Analysis

Prudential Financial: A Deeper Look at the Performance

Analysis

In 1875, insurance agent John Fairfield Dryden opened his own business in Newark, N.J., focused on policies to cover burial-related costs. Since then, Prudential Financal has expanded to become the largest life insurer in the U.S. and the 11th-biggest asset manager in the world. It oversees some $4 trillion of gross life insurance policies and employs about 51,000 workers in more than 40 countries.1

Still, Prudential -- a Fortune 500 company that trades on the New York Stock Exchange (NYSE: PRU) -- in recent years has run into increasing headwinds amid a low interest rate environment and fierce competition in core insurance-related businesses. At its 2019 Investor Day conference, company executives announced a $500 million cost savings program.

A bright spot for Prudential, though, has been its global investment management (PGIM) unit. Despite ebbing interest rates, the firm's asset managers have benefited from appreciation in equity markets, notes Morningstar's Rajiv Bhatia.

Even so, the veteran independent analyst points out that PGIM represents a relatively small percentage (slightly more than 10%) of the insurer's total operating profit, and a bulk of its fund assets come from fixed-income strategies.2 

Many investors know about Prudential through its U.S. Workplace Solutions division, which provides funds and related administrative services for 401(k) and similar types of corporate retirement plans. As a provider of record-keeping services for such defined contribution plans, Bhatia estimates Prudential has a market share by assets of about 3%, putting it "well behind" market leader Fidelity.

"Given recent ERISA (Employee Retirement Income Security Act) litigation," he warns, "we believe plan sponsors are increasingly discerning on fees and able and willing to switch to another provider for favorable pricing."

Like several other conglomerates that've tried to wrap investment management into selling core insurance products, Prudential's value proposition as an asset manager has been challenged in court. In early 2020, for example, regulators made public an agreement by PGIM to pay a fine of $1 million to settle charges that it'd provided inaccurate expense ratio information and historical performance data to thousands of plan participants, according to the Financial Industry Regulatory Authority.3 

A separate lawsuit filed later in the year against a $1 billion retirement plan sponsored by Evonik Corp. using Prudential funds involved complaints of excessive fees and a lack of performance comparisons to rival funds.4 

That came after a former employee sued Prudential Insurance Co. of America over alleged ERISA violations in the company's 401(k) plan, which had more than $8 billion in assets entering 2019. The suit accused the company of "selecting and retaining high-cost and poor-performing investments" and choosing to "overpopulate" the plan with Prudential's own funds instead of considering funds from "unaffiliated" managers. It also complains that Prudential serves as the platform's record-keeper, "providing yet a further stream of revenue and extra benefit for Prudential."5

Given such a backdrop, we thought it'd be worthwhile to put under our research microscope Prudential's family of active mutual funds. This analysis is part of our ongoing Deeper Look series, which investigates claims by managers of peer performance superiority by holding them to a higher standard -- i.e., how they've done over longer periods against their respective indexes.

Controlling for Survivorship Bias

It's important for investors to understand the idea of survivorship bias. While there are 49 active mutual funds with five or more years of performance-related data currently offered by Prudential, it doesn't necessarily mean these are the only strategies this company has ever managed. In fact, there are four mutual funds that no longer exist. This can be for a variety of reasons including poor performance or the fact that they were merged with another fund. We will show what their aggregate performance looks like shortly.  

Fees & Expenses

Let's first examine the costs associated with Prudential's surviving 49 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, sales loads -- front-end (A), back-end (B) and level (C) -- as well as 12b-1 marketing 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 49 surviving active funds offered by Prudential that have at least five 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).

Fund Name Ticker Turnover Ratio % Prospectus Net Expense Ratio 12b-1 Fee Deferred Load Max Front Load Global Broad Category Group
PGIM Short Duration Muni Z PDSZX 83.00 0.32       Fixed Income
PGIM Muni High Income A PRHAX 53.00 0.81 0.25 1.00 3.25 Fixed Income
PGIM Global Total Return A GTRAX 37.00 0.88 0.25   3.25 Fixed Income
PGIM Core Short-Term Bond   43.00 0.03       Fixed Income
PGIM California Muni Income A PBCAX 61.00 0.69 0.25   3.25 Fixed Income
PGIM National Muni A PRNMX 42.00 0.61 0.25   3.25 Fixed Income
PGIM Core Bond Z TAIBX 69.00 0.33       Fixed Income
PGIM Corporate Bond Z TGMBX 71.00 0.55       Fixed Income
PGIM Government Income A PGVAX 119.00 0.96 0.25   3.25 Fixed Income
PGIM Short-Term Corporate Bond A PBSMX 60.00 0.76 0.25   2.25 Fixed Income
PGIM Short Duration Multi-Sector Bond Z SDMZX 67.00 0.39       Fixed Income
PGIM Total Return Bond A PDBAX 45.00 0.76 0.25   3.25 Fixed Income
PGIM Jennison Global Infrastructure Z PGJZX 62.00 1.17       Equity
PGIM High Yield A PBHAX 43.00 0.80 0.25   3.25 Fixed Income
PGIM Short Duration High Yield Income Z HYSZX 49.00 0.75       Fixed Income
PGIM Absolute Return Bond Z PADZX 50.00 0.73       Fixed Income
PGIM Emerging Markets Dbt Lcl Ccy Z EMDZX 69.00 0.72       Fixed Income
PGIM Jennison International Opps Z PWJZX 53.00 0.90       Equity
PGIM QMA International Equity Z PJIZX 94.00 1.03       Equity
PGIM Jennison Global Equity Income C AGOCX 77.00 1.83 1.00 1.00   Equity
PGIM Jennison Global Opportunities Z PRJZX 52.00 0.94       Equity
PGIM Jennison Emerging Markets Eq Opps Z PDEZX 33.00 1.20       Equity
PGIM Jennison MLP Z PRPZX 23.00 1.17       Equity
PGIM Income Builder Z PDCZX 110.00 0.70       Allocation
PGIM Real Assets Z PUDZX 60.00 0.94       Allocation
PGIM Balanced Z PABFX 128.00 0.78       Allocation
PGIM Jennison Diversified Growth A TBDAX 125.00 1.23 0.30   5.50 Equity
PGIM Jennison 20/20 Focus Z PTWZX 58.00 0.89       Equity
PGIM Jennison Growth A PJFAX 43.00 1.03 0.30   5.50 Equity
PGIM Jennison Blend A PBQAX 50.00 0.96 0.30   5.50 Equity
PGIM Jennison Focused Growth Z SPFZX 72.00 0.75       Equity
PGIM Jennison Rising Dividend Z PJDZX 100.00 0.99       Equity
PGIM QMA Large-Cap Core Equity Z PTEZX 88.00 0.48       Equity
PGIM Jennison Value A PBEAX 26.00 1.11 0.30   5.50 Equity
PGIM Jennison Focused Value Z PJGZX 47.00 0.80       Equity
PGIM QMA Large-Cap Value Z SUVZX 56.00 0.80       Equity
PGIM Jennison Small Company A PGOAX 30.00 1.17 0.30   5.50 Equity
PGIM QMA Small-Cap Value Z TASVX 80.00 0.69       Equity
PGIM Jennison Mid-Cap Growth Z PEGZX 31.00 0.79       Equity
PGIM QMA Mid-Cap Value C NCBVX 58.00 1.94 1.00 1.00   Equity
PGIM Jennison Financial Services Z PFSZX 14.00 1.04       Equity
PGIM Jennison Health Sciences Z PHSZX 30.00 0.86       Equity
PGIM Jennison Utility A PRUAX 31.00 0.84 0.30   5.50 Equity
PGIM QMA Long-Short Equity Z PLHZX 142.00 1.82       Alternative
PGIM Select Real Estate Z SREZX 242.00 1.05       Equity
PGIM Global Real Estate Z PURZX 82.00 0.92       Equity
PGIM Jennison Natural Resources A PGNAX 39.00 1.35 0.30   5.50 Equity
PGIM US Real Estate Z PJEZX 211.00 1.00       Equity
PGIM Floating Rate Income Z FRFZX 66.00 0.72       Fixed Income

Please read the prospectus carefully to review the investment objectives, risks, charges and expenses of the mutual funds before investing. Prudential Financial mutual fund prospectuses are available at pgim.com


On average, an investor who utilized a surviving active stock mutual fund strategy from Prudential experienced a 1.03% expense ratio. Similarly, an investor who utilized a surviving active bond strategy from the company experienced a 0.64% 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 surviving active stock and bond strategies from Prudential were 68.11% and 60.41%, respectively. This implies an average holding period of 17.62 to 19.86 months.

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. Again, turnover is a cost that is not itemized to the investor but is definitely embedded in the overall performance.

Performance Analysis

The next question we address is whether investors can expect superior performance in exchange for the higher costs associated with Prudential's implementation of active management. We compare all of its 53 strategies, which includes both current funds and funds no longer in existence, against its 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:

  • 49.06% (26 of 53 funds) have underperformed their respective benchmarks or did not survive the period since inception.

  • 50.94% (27 of 53 funds) have outperformed their respective benchmarks since inception, having delivered a POSITIVE alpha.

Here's the real kicker, however:

  • 3.77% (2 of 53 funds) wound up outperforming their respective benchmarks consistently enough since inception to provide 97.5% confidence that such outperformance would persist (as opposed to being based on random outcomes).

As a result, this study shows that a majority of funds offered by Prudential have not outperformed their Morningstar-assigned benchmark on a consistent and statistically significant basis. The inclusion of the statistical significance of alpha is key to this exercise, as it indicates which outcomes are due to a skill that is likely to repeat and those that are more likely due to a random-chance outcome.

Regression Analysis

How we define or choose a benchmark is extremely important. If we relied solely on commercial indexes assigned by Morningstar, then we may form a false conclusion that Prudential has found to some degree active management's "secret sauce." 

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 Prudential that've been around for the past 10 years, we could run multiple regressions to see what each fund's alpha looks like once we control for the multiple betas that are being systematically priced into the overall market.

The chart below displays the average alpha and standard deviation of that alpha for the past 10 years through 2019. Screening criteria include funds with holdings of 90% or greater in U.S. equities and utilize the oldest available share classes.

As shown above, none of the mutual funds had a positive excess return over their stated benchmarks. At the same time, none of the equity funds reviewed produced a statistically significant level of alpha, based on a t-stat of 2.0 or greater. (For a review of how to calculate a fund's t-stat, see the section of this study that follows the individual Prudential alpha charts.)

Why is this important? A t-stat of the alpha which is 2.0 or greater would give an investor confidence that a manager's results would be attributable to skill and repeatable. A t-stat of less than 2.0, would indicate that a manager's performance was attributable more to luck. 

Conclusion

Like many of the other largest financial institutions, a deep analysis into the performance of Prudential 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 Prudential actively managed mutual funds that have five years or more of a track record.

 


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Here is a calculator to determine the t-stat. Don't trust an alpha or average return without one.
The Figure below shows the formula to calculate the number of years needed for a t-stat of 2. We first determine the excess return over a benchmark (the alpha) then determine the regularity of the excess returns by calculating the standard deviation of those returns. Based on these two numbers, we can then calculate how many years we need (sample size) to support the manager's claim of skill.

Footnotes:

1.) Prudential, "Final 2Q2020 Fact Sheet," Aug. 4, 2020. 

2.) Morningstar, "Earnings Should Improve in Q3, but Environment Still Challenging for Prudential," Rajiv Bhatia, Aug. 5, 2020.

3.) Financial Industry Regulatory Authority, "Letter of Acceptance, Waiver and Consent (RE: Prudential Investment Management Services)," Jan. 14, 2020.   

4.) United States District Court of New Jersey, Daniel Silva and Rhonda Allen vs. Evonik Corp., Feb. 28, 2020 (filing date). 

5.) Pensions & Investments magazine, "Prudential 401(k) Participant Sues Company Over Self-Dealing," Nov. 8, 2019. 


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. Performance may contain both live and back-tested data. Data is provided for illustrative purposes only, it does not represent actual performance of any client portfolio or account and it should not be interpreted as an indication of such performance. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.