Principal Financial Advisors - Fourth Quarter 2017

Economic commentary

Global markets continued their upward trend given improving economic fundamentals, low interest rates, low volatility, and low inflation. This further supporting the risk-on environment and compression of risk premiums/spreads. U.S. Fed raised rates again in December 2017, reflecting 3 rate hikes in 2017. Expectations for more of the same macro-environment in the 1st half of 2018; perhaps higher volatility in the 2nd half of the year.

Quarterly performance detail

  • U.S. equity markets posted positive absolute returns, led by large-cap stocks. Large-cap outperformed mid-and small-cap equities throughout the quarter, while growth continued to outpace value equities.
  • Non-U.S. equity markets lagged U.S. markets, despite solid returns from emerging market equities. Lower volatility supported returns.
  • Fixed income posted positive results as long-term rates were steady to lower quarter over quarter and the yield curve flattened; spreads tightened across most sectors outperforming U.S. Treasuries.
  • Real assets also posted positive absolute results, rebounding some from improving commodity prices and better (less weak) CPI prints.

One-year performance detail

  • U.S. equities posted solid results across the board, with the strongest performance coming from large-cap and growth equities.
  • Non-U.S. equities outpaced U.S. equities given generally stable commodity prices, improving economic conditions, and weak U.S. dollar.
  • Fixed income posted respectable returns for the period even with higher interest rates; investment grade and high yield corporate bonds outpaced U.S. Treasuries.
  • Real assets posted positive absolute results, outpacing fixed income but lagging equities. Higher inflation expectations and stable-to-improving commodity prices were beneficial to the asset class.

Composition and Performance of PFA Underlying Index (as of 12/31/2017)*

Broad Asset Class Asset Class Index 3-Month 1-Year 5-Year 10-Year
Fixed Income Core Fixed Income
High Yield
Alternative
Bloomberg Barclays US Aggregate Bond Index
Bloomberg Barclays US Corp High Yield 2% Issuer Capped Index
HFRI Fund of Funds Composite
0.39%
0.47%
2.03%
3.54%
7.50%
7.74%
2.10%
5.78%
4.00%
4.01%
8.09%
1.08%
U.S. Equity
Large-Cap
Mid-Cap
Small-Cap
S&P 1500 Index
S&P 500 Index
S&P Mid-Cap 400 Index
S&P Small-Cap 600 Index
6.53%
6.64%
6.25%
3.96%
21.13%
21.83%
16.24%
13.23%
15.74%
15.79%
15.01%
15.99%
8.69%
8.50%
9.97%
10.43%
Non-U.S. Equity
Developed Non-U.S.
Emerging Market Equity
MSCI ACWI ex USA Index ($Net)
MSCI EAFE Index ($Net)
MSCI Emerging Markets Index ($Net)
5.00%
4.23%

7.44%
27.19%
25.03%
37.28%
6.80%
7.90%
4.35%
1.84%
1.94%
1.68%
Real Asset Inflation Hedge Blended Real Asset Index
CPI + 150 bps
Diversified Real Asset Strategic Index
1.61%
0.98%
3.52%
5.30%
3.65%
10.38%
1.86%
2.89%
1.62%
0.48%
3.09%
     -

*PFA custom index includes appropriate historical mix of the indices in bold.

The Blended Real Asset Index through September 30, 2011, is as follows: 75% NFI-ODCE Equal-Weight and 25% MSCI US REIT Index. The NFI-ODCE Equal-Weight is the NCREIF Fund Index-Open End Diversified Core Equity. It is a fund-level equal-weighted, time-weighted return index and includes property investments at ownership share, cash balances and Leverage. The return series is net of the average fee charged by accounts that make up the index. The MSCI US REIT Index is a capitalization-weighted benchmark index of most actively traded Real Estate Investment Trusts (REITs), designed to measure real estate performance. Effective October 1, 2011, the Blended Real Asset Index is comprised of 60% Consumer Price Index (CPI) plus 1.5% and 40% Diversified Real Asset Strategic Index. Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. The Diversified Real Asset Strategic Index is composed of 35% Bloomberg Barclays U.S. Treasury TIPS Index, 20% S&P Global Infrastructure Index, 20% S&P Global Natural Resources Index, 15% Bloomberg Commodity Index, and 10% FTSE EPRA/NAREIT Developed Markets Index. Effective July 1, 2012, the Blended Real Asset Index is comprised of 50% Consumer Price Index (CPI) plus 1.5% and 50% Diversified Real Asset Strategic Index. Effective April 1, 2016, the Blended Real Asset Index is comprised of 75% Consumer Price Index (CPI) plus 1.5% and 25% Diversified Real Asset Strategic Index.

 

Bloomberg Barclays Aggregate Bond Index represents securities that are domestic, taxable, and dollar denominated. The index covers the U. S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.

 

Bloomberg Barclays US Corp High Yld 2% Issuer Capped Index is an unmanaged index comprised of fixed rate, non-investment grade debt securities that are dollar denominated. The index limits the maximum exposure to any one issuer to 2%.

 

Bloomberg Barclays US Treasury TIPS Index consists of inflation-protected securities issued by the U.S. Treasury.

 

Bloomberg Commodity Index is made up of 22 exchange-traded futures on physical commodities and currently represents 20 commodities, which are weighted to account for economic significance and market liquidity. Weighting restrictions on individual commodities and commodity groups promote diversification.

 

Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

 

Diversified Real Asset Strategic Index is composed of 35% Bloomberg Barclays U.S. Treasury TIPS Index, 20% S&P Global Infrastructure Index, 20% S&P Global Natural Resources Index, 15% Bloomberg Commodity Index, and 10% FTSE EPRA/NAREIT Developed Markets Index.

 

FTSE EPRA/NAREIT Developed Markets Index NR is designed to represent general trends in eligible real estate equities worldwide.

 

The Hedge Fund Research, Inc. Fund of Funds Composite Index is an equal-weighted index composed of over 650 constituent fund of funds, including both domestic and offshore funds.

 

NFI-ODCE Equal-Weight is the NCREIF Fund Index – Open End Diversified Core Equity. It is a fund-level equal-weighted, time-weighted return index and includes property investments at ownership share, cash balances and leverage. The return series is net of the average fee charged by accounts that make up the index.

 

MSCI ACWI Ex USA Index is a free float-adjusted market capitalization index that is designed to measure the combined equity market performance of developed and emerging market countries excluding the US.

 

MSCI EAFE NR Index is listed for foreign stock funds (EAFE refers to Europe, Australia, and Far East). Widely accepted as a benchmark for international stock performance, the EAFE Index is an aggregate of 21 individual country indexes.

 

MSCI Emerging Markets NR Index measures equity market performance in the global emerging markets. It consists of 26 emerging market countries in Europe, Latin America and the Pacific Basin.

 

The MSCI US REIT Index is a free float-adjusted market capitalization weighted index that is comprised of equity REITs that are included in the MSCI US Investable Market 2500 Index, with the exception of specialty equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations. The index represents approximately 85% of the US REIT universe.

 

S&P Global Infrastructure Index is designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability. To create diversified exposure, the index includes three distinct infrastructure clusters: energy, transportation, and utilities.

 

S&P Global Natural Resources Index includes 90 of the largest publicly-traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified and investable equity exposure across 3 primary commodity-related sectors: agribusiness, energy and metals & mining.

 

Standard & Poor's 1500 Total Market Stock Index is an index of small, medium and large stocks. It is comprised of stocks from the Standard & Poor's 500, 400 and 600 stock indices

 

Standard & Poor's 400 MidCap Stock Index includes approximately 10% of the capitalization of U.S. equity securities. These are comprised of stocks in the middle capitalization range.

 

Standard & Poor's 500 Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market.

 

Standard & Poor's 600 Stock Index is a small cap index that consists of 600 domestic stocks chosen for market size, liquidity, and industry group representation.

 

Index performance information reflects no deduction for fees, expenses, or taxes. Indices are unmanaged and individuals cannot invest directly in an index.

 

Investing involves risk, including possible loss of principal.

 

Asset allocation and diversification do not ensure a profit or protect against a loss.

 

Real estate investment options are subject to some risks inherent in real estate and Real Estate Investment Trusts, such as risks associated with general and local economic conditions.

 

Fixed-income investment options (inclusive of U.S. Treasury Inflation-Protected Securities) are subject to interest rate risk, and their value will decline as interest rates rise. Neither the principal of the bond investment options nor their yields are guaranteed by the U.S. government or any other government entity.

 

Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options. Fixed-income investment options are subject to interest rate risk, and their value will decline as interest rates rise.

 

Small-cap and mid-cap investment options are subject to more fluctuation in value and may have additional risks than other investment options with stocks of larger, more stable companies.

 

High yield investment options are subject to greater credit risk associated with high yield bonds.

 

International and global investment options are subject to additional risk due to fluctuating exchange rates, foreign accounting and financial policies, and other economic and political environments.

 

Concentrating investments in natural resources industries can be affected significantly by events relating to those industries, such as variations in the commodities markets, weather, disease, embargoes, international, political and economic developments, the success of exploration projects, tax and other government regulations and other factors.

 

REIT securities are subject to risk factors associated with the real estate industry and tax factors of REIT registration.

 

Global infrastructure companies may be subject to additional risk due to fluctuating exchange rates, foreign accounting and financial policies, and other economic and political environments.

 

Commodity-Related Investment Risk: The value of commodities investments will generally be affected by overall market movements and factors specific to a particular industry or commodity, which may include weather, embargoes, tariffs, and economic health, political, international regulatory and other developments. Exposure to the commodities markets may subject the fund to greater volatility than investments in traditional securities.

 

There is a risk of substantial loss associated with trading commodities, futures, options, derivatives and other financial instruments. Before trading, investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when trading futures, commodities, options, derivatives and other financial instruments one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading derivatives or using leverage. All funds committed to such a trading strategy should be purely risk capital.

 

Commodity Index-Linked Notes Risk: The value of commodities may be affected by overall market movements and other factors affecting the value of a particular industry or commodity. These notes expose the fund to movements in commodity prices. They are also subject to credit, counterparty, and interest rate risk. Commodity index-linked notes are often leveraged. At the maturity of the note, the fund may receive more or less principal than it originally invested. The fund may also receive interest payments on the note that are less than the stated coupon interest payments.

 

Principal Financial Advisors, Inc. is a registered investment adviser and member company of the Principal Financial Group®. Registration does not imply any specific level of skill or training.

 

Asset allocation strategies are developed using Separate Accounts available through a group annuity contract of Principal Life Insurance Company.

 

Separate Accounts are available through a group annuity contract with Principal Life Insurance Company. Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group, Des Moines, IA 50392. See the group annuity contract for the full name of the Separate Account. Certain investment options may not be available in all states or U.S. commonwealths. Principal Life Insurance Company reserves the right to defer payments or transfers from Principal Life Separate Accounts as permitted by the group annuity contracts providing access to the Separate Accounts or as required by applicable law. Such deferment will be based on factors that may include situations such as: unstable or disorderly financial markets; investment conditions which do not allow for orderly investment transactions; or investment, liquidity, and other risks inherent in real estate (such as those associated with general and local economic conditions). If you elect to allocate funds to a Separate Account, you may not be able to immediately withdraw them.

 

© 2018 Principal Financial Services, Inc.
February 2018
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