Market Sector Update

• Real estate stocks delivered solid return for the quarter, with real estate investment trusts (REITs) outperforming the broader market.
• A handful of announced mergers and acquisitions (M&A) and better than expected reported results aided the performance of several sub-sectors, but REITs were roughly in line with the broader market until mid-quarter.
• As the quarter progressed, concerns about the impact of trade wars and stabilization in interest rates led to a shift to higher-yielding and more defensive stocks, including REITs, leading to the outperformance versus the broader equity market into quarter end.
• Even after this recent strong run, REITs continue to trade at discounts to the private market value of their properties; we expect selective M&A activity, with REITs either taken private or purchased by other public companies, to close that discount.

Portfolio Strategy

• The Fund underperformed its benchmark for the quarter.
• Sharp reversals toward slower-growth, defensive oriented stocks were the primary driver of underperformance for the quarter. The portfolio has been constructed to take advantage an environment characterized by accelerating economic growth, modestly rising inflation, higher interest rates, and a somewhat stable political landscape. Those conditions, which were prevalent in the first quarter, stalled for the most recent period.
• Data center REITs lagged the broader sector for the second consecutive quarter, with increased tenant turnover and decreasing yields on new developments suggesting that supply pressures could be ramping. That stated, record lease signings and growing leasing funnels, combined with the tailwind from increased adoption of cloud and edge computing, artificial intelligence, and data analytics, suggest strong upcoming earnings growth and we are overweight to the group.
• Following a lackluster first quarter, health care REITs were among the top performers on a total return basis for the period. A supportive regulatory pronouncement for skilled nursing, one of the most beleaguered facility types, also drove the sector. We have closed the gap on our underweight position to the group, recognizing the benign interest rate environment and the current reversal of sentiment.
• Retail REITs outperformed the broader sector. Expectations were low for the group going into quarterly earnings; with results being better than feared for earnings and tenant performance also coming in strong, most names rallied. While we added to our holdings in shopping centers in the quarter, we decreased our mall holdings and we remain underweight to retail, with the belief that store closings and leasing costs will remain elevated and mute returns for the space.
• Hotels outperformed in the quarter, benefitting from better than expected quarterly revenue and earnings growth, strong weekly demand and pricing data, and a series of increased M&A bids. We remain overweight the group, with our holdings favoring hotel operators over hotel owners. This weighting mix detracted from performance in the quarter.

Outlook

• With regard to the current commercial real estate cycle, we continue to see stable operating conditions across the sector with few material concerns on the horizon. Bank lending, commercial construction, equity allocations and overall pricing metrics remain much healthier than was often the case in previous cycle peaks. As we’ve previously suggested, simply moving into the later stages of this recovery does not mean the sector’s fundamentals will turn negative. In fact, the prospect for re-acceleration of earnings growth for 2019 appears quite plausible if current expectations for corporate earnings materialize.
• We continue to believe that REIT share price performance will be heavily influenced by macro events, with support coming from an improving economy and gross domestic product growth while potentially rising borrowing costs, such as a rising 10-year U.S. Treasury yield, could offer resistance. Should expectations for economic growth promote a sharp, sustained rise in U.S. Treasuries, REIT stock prices will likely struggle.
• Valuations of private market transactions continue to support REIT valuations, suggesting REITs currently trade at a discount to net asset value, while REIT pricing compared to broader fixed income and equity markets also looks attractive compared to historic averages. Significant fund raising in real estate private equity funds suggests further support for real estate valuation.

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 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. 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. 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.