Market Sector Update

• After a joltingly negative close to 2018, the first quarter of 2019 marked a nearly equally robust upward move. The Portfolio’s benchmark increased nearly 10% during the period. The first quarter saw several favorable fundamental developments that underpinned this robust performance in three key areas: 1) near-term growth, 2) trade frictions, and 3) policy. During the fourth quarter, numerous factors drove substantial concern regarding a stark weakening of nearterm growth. A combination of weakening soft and hard data fueled concerns regarding the economic outlook for 2019 on a global basis.
• The worsening outlook for U.S.-China trade shifted more positively during the first quarter as well with the U.S. and China showing a willingness (albeit a potentially temporary willingness) to work toward a framework and eventual agreement that addressed many of the issues of interest for both sides. Clear and critical differences of interest and core values persist; however, markets cheered the perceived progress that has been made.
• Perhaps most importantly, there was an overall shift in policy during the last three months. China has taken numerous targeted steps to stimulate its economy. However, the lack of traction in hard and soft data out of China had raised skepticism about the nature and efficacy of those programs. In the past quarter, there have been clearer signs that those targeted steps were in fact having an impact.
• Perhaps the most significant shift came out of central banks. For much of last year both the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) seemed to be on an autopilot program of monetary tightening. This was despite clear signs of rising turbulence, and perhaps more importantly a lack of genuine upward pressure on inflation even during robust growth spurts over the last few years. During the quarter the ECB pushed out the timeline for initial rate hikes into 2020, which served as a positive policy surprise. The Fed went even further in our view. Not only did the Fed reduce expectations for tightening in 2019, but it has also begun to discuss a clear policy pivot toward allowing inflation to run well above its 2% long-run view during times of economic expansion. The Fed is now not considering tightening at present, but would ease even without a slowdown or recession in order to hit its long-run inflation goal. This important shift in the current environment cannot be under-estimated and is responsible for much of the optimism in the most recent quarter.

Portfolio Strategy

• The Portfolio posted a double-digit positive return and outperformed its benchmark during the quarter. Stock selection was the primary driver of outperformance, with sector allocation and regional allocation also minor positives.
• The Portfolio’s overweight positions in consumer staples, energy and industrials as well as underweight positions in financials and communication services helped performance. The Portfolio’s overweight position in health care adversely impacted performance. From a regional perspective, the Portfolio’s overweight in Europe and underweight in Japan helped relative performance.
• Stock selection in financials, consumer staples, consumer discretionary and materials were all noteworthy contributors to relative performance, while stock selection in energy was a noteworthy drag on relative performance. Phillips Morris International, Inc., Tokyo Electron Ltd., British American Tobacco plc, 3i Group plc and Anglo American plc were the largest positive contributors to performance. Pfizer, Inc., Orange S.A., AbbVie Inc., Medtronic plc and not owning Cisco Systems, Inc. were the largest detractors from relative performance.
• Our investment approach remains steadfastly focused on investing in perceived high-quality businesses with favorable near and intermediate fundamentals, generally rising dividends and attractive valuations. This approach is consistent across sectors and regions.
• At this point, we remain balanced in the overall positioning of the Portfolio. The fundamental outlook in many areas has improved notably. However, in many cases valuations have coincidentally improved with sentiment and now more accurately reflect long-term business prospects. However, this is not uniformly the case – and as such we continue to find perceived attractive opportunities that fit our framework in a variety of sectors and geographies.

Outlook

• The outlook for global growth has slowed over the past several quarters. However, in most regions growth remains at levels consistent with solid economic expansion and a solid rate of corporate earnings growth. While the economic expansion is certainly older in chronological terms relative to most in modern history, the current expansion appears strikingly devoid of the significant excesses or bubbles that ended most prior cycles. Consumer finances are in good condition, corporate leverage is mostly manageable (some concerns clearly evident in the leveraged loan market), capex has been reasonable during the expansion and inflation remains benign (if not too low for some). Europe and Japan are two areas that are an exception to this viewpoint, as these areas have been innocent bystanders who have been caught in the crossfire of the trade conflict.
• Likewise, the picture on U.S.-China trade is also evolving positively in our view. It appears clear that both sides want to avoid a worst-case scenario outcome and perhaps find enough common ground to strike a deal that offers some sort of compromise. Longer-term we believe there could be a series of trade skirmishes, but for now some stability in outlook is likely.
• Given the backdrop of slowing global growth, benign inflation, and risk skewed to the downside, the financial markets had grown increasingly concerned that central banks (including the Fed) had already, or were at high risk of overtightening. This variable was clearly heightening anxiety that the Fed and central bank tightening would be the driver of the end of the current expansion. We believe the stark pivot by the Fed and other central banks away from incremental tightening, and toward allowing inflation to rise dramatically, reduces policy risk in this quadrant.

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, 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.

Top 10 equity holdings as a percent of net assets as of 03/31/2019: Royal Dutch Shell plc, Class A 4.0%, Pfizer, Inc., 3.8%, Nestle S.A., Registered Shares 3.7%, Roche Holdings AG, Genusscheine 3.3%, Total S.A. 3.1%, Lockheed Martin Corp. 3.0%, Procter & Gamble Co. 2.8%, AstraZeneca plc 2.6%, Samsung Electronics Co. Ltd. 2.6% and Tokio Marine Holdings, Inc. 2.6%.

Risk factors: The value of the Portfolio’s shares will change, and you could lose money on your investment. 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. Fixed income securities 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. Dividend-paying investments may not experience the same price appreciation as non-dividend paying instruments. Dividend-paying companies may choose to not pay a dividend or the dividend may be less than expected. 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.