Market Sector Update

• The third quarter saw a continued strong recovery in risk assets due to improving macroeconomic data and continued monetary policy support resulting in domestic equities rallying almost 9%.
• Despite the upswing in risk assets, U.S. Treasury yields only rose slightly as the Federal Reserve (Fed) announced it would adopt an average 2% inflation policy, which served to anchor U.S. Treasuries as rates are likely to remain near zero for years. The yield on the 10-year U.S. Treasury rose 2 basis points (bps) to 0.68%, while the yield on the 2-year U.S. Treasury fell 2 bps to 0.13%. During the quarter, the yield curve steepened slightly as the difference between the 10-year U.S. Treasury and the 2-year U.S. Treasury rose 5 bps to 55 bps.
• The Fed significantly dialed back its corporate bond purchases during the quarter, ending the period at a pace of just over $100 million per week, down from roughly $300 million per week at the start of the quarter. Despite this shift, the improving macro backdrop caused the spread on the Portfolio’s benchmark, the Bloomberg Barclays U.S. Credit Index, to fall modestly from 142 bps to 128 bps. High yield gained 4.6% as the spread on the Bloomberg Barclays U.S. Corporate High Yield Index fell from 626 bps to 517 bps, while leveraged loans gained 4.1%.
• Investment-grade issuance continued to be highly elevated relative to historical norms as companies continued to shore up liquidity and refinance. Third quarter issuance increased to $460 billion, up 19% over last year. Year-to-date issuance of $1.84 trillion is substantially above the $1.3 trillion issued during the entirety of last year. Issuance net of maturities has been even more dramatic with net issuance of $1.07 trillion year to date versus just $356 billion of net issuance all of last year.
• Ratings actions improved slightly but continued to be negative in the third quarter with Standard & Poor’s upgradeto- downgrade ratio in investment grade at 0.38 versus 0.30 in the second quarter and 1.12 in 2019. Fallen angel activity declined from $38 billion in the second quarter to roughly $20 billion in the third quarter.

Portfolio Strategy

• The Portfolio had a positive return and outperformed its benchmark.
• The Portfolio’s duration rose slightly during the period and remains modestly under the benchmark’s duration of 8.39 years. Higher duration means higher price volatility for a given change in spreads as well as interest rates.
• The Portfolio increased its allocation to AA rated securities, while decreasing its exposure to A, BBB and BB rated securities.
• The largest changes in sector positioning were increases in the consumer cyclical and technology sectors and decreases in the industrial and consumer non-cyclical sectors.

Outlook

• After an extremely volatile year, the investment-grade market stabilized in the quarter with index spreads trading in a relatively narrow 24 bps range. We believe the Fed’s actions have suppressed volatility and provided material support for risk assets. This support for risk is unlikely to go away anytime soon, however one must balance it with the risks and fundamentals. The future continues to have numerous material risks that will likely impact markets going forward. We are in a pandemic, have a weak economy, and the upcoming U.S. Presidential election presents risks to the markets broadly as well as individual sectors. We’ve already started to see substantial hedging across asset classes ahead of the U.S. election cycle, the impact of which is considerably larger than the normal election hedging.
• Investment-grade fundamentals continue to be extremely weak, with leverage remaining at record highs and duration in the market being near a record high. However, credit spreads sit at 128 basis points for investment grade, well below their 20-year average of 146 bps. The reason for this disconnect between the fundamentals and valuations is the favorable technical picture and the search for yield driven by the Fed’s actions.
• The technical backdrop continued to be favorable as historically high investment-grade supply was offset by fund inflows and substantial foreign demand. However, towards the end of the quarter we saw a weakening of fund inflows, which remained positive. Supply going forward is likely to be supportive. In aggregate, companies issued more than enough debt to shore up liquidity in the pandemic and subsequently refinanced a great deal of debt, which coupled with low levels of mergers and acquisitions, suggests low issuance in the fourth quarter and beyond.
• Going forward, we believe record leverage and near-record duration, along with the myriad of risk factors in the future, is likely to lead to more frequent periods of volatility and prevent spreads from rallying materially in the coming quarter and beyond. While the technical picture remains favorable, it is fleeting while the weak fundamentals are likely to persist for years. Our current conservative positioning is designed to allow us to opportunistically take incremental risk into these periods to capitalize on the volatility as it presents itself.
• We continue to believe that credit selection will be paramount, and we continue to find many mispriced credit situations as the pandemic continues to drive vastly different results from companies across the investment-grade universe. As always, our team is continually focused on assessing the rapidly changing landscape to ensure our positioning optimizes the risk and reward for our investors.

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 Sept. 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.

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.

The Bloomberg Barclays U.S. Credit Index measures the investment grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related bond markets, including a non-corporate component of non- U.S. agencies, sovereigns, supranationals and local authorities. It is not possible to invest directly in an index.

Bloomberg Barclays U.S. Corporate High-Yield Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. 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. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. These and other risks are more fully described in the Portfolio's prospectus. Not all funds or fund classes may be offered at all broker/ dealers.

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.