Market Sector Update

• Mid-cap growth stocks staged a dramatic 16% decline in the fourth quarter of 2018, erasing the year’s earlier gains and more, and landing the Russell Midcap Growth Index, the Fund’s benchmark, at an almost 5% deficit for the year. This was the first quarterly loss for the index in more than three years. The index had been on a streak of positive quarterly performances that started in the fourth quarter of 2015.
• Outperformance within the index came from the consumer staples, real estate, communication services, materials, consumer discretionary and information technology sectors. Only consumer staples and real estate showed any substantial outperformance versus the index as both sectors posted low single-digit declines. The other outperforming sectors were only slightly worse than the index in the quarter. Energy turned in the worst performance, falling 25%. Health care, industrials and financials posted steep declines in the high teens.
• Concerns over Federal Reserve (Fed) policy and the direction and level of interest rates, plus a shift in business confidence related to the trade and tariff uncertainty moved investors to a decided risk-off stance. The market’s valuation was rich, having discounted high expectations for the economy in recent years based on regulatory relief and tax reform. There was no tolerance for uncertainty, and stocks across all aspects of the mid cap universe – growth, core and value – traded off hard, with the indices all declining in sync, within 1% of each other.

Portfolio Strategy

• After significantly outperforming the index over the course of 2018, the Fund slightly underperformed the index for the quarter ending Dec. 31, 2018 (based on Class I shares). The consumer discretionary, information technology and communications services sectors drove much of the underperformance during the period.
• Our consumer discretionary names had been a source of significant outperformance for much of 2018, and while many of our holdings fared relatively well in the quarter, three of our names, GrubHub, Tiffany and Mohawk Industries, were responsible for much of the group’s weakness. GrubHub and Tiffany both guided investors to expect increasing investments in their businesses, a result not well-received by investors who were already becoming nervous about the earnings trend for the market, in general. Further, Tiffany cited slower topline results due to weaker Chinese tourism in its markets. Mohawk was a more recent and ill-timed investment that suffered due to a number of near term shortcomings at the company, including raw material and freight costs, capital investments to meet demand, and a competitive environment that is pressuring pricing. Many of the issues at the company have proven to be more intransigent than we anticipated. We have sold Mohawk given the depth of the issues and likely protracted work-out period ahead of the company.
• Our information technology exposure was weak relative compared to the index. We were underweight this sector in the quarter, as we have been much of the year. One name in particular, Square, accounted for much of the underperformance from our technology names. The business continues to grow nicely, but an announcement from the company during the quarter that it’s well-regarded CFO would depart to become CEO of another small technology firm resulted in considerable weakness in the stock. Its high multiple was also a liability as the market devalued across the quarter.
• The underperformance from our communications services stocks came largely from Electronic Arts, a sizeable and long-standing position in the Fund. A deceleration in the growth of the company’s highly profitable live services business and the delay in the launch of an important game were not well-received by investors.
• Our industrials sector underperformed. We were overweight this underperforming group and saw drawdowns across the group in the quarter that resulted in weakness relative to the sector in the index. Westinghouse Air Brake Technologies, CoStar Group and TransUnion drove the most significant share of this underperformance for reasons related to concerns about global economic weakness, as in the case of Westinghouse; high multiples on growth stocks, in the case of CoStar; and concerns about demand for credit, primarily in the mortgage market, in the case of TransUnion.
• Fund outperformance in the quarter came from the health care, financials and energy sectors. Our health care names fared quite a bit better, on average, than the stocks in the index, which fell almost 20%. In our exposure, Zoetis was a standout given its defensive and stable business in animal health care. Where we saw weakness, it was often related to significant multiple compression on highly valued growth stocks such as Abiomed and Seattle Genetics. Laboratory Corporation of America, a typically more defensive stable growth company, was quite weak related to demand weakness in its diagnostics business.
• Our financials names largely withstood the thrashing characteristic of those in the index, and in fact, our exchange stocks, MarketAxess Holdings and CME Group, both rose in price in the period. Our general lack of exposure to the capital markets and credit names was a plus for relative performance, and our bank holdings performed relatively well, with the exception of SVB Financial, which disappointed investors with soft guidance related to higher expenses. The company is also closely aligned with the technology sector as its customer base, and generally performs poorly when the technology stocks are weak.

Outlook

• Our portfolio 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 or early 2018. 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 macroeconomic factor perspective, we expect a stable-to-rising rate environment to be generally positive for our approach, related to our focus on very profitable business models and sound capital structures. The time of quantitative easing was a challenge to our returns, as lower and lower interest rates played to the benefit of the stocks of companies with lesser quality business models and/or capital structures. We expect the change in trend to favor our investment style.

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 Dec. 31, 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.

Top 10 holdings (%) as of 12/31/2018: Chipotle Mexican Grill, Inc. 3.1, Zoetis, Inc. 3.0, CoStar Group, Inc. 3.0, Tractor Supply Co. 2.8, Electronic Arts, Inc. 2.3, ServiceNow, Inc. 2.3, Ulta Beauty, Inc. 2.2, Edwards Lifesciences Corp. 2.2, Intuitive Surgical, Inc. 2.0 and O’Reilly Automotive, Inc. 2.0.

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.

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.