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Principal’s Complex Growth Plan Reveals a Muddled Culture

Principal Funds continues to grow on multiple fronts, but its core identity remains elusive.

Michael Holt, CFA, 05/05/2015

Morningstar recently issued a new Stewardship Grade for Principal Funds. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is a C. What follows is Morningstar's analysis of the firm's corporate culture. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).

Principal Funds’ leadership remains steadfast in its multiyear effort to establish its identity as a top-tier asset manager. The firm has begun to see the fruits of this effort as its stake in open-end mutual fund assets has grown to approximately $110 billion as of Dec. 31, 2014, placing it among the largest U.S.-based fund families in terms of assets under management. The firm has doubled its mutual fund assets since the end of 2010, bolstered through market appreciation and inflows. While the firm’s growth is apparent, it’s not clear whether Principal Funds can carve out a distinct identity within its storied parent company and an ultracompetitive industry.

Principal Financial Group--the parent company of Principal Funds--began as a life insurance company in 1879, and insurance still represents a significant part of its business. The firm began administering pension and retirement plans in the 1940s and remains a major player in the defined-contribution recordkeeping industry. As can be expected, the firm’s asset-management effort, including its mutual fund offerings, has close ties to its insurance and retirement lines of business. For instance, as of Sept. 30, 2014, Principal Financial Group reported that nearly half of its roughly $510 billion in assets stem from its Principal Retirement & Investor Services business.

Within the Principal Funds’ lineup are three different management approaches: Homegrown, affiliated firms, and external subadvisors. Such a structure isn’t unusual among large asset managers that have grown via bolt-on acquisitions to serve a wide-ranging client base. This structure, however, makes it difficult to maintain a single corporate culture. Principal must rely on the individual parts of its asset-management structure to consistently put its fundholders’ best interests before its own corporate interests. While there are glimmers of strong corporate cultures among the distinct areas of Principal Funds, the units do not collectively demonstrate a corporate culture that exceeds the industry standard. Much of the investment lineup fails to stand out or has been constructed with assets in mind.

Principal Global Investors now consists of 14 boutique firms that collectively run the gamut of fund assets. Three of those boutiques are homegrown: Principal Global Equities, Principal Global Fixed Income, and Principal Real Estate Investors. Their roots trace back to Principal Life Insurance Company’s investment department. These teams maintain a heavy presence in Des Moines, Iowa, where Principal Financial Group is headquartered. They manage 23 of the firm’s 56 mutual funds, excluding the target-date funds, and the homegrown funds account for roughly 40% of the firm’s mutual fund assets.

Although the homegrown teams run the most assets of the three approaches and have sufficient resources, few of their strategies stand out as exceptional, and the corporate culture varies from team to team. Principal MidCap PEMGX earns a Morningstar Analyst Rating of Silver, but that is the only fund in this group that receives a medal from Morningstar. Bill Nolin has been at the helm of the fund since 2000, and his successful long-term track record caught investors’ attention. The fund has grown to over $10 billion in assets--the firm’s second-largest fund--and closed to new investors in August 2013. Nolin’s large-cap version of the strategy--Principal Blue Chip PBLAX--has seen healthy inflows from investors since its mid-2012 inception and now holds over $1 billion in assets. Nolin has a dedicated team that consists of four research analysts and comanager Tom Rozycki. The distinct team structure results in an assortment of investment cultures.

Of the homegrown strategies, Principal Bond & Mortgage Securities PRBDX saw the largest inflows over the past year, but that was largely attributable to receiving assets from the liquidation of PIMCO-managed Principal Core Plus Bond I in early 2015. Two real estate strategies--Principal Global Real Estate Securities POSAX and Principal Real Estate Securities PRRAX--are the only other strategies that saw notable inflows over the past year.

Principal also has expanded its asset base and investment capabilities through the acquisition of niche investment shops. These affiliated shops manage 17 mutual funds that represent roughly a fourth of the firm’s mutual fund assets. They 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); Morley Financial Services, a stable-value investment firm (bought in 2007); Finisterre Capital, a London-based emerging-markets shop (bought in 2011); Origin Asset Management, a London-based global equity firm (bought in 2011); and Liongate Capital Management, an alternatives boutique (bought in 2013).

Michael Holt, CFA, is a senior stock analyst with Morningstar.
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