Market Sector Update

• High yield bonds posted positive gains in the second quarter by returning 2.57%, as measured by the ICE BofAML US High Yield Index. Year to date, the index has returned 10.16%. Meanwhile, leveraged loans underperformed high yield, returning 1.63% and 5.58% for the quarter and year to date, respectively.
• The Federal Reserve (Fed), tariffs and the trade war between the U.S. and China continued to dominate the markets in the quarter. At the Fed’s June meeting, the interest rate forecast “dots” were lowered, indicating participants are looking for 50 basis point (bps) in cuts by the end of the year. This helped extend the equity and bond market rallies as a dovish Fed is seen as supportive of asset values. The U.S. and China agreed to continue talks after the G20 Summit, which was viewed positively.
• After seeing $14.1 billion of inflows in the first quarter, the high yield asset class recorded $600 million in outflows in the second quarter. Year to date, high yield mutual fund inflows are $12 billion compared with outflows totaling $24.5 billion during the first six months last year.
• Leveraged loans continued to experience outflows in the quarter with approximately $8.8B leaving the asset class mainly due to the Fed’s dovish pivot and high likelihood of a 25 bps rate cut at the end of July.
• High yield new-issue volume in the second quarter was strong at $74.7 billion versus $65.4 billion last quarter. Yearto- date volume is up 11% over last year. Leveraged loan new-issue volume was $90.9 billion in the quarter versus $66.8 billion in the first quarter. However, year-to-date gross loan issuance is down 38% relative to last year reflecting the negative sentiment and technicals in the loan market.

Portfolio Strategy

• The Portfolio had a positive return, but underperformed the benchmark.
• The Portfolio’s weighting in bonds versus loans did not change materially from quarter over quarter. Currently, the allocation breakdown is 66% bonds, 20% loans, 6% other and 8% cash. Our weighting by rating category is 16% BB, 50% B and 24% CCC, as measured by Standard & Poor’s ratings.
• We have maintained our exposure to leveraged loans as they continue to offer attractive yields relative to their seniority in the capital structure. They also offer the potential for less volatility in times of stress, such as fourth quarter of 2018, when leveraged loans outperformed the Portfolio’s benchmark by 339 bps.
• As yields have tightened and spreads compressed year to date, we have become more cautious about the risks we are taking. The outperformance of the BB rated bonds has mostly been rate-driven as the 10-year U.S. Treasury note has moved from 2.68% to start the year to 2% at the end of the quarter. We view our loan exposure as a replacement to our exposure to the BB rated category and has underperformed year to date. When looking at the yield pick-up we are getting in loans relative to that of BB rated paper, we think it continues to make sense holding loans, especially as the 10-year Treasury note is close to 2%.
• Our structural underweight in high yield bonds, when compared to the all-bond benchmark, again detracted from performance as bank loans underperformed the ICE BofAML High Yield Index. The allocation to loans was the largest single detractor during the quarter, for reasons outlined above. We continued to have a meaningful underweight to the energy sector, but unlike the first quarter, the energy sector in the second quarter underperformed which helped our relative performance.
• Credit selection in health care services and cable sectors contributed to performance in our bond portfolio, while credits in agriculture and gaming detracted. Our weighting in equites also detracted from performance.

Outlook

• Our outlook for a sharp rebound in growth in the second half of 2019 has been tempered by the continued global slowdown stemming from the uncertainty around U.S.-China trade. Our tempered outlook is somewhat offset by the fact that a global easing cycle is now in place and looks likely to build in the coming months along with growth in the U.S. continuing, albeit at a slower pace.
• Longer term, “extending the cycle” depends on the stabilization of global growth which will be highly influenced by a resolution, or not, between the U.S. and China on trade negotiations. According to the Duke CFO survey completed in June, the outlook for earnings, wages, inflation and capital spending deteriorated in Q2. To be certain, trade wars and broad economic uncertainty are hurting the economic outlook.
• As always, our focus when evaluating investments is on a company’s business model and competitive advantages in order to weather a recession and perform throughout the cycle.

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 June 30, 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.

Diversification is an investment strategy that attempts to manage risk within your portfolio but it does not guarantee profits or protect against loss in declining markets.

The ICE BofAML US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic 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 Portfolio 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. 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. 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.