Market Sector Update

• The black swan theory developed by Nassim Nicholas Taleb is an event with the following three attributes: 1) it is an outlier, as it lies outside the realm of regular expectations, 2) it carries an extreme impact, and 3) despite its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable. COVID-19 is truly a black swan event. As of this review, we have been sequestered to our homes, Disney is not welcoming guests, movies, sporting events and Broadway shows have been cancelled, and people are fearful to go to the hospital or their doctors' offices. With anxiety, fear and economic destruction occurring due to the virus, the Russell Midcap Index (Fund’s benchmark) was down 27.1% during first quarter. Investors and economists are still struggling to assess the depth and duration of downturn. While all sectors within the benchmark generated negative returns in the quarter, the more defensive sectors – health care, consumer staples and utilities – were the best performing areas of the market. Information technology also outperformed with relative strength in software.
• Long-term interest rates decreased 1.2% ending the quarter at 0.7% on 10-Year US Treasuries. Despite a decisive riskoff environment, dividend payers significantly underperformed non-dividend payers. Those stocks with a dividend yield of greater than 2.8% (the top quintile of dividend yield) underperformed the benchmark by 9.10%. This continues the trend that was evident throughout most of 2019 despite a significantly lower interest rate environment, which should have benefited income-producing equities particularly relative to fixed-income markets. Given the evaporation of revenue for many sectors, dividend sustainability became a significant concern.

Portfolio Strategy

• The Fund posted a negative return for the quarter, underperforming its benchmark. Dividend income added to performance in the period. Sector allocation explained the negative variance to performance owing to overweight positions in both consumer discretionary and energy and underweight positions in health care and information technology. Allocation to high-dividend paying securities was also a sizable detractor to relative performance.
• Energy produced the worst relative performance during the quarter. We were overweight the significantly underperforming sector with exposure to the volume driven sector of oil and gas pipeline companies. Given the significant decline in oil prices altering a view from volume growth to volume contraction in the U.S., the pipeline companies we owned, Targa Resources and Rattler Midstream, experienced significant contraction in equity prices. We sold Targa during the quarter as we questioned its ability to sustain its dividend over the medium term given the lower levels of production. The Fund also experienced underperformance in the communication services sector. We own Cinemark, a movie theater operator in the U.S. and South America. Given the impact of COVID-19, Cinemark closed all of its theaters to comply with local and national social distancing guidelines.
• Consumer discretionary was also an area of weakness for the Fund. Cracker Barrel Old Country Store and Wyndham Destinations are very strong cash flow generators in normal economic times and have shown the desire to return that cash flow to investors. Unfortunately, these are not normal times and like Cinemark, both businesses have been dramatically impacted. Financials produced the best relative performance in the quarter. Materials was also an area of strength for the Fund. All stocks owned in this sector outperformed the benchmark and the sector.

Outlook

• We continue to watch several key variables to determine Fund positioning. These variables (domestic economic growth, change in interest rates, change in commodity prices and foreign economic growth) have remained consistent and continue to be monitored. Second quarter 2020 gross domestic product (GDP) estimates vary greatly and all forecasters point to little confidence in their numbers as they are seemingly declining at a daily pace. At this point, we don’t know how bad it is going to be and can’t use history as a guide. We can do a bottom-up forecast by eliminating those industries that have shuttered their doors; however, we don’t know the tangential impact to other industries, except to say that we feel for the clear majority, it is negative. It is our belief, this situation will be relatively short-lived, and the U.S. economy will quickly bounce back once the virus concern has passed. Supporting this belief are the significant quantities of fiscal and monetary stimulus that have been put in place to support the U.S. economy.
• As we extend our forecasting time to beyond the havoc, we are left asking, “Do we believe there are structural shifts that will cause step function changes versus the long term trend line of the economy and various sectors?” To date, our general answer is “No.” On the margin, more employees will work from home. Adoption rates of e-commerce and streaming video will retain the step function benefit that has occurred. However, over the medium term, we expect people will return to going out to restaurants, taking vacations and watching sporting events at the same level prior to self-quarantine.
• The Federal Reserve (Fed) has responded swiftly and significantly to the virus, lowering the fed funds rate to 0% and deploying a plethora of programs designed to ensure ample liquidity and healthy market functioning. Interest rates have significantly compressed across the treasury curve and lending spreads have increased due to the economic uncertainties. The Fed has made it clear it will likely keep the short end of the curve low for the medium term, which will anchor rates preventing them from significantly increasing. As time passes, our expectation would be rates move higher off the current low base, but are unlikely to return to pre-virus levels given the anchoring put in place by the Fed. We anticipate being able to provide investors with a competitive yield relative to the fixed-income markets over the near to medium term.
• Unsurprisingly, we have seen the industrial commodity complex experience significant pressure during the quarter and that is likely to continue over the near term. Oil has seen a collapse in price given the market share battle between Saudi Arabia and Russia. While production cuts and bankruptcies will marginally help the industry, for a full recovery to occur, demand needs to return, and supply needs to be curtailed.
• We are acutely watching the health and economies of China, Italy and South Korea with the current view of first-in, first out regarding the virus. China appears to be on the other side of the virus with stores re-opening and factories ramping up. It remains to be seen how quickly demand will recover. Central bankers and fiscal policies are mirroring some of the efforts in the U.S. to support markets by adding needed liquidity into systems and providing significant stimulus.

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 March 31, 2020, 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 03/31/2020: RPM International 3.4, L3Harris Technologies. Inc. 3.4, Maxim Integrated Products, Inc. 3.4, Ares Management Corp. 3.4, Hasbro, Inc. 3.4, Glacier Bancorp, Inc. 3.3, Encompass Health Corp. 3.3, Garmin Ltd. 3.3, Scotts Miracle-Gro Co. 3.2 and Avery Dennison Corp. 3.2. All information is based on Class I shares.

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

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. 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. Investing in mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. The Fund’s emphasis on dividend-paying stocks involves the risk that such stocks may fall out of favor with investors and underperform non-dividend paying stocks and the market as a whole over any period of time. In addition, there is no guarantee that the companies in which the Fund invests will declare dividends in the future or that dividends, if declared, will remain at current levels or increase over time. The amount of any dividend the company may pay may fluctuate significantly. In addition, the value of dividend-paying common stocks can decline when interest rates rise as fixed-income investments become more attractive to investors. This risk may be greater due to the current period of historically low interest rates. The Fund typically holds a limited number of stocks (generally 35 to 50). As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a large number of securities. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.