Market Sector Update

• The turn of the calendar into 2021 did little to slow the markets down, as the Russell 2000 Index followed up its strongest quarter ever with another double-digit gain in the first quarter of 2021. However, all was not smooth within the Index as the 10-year U.S. Treasury interest rate rose from 0.92% to 1.75% during the quarter, triggering a rally in cyclical stocks at the expense of growth stocks. This rate move appears to be reflecting higher inflation expectations on the back of unprecedented fiscal and monetary stimulus and greater confidence in domestic growth as the U.S. vaccination effort has accelerated relatively smoothly.
• The newly inaugurated Biden administration proposed and worked through Congress a $1.9 trillion aid package in March, on top of the $900 million the Trump administration cleared in December. Additionally, President Joe Biden introduced a $2.25 trillion infrastructure proposal at the end of the quarter, aimed at a wide range of investments from roads and bridges to technology research and development, partially funded with an increase in the corporate tax rate. The amount of fiscal spending over the last year in response to the pandemic dwarfs any other time period, and with a Federal Reserve that is no rush to tighten monetary policy, higher inflation expectations are completely reasonable and should be accounted for in portfolio construction.
• Higher rates and higher expected economic growth positively impacted sentiment for small cap stocks, as small cap exchanged-traded funds saw their highest quarter of inflows ever. Well-documented short-squeezes in stocks like Gamestop and AMC Entertainment drove volatile day-to-day index performance, particularly early in the quarter. Overall, the Russell 2000 Index returned more than 12.5% in the first quarter after posting a better than 19% return in 2020, led by cyclical sectors energy (+41.9%), consumer discretionary (+26.6%), and materials (+20.0%). Unsurprisingly, sectors with higher valuations or those that are more rate sensitive underperformed, with health care (+0.4%), utilities (+3.4%) and information technology (+5.2%) lagging.
• While we are clearly not completely out of the woods with the pandemic given recurring lockdowns in Europe, virus variants, and global vaccine rollout hiccups, we are drawing nearer to a resumption of normal life. Investors are positioning for this rebound as evidenced by the furious rally from the bottom, but the question will be whether the expectations can be met. As the reopening uncertainty starts to clear over the coming months and quarters, some companies will exceed expectations and some will fail to meet them, but the return of a more normal cadence of business should help the market be more driven by fundamental business performance as opposed to the more thematic and macro-driven trading we have seen over the last year.

Portfolio Strategy

• The Fund produced a positive return in the quarter and exceeded its benchmark. The Fund ended the quarter in the top half of its peer group in a period where nearly three-quarters of funds in the category outperformed the index.
• Performance for the quarter was driven nearly equally between stock selection and allocation. Higher beta, less expensive, and smaller stocks outperformed again though with a higher quality tilt than the previous two quarters. As a result, the environment shifted somewhat in our favor stylistically.
• The Fund saw positive attribution out of seven sectors, led by health care, communication services and financials. Consumer discretionary, materials and information technology detracted for the first three months of the calendar year.
• 60% of the top 20 average holdings produced positive attribution this quarter and contributed more than 70 basis points to outperformance. TripAdvisor, Inc., Coherent, Inc., and Gap, Inc. were the highest contributors to attribution, while 2U, Inc., Switch, Inc., and Encompass Health Corp. dragged on performance.
• The additions the Fund had made to cyclical companies over the past few quarters were rewarded in the quarter, and predicted beta remains higher than usual (5 yr. average beta for the Fund has been just under 0.9 and now we are in the mid-0.9 range) as we expect the benefits from stimulus and reopening to boost more economically sensitive areas for at least several more quarters as we see outsized economic growth.

Outlook

• With vaccination progress continuing, some answers around how the economy will emerge from the pandemic will soon become clearer. Industries that may have been permanently transformed may be overlooked as the market has gotten excited about stocks that stand to benefit from reopening. The normalization of the economy post-pandemic will create opportunities as perceptions and realities get recalibrated.
• The start to 2021 was encouraging relative to the benchmark, and we hope to build off that throughout the year and over the rest of the cycle through our commitment to identifying quality, underappreciated companies and constructing them thoughtfully into the portfolio.

The opinions expressed are those of the Fund’s manager 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, 2021, 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 Russell 2000 Index is an index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. It is not possible to invest directly in an index. The Purchasing Managers' Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

Top 10 holdings as a % of net assets as of 3/31/2021: 2U, Inc. 3.2%, Encompass Health Corp. 3.1%, Skechers USA, Inc. 3.0%, Beacon Roofing Supply, Inc. 2.8%, Triton International Ltd. 2.7%, Regal-Beloit Corp. 2.6% LPL Investment Holdings, Inc. 2.6%, Pinnacle Financial Partners, Inc. 2.5%, Envista Holdings Corp. 2.5%, Tabula Rasa HealthCare, Inc. 2.5%.

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. 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. Investing in small-cap growth and value stocks may carry more risk than investing in stocks of larger, more well-established companies. Growth stocks may be more volatile or not perform as well as value stocks or the stock market in general. Value stocks are stocks of companies that may have experienced adverse developments or may be subject to special risks that have caused the stocks to be out of favor and, in the opinion of the Fund’s manager, undervalued. Such security may never reach what the manager believes to be its full value, or such security’s value may decrease. The Fund typically holds a limited number of stocks (generally 40 to 60). As a result, the appreciation or depreciation of any one security held by the Fund may have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger 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.