Market Sector Update

• The spread of COVID-19 dominated both the economic and market backdrop during the quarter, causing nearly unprecedented market volatility. The “viral” impact was exacerbated by falling oil prices, when what began as an expended demand shock was compounded by Russia’s lack of cooperation with Organization of Petroleum Exporting Countries (OPEC) in cutting oil production, and then Saudi Arabia’s reaction to increase its own production punitively.
• Equity markets declined sharply as uncertainty over earnings and liquidity made visibility over valuations difficult. Credit markets experienced a painful leverage unwind that was felt across a broad swatch of instruments. Investment grade, high yield and emerging credit all experienced sharp price declines as did other parts of fixed-income markets, including mortgages, commercial mortgage-backed securities, and Municipals.
• The U.S. Federal Reserve (Fed) initially cut the Federal Funds Rate by 50 basis points at the beginning of March to combat the slowing economy. This proved woefully inadequate and, within a few weeks, rates had been cut to zero and an extensive quantitative easing program was launched that eventually included assets beyond the traditional instruments of Treasuries and agency mortgage-backed securities.
• Fed easing was eventually complemented by a large fiscal policy response to try to combat the dramatic slowing of the real economy. Similar policy steps were taken internationally with many countries enacting fiscal legislation complemented by aggressive monetary policy from global central banks to ease financial conditions.

Portfolio Strategy

• The Portfolio outperformed its global equity benchmark during the quarter. The Portfolio experienced more volatility than expected as asset correlations rose significantly during March. Despite entering the quarter below our median risk allocation, the portfolio performed below expectations, capturing about 91% of the benchmark index’s downside. Exacerbating the cross-asset correlations, on an equity-only basis, the Portfolio slightly underperformed the benchmark. Our fixed-income portfolio, which is credit heavy, suffered through much of the leveraged unwind we saw across asset markets. The one standout during the quarter was our gold position, which returned more than 3%.
• Within equities, stock selection was the biggest culprit to performance combined with the Portfolio’s underweight allocation to the U.S., and thus underweight to the U.S. dollar which strengthened during the period. Our health care stocks underperformed, with Zimmer Holdings, Inc. hit the hardest as investors attempted to gauge the impact on elective procedures like knee and hip replacements. We added to our position during the quarter. Poor selection also impacted financials, industrials and consumer discretionary. Airbus SE, a long-term Portfolio holding, declined more than 55% during the quarter. We believe this sell-off was a bit overdone, and also added to Airbus during the quarter. Our auto-related positions were hard-hit in the sell-off. We have reduced our exposure to auto original equipment manufacturers (OEMs) but have retained our key auto parts positions, which we believe should benefit from continued content shift toward electric vehicles, hybrids and driver assistance. On the positive side, both stock selection and our overweight to information technology provided a positive effect, along with an underweight allocation to oilfield services and exploration and production (E&P).
• As previously mentioned, the fixed-income side of the portfolio had a rough quarter. Several of our credit positions were hit particularly hard. While our credit research prioritizes the ability of companies to create cash flow over the cycle, that analysis had not contemplated the real economy coming to almost a complete stop. Even some of our higher quality fixed-income assets in the mortgage market suffered as levered unwinds of positions and fears over deferred payments and defaults dominated the landscape.

Outlook

• The economic backdrop contains an almost unprecedented amount of uncertainty. It is unknown exactly how long COVID-19 shutdowns will last, and how much human behavior will change given the extraordinary events we are living through. With this backdrop, we try to look at what is known to dictate how we make portfolio decisions. This, for the moment, has led us towards two different ideas, including gold and investment-grade credit.
• While gold has long been a staple of the Portfolio, our preference for the metal as a safe, diversifying asset continues to grow. Across the globe, huge fiscal programs are being enacted in an effort to plug gross domestic product (GDP) holes being created by COVID-19 shutdowns. Those fiscal programs are being funded largely by central banks providing huge amounts of liquidity and expanding central bank balance sheets to unprecedented levels. In the U.S., we could very well see the Fed’s balance sheet grow to $10 trillion. We believe the debasement of fiat currencies further strengthens the case for gold in portfolios. Given the low level of yields, growing deficits and central bank balance sheet expansion, we increasingly favor holding gold over other safe-haven assets such as Treasury notes or highly rated government bonds. We have also added a gold miner to the equity portfolio in an effort to take advantage of its leverage to the price of gold.
• Our other strong preference is for investment-grade credit. This is an asset class which sold off heavily in mid-March as leveraged unwinds drove spread widening in violent fashion. Investment-grade companies tend to have large liquidity buffers and credit metrics which allow them to withstand economic shocks. In a world where most of the Treasury curve yields less than 1% and companies are cutting dividends, we believe the search for safe income will drive credit spreads tighter, providing good opportunities for total return.

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 March 31, 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 horizonPast performance is not a guarantee of future results.

Top 10 equity holdings as a percent of net assets as of 03/31/2020: Microsoft Corp., 3.1%; Taiwan Semiconductor Manufacturing Co. Ltd., 2.9%; Wal-Mart Stores, Inc., 2.5%; Visa, Inc., Class A, 1.9%; Adobe, Inc. 1.8%; ORIX Corp. 1.6%; Subaru Corp. 1.5%; Fiserv, Inc., 1.5%; Ping An Insurance (Group) Co. of China Ltd., H Shares, 1.5%; and Northrop Grumman Corp. 1.4%.

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. In addition, 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.

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.

Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.