Market Sector Update

• Markets continued to rebound during the quarter with the MSCI ACWI Index posting high, single-digit returns and credit spreads continuing to compress. While Treasury yields did rise slightly on concerns of increased fiscal spending, yields remain near all-time lows.
• The U.S. Federal Reserve (Fed) began to outline its new policy framework, shifting more to an average inflation target and a policy stance more focused on social factors. The European Central Bank (ECB) is undergoing a similar move as major central banks re-evaluate how they conduct policy in a changing world.
• The economy began to rebound as the world learns to deal with the COVID-19 pandemic. More than three million jobs returned in the first two months of the quarter and, as of August, roughly half of the jobs lost since the start of the pandemic have been regained. The unemployment rate has declined at a faster pace than consensus expectations. Similarly, we have seen strong rebounds in housing, personal consumption and manufacturing as low interest rates buttress demand and restocking takes place.
• In September, the market started to experience more volatility as U.S. election uncertainty and sustainability of the economic recovery came into question. Aggressive central bank policy actions ensured markets remained well supported during initial stages of the pandemic, but for a sustaining recovery as the pandemic drags on, more fiscal responses are likely necessary.

Portfolio Strategy

• The Portfolio performed well during the quarter, capturing just over 90% of its all-equity benchmark’s return, with our equity sleeve outperforming that index, offsetting the more muted returns from gold and fixed income within our diversifying sleeve. While equities averaged 65% of Portfolio assets during the quarter, the expected volatility of the Portfolio spent most of the quarter in the top half of our 70-90% target range, largely due to correlations rising across asset classes. While we have mentioned the difficulty of finding attractive less-correlated assets in today’s environment, this rise in correlations appears to confirm that.
• Positive relative returns in equities were driven primarily by positions in information technology and industrials – our two largest sector overweights and where stock selection provided additional tailwind. Stock selection in health care and consumer staples also helped, while our stock picks within consumer discretionary did the most harm. In addition, our U.S. stocks outperformed by more than 2% so it’s fair to say that our slight underweight to the U.S. was also a drag. That said, that underweight has been shrinking during the calendar year.
• Reliance Industries Ltd., an Indian conglomerate classified in the energy sector, once again had a strong quarter, surging another 34% and handily outpacing that sector. As we have pointed out before, our attraction to Reliance stems more from its telecommunications and retail operations, which we believe are very well-positioned in India. Taiwan Semiconductor Manufacturing Co. Ltd. enjoyed a much better third quarter, rising 40% on improved clarity with respect to American trade policy as well as its ever-improving competitive position as competitors slip by the wayside. Our industrial performance was led by Ingersoll-Rand, Inc. as well as Ferguson plc, a British plumbing an HVAC distributor focused primarily in the U.S. We trimmed both positions during the quarter and began a new position in Waste Management, Inc. Our rail exposure also helped, with solid performance from Union Pacific Corp. and Kansas City Southern. Merck KGaA and Zimmer Holdings, Inc. lead our health care performance, both positions having been increased in the prior quarter.
• On the negative side of the equity ledger, within consumer discretionary, strong performance from Adidas AG and Aptiv plc could not offset declines in Subaru Corp. and Dollar Tree Inc. as well as the fact that we did not own Alibaba (+36%) or Tesla (+94%) during the quarter. Sarepta Therapeutics, Inc., a gene therapy company we like and continue to hold, also declined during the quarter along with GlaxoSmithKline plc (-6%). French company Vinci (-10%), along with Airbus SE (+1%), both suffered from continued weakness in commercial air travel, with the former holding concessions in several international airports. We continue to wrestle with what is discounted in these stocks and for what duration, relative to what is likely to unfold in this COVID-19 economy.
• Fixed-income returns during the quarter were pedestrian, with the portfolio returning just more than 1%. Few changes were made to the portfolio during the quarter. We continued to be active in the new issue, investment-grade market, rotating into relatively more attractive new issues. More importantly, several fixed-income positions, which we own on restructuring theses, completed their restructurings. We are optimistic about our ability to realize value from the positions now that they have new capital structures. In our quest to find non-correlated returns, we will at times participate in this market. New Cotai Participation Corp., Frontier Communications Corp. and several issues at both the sovereign and provincial level in Argentina all had resolutions during the quarter, which we are hopeful will lead to future value creation.

Outlook

• While the world has adjusted and learned to live with the COVID-19 pandemic, significant uncertainties still exist. Second wave fears persist and, as we write this, it looks like we may be seeing additional spikes in COVID-19 cases in several countries around the globe. The economic environment still holds a large amount of uncertainty which causes our stance to be relatively unchanged from last quarter. Our equity portfolio still has not seen any large-scale changes. Given some of the valuation dispersions present in the market and what we feel is our inability to accurately predict COVID-19 outcomes, we are very focused on making sure the equity portfolio has as little factor exposure as possible. We are mainly doing that through a heavy focus on bottom-up and individual security selection.
• In the diversifying portfolio, our preference since March to bias incremental dollars towards investment-grade credit is beginning to wane. High-quality spreads now much more accurately reflect risk present in the market as many investment-grade companies have elevated leverage due to hits in revenue and earnings from the pandemic.

The opinions expressed are those of the Portfolio'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 September 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.

Top 10 equity holdings as a percent of net assets as of 09/30/2020: Microsoft Corp., 3.0%; Amazon.com, Inc. 3.0%, Taiwan Semiconductor Manufacturing Co. Ltd., 2.6%; Visa, Inc., Class A, 2.0%; Adobe, Inc. 1.9%; Reliance Industries Ltd., 1.7%, Intuit, Inc. 1.6%, Qualcomm, Inc., 1.6%, Apple, Inc. 1.5% and Union Pacific Corp. 1.5%.

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 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.

The MSCI ACWI Index is designed to measure the equity market performance of developed and emerging markets. The Index consists of 46 country indexes comprising 23 developed and 23 emerging market country indexes. It is not possible to invest directly in an index.

Risk factors: The value of the Portfolio’s shares will change, and you could lose money on your investment. An investment in the Portfolio is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Portfolio may allocate its assets among different asset classes of varying correlation around the globe. The Portfolio’s Equity Sleeve typically holds a limited number of stocks (generally 50 to 70). As a result, the appreciation or depreciation of any one security held by the Portfolio may have a greater impact on the Portfolio’s NAV than it would if it invested in a larger number of securities. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. The Portfolio’s Diversifying Sleeve includes fixed-income securities, that are subject to interest-rate risk and, as such, the net asset value of the Portfolio may fall as interest rates rise. Investing in high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. The Portfolio may seek to hedge market risk via the use of derivative instruments. Such investments involve additional risks. Investing in commodities is generally considered speculative because of the significant potential for investment loss due to cyclical economic conditions, sudden political events, and adverse international monetary policies. Markets for commodities are likely to be volatile and the Portfolio may pay more to store and accurately value its commodity holdings than it does with the Portfolio’s other holdings. These and other risks are more fully described in the Portfolio's prospectus.

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