Market Sector Update

• Despite the worst global pandemic since the 19th century and the worst economic contraction since the 1930s, domestic equity markets have proved to be resilient, posting historically notable gains during the quarter. The Portfolio’s benchmark, the Russell 1000 Growth Index, rallied 27.8%, erasing all the downside realized during the market drawdown. It is nothing short of amazing to note the index was up 9.8% year-to-date as of June 30, 2020. Growth styles remained in a leadership position during the quarter despite the aggressive market recovery. Value lagged during the quarter and is well behind growth styles year-to-date. The preference for large-cap growth apparent during the first quarter drawdown yielded to small- and-mid-cap growth outperformance during the second quarter. This shift was not surprising given the preference for risk-on investments as these smaller companies were relatively more exposed to the downside tail risk, which was removed through the actions of global central banks.
• The pace of the recovery was surprising during the quarter, with economic data points mending more quickly than investors expected. This improvement in economic activity paralleled an improvement in population mobility as shelter-in-place restrictions were loosened and businesses were allowed to reopen. Consumers jumped at the opportunity to “return to normal” in several aspects of their daily lives while refraining from activities deemed most risky.
• The quarter ended with spiking levels of COVID-19 transmission as a lagged result of increased mobility, suggesting that the pandemic overhang will likely create a series of volatility events. It also worked as a reminder that a complete return to business as usual would take time. All sectors of the benchmark posted positive gains during the quarter with energy, although a very small part of the index, consumer discretionary and information technology as the leaders. Lagging sectors included consumer staples and real estate. The performance of risk (high beta, low price) and momentum (relative strength, price return) factor strategies outperformed both value (low valuations, such as price-toearnings and price-to-cash flow) and quality (return on capital and return on equity) factor strategies during the period. Growth (positive earnings revisions and strong long-term growth estimates) performed well but was more mixed. What has been apparent during the market recovery is the disregard for valuations and quality and the focus on near-term trends and momentum.

Portfolio Strategy

• The Portfolio trailed its benchmark during the period despite posting a strong gain. During the second quarter, the markets benefitted from an aggressive bounce in what we identify as the “tails.” One tail can be described as lower valuation (cheap) stocks, and likely questionable businesses that were rescued from dire straits through aggressive Federal Reserve liquidity actions. The other tail, also posting outsized performance, is comprised of highly valued stocks, sometimes with negative earnings companies, with very high growth rates that were mainly considered unique beneficiaries from the COVID-19 environment. The uniqueness of this period presented a challenge to the Portfolio’s long-tenured investment philosophy that focuses on owning the highest quality companies and businesses models poised to outperform throughout a market cycle not just in one phase. We typically have limited exposure to the “tails” mentioned above as we see them as areas for excess downside due to business model risk and, over time, failure to meet embedded expectations.
• In terms of Portfolio’s relative performance, notable detracting sectors included consumer discretionary, information technology and health care. Performance was positively impacted from underweight positions in real estate, communication services and materials. Consumer discretionary was the largest detractor to performance driven by overweight positions in Ferrari NV, Booking Holdings and VF Corp., all of which posted positive returns during the quarter, but lagged the aggressive market return. This headwind was partially offset by positive contributions from overweight positions in Tractor Supply and Home Depot. A key notable detractor included an underweight position in Tesla, Inc., which continued its strong performance during the quarter. Information technology was a detractor with overweight positions in Motorola Solutions, Inc. and VeriSign, Inc., partially offsetting positive contributions from overweight positions in PayPal Holdings, Inc., NVIDIA Corp. and Fleetcor Technologies, Inc. An underweight position in Apple, Inc., the benchmark’s second largest weight, was a notable source of negative performance as the stock posted strong gains in the period. Similarly, health care was a headwind to performance with overweight positions in Cerner Corp., Cooper Companies, Inc. and Intuitive Surgical, which posted positive returns but returns below that of strong market appreciation. A source of positive contribution was in communication services. The Portfolio benefitted from adding to an overweight position in Electronic Arts during the period and maintaining no exposure to Netflix. Detractors within the sector included underweight positions in several companies with attributes the Portfolio tends to avoid including Spotify, Interactive Corp., and Viacom. Lastly, underweight positions in the real estate and materials sectors also provided a source of positive contribution.

Outlook

• The market’s next period of digestion could be the realization that even though fiscal and monetary stimulus have removed the downside tail risk related to a deep economic depression, what lies ahead is a potentially drawn out period of subdued economic activity and elevated volatility. We think it is difficult to suggest overall growth prospects have improved sustainability as a result of COVID-19, which may not square with what the market is currently suggesting in multiple sectors. The recovery has not been uniform. Many names negatively impacted by lockdowns and shelter-in-place orders have not recovered to the same extent as those perceived to benefit from the pandemic, implying that investors are not fully convinced that all is well. We find this perplexing, as either the “return to normal” supports a healthy, broad market rally or realization sets in that sustained economic weakness presents challenges for even the most attractive growth stocks. We are finding opportunity in a handful strong businesses and long-term growers that we believe are being penalized simply because they do not fit into the narrow definition of being a nearterm winner from consumer spending shifts or technology transitions related to the COVID-19 pandemic. We continue to frame our performance in long-term strokes and are not trying to maximize near-term success by reaching deeper into risky securities. While this may impact near-term performance given the current market preference for risk and high growth, we believe through-cycle our strategy is more durable and repeatable, while hopefully minimize downside risk on unmet expectations. Looking forward, the COVID-19 pandemic will have to share space with numerous other potential volatility related events this year, of which the U.S. presidential election stands out. Other outstanding concerns include the continuation of incremental unemployment benefits, potential election ramifications on corporate tax rates, resolution or re-escalation of the simmering trade war with China, and continued regulatory concerns regarding health care and mega-cap technology companies. Thank you for your continued support.

The opinions expressed are those of the Portfolio’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.

Top 10 holdings (%) as of 06/30/2020: Microsoft Corp. 9.8, Apple, Inc. 7.0, Amazon.com, Inc. 6.0, Visa, Inc. 4.6, Alphabet, Inc. 3.9, Facebook, Inc. 3.5, Motorola Solutions, Inc. 3.3, Adobe, Inc. 3.2, Coca-Cola Co. 3.1 and Cerner Corp. 2.9.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It is not possible to invest directly in an index.

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. Investing in companies involved primarily in a single asset class (large cap) may be more risky and volatile than an investment with greater diversification. The Portfolio typically holds a limited number of stocks (generally 40 to 60), and the Portfolio’s portfolio manager also tends to invest a significant portion of the Portfolio’s total assets in a limited number of stocks. 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 the Portfolio invested in a larger number of securities or if the Portfolio’s portfolio manager invested a greater portion of the Portfolio’s total assets in a larger number of stocks. 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. 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.