX 33.7 0.71       Allocation
Principal LifeTime 2050 Institutional PPLIX 29.6 0.71       Allocation
Principal LifeTime 2055 Institutional LTFIX 39.4 0.74       Allocation
Principal LifeTime 2060 Institutional PLTZX 34.2 0.75       Allocation
Principal LifeTime Hybrid 2015 Instl PHTMX 49.3 0.43       Allocation
Principal LifeTime Hybrid 2020 Instl PHTTX 20.6 0.44       Allocation
Principal LifeTime Hybrid 2025 Instl PHTQX 18.3 0.44       Allocation
Principal LifeTime Hybrid 2030 Instl PHTNX 20.5 0.45       Allocation
Principal LifeTime Hybrid 2035 Instl PHTJX 21.7 0.46       Allocation
Principal LifeTime Hybrid 2040 Instl PLTQX 21 0.46       Allocation
Principal LifeTime Hybrid 2045 Instl PHTYX 19.8 0.47       Allocation
Principal LifeTime Hybrid 2050 Instl PHTUX 18.3 0.47       Allocation
Principal LifeTime Hybrid 2055 Instl PLTNX 19.3 0.48       Allocation
Principal LifeTime Hybrid 2060 Instl PLTHX 50.3 0.48       Allocation
Principal LifeTime Hybrid Income Instl PHTFX 40.7 0.42       Allocation
Principal LifeTime Strategic Inc Instl PLSIX 18.2 0.62       Allocation
Principal MidCap Growth III R5 PPQPX 81.6 1.17       Equity
Principal MidCap Growth R5 PHPPX 128.5 0.93       Equity
Principal MidCap R5 PMBPX 15.4 0.85       Equity
Principal MidCap Value I Inst PVMIX 58.5 0.91       Equity
Principal MidCap Value III R5 PLPPX 80.8 0.9       Equity
Principal Opportunistic Municipal A PMOAX 67.9 0.89 0.25   3.75 Tax Preferred
Principal Overseas Instl PINZX 50.5 1.02       Equity
Principal Preferred Securities Inst PPSIX 16.1 0.77       Fixed Income
Principal Real Estate Debt Income Instl PRDIX 13.1 0.59       Fixed Income
Principal Real Estate Securities R5 PREPX 24.3 1.07       Equity
Principal SAM Balanced A SABPX 17.6 1.31 0.25   5.5 Allocation
Principal SAM Conservative Bal A SAIPX 21.8 1.24 0.25   5.5 Allocation
Principal SAM Conservative Growth A SAGPX 20.9 1.32 0.25   5.5 Allocation
Principal SAM Flexible Income A SAUPX 19.1 1.13 0.25   3.75 Allocation
Principal SAM Strategic Growth A SACAX 19.5 1.34 0.25   5.5 Allocation
Principal Short-Term Income A SRHQX 59.5 0.68 0.15   2.25 Fixed Income
Principal SmallCap Growth I Instl PGRTX 52.3 1.03       Equity
Principal SmallCap R5 PSBPX 67.5 1.03       Equity
Principal SmallCap Value II Instl PPVIX 58.6 1.05       Equity
Principal Small-MidCap Dividend Inc Inst PMDIX 25.5 1.09       Equity
Principal Tax-Exempt Bond A PTEAX 30.9 0.79 0.25   3.75 Tax Preferred

 

On average, an investor who utilized an equity strategy from Principal experienced a 0.97% expense ratio. Similarly, an investor who utilized a bond strategy from Principal experienced a 0.74% expense ratio.

These expenses can have a substantial impact on an investor's overall accumulated wealth if they are not backed by superior performance. The average turnover ratios for equity and bond strategies from Principal were 59.66% and 51.43%, respectively. This implies an average holding period of about 20.11 to 23.33 months.

It is safe to say that Principal makes investment decisions based on short-term outlooks, which means they trade quite often. Again, this is a cost that is not itemized to the investor but is definitely embedded in the overall performance. In contrast, most index funds have very long holding periods--decades, in fact, thus deafening themselves to the random noise that accompanies short-term market movements, and focusing instead on the long term.

 

Performance Analysis

The next question we address is whether investors can expect superior performance in exchange for the higher costs associated with Principal's "expertise." We compare each of their 70 strategies -- which includes both current funds and funds no longer in existence (since inception) -- against its current Morningstar assigned benchmark to see just how well each has delivered on their perceived value proposition.

We have included alpha charts for each of their current strategies at the bottom of this article. Here is what we found:

  • 50% (35 of 70 funds) have underperformed their respective benchmarks or did not survive the period since inception.
  • 50% (35 of 70 funds) have outperformed their respective benchmarks since inception, having delivered a POSITIVE alpha
  • 0% (0 of 70 funds) have outperformed their respective benchmarks consistently enough since inception to provide 97.5% confidence that such outperformance will persist as opposed to being based on random outcomes.

It is safe to say that the majority of funds offered by Principal have not outperformed their Morningstar assigned benchmark or survived over their lifetime. Of the strategies that did have a positive alpha, zero delivered enough consistency to yield a statistically significant result. The inclusion of statistical significance is key to this exercise as it indicates which outcome is the most likely vs. random-chance outcomes.

We would expect 1 out of every 40 funds to have a t-statistic greater than 2 just by random chance alone. Principal, though, didn't have any funds with a t-statistic greater than 2, likely due to high turnover and costly fees.

 

Regression Analysis

How we define or choose a benchmark is extremely important. If we relied solely on commercial indices assigned by Morningstar, then we may form a false conclusion that Principal has the "secret sauce" as active managers.

Since Morningstar is limited in terms of trying to fit the best commercial benchmark with each fund in existence, there is of course going to be some error in terms of matching up proper characteristics such as average market capitalization or average price-to-earnings ratio.

A better way of controlling these possible discrepancies is to run multiple regressions where we account for the known dimensions (betas) of expected return in the U.S. (i.e., market, size, relative price, etc.).

For example, if we were to look at all of the U.S. based strategies from Principal that have been around for the last 10 years, we could run multiple regressions to see what their alpha looks like once we control for the multiple betas that we know are being systematically priced into the overall market.

The chart below displays the average alpha and standard deviation of that alpha for the last 10 years ending 12/31/2017.

Principal Financial Group - T-Stat Scatter Plot

As you can see, of the 15 funds that met the criteria none produced an alpha that was statistically significant at the 97.5% confidence level (green shaded area).

What we can say is that all strategies from Principal do not have a statistically significant alpha once we control for their overall risk exposure. Why is this important? It means that if we wanted to simply replicate their risk exposure, we could do so more cost effectively through the use of index funds.

Given the lower costs associated with index funds, we could have more confidence that we will experience a more desirable result compared to more expensive actively managed funds.

 

Conclusion

Like many of the other largest financial institutions, a deep analysis into the performance of Principal has yielded a not so surprising result: active management is likely to fail many investors. We believe this is due to market efficiency, costs, and increased competition in the financial services sector. As we always like to remind investors, a more reliable investment strategy for capturing the returns of global markets is to buy, hold, and rebalance a globally diversified portfolio of index funds.

Below are the individual alpha charts for the existing Principal funds that have three years or more of a track record.


Principal Blue Chip Institutional


Principal California Municipal A


Principal Capital Appreciation A


Principal Capital Securities S


Principal Core Plus Bond R5


Principal Diversified Intl R5


Principal Diversified Real Asset Instl


Principal Dynamic Fltng Rt Hi Inc Instl


Principal Equity Income A


Principal Global Div Inc Instl


Principal Global Multi-Strategy Instl


Principal Global Opportunities Instl


Principal Global Real Estate Sec Instl


Principal Government & High Qual Bd A


Principal High Yield A


Principal High Yield Fund I Inst


Principal Income A


Principal Inflation Protection J


Principal International I Inst


Principal International Small Company A


Principal Intl Emerging Markets R5


Principal Large Cap Growth R5


Principal Large Cap Value III Inst


Principal LargeCap Growth I Instl


Principal LargeCap Value R5


Principal LifeTime 2010 Institutional


Principal LifeTime 2015 Institutional


Principal LifeTime 2020 Institutional


Principal LifeTime 2025 Institutional


Principal LifeTime 2030 Institutional


Principal LifeTime 2035 Institutional


Principal LifeTime 2040 Institutional


Principal LifeTime 2045 Institutional


Principal LifeTime 2050 Institutional


Principal LifeTime 2055 Institutional


Principal LifeTime 2060 Institutional


Principal LifeTime Hybrid 2015 Instl


Principal LifeTime Hybrid 2020 Instl


Principal LifeTime Hybrid 2025 Instl


Principal LifeTime Hybrid 2030 Instl


Principal LifeTime Hybrid 2035 Instl


Principal LifeTime Hybrid 2040 Instl


Principal LifeTime Hybrid 2045 Instl


Principal LifeTime Hybrid 2050 Instl


Principal LifeTime Hybrid 2055 Instl


Principal LifeTime Hybrid 2060 Instl


Principal LifeTime Hybrid Income Instl


Principal LifeTime Strategic Inc Instl


Principal MidCap Growth III R5


Principal MidCap Growth R5


Principal MidCap R5


Principal MidCap Value I Inst


Principal MidCap Value III R5


Principal Opportunistic Municipal A


Principal Overseas Instl


Principal Preferred Securities Inst


Principal Real Estate Debt Income Instl


Principal Real Estate Securities R5


Principal SAM Balanced A


Principal SAM Conservative Bal A


Principal SAM Conservative Growth A


Principal SAM Flexible Income A


Principal SAM Strategic Growth A


Principal Short-Term Income A


Principal SmallCap Growth I Instl


Principal SmallCap R5


Principal SmallCap Value II Instl


Principal Small-MidCap Dividend Inc Inst


Principal Tax-Exempt Bond A