Market Sector Update

• Optimism around a phase one trade resolution between the U.S. and China, ongoing monetary loosening from central banks and merger and acquisition (M&A) activity in the biotechnology space helped propel the strong fourth quarter performance of the Russell 2000 Index, the Fund’s benchmark. Despite deteriorating PMIs and earnings estimates, the market began pricing in the bottom of a small industrial recession and rewarded those companies that would stand to benefit the most from a pick-up in economic activity.
• While encouraging, the phase one agreement between the U.S. and China has not addressed many of the key issues between the nations, such as subsidized competition and robust intellectual property protections. With the lowhanging fruit now out of the way, headlines around the next rounds of negotiations have the potential to be an overhang to markets and the economy once they begin.
• With inflation still running below target, the U.S. Federal Reserve has set a fairly high bar to raise rates again, creating a backdrop of easy financial conditions that are supportive of asset prices in the near-term. Given the elevated amount of leverage already on corporate balance sheets, it is unlikely that the continuation of low rates will spur much incremental borrowing or capital investment.
• The health care sector (up 22%) led the benchmark higher as increased M&A activity in the biotechnology and pharmaceuticals space resulted in the two industries contributing over a quarter of the return of the index by themselves. In addition, the cyclical rally that began the previous quarter continued into the fourth quarter as information technology (up 12%, led by semiconductors) and materials (up 12%) followed as the top performing sectors for the period.
• Going forward, the questions likely to dominate investors’ minds are centered on the realization of an anticipated cyclical recovery in 2020, the U.S. elections, ongoing trade negotiations, and implications of rising geopolitical tensions. We continue to believe a balanced approach to sector and style allocation with a bias toward higher quality companies is warranted given the mixed outlook.

Portfolio Strategy

• The Fund delivered a positive return for the quarter, but underperformed its benchmark.
• The majority of this underperformance was due to a lack of exposure in biotechnology and pharmaceuticals within health care and weakness of a top position, Vonage Holdings Corp., which executed poorly in the quarter and is now experiencing greater concerns regarding competition.
• Across the 11 sectors in our benchmark, we had positive performance attribution in four, with energy, technology, and real estate performing the best. While the remaining sectors were negative, the two biggest detractors were health care and communication services (Vonage), which accounted for over 90% of the shortfall. In terms of the negative attribution from health care, we were not alone as many managers were underweight the biotechnology and pharmaceutical industries that drove the outperformance. This was also evidenced by only 15% of peers outperforming the benchmark for the period.
• The top 20 average holdings provided a performance headwind of roughly 130 basis points (bps) with Vonage representing just over 110 bps of the drag.
• Three holdings contributed performance attribution greater than 25 bps in the quarter, with one stock contributing more the 50 bps. Conversely, six stocks detracted more than 25 bps and one detracted more than 50 bps. On net, biggest performance drivers detracted nearly 100 bps from the performance of the Fund.
• We have continued the process of positioning the portfolio to have a more balanced orientation from the more defensive posture we took in the first part of the year. With 60 stocks in the portfolio, we also continue to be at the high end of our stated range yet continue to have over 50% weighting in our top 20 holdings.
• Overall, this was a difficult quarter in that our highest conviction ideas did not deliver and areas of the market where we don’t traditionally frequent were leadership. While frustrating, we remain committed to our process and continue to believe that it will prove out over time as it has in the past.

Outlook

• Looking forward into 2020, we hold to our view that the business cycle is still in its later stages. When it ends is hard to exactly predict, but we believe having a sharper focus on risk at this stage is warranted.
• While it might be true that this is just a mini cycle that we just experienced (within a broader cycle), and this cycle could be longer than what has been experienced historically because of its lower slope and the magnitude of the last recession we do not believe that we will see a substantial reacceleration in global growth wherever in the cycle we reside.
• Not only do we believe that China, one of the biggest growth engines over the past decade, will see moderating growth, but we also believe that globally demographics are a headwind, interest rates are already very low across the world, leverage is high, and that much stimulus has already been exhausted (major cut in taxes dramatically and lots of deregulation.)
• How this all translates to equity returns remains to be seen, but it would seem logical that if growth slows returns would follow suit.
• Independent of what the market holds we believe our process of identifying quality, underappreciated companies coupled with thoughtful portfolio construction will set us up to outperform our peers and benchmark over time.

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 Dec. 31, 2019, 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.

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.