Market Sector Update

• We believe a recession is here, but it’s not the downturn that investors were expecting. The COVID-19 pandemic has the economy facing what might be the worst downturn since shortly after World War II, but the Federal Reserve (Fed) and U.S. government are using all policy levers to soften the blow. We’re experiencing a multi-pronged challenge – what will likely become unprecedented employment weakness, a correction in asset valuations, a liquidity squeeze, a collapse in energy prices, and an upturn in defaults stemming from high corporate leverage and pandemic-specific shocks. Uncertainty is exceptionally high, placing a premium on a strong framework for assessing new information.
• The Fed re-instituted liquidity facilities developed during the great financial crisis and added a new facility to support the corporate bond market directly. In addition, the federal funds target was virtually cut to 0%. The U.S. Congress is doing its part, too. After passing legislation to fund COVID-9 vaccine research and an additional $104 billion in increased state aid, it passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, an unprecedented $2 trillion bill of support, targeting hard hit segments of the economy. It includes $1.2 trillion in direct support for consumers and small businesses, and $500 billion in first loss capital and direct lending to affected industries, healthcare funding, and increased unemployment benefits, including broadened access.
• The COVID-19 pandemic is driving highly correlated downturns in certain segments of the economy. The outlook is especially daunting for the consumer and certain commercial real estate property sectors primarily retail and hotels. It remains to be determined the long-term impact on office demand, but the co-working business model appears dead and the resulting influx of that space back to landlords will drive up vacancy levels and depress rental rates. In the short-term it is likely that most real estate owners, regardless of property type, will deal with tenant fallout and requests for rent relief and/or lease modifications.

Portfolio Strategy

• The Fund delivered a negative return, but outperformed its benchmark for the quarter.
• Favorable sector allocation was the primary driver of the portfolio’s superior relative performance, although individual stock selection was also a material contributor. The most pronounced drivers of performance included an overweighting to datacenter and cell tower owners, and an underweight to retail and hotel owners. The Fund also benefitted from favorable stock selection in the office sector.
• Datacenter and cell tower real estate investment trusts (REITs), which both provide real estate that is essential for those working or learning from home, significantly outperformed the broader REIT index in the quarter. Demand for space remains strong, with enterprise migrations in datacenters and 5G build outs in towers expected to accelerate. At the same time, edge and cloud computing, mobile data usage growth, and artificial intelligence are all expected to provide tailwinds to demand for the foreseeable future. We continue to see the communications infrastructure names as attractively valued when considering their growth prospects and defensive lease structures, and the portfolio remains overweight to this sector.
• Retail REITs grossly lagged the broader REIT group in the quarter. The shopping center and mall sectors were two of the portfolio’s largest underweight positions, which aided relative performance. While the sub-sector has been battling concerns over tenant health for several years, the Covid-19 pandemic magnified those concerns as numerous tenants were under government-mandated closures for part of the quarter. While the full magnitude of the impact on REIT income statements remains to be seen, we expect rental cash flows to be severely impacted for at least the next several quarters and we remain underweight the space.
• The shutdowns and stay-at-home orders that impacted much of the world in March had a particularly acute impact on hotels and the REITs that own them, with many hotel REITs reporting unprecedented drops in occupancy numbers. Stock prices for these companies followed suit and lagged the REIT group significantly. The sub-sector positively contributed to relative performance, as the portfolio shifted to a relative underweight position to the space in the middle of the quarter. We expect the next several quarters to be challenging for this group. Current portfolio positioning is focused on names with better balance sheets and more defensive demand characteristics.
• Office stocks underperformed the index, but selection decisions within the sector aided the portfolio’s relative performance. A long-held overweight position in biotech/life science owner was a sizable outperformer. This company continues to benefit from owning an A+ portfolio of buildings with a highly attractive tenant roster. Near complete avoidance of New York City (NYC) office owners also benefitted the portfolio. Owners of NYC office face significant challenges now and into the foreseeable future with the collapse of shared office space, and the likelihood that dense urban office leasing will become taboo in the post-COVID-19 world.

Outlook

• We believe it’s prudent to acknowledge that the outlook for the economy and commercial real estate is murky at best right now. Indeed, the same could be said for most all portions of the investment landscape. The dramatic decision to essentially shut down the U.S. economy – and worse, the primary engine of its growth: the consumer – as well as the lingering effects of that necessity will likely continue to weigh on real estate equities.
• As for the Fund, we were early to react to this downturn and put defensive measures in place in an effort to limit downside participation. We have concentrated our positioning in sectors that we believe will continue hold up relatively well in a tough economic environment – mainly datacenters, cell towers, biotechnology and life sciences offices, as well as single family residential rentals. We have largely stayed away from retail related owners and poorly positioned owners of healthcare facilities.
• Valuations in certain sectors has become historically cheap. We believe a lot of the real estate companies we activity follow, and many we currently own, are currently trading significantly below their intrinsic value.
• Prior to the pandemic outbreak in the U.S. we were unfazed by valuation levels and operations within real estate were solid pretty much across the board. Given time we are confident those conditions will return, but now isn’t the time to go “bottom fishing” in the space. We expect there will be (and have been) REITs who will suffer occupancy losses and will be forced to cut their dividend. It is likely these holdings will not be found in our portfolio. We are sticking with our quality bias in our companies’ property holdings, balance sheets, management teams and operational acumen.

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.

All information is based on Class I shares.

The FTSE NAREIT Equity REITs Index is designed to present investors with a comprehensive family of REIT performance indexes that spans the commercial real estate space across the U.S. economy. The FTSE NAREIT Equity REITs index contains all Equity REITs not designated as Timber REITs or Infrastructure REITs. The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. 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. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. Because the Fund invests more than 25% of its total assets in the real estate industry, the Fund may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. 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.