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Is Principal Your Pal?

The retirement giant draws on outside talent in push for mutual fund assets.

David Kathman, 07/14/2010

Principal keeps a lot of balls in the air, but hasn't dropped any yet.

Its funds operate under the umbrella of Principal Financial Group PFG, a publicly traded financial conglomerate based in Des Moines, Iowa, that has roots going back more than a century. PFG originated as a life-insurance company, and insurance still makes up a big part of its business. In the 1940s, the firm began administering pension and retirement plans, and it is now one of the largest operators of 401(k) and other defined-contribution retirement plans for small and midsize U.S. businesses. PFG's asset-management arm, including the mutual fund lineup, has long had close ties to these other two businesses. Over the past decade, Principal has been trying to loosen those ties and make the asset-management business more independent, with varied success.

Funds Are a Small Piece of the Pie
Principal's asset-management arm has a somewhat complicated structure. At the end of 2009, it had $285 billion in assets under management, most of which was in pension and retirement portfolios (tied to the firm's retirement-services arm) and fixed and variable annuities (tied to the firm's life-insurance arm). Only about $50 billion was in the Principal mutual funds. Those mutual funds always have been used in Principal's retirement portfolios, and in 2000 the firm launched a parallel lineup of clone mutual funds (the Principal Investors funds) designed specifically for use in retirement portfolios. In 2005, the original retail funds were merged into newly created retail shares of the Principal Investors funds, so there's now a single lineup of funds with as many as 11 different share classes, including five for retirement accounts and three for retail investors.

Because the mutual fund portion of Principal's business is relatively small, there's some risk that fund shareholders will get lost in the corporate shuffle. Principal, however, has taken steps in recent years to improve its fund lineup by acquiring smaller boutique investment firms and their funds or hiring well-regarded subadvisors to run other Principal funds.PAGEBREAK

Acquisition Streak
In the past, Principal's in-house asset-management arm, Principal Global Investors, managed most of Principal's funds. In keeping with its institutional roots, PGI traditionally has taken a somewhat conservative, index-conscious approach in which risk controls play an important role. Now, however, roughly 30% of Principal's assets under management are managed by unaffiliated subadvisors with a wider variety of strategies. In the firm's target-date series, which includes its two largest funds by assets, the percentage of assets managed by outside subadvisors has gone from 20% in 2007 to 50% in 2010.

Principal also has bought up a series of niche investment shops that now manage a good chunk of the firm's assets. These "affiliated" firms include Spectrum Asset Management, a leading investor in preferred securities (bought in 2001); Post Advisory Group, a high-yield bond shop (bought in 2004); Columbus Circle Investors, a growth-equity shop (bought in 2005); Edge Asset Management, formerly WM Advisors, the mutual fund arm of Washington Mutual (bought in 2006); and Morley Financial Services, a stable-value-investment firm (bought in 2007).

The Edge Asset Management deal included not only the former WM funds, a dozen of which were integrated into the Principal lineup, but Washington Mutual's fund-distribution infrastructure. Previously, the Principal funds were distributed only through proprietary channels connected with the firm's insurance and retirement businesses, but now they're also distributed through banks, large brokerage firms, and registered investment advisors, giving Principal a much bigger retail presence. With an enhanced distribution network, Principal can become a bigger player in the mutual fund world, both through organic growth (by launching new funds) and by purchasing investment boutiques. The firm says it's still looking to buy boutiques that have good investment capabilities but could use better distribution.

There are risks inherent in Principal's expansion strategy. For example, companies that are focused on asset-gathering can stray beyond their core competencies and deliver poor returns. That said, Principal's expansion has been relatively thoughtful and measured. Nora Everett, the president of the Principal funds, has said the funds' close ties to Principal's retirement business means a fiduciary culture is "in their DNA," since they've had to help plan sponsors meet their legally required fiduciary duty. The boutiques it has bought are established (though not industry leaders), and it has hired external subadvisors in areas where its internal capabilities are weak, thus raising the quality of the whole lineup.

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