Market Sector Update

• Tied to the acceleration of the coronavirus pandemic, unemployment saw one of the biggest jumps in U.S. history, reaching approximately 15% after being close to record lows only weeks prior. With this change, consumer sentiment and spending, the Purchasing Managers' Index, industrial production and forward earnings estimates correspondingly plunged. Unprecedented global fiscal and monetary stimulus soon followed, which was implemented with uncharacteristic rapidity, and appears to have helped steer the economy from a certain depression, buttressed economic activity and triggered a furious rally in markets all in the matter of days.
• The Russell 2000 Index, the Fund’s benchmark, acted like many other indexes during the quarter, rebounding rapidly after hitting a bottom on March 18. The index retraced more than 75% of its losses by early June before fading the remainder of the month to end the quarter down 13% year to date (YTD). While volatility and credit spreads have relaxed from their peaks, they remain in an elevated state reflecting the continued uneasiness in the market. Apart from utilities, all sectors of the benchmark posted double-digit positive returns in the second quarter, led by consumer discretionary (+58.1%), health care (+32.4%) and materials (+29.2%). Utilities (-3.7%), financials (-11.5%) and real estate (- 15.2%) were the laggards.
• The soft landing the Federal Reserve (Fed) was trying to engineer with three interest rate cuts between July - November 2019, rapidly turned into crisis management in March. In total, the federal funds rate was cut by 175 basis points (bps) and is now back to its lower bound. Global central banks have taken similar action and unleashed massive liquidity into their respective markets to combat seizures in funding markets stemming from virus-related shutdowns. In addition, fiscal programs –some exceeding 10% of gross domestic product (GDP) in certain countries, including the U.S. – have been launched in an attempt to help both businesses and consumers bridge the gap until daily life can return to some semblance of normalcy.
• While the enormity of the fiscal and monetary response in the U.S. has been nothing short of stunning, it is not inherently a job creator. How companies and the consumer respond when stimulus wears off and at what level economic activity plateaus after rebounding from extreme lows remains an unknown. Some of what has happened is not fixable in short order. It would not be surprising for it to take several years for the overall economy to recover from a shock of this magnitude.
• Another unknown is how the pandemic progresses. While we are more inclined to believe the worst is behind us we also believe a vaccine will be required for life to return close to normal. Given the intense global effort currently being invested in discovery there is a decent chance success will likely come much sooner than history suggests. However, even after finding a vaccine the challenges of ramping of production and garnering public adoption remain. The bottom line is that even if all goes well a solution is unlikely to be found until mid 2021 at the earliest.

Portfolio Strategy

• The Fund posted a positive return for the quarter, but lagged its benchmark for the period. The Fund now trails the benchmark YTD, placing it closer to the middle of the pack versus its peers.
• There are three primary drivers for the underperformance in the quarter. First, due to how the strategy is managed – higher weighted market capitalization, higher quality and a consistent tilt to lower beta than the market – makes it vulnerable during extreme periods of risk on. This period would qualify as it was the third best quarter ever for the benchmark. We believe that over a full cycle we can more than compensate for this, but in shorter time periods this can create headwinds, which it did. Second, independent of being more conservative in our approach we also admittedly underappreciated the speed and depth of the government’s response to the crisis and the enormous impact it would have on markets. While this is far from concluded, we missed opportunities to add more risk assets during the selloff. Lastly, with concentration you can sometimes overcome portfolio construction obstacles and missed opportunities, but during this period it was quite the opposite, we also struggled at the top of the portfolio.
• Overall, the underperformance was primarily driven by stock selection with some negative impact from allocation. The best performers in the index tended to have higher beta, lower return on equity and were small. These attributes are not as prominent in our construction. Over half of the negative attribution came from the health care sector as an underweight in biotechnology, which thrived in the risk on environment, was a big drag and poor stock selection elsewhere drove the remainder. We also trailed in the consumer discretionary sector for many of the same reasons: we were underweight and not taking great enough risk. Positive stock selection in financials, information technology and energy offered some relief to what proved to be a tough quarter.
• The Fund generated positive attribution in five of the 11 sectors in comparison to the benchmark, with financials, materials and information technology performing the best. The largest detractors were health care, consumer discretionary and industrials.
• The top 20 average holdings struggled in the quarter, amounting to greater than 500 basis points (bps) in underperformance.In terms of the biggest contributors and detractors (those greater than 25 bps or more to attribution) they netted to detract just over 450 bps from performance.

Outlook

• It remains to be seen whether monetary and fiscal stimulus can fully and effectively bridge us to the other side of the economic crater caused by COVID-19 pandemic. It has certainly softened the initial blow, though cases have surged recently in some areas of the U.S. and put a stall on re-openings. We believe focused responses to localized hotspots will be the norm going forward and broad, nationwide lockdowns will not recur.
• Given the uncertainties outstanding and the retraction of company guidance across most of the market, Wall Street and investors have limited visibility, which has led to a wide dispersion in earnings estimates and expectations. This has the potential to create tremendous volatility and opportunities that hopefully we can exploit.
• While we were very disappointed by our performance in the quarter the year is far from over, and we believe in our process of identifying quality, underappreciated companies coupled with thoughtful portfolio construction. We fully expect to recover and deliver results more in line with our history as the year progresses.

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 June 30, 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 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.

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.