Market Sector Update

• The Portfolio’s benchmark, the Russell 1000 Growth Index, maintained upward momentum during the quarter and boldly posted strong year-to-date gains. Specifically, the index rallied 13.2% during the quarter and ended the quarter up a remarkable 24.3% year to date as of Sept. 30, 2020.
• Growth styles remained leaders during the quarter and have significantly outpaced value styles, with the difference most striking in large cap, as the Russell 1000 Growth Index was nearly 40 percentage points ahead of the Russell 1000 Value Index year to date as of Sept. 30, 2020. Large-cap growth outperformed small- and mid-cap growth styles and remains well ahead of those styles for the year. Who would have thought that an economic recession would be marked by an increase in both household net worth and disposable income? This outcome was produced by extremely low rates, and a promise to maintain such level, unprecedented fiscal stimulus and a stock market propelled forward by narrow set of perceived pandemic victors. A rather unique set of variables. While the economic downturn was cushioned by monetary and fiscal measures, which may prove difficult to sustain over an intermediate horizon, other variables improved during the quarter. Freight volumes, auto production, housing, improvements in manufacturing data and other data points saw either steps toward normalization or absolute strength. These improvements in economic data are comforting but do not fully erase the impacts from the downturn or provide confidence in a self-sustaining growth environment. Sector performance in the benchmark was divergent with consumer discretionary posting the strongest gains followed by materials and information technology. Relatively weak sectors were energy, financials and utilities (small portion of the Portfolio’s benchmark), but also health care. The observation from a sector return analysis is that sector leadership broadly stayed in place this quarter. It is worth noting that consumer discretionary and information technology contributed strongly to the index’s return during the quarter as well as year to date. Notably, six stocks – Facebook, Amazon, Apple, Alphabet, Microsoft and Netflix – accounted for sizable returns during the quarter and year to date. Momentum (relative strength and price return) was a stand-out factor strategy during the quarter as the market continued to favor the year-to-date winners. High risk (beta) and growth (projected long-term earnings growth and positive revisions) factors also performed. Value factors (low valuations, such as price-to-earnings and price-to-cash flow) were a significant laggard. Quality (return on capital and return on assets) factor strategies were mixed during the period. What remained apparent again during this quarter was a preference for near-term momentum regardless of valuation or quality.

Portfolio Strategy

• The Portfolio trailed the benchmark during the period ended Sept. 30, 2020 despite posting a strong gain. Benchmark returns were again unique and primarily driven by the six large technology companies previously mentioned but also by companies with unproven business models (e.g. Tesla, Zoom and Roku, etc.). This latter group of companies is typically an area the Portfolio maintains limited exposure to due to our view of excess business model risk that doesn’t align with the Portfolio’s long-tenured philosophy – a focus on the highest quality companies and businesses models poised to outperform throughout a market cycle not just in one phase.
• In terms of relative attribution for the Portfolio, notable detracting sectors included consumer discretionary, information technology and communication services. Performance was positively impacted from stock selection in health care and an underweight position in real estate.
• Consumer discretionary was the largest detractor to performance driven primarily by an underweight position in Tesla, which continued its strong performance for the second quarter in a row. Several of the Portfolio’s overweight positions were detractors to performance including Booking Holdings, V.F. Corp. and Ferrari. Information technology was a detractor as the Portfolio was underweight during the period. Overweight positions in FLEETCOR Technologies, Visa and VeriSign were detractors but were partially offset by positive contributions from overweight positions in salesforce.com and NVIDIA Corp. An underweight in Apple, the largest weight in the benchmark, was a notable source of negative performance as the stock posted strong gains. Communication services was a headwind to performance with an overweight position in Electronic Arts, a company that experienced negative performance during the period. Health care was a source of positive contribution. The Portfolio benefitted from overweight positions in Intuitive Surgical, Danaher, Cooper Companies and Zoetis. Underweights across large biopharmaceuticals proved to be another source of benefit and offset detraction from overweights in Cerner, Vertex Pharmaceuticals and UnitedHealth Group.

Outlook

• We remain concerned regarding the way the U.S. market has recovered, which has been comprised of a set of assets that appear to be benefitting from positive near-term revisions and confirmatory price action. Valuations for these stocks have been set aside and, for the time being, seem justified by the perception that these are the scarce handful of growers remaining. We see the optimism being conveyed by market strength misaligned with the underlying performance of the average stock. We continue to hold the opinion that a new reality could emerge, which instructively is the basis of our long-tenured investment philosophy, in which many (but not all) perceived pandemic victors will be met with incremental competition, gross margin headwinds, cash flow needs to defend positioning, fading consumer interest and decelerating growth prospects. The competitive forces facing growth companies are unrelenting. Starting from a place of high valuations, which implies highly optimistic assumptions regarding long-term success of the business models, the go forward could be ripe for disappointment. Looking forward, there appears to be a healthy balance between positive headlines but also headlines that could spur elevated volatility. An improving employment backdrop, resilient housing market, strong consumption data, lean inventories and positive estimate revisions due to the sharp recovery should continue to optically push the recovery narrative forward. Potential speed bumps ahead include: politicization of needed government stimulus, ebbing consumer support, U.S. presidential election, COVID-19 pandemic flare-ups, corporate tax rates changes, rising deficient concerns, resolution or re-escalation of the simmering trade war with China, anti-trust concerns for mega-cap technology companies and continued regulatory concerns regarding the health care sector. We are tasked with remaining patient and balanced with a long-term mindset. We continue to seek opportunities wherein strong businesses and long-term growers are being penalized simply because they do not fit into the narrow definition of being near-term pandemic winners. While this has and may continue to impact the Portfolio’s relative performance given the current market preference for risk and high growth, we believe our strategy is more durable and repeatable over the course of a cycle, with the potential for minimizing downside risk on unmet expectations. 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 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.

Top 10 holdings (%) as of 09/30/2020: Microsoft Corp. 9.7, Apple, Inc. 8.6, Amazon.com, Inc. 7.4, Visa, Inc. 4.3, Alphabet, Inc. 3.8, Facebook, Inc. 3.7, Motorola Solutions, Inc. 3.3, Adobe, Inc. 3.2, Coca-Cola Co. 2.9 and Electronic Arts, Inc. 2.8.

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 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.