Market Sector Update

• Mid-cap growth stocks gained 3.16% in the second quarter of 2018, continuing a string of quarterly gains for the Russell Midcap Growth Index (the Fund’s benchmark) that started in the fourth quarter of 2015.
• Outperformance within the index came from the consumer discretionary, health care, technology, energy, real estate and telecommunications sectors – a broadening of relative performance across sectors versus the first quarter of 2018.
• Sectors and stocks more exposed to concerns over potential changes in trade policy saw some pressure in the quarter, while interest rate sensitive sectors, such as real estate, posted better performance as yields backed off in the quarter from their climb earlier in the year.

Portfolio Strategy

• The Fund outperformed the index in the second quarter, based on Class I shares. Consumer discretionary and health care drove much of the outperformance. Technology also performed well, as did the industrials names relative to the sector within the index. Our underweight position in the weak materials group was a modest positive in the quarter, while the underexposure to energy was a negative. Consumer staples and financials underperformed the index and were negative to relative returns. The Fund has no exposure to telecommunications or utilities, both of very small weight within the index, and had no impact to performance. The Fund has no exposure to real estate, a group that outperformed in the quarter, creating a very slight drag to our relative performance.
• Our consumer discretionary names made the strongest contribution to relative performance in the quarter. We were significantly overweight this outperforming group, an opportune positioning as investors came to understand that the world may not be coming to an end for all retailers, as evidenced by a broadly strong holiday season, and improved results as investments in their businesses begin to bear fruit. Lululemon Athletic, Tiffany & Company and Tractor Supply all posted strong returns. The biggest positive contribution in both this sector and the Fund came from Chipotle Mexican Grill, where new management and improvement in sales results translated into strong returns for this name.
• Our technology names continued their run of outperformance, now six quarters strong. We were underweight this slightly outperforming sector, but stock picking drove performance. Pandora Media turned in a particularly strong result. This is a welcome result from a stock that has been troubled for several years by management missteps and competitive encroachment. New management is working diligently to move the business strongly forward. Electronic Arts, Square and Guidewire all turned in strong performances and made solid positive contributions to the Fund’s relative return. MercadoLibre, Inc. was the weakest name in the group, a result of related currency weakness and investor concerns of investments in the business, particularly with respect to distribution and delivery.
• Our health care stocks posted another quarter of strong performance, more than doubling the performance of the sector within the index. We were overweight this outperforming sector. Strength in Abiomed and Intuitive Surgical led the outperformance. BioMarin Pharmaceuticals and Laboratory Corporation of America also delivered strong returns.
• Our industrials exposure made a strong contribution to relative performance. We were overweight this underperforming group, so stock picking was key. Names of note included TransUnion, CoStar Group, Expeditors International of Washington and Westinghouse Air Brake Technologies Corporation. We had no exposure to energy.
• Financials made a modest negative contribution to relative returns. We were overweight this underperforming group, and with respect to stock selection, performance of our banks backed off as interest rates receded in the quarter.

Outlook

• We see the environment as on-balance constructive for corporate profit growth and firm markets. Economies are still growing synchronously around the world, businesses are optimistic, which usually feeds on itself in terms of generating more activity, and consumers are employed and enjoying wage gains. A corporate profit picture that is already firm will be enhanced by the tax legislation passed by the U.S. Congress at the end of 2017.
• We expect the market to continue to move higher, but we also understand that we must consider valuation levels as we invest. The valuation differential between growth and value stocks is at a historically wide level, a situation that eventually corrects itself to the detriment of the group in favor, in this case growth. We think this disparity could persist, given the struggle many companies are having in an economy where innovation is fast and merciless, but there is risk to growth stock investors who turn a blind eye to valuation excesses. Managing position sizes and exposures where there has been great success within the portfolio is a key aspect of risk management.
• We must also monitor interest rates, yield spreads and credit conditions for clues about excesses or concerns that can build in the economy and potentially impact the market as the business cycle progresses. We do not see these issues as sufficient to impede the economy at this time, but it is clear that the level of corporate debt has grown so significantly over the past few years such that any help it might have given to companies using cheaper debt to lower interest expense or enhance earnings through debt financed stock repurchases is waning.
• Further, any company that has used variable rate debt is beginning to see a bigger interest expense bill. These near term pressures on earnings can be counterbalance by the current vibrant demand environment, but this is clearly a trend change that could become a burden to companies should the economic growth weaken. We think the companies in our portfolio are better conditioned to face that environment, as they use much less debt to finance their businesses than the average company in our universe.
• The Fund continues to express a more economically constructive and optimistic view, with a more assertive progrowth, less defensive stance – although slightly less so than in 2017.
• The Fund is overweight consumer discretionary, financials, health care and industrials. We still have a healthy exposure to technology, but had moved to an underweight position, having seen valuations increase dramatically in this sector, and enjoyed significant appreciation in our names. Technology valuations are more reasonable post the recent stock market down draft, so we have renewed interest in adding exposure to that sector. We are also underweight consumer staples. We are underweight materials, and have no exposure to telecommunications, real estate, utilities and energy. Within the last year, energy was added to the “no exposure” list, as the secular trends for growth and efficient capital deployment in that sector are challenged, and we think we can invest more productively elsewhere.
• While our portfolio represents an economically constructive point of view, our approach is essentially balanced based on stock selection as opposed to overt sector allocations. From a broader perspective, we expect a stable-to-rising rate environment to be generally positive for our approach.

The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2018, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon. Past performance is not a guarantee of future results.

The Russell Midcap Growth Index measures the performance of the mid-cap growth segment of the U.S. equity universe. It is not possible to invest directly in an index.

Top 10 holdings (%) as of 06/30/2018: CoStar Group, Inc. 3.3, Zoetis, Inc. 2.9, Electronic Arts, Inc. 2.9, GrubHub, Inc. 2.9, Chipotle Mexican Grill, Inc. 2.8, Intuitive Surgical, Inc. 2.8, Tractor Supply Co. 2.7, Fastenal Co. 2.5, Tiffany & Co. 2.5 and Polaris Industries, Inc. 2.3.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Investing in mid-cap growth stocks may carry more risk than investing in stocks of larger more well-established companies. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.