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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to the Principal Financial Group Third Quarter 2018 Financial Results Conference Call. [Operator Instructions]. I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.
Thank you, and good morning. Welcome to Principal Financial Group's third quarter conference call. As always, materials related to today's call are available on our website at principal.com/investor. With the annual actuarial assumption review this quarter, we've included 2 additional slides in the earnings call presentation. We've entered a comparison of third quarter operating earnings, excluding significant variances as well as the income statement line item impacts of the 2018 actuarial assumption review and other significant variances.
Following a reading of the safe harbor provision, CEO, Dan Houston; and CFO, Deanna Strable, will deliver some prepared remarks. Then, we will open up the call for questions. Others available for the Q&A session include Nora Everett, Retirement and Income Solutions; Luis Valdés, Principal International; Amy Friedrich, U.S. Insurance Solutions. While this is certainly not Tim Dunbar's first call, we want to welcome him in his new role as President of Global Asset Management.
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. Risks 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 the non-GAAP measures. Reconciliation of the non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures may be found in our earnings release, financial supplement and slide presentation.
Before I turn the call over to Dan, I want to extend an invitation to our 2018 Investor Day on the afternoon of Thursday, November 15 in New York City. Our leadership team will highlight future opportunities across our businesses and provide a deeper dive into our accelerated investment and digital strategies. Additionally, our 2019 outlook call will be held on December 3. Dan?
Thanks, John, and welcome. This morning, I'll share performance highlights and key accomplishments in helping clients and customers achieve financial security and success. Then, Deanna will provide additional details on financial results, including our significant variances during the quarter and capital deployment.
For the third quarter, we reported $481 million of non-GAAP operating earnings. Excluding the significant variances that Deanna will discuss, non-GAAP operating earnings were $422 million, a 1% increase compared to strong results in the year ago quarter. On a trailing 12-month basis, reported non-GAAP operating earnings of $1.6 billion increased 9% from a year ago, reflecting solid net revenue growth, including the accelerated performance fee in the current quarter, ongoing expense discipline and the benefit of U.S. tax reform.
I'd like to highlight the outstanding performance of the U.S. Insurance Solutions. Strong sales and retention and continued discipline drove a double-digit increase in pretax operating earnings over the trailing 12-month period. Beyond these strong results, this segment has a critical role in advancing our small- to medium-sized business strategy and growing our franchise. Though recent growth overall has been muted by our accelerated investment in digital strategies and unfavorable foreign currency translation, our fundamentals and industry opportunities remain intact.
While we're continuing to face increasing fee pressure, particularly in our asset management business in the U.S. retirement business, I'm confident we're taking appropriate steps to combat these pressures, to differentiate the marketplace and to position Principal to continue to deliver above-market growth over the long term.
With $668 billion at quarter end, we've increased assets under management by $12 billion or 2% compared to a year ago. Excluding the previously announced realignment of a real estate investment team within Principal Global Investors and the effect of the exchange rates, AUM would be up $40 billion or 6% compared to a year ago.
Total company net cash flow was modestly positive for the quarter and the trailing 12 months but down from the prior year periods. Retirement and Income Solutions generated $4.8 billion of positive net cash flow over the trailing 12 months. This reflects strong sales in our pension risk transfer and fixed annuity businesses and RIS-Spread and strong sales retention and reoccurring deposits within RIS-Fee.
Despite a soft third quarter, Principal international generated nearly $7 billion of positive net cash flows on a trailing 12-month basis, a 10% increase over the year ago period. We've gained meaningful traction in Southeast Asia and Hong Kong with $2.7 billion and $1 billion of positive net cash flow, respectively, over the trailing 12 months. Combined, these operations have generated net cash flows of 14% of beginning AUM over the trailing 12 months. China also improved over the trailing 12 months with nearly $38 billion of positive net cash flow compared to $12 billion of net outflows in the year ago period. Keep in mind, China is not included in reported net cash flow.
As discussed at our investor event in Tokyo last month, due to the ongoing U.S.-China trade tensions, we now anticipate a longer time line to receive approval to participate in the pension opportunity in China. The economic and political uncertainty in Brazil has had an impact on net cash flows as pension deposits across the industry have declined more than 40% through third quarter.
While we expect pressure to continue after the first round of presidential elections on October 7, there was improvement in the Brazilian equity market and strengthening over the Brazilian real. The runoff election 2 days from now should provide further clarity and stability to the political situation.
Over the long term, we remain optimistic about the Brazilian pension and savings market and we remain confident in our joint venture partner, Banco do Brasil and our ongoing ability to maintain our market-leading position.
Principal Global Investors, however, remains under pressure. With PGI source net outflows of $3.7 billion in the third quarter, this was PGI's fourth consecutive quarter of negative net cash flow. The good news, this isn't an investment performance issue. For our Morningstar-rated funds, 80% of the fund-level AUM had a 4- or 5-star rating as of September 30. And as shown on Slide 5, 74%, 68% and 89% of Principal's mutual funds, separate accounts and collective investment trust were above median for the 1-, 3- and 5-year performance periods, respectively.
Withdrawals as a percentage of beginning of period AUM have remained consistent with our historical averages and are comparable to industry results. The main issue has been deposits, both institutional and retail, and several factors have created some headwinds.
First, demand for lower-cost investment options has continued to become more pronounced. According to Morningstar, there were nearly $400 billion of positive net cash flow for funds and the lowest fee quintile in 2017. Outflows for all other funds have increased fourfold from 2014 to over $400 billion in 2017.
Second, higher interest rates have created headwinds for some of our yield-oriented products. While these continue to perform well, they've garnered less interest. Higher interest rates have also created headwinds for Japanese and European clients with currency hedging cost rising to 250 to 300 basis points.
Lastly, the higher interest rate environment has also led to increased volatility and uncertainty in the equity markets. As the macro environment continues to transition, we're seeing institutional retail clients investing in cash as they wait for some of the volatility to subside.
While there are clearly several contributing issues, we haven't achieved enough sales to offset withdrawals, and we haven't pivoted quickly enough to investments that resonate in a rising interest rate environment. While the context is important, what's more important is what we're doing to turn things around.
As announced last month, Tim Dunbar was promoted to President of Global Asset Management. This role encompasses oversight of all Principal's asset management capabilities, including Principal Global Investors, Principal International investment operations as allowed by regulation, the general account and RobustWealth, our recent digital investment advice acquisition. We've also promoted Pat Halter from Chief Operating Officer of PGI to President and CEO of this segment.
The new structure is designed to further integrate asset management capabilities across the enterprise, expand our investment solutions and make those solutions more accessible to clients around the world, with the ability to better serve retirement, individual and institutional investors.
We've also made key changes to leadership within PGI distribution to create a more focused approach to serving clients around the world, better position us by distribution, channel and client type and work closely with Principal International and its joint venture partners to achieve greater reach and market share.
In addition, we continued to intensify our focus on expanding our suite of lower-cost investment vehicles, including ETFs and CITs, and getting them placed on key third-party distribution platforms. At the same time, we remain committed to enhancing our active investment capabilities to help institutional and retail clients diversify, build wealth, generate income, protect against downside risk and address inflation. We're doing this, for example, through private real estate in Europe, LDI solutions and asset allocation models as well as refreshing a number of existing products.
Additionally, we're increasing our focus on data analytics and technology to advance our investment process and improve our alpha-generating capabilities. We're also realigning certain boutiques to create greater scale and efficiency. Under Tim and Pat's leadership, we're a taking a fresh look at everything to ensure we're appropriately addressing changes in client preferences and executing with a high sense of urgency.
As I'll share in some detail at our upcoming Investor Day, the global asset management opportunity remains exceptional. I'm extremely optimistic about our ability to make the necessary changes to further capitalize on it. That said, we've got a lot of work to do here, and we won't see results overnight.
I'll now share some key execution highlights, starting with our investment platform. In the third quarter, we launched a dozen new funds in Latin America and Asia. Through 9 months, we've launched more than 40 new investment options across our U.S. and international platforms, responding to increasing demand for multi-asset and income-oriented solutions.
I'll also share a couple of new launches for RIS and USIS. Our new Principal Milestones programs helps retirement plan participants access comprehensive financial education resources. In addition to investment and benefits planning, our new platform helps employees improve financial literacy, minimize financial stress and reach personal goals through an in-depth online assessment.
As an aside, I attended our institutional client conference 2 weeks ago and spoke directly with many of our largest U.S. retirement clients. They were excited about the ongoing advancements in our education resources and digital capabilities and pleased with our value proposition overall, including our retirement investment platform, Total Retirement Suite, My Virtual Coach enrollment platform and use of best practice plan design.
Within USIS, we've expanded our consumer engagement platform, My Principal Lifestyle. The program is focused on health and financial wellness through a mobile app that rewards insurance customers for setting and reaching physical and financial goals. In addition to encouraging healthy behaviors and providing value in people's daily lives, we're also strengthening our customer relationships.
Moving to distribution. We continue to get our investment options added to third-party platforms' recommended list and model portfolios with over 40 new placements during the third quarter. Over the trailing 12 months, we've earned nearly 100 total placements over 40 different offerings on more than 30 different platforms. We continue to have success across asset classes and we're gaining meaningful traction with our ETFs and CIT options. Ant Financial continues to stand out as an exceptional growth platform for CCB-Principal Asset Management, our joint venture with China Construction Bank.
In a single quarter, we increased both the number of our clients and AUM by more than 20%, reaching $3.7 million investors and $7.7 billion of AUM as of the quarter end. While revenues and earnings from the platform is currently modest, I'm confident it will continue to grow and continue to provide our joint venture exposure to millions of users.
In closing, I'd like to highlight 4 points: continued strong execution of our customer-focused, solutions-oriented strategy and an appropriate balance between investments in growth and expense discipline, the effect of our shareholder capital as well as meaningful advancement of our brand. We have our challenges, but we also go forward from a position of strength and with a willingness to drive change throughout the organization to position Principal for long-term success. Deanna?
Thanks, Dan. Good morning, and thanks for participating on our call. Today, I'll discuss our third quarter financial results and provide an update on capital deployment.
Net income attributable to Principal was $456 million for third quarter 2018, including net realized capital losses of $25 million with immaterial credit losses. Reported non-GAAP operating earnings were $481 million in third quarter or $1.67 per diluted share, an increase of 29% and 30%, respectively, over the prior year quarter.
Year-over-year earnings growth benefited from record earnings in PGI, driven by the accelerated real estate performance fee, strong underlying business fundamentals and a favorable equity market. These benefits were partially offset by volatile foreign currency exchange rates and our accelerated investment in digital strategies.
As shown on Slide 6, we had 3 significant variances during third quarter that had a $65 million net positive impact to reported non-GAAP pretax operating earnings. The significant variances included a negative $44 million impact as a result of the annual assumption review, primarily in Brazil; an $86 million benefit in PGI that includes the accelerated real estate performance fee, which is partially offset by elevated expenses and a $23 million benefit from higher-than-expected variable investment income. As a reminder, in the year ago quarter, the assumption review was the only significant variance, and it negatively impacted reported non-GAAP pretax operating earnings by $66 million.
The most significant drivers of this year's assumption review were due to experience/assumption changes and model refinement, including experience adjustments in Brasilprev, primarily reflecting lower expected recurring deposits and fees as well as an update to our premium payment assumptions in Individual Life, and model refinements in Brasilprev and variable annuities in RIS-Fee. These items were partially offset by higher U.S. interest rates relative to what was assumed a year ago.
The assumption review negatively impacted total company non-GAAP operating earnings by $22 million after tax and positively impacted net income by $32 million. The positive net income impact was driven by a net realized capital gain from the variable annuity model refinement. Additionally, the assumption review had an immaterial impact on statutory results.
Looking forward, we expect the assumption review will negatively impact Principal International's pretax operating earnings by $5 million per quarter for the next several quarters with the diminishing impact thereafter. The run rate impacts for the other businesses are negligible.
During the quarter, we agreed to a realignment of a real estate investment team in PGI, resulting in an accelerated performance fee with a net $101 million benefit to pretax operating earnings. The team created an effective investment strategy and executed on behalf of the client for over 20 years.
In addition to the earnings impact, $9 billion of AUM transferred with the team. This transaction is not expected to have a material impact on management fees and pretax operating earnings going forward. $15 million of elevated expenses in PGI partially offset this performance fee in large part due to employee-related costs from several strategic staffing changes during the quarter. $23 million of higher-than-expected variable investment income was driven by real estate sales and higher income from alternative investments, partially offset by lower prepayment fees.
As shown on Slide 6. Excluding significant variances in both periods, total company non-GAAP operating earnings increased 1% or 4% per diluted share over strong earnings in the year ago quarter. ROE, excluding AOCI, other than foreign currency translation adjustment was 14.3% on a reported basis for the third quarter. Excluding the impact from the assumption reviews, ROE was 14.5%.
The non-GAAP operating earnings effective tax rate, excluding significant variances, was 20.1% for the third quarter. Despite volatility on a quarterly basis, we continue to expect the full year to be within our previously guided range of 18% to 21%.
Macroeconomics were volatile during the quarter. Favorable U.S. equity market performance had a positive impact on our U.S. fee-based businesses. The S&P 500 daily average increased more than 5% during the quarter, relative to our assumed 2% total return per quarter.
A weakening of certain currencies against the U.S. dollar, primarily in Brazil, Chile and China, negatively impacted Principal International's pretax operating earnings by about $6 million compared to second quarter 2018 and $10 million relative to third quarter of 2017. Actual encaje performance was in line with our expectations.
Mortality and morbidity were within our expectations and provided a slight benefit to both Individual Life and Specialty Benefits. In RIS-Spread, we did experience a mortality loss, as is typical in the third quarter, but a slight improvement from third quarter 2017.
Moving to segment results. The fundamentals of our businesses remained strong. In our U.S. segment, our small- to medium-sized business target market remains healthy. In RIS-Fee, deposits were up more than $3 billion over the trailing 12 months with 13% growth in transfer deposits and 7% growth in recurring deposits. And we've added more than 1,100 net new Defined Contribution plans and nearly 200,000 Defined Contribution participants with account values from a year ago.
RIS-Spread sales increased nearly 40% from the prior year quarter, including $1.2 billion of pension risk transfer sales and $1 billion of fixed annuity sales. Heading into the fourth quarter, the RIS-Spread pipeline remains strong.
Specialty Benefits sales increased 9% due to strong sales in our core SMB market. On a trailing 12-month basis, in-group growth or life covered in existing cases increased a record 2% with even stronger growth in our small case target market.
Individual Life sales increased 13% on strong business market sales. In addition to providing earnings diversification and with strategic importance of these businesses overall, in third quarter alone, our affiliated businesses generated $2 billion of positive net cash flow for PGI through the general account.
In my following comments on business unit results for the quarter, I'll exclude the significant variances we've called out in both periods. Slide 6 provides a comparison of business unit pretax operating earnings, excluding significant variances for third quarter 2018 and the prior year quarter.
Pretax operating earnings for RIS-Fee, PGI, Specialty Benefits and Individual Life were all in line with or exceeded our expectations for third quarter. Principal International's pretax operating earnings were also in line, excluding the impact of foreign currency translation. RIS-Spread's pretax operating earnings of $83 million reflects slight mortality losses, typical in the third quarter, as well as higher non-deferrable sales-related expenses.
Corporate pretax operating losses of $32 million were lower than our expected run rate due to a positive outcome from negotiations with the IRS on prior years' income taxes. As a result, for the full year, we expect corporate losses to be slightly favorable compared to our guidance of $190 million to $210 million. It's important to note that on an after-tax basis, corporate losses were in line with our expectations as income taxes offset the pretax benefit.
Moving to capital deployment on Slide 14. We deployed $216 million of capital during the third quarter, including $151 million in common stock dividends and $65 million in share repurchases. This brings our year-to-date capital deployment to just over $1 billion. We expect full year deployments will be at the high end of our $900 million to $1.3 billion range.
Last night, we announced a $0.54 common stock dividend payable in the fourth quarter, the 11th consecutive increase in our dividends. This is a $0.01 increase from the third quarter 2018 dividend and a 10% increase from the prior year period. This translates into a dividend yield of approximately 4%. We continue to target a 40% dividend payout ratio, and going forward, our dividend will be more aligned with net income.
As highlighted on previous calls, M&A is an important part of our balanced capital deployment strategy and the pipeline remains active. Integration of our recent acquisitions is progressing well. The Mexico Afore transaction, Principal Real Estate Europe and our joint venture in Southeast Asia all contributed positively to results during the quarter.
Our accelerated digital investments remain on track and in line with the impact communicated at last year's outlook call. Excluding the impacts of the accelerated real estate performance fee in PGI, growth in total company operating expenses is in line with our expectations. Looking ahead to fourth quarter, I want to remind you that our fourth quarter operating expenses are typically higher than other quarters as we usually see more branding expenses, benefit costs and variable sales expenses.
Our estimated risk-based capital ratio remains above 450%, well above our target range of 415% to 425%. This puts us in a very strong position to absorb the NAIC's change to the risk-based capital formula to reflect tax reform. We continue to estimate a negative 40 to 50 percentage point impact to our ratio from this change.
Our capital and liquidity position remains very strong. We ended the third quarter with over $1 billion at the holding company, $500 million of capital in excess of a 420% RBC ratio and over $450 million of available cash in our subsidiaries. In addition, a low leverage ratio and no debt maturities until 2022 provides a significant financial flexibility.
We hope you can join us at our Investor Day in New York on November 15 and on our 2019 outlook call on December 3.
Operator, please open the call for questions.
[Operator Instructions]. The first question comes from John Barnidge with Sandler O'Neill.
The fee rate was the highest level pro forma for the performance fee since 4Q '16. Clearly, the assets coming in are higher fee-generating than the assets leaving. Can you talk about what those higher fee-generating products are and what you can do to grow that?
Thanks for the question, and we'll throw that right over to Tim Dunbar to respond to.
Yes. I think what you're looking at is that our basis points for AUM is really up on the quarter, and I think that's a factor of 2 things. One is what we talked about before is that we're seeing our clients interested in our really higher-value products, our yield-oriented products and that continues to be the case. But I think another important impact is that the PE fee, performance fee and the $9.2 billion of assets under management that went out the door were actually very low management fees. Most of the value of that arrangement came from performance fees that was over 20-year relationships. Those performance fees were paid out every 10 years. And so you'll see a very large performance fee based on what the team was able to accomplish over that last 10 years and period of time. So probably want to take credit for the good work that the team did. The assets going out the door really have a low fee, and that's a large part of what brought those basis points up.
And then a follow-up. On flows and PGI, it seems that's definitely more of a deposit than a withdrawal issue. The withdrawal rate is actually down from last year, which tells me it's about finding the next product that's really in demand. Do you have thoughts around that? And maybe can you talk about your ESG product offering, interest in M&A to drive that and then maybe more rational multiples given where asset management multiples have fallen in the public market this year?
Yes. Good question, John. Let me just maybe make a couple of quick comments. I was just fortunate enough to be with our sales organization, along with Pat and Tim, in Miami earlier this week, having this exact same conversation. They are eager to engage with management about these opportunities, and Tim will get into that in more detail. But I did want to make a comment as it related specifically to ESG. That's not new to Principal. We've been around this topic all way back to the early '90s. As a matter of fact, it was my first assignments from Ron Keller when joining the investment committee. We understand the importance of that. There's certainly been a lot of momentum that's been gaining in the last five years, and we've been participating in that. Obviously, Europe is probably a good five years ahead of where we're at here in the U.S. I think our culture here at Principal aligns well with it, and we are frankly, we think, in a very good position, both -- and I'll ask Tim to add some additional detail. Tim?
Okay. So I'll try to take your questions as you asked them. So John, one of the things that we're seeing in the macro environment is this move toward higher interest rates, and Dan mentioned that a little bit in his remarks. And so I'm not going into a lot of detail there. But also what we're seeing is a lot of geopolitical uncertainty. And those 2 issues together are creating quite a lot of volatility in the marketplace today. And so that's having an impact on our flows in a couple of different ways and I think really on the market. One of the things that we're seeing is that a lot of our clients and a lot of investors are actually sitting on the sideline today. So they're sitting in cash and waiting for a better time to enter in the market. A lot has been said about equity prices being particularly high. Hopefully, this pullback means that it's a better entry point for some of those who we start to see some of that move. We do have a really robust pipeline of mandates. But then when we have about $5.5 billion of mandates that are sitting in that bucket, and they are taking longer to fund as we work through the issues and I think they see the volatility in the market, they're not quite as eager to put their money to work. The other thing I'd say is that, and we've seen this in a PEC situation but a couple of other real estate clients, as there's more volatility in the marketplace, they see very robust pricing in private equity commercial real estate. And so a few of those players are taking some of the chips off the table. And really, we think that's the right thing to do for clients.
So those are all -- some of the things that have impacted our flows today and some of the things that we think will turn around. In terms of products, we actually have a broad suite of well-diversified products, and we have a lot of products that do work in today's environment. I think what Dan had said is actually quite correct. We need to make sure that the PGI organization moves quicker to pivot to those products when macro environment changes occur, and we're working with them to do that. So just to go through a few things that we've done so far, and you've seen some of this, October 2, we announced the realignment of the distribution organization. So Tim Hill will be leading U.S. -- all of U.S. distribution for us. Kirk West will be leading all non-U.S. distribution. And while I'm not going to go into their resumes, those are 2 very seasoned investment professionals. We have all the confidence in the world that they will have the focus and they will have the support they need to make sure that we turn this net cash flow situation around. Another thing you probably don't know is that we've made a couple of key hires to improve our talent, both on the marketing side and the institutional distribution side of things.
We've also realigned our global client service team. All of that to make sure that we're communicating well with clients, that we're building the relationships we need to, that we're understanding really what their needs and what their investment -- what investment options resonate with them. So in our product development efforts, we are building the products that they desire and that obviously meet their needs. That's our #1 focus as we move forward. I'm going to go on and talk just about a couple of other things we've done just to give you a sense for some of the things we accomplished in the first, what, 5 weeks that Pat and I have been at the helm. We've also taken a broad look at our investment capabilities. And what we deduced is that we have an incredibly talented group of investment professionals that offer diverse set of products, and they're actually producing some excellent investment results. And Dan talked about that as well in his comments.
Of course, there's always -- there are always areas where we can improve and some of our digital investments really goes to that. So our official intelligence, really making sure that we are simulating the data appropriately and disseminating that to our investment boutiques. As we look through that and we look where we're headed, we've taken the opportunity to realign talent in some of our boutiques, fixed income, Principal portfolio strategies and real estate, just to name a few, and we've also looked at the capabilities that we're offering. And we've made the decision to close down our active macro currency space. We just don't see the need for that with our clients going forward and that, that particular capability is resonating with them. So in fourth quarter, you're going to see about $1.8 billion show up on our operation dispose line, but I want to stress that, that will be OE neutral. That won't have a negative impact on our operating earnings. I will mention, we did retain our passive currency capabilities and we do see a lot of client interest in that. So as you can see, we've taken a lot of actions to really focus the organization. And your last question, I'm going to try to cover here quickly, is ESG. First of all, we have scored A+, which is the highest score for the UN Principles for Responsible Investing. And in ESG, as Dan said, we've been at this for quite some time. We really approached this from three perspectives.
The first is to create actual funds that are ESG focused, and we've done an excellent job of that in the real estate area. We've developed two, what we call green real estate funds that have been very successful, both -- and then funds that have had very good returns and very good client response. And we also have 10 funds with very high Morningstar suitability ratings, and those resonates very well with clients. The second approach is really negative screening mandates. So think of these as socially responsible investing mandates where we screen out the issues that are particular to that investment client. And we have about $12.5 billion of assets under management in those efforts. And then really, the last is to integrate ESG issues into our investment process. And really, we've done that throughout most of our boutiques. All of them understand that companies that have good ESG ratings are likely to outperform, and that's definitely part of our security selection. So hopefully, I covered your points and those help answer the questions.
John, did you want some additional detail?
The next question comes from Humphrey Lee with Dowling & Partners.
Just to follow up on PGI a little more. So obviously, the past couple of quarters, there are some -- the overhang on some of the kind of foreign currency -- I mean, foreign institution investors kind of taking money off the table because of higher hedging costs. But I think more recently, there are some of the institutional investors that have been using that strategy, have talked about willing to go unhedged on some of the kind of U.S. bond investments. I was just wondering if Tim have seen anything kind of when talking to clients or a change of appetite despite the higher hedging cost for some of these products?
Yes, Humphrey. Thanks for the question. Ironically enough, Tim and I were just traveling together within the last 3 weeks in Japan, visiting with some of our largest clients and some of our largest investors, as you know, and we had our investor conference there. But Tim, you had an opportunity to sit down directly with some of our largest clients and speak specifically to this issue. Do you want to provide some insights there?
Sure, Humphrey. I think the answer to your question is it really depends on the clients and it depends on what they're investing for. I would tell you that we talked about a large mandate that we had for an investment grade of about $3 billion, that is still outstanding and I would say, is still at risk. What we've seen in that situation is that the hedging costs have gone up to -- from 250 basis points to almost 300 basis points. And so if you were an asset liability manager client, you probably don't want to go unhedged and that cost becomes very real and very dear to them for especially an investment-grade mandate. But it does depend on the client and it depends on the risks that they're willing to take. So one of the things, I would say, in meeting with that particular client, we have an excellent relationship with them. We are trying to understand exactly how we can help them more, and we actually have sold other mandates to them, which resonate very well, are more yield oriented and are meeting their needs appropriately. So hopefully, that answers your question.
That's helpful. And then maybe shifting gears a little bit to Principal International. In your prepared remarks, you've talked about some of the headwinds you're seeing in Brazil. But like I was just wondering if you can kind of broadly talk about the rest of the countries that you have exposure to. Like what are you seeing from a macro perspective? And how do you think about the potential impact to your operations there?
Yes. Thanks, Humphrey. You know what, I reflect on that portfolio of businesses around the world. It's just interesting to me to see how uncorrelated they can be because as you know, we're enjoying a lot of success in Southeast Asia, generating very positive earnings and very nice cash flows. And then we can get them over to Latin America and see the pressure on our Brazilian operations. No one's better positioned to talk about Brazil than these other operations. And Luis felt this, so I'll ask him to provide some additional color.
Okay. Thanks, Humphrey. Good question. We continue, as I said, in the last -- in our last earnings call, we continue -- very positive about Brazil, particularly now. I mean, from a macro perspective, what I said to you is that Brazil, from a macro perspective, is fixable. The problem that Brazil has is not like other sort of emerging countries. They do have a fiscal problem, which is fixable. Particularly, we are going to see what is going to happen with the elections that are coming this weekend. But we are under a cyclical rebound -- possible rebound now in Brazil. Probably, we're going to see some good news about growth quarter-over-quarter. Probably, we're going to see quarter-over-quarter about 1%, which is not that big but is a pretty interesting rebound and year-over-year, probably over 2% job creation. That's been positive in the last quarter for Brazil.
And again, if you're looking at their external accounts, very positive; their reserve, very positive. And if you're looking at their -- as I'm saying, their external position is also very positive. So we think that it's fixable. We are confident that whoever is going to be the next president in the next administration, they're going to do a good work in order to stabilize, elevate their fiscal deficit. And the only thing that -- or the major thing that they have to do in order to stabilize their macro is to go through a very sort of patient reform that's going to certainly benefit to companies like us and Brasilprev that were -- are long-term savings providers and certainly, pension providers in that country. So that's our particular view. It's been very difficult years for Brazil, probably the most difficult years from a macroeconomic standpoint of view and political point of view in many, many decades. But having said that, if you could see in the trailing 12 months, our franchise has been able to put $3.1 billion in positive net customer cash flows. So it's a very commendable 5% DOP over AUMs, and we certainly will remain very confident. So that's my answer. And again, we continue very positive about the macroeconomics and demographics and the never-ending need to save more for -- to really secure their financial security. So those are my views about Brazil, Humphrey.
I think Humphrey is maybe looking for a little more color, Luis, in some of the other countries as well. So maybe a couple of comments on some of the big ones quickly, something perhaps around Chile and some of what's happening in Asia quickly.
Okay, Humphrey. Let me go with agile comments about our countries in Lat Am, particularly Chile. Chile has had a very interesting positive and very important positive -- and swing in terms of its execution. You could see in your supplement, and if you're looking, the net customer cash flow trailing 12 months, it's a $1.7 billion positive swing in net customer cash flows. And I will say that Chile is doing extremely much better. They have more sales. They're gaining more clients. They're investing in new technologies. They're investing in new CRMs. They're putting more money in digital. They're connecting better with their clients. You could see, even if you're going into your supplement, if you're going to Page 22, you will see that their revenue stream is a positive story. So they do have a positive story in their revenue stream, about 5% adjusted. But it seems to me that they're -- that is a very good story. You have to remember that Chile is a very interesting platform with de-accumulation, accumulation and payout products. So when you're looking -- the total net customer cash flows, the aggregation of all those business together and what we have been able to see, it is that swing dimension to you first, $1.7 billion, but also because probably, the overhang of a low cycle -- probably, we have been able to see more payout solutions.
So more money going into outcome solutions for our clients, but essentially, that's what we have been able to see. We have positive flows in terms of customers during this year. And I have said to you also, we have positive flows in terms of AUMs. That's my view about Chile. Asia, while Asia is a totally different story, very positive story for this year. You heard about our net customer cash flows in China, $4 billion and -- for the last quarter for Mainland China, and $1 billion trailing 12 months for Hong Kong and very positive net customer cash flows for Southeast Asia. So this is a franchise and this is a very interesting portfolio, which is working extremely well, very well diversified, and we're very pleased about how these different countries and different assets are working in our favor.
Thanks, Luis, and thank you for the question, Humphrey.
The next question comes from Tom Gallagher with Evercore.
Just a quick question on, if we step back for a minute, the asset management business. So from what I've heard, it's a bit of you guys benefited from the low rate environment for a while. And now that we're moving into a different macro environment, you feel like you need to reposition things. Can you talk a bit about how you're thinking about restructuring and the -- how long you think the transition takes to kind of reposition yourself in terms of PGI?
Yes. Thanks, Tom, for the question. I suspect it's not as much about restructuring as refocusing and pivoting within a lot of the strategies, starting with our sales organizations and working closely with our portfolio managers and our strategists. But Tim, do you want to take that one?
Sure. You're right. I mean, we had seen a lot of sales coming from several specific products, not all from yield oriented, but preferred securities, global diversified income. We're in certainly two of those. And I think actually yield is not dead. And while it's taking a pause, as interest rates move higher, I think we have a lot of clients that are still interested in yield, and the desire and the demand for those products will come back. Having said that, in an environment where interest rates are increasing, even though there's volatility, that's usually a sign of a robust economy. And generally, I'd say that's supporting for -- supportive for earnings of companies and stocks. And so equity markets are a place that we'd say a lot of folks want to be. We have some very good equity products, mid-cap, small-cap, blue chip is very good, income-oriented products that we think resonate really well. I'd also say that we have a good suite of short-duration fixed income products. So as you're thinking about the volatility with interest rates moving up, short-duration fixed income is an obvious place that you might want to go. Absolute re-term products have been increasing in interest. We have Finisterre emerging market long-short group that's developed some nice products there and have some good performance. And that's another space that we think we can make progress in and actually have been making good progress in. And then we -- the one thing that I think we are really strong at, I know really we're strong at is when we think about our Principal portfolio of strategies. So a diversified group of asset allocation products that can resonate for 401(k) platforms and resonate actually with our Principal International operations around the world. And those are things that we're continuing to develop and build out and get out the door.
That does, yes. And then just one other question on asset management. I know -- my understanding is when certain -- in certain instances, when senior people within asset management organizations leave, there's going to be certain amount of customers that may have to reevaluate due -- further due diligence on that relationship. Is -- given Jim's departure, is there any way to think about whether there will be that kind of impact on PGI?
Yes. So thanks for the question. The first thing I want to say is thanks to Jim for his many years of contributions here at the Principal. He just did an extraordinary job for the organization. We're fortunate that he was here. Secondly, we have been out to visit the consulting firms, our largest clients, our distribution partners. And frankly, it did not raise the status of a need to do a search or to pause or to do anything differently than what they're doing. That's certainly, what you had described, Tom, very true when it gets down to portfolio managers and senior analysts. And as you very well know that our -- even our economics committee, which is made up of roughly a dozen professionals around the organization, Jim was one of those dozens, and we don't have a system or a star manager or a one-view top-down CIOs sort of macro view that says this is where interest rates are going or this is how we feel about currencies and so forth. So again, it's a testament, I think, to the structure that was built, which isn't overly dependent on any one person, but rather spread across a team of individuals. So hopefully, that helps answer that question for you, Tom.
The next question comes from Ryan Krueger with KBW.
Deanna, you mentioned the higher seasonal expenses in the fourth quarter. Can you give us some more perspective on how to think about that because I think when we go back to last year, you had very favorable expenses for the first 3 quarters and a bit of a catch-up in the fourth quarter as I assume that would -- maybe more weighted to the fourth quarter than normal. So if you could help us think about some sizing of how much that could shift a bit here?
Yes, it seems to be a pattern there. You're breaking up just a little bit, but I think she got the full question. Thanks.
Yes. So on the prepaid amounts, I did mention a reminder around fourth quarter expenses being higher. I would say and agree with what you said that the pattern in 2017 was abnormal, so I wouldn't use that as the kind of trend to go off of. But if you went back to '14 and '15 and '16, what you would see is that if you look at total expenses, you would see that fourth quarter tends to come in about 5% to 8% higher. And I think that would be a good trending to look at when you look at 2018. I think the one thing you'd have to do is, as you know, the PGI, a lot of that significant variance in third quarter did run through the expenses, so you'd want to normalize for that and then ultimately kind of look at that 5% to 8% trend. The other thing, I would say, is unlike 2017, we have been seeing each quarter expenses to kind of be right at what we would've expected, so I don't think we'll have that timing impact that did help drive the fourth quarter '17 expenses to be outside that normal trend. Hopefully, that helps.
Yes, very helpful. And then as a separate question, you had very strong retention in RIS-Fee this quarter. Could you provide some additional color on what you saw there?
Yes. I'd say first, thanks for noticing because it's a very concerted effort to regain our clients. And it's also worth noting that we had very strong recurring deposits. It's a reminder of just how strong of a franchise that is. But Nora, do you want to provide some additional color on retention?
Sure. Yes, we had a -- thanks, Ryan. We had a very strong quarter on both ends, which pushed that net cash flow up, really strong deposits, transfer deposits, recurring deposits. Whether you look at it at a -- on a trailing 12-month basis or just 3Q, it's a really strong number and reflects both our work and obviously, the economy and in particular, the SMB market. With regard to lapse, it was a very strong quarter with regard to retention. And again, and we said this both when it's up and it's down, it's really important to take a 12-month view. Quarter-to-quarter, any of these stats can be a little bit noisy, so I would encourage you to continue to take that trailing 12-month view. But even when you do that, we have a very strong retention stat there. And that, you can put that against a lot of things.
Our service model, satisfaction with a strong performance in our target date suite. We have a service model that touches both at the plan sponsor level and also at the participant level. And I can tell you that more and more plan sponsors are really focused at the experience for their participant, and we're leading in a lot of places with regard to that experience. And it's nice to see that conversation really starting to pivot to looking at retirement readiness and understanding how the experience we can provide to their participant is a very personalized experience, can really help drive the end game for them. And so that's been an increasing piece of the conversation. I think all of those things wrap into this stat that says we're able to keep these clients and keep them for long periods of time. Dan mentioned the institutional client conference. I was down there with Dan as well, and we're sitting with clients who have been with literally 20, 30, in some cases, 40 years. So it really resonates, and we take a lot of pride in that.
The next question comes from Andrew Kligerman with Crédit Suisse.
First question is with regard to the digital investment. So as I looked at RIS and PGI, it looked like top line growth was low to mid-single digits, but the earnings were kind of flattish to down, and it looks like it was primarily or in large part, digital investment. So my question is, could you highlight 1 or 2 of the digital investments that you've made and the kind of impact? And then the second part is what can we expect next year in terms of the year-over-years on digital expenses?
Yes. And really appreciate the question, Andrew. And As you know, from the comments that John made to kick things off, we're very much looking forward to discussing this in a lot more detail with you on November 15 for our Investor Day when we can do specific case studies. But out of respect for everyone's time, I'm going to ask Deanna just to give a little bit of color and then really dig into that question on the 15th. Deanna?
Yes. So just one of the things I would remind is if you're just comparing expenses in third quarter of '17 to third quarter of '18, I want to remind you of something I just said, we had very low expenses in third quarter of '17. And so that plays into the comparison. And in addition, we do have the digital investment that's impacting our expenses in '18. That's spread across all of those businesses, but the 2 businesses that you did discuss does have some of that. And so want to -- so I would say that, really, it's a third quarter '17 issue as well as a third quarter '18. But if you kind of take out all the noise, even when you look at third quarter, our adjusted expense growth is tracking right with our adjusted revenue growth. So I think we're doing a good job of managing those expenses while still investing in the business. And just in total, I would say that our digital spend this year is right on track with what we would have expected and the impact that it's having to our operating earnings growth. And that those -- we'll still have those expenses in 2019, but we'll start to have some of the benefits to offset it. So with that, I'll hold you off until our Investor Day in November because I think we're going to give a lot more detail both on what we're actually doing, how that will impact us going forward as well as some of the expense expectations as well.
Andrew, can you wait and do you have another follow-up for us?
We have reached the end of our Q&A. Mr. Houston, your closing comments, please?
Well, the first thing I would say to everyone who called in, thanks for doing so and we apologize. We know there were number of individuals in the queue, which we did not have a chance to answer your questions. John will follow up accordingly and respond to those questions, so we apologize. We were probably a little long-winded in some of our responses but felt it was important we tell a very important story as we go through the transition.
Secondly, we're going to continue to stay focused on our customers, invest for growth. We're going to eliminate expense that's not additive, and that's something that all the divisional presidents and other leaders are pursuing. Also, again, we're very proud of the deployment of capital. We'll continue to be judicious in how we deploy capital on behalf of our long-term shareholders. And I said -- as I said earlier, we look forward to seeing many of you on November 15 for the Investor Day in New York City. So have a wonderful weekend. Thank you.
Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 p.m. Eastern Time until the end of day, November 2, 2018. 8587837 is the access code for the replay. The number to dial for the replay is 855-859-2056 for U.S. and Canadian callers or 404-537-3406 for international callers.