Market Sector Update

• The high yield sector posted modest quarterly gains of 1.22%, while year-to-date (YTD) returns are 11.50%, as measured by the ICE BofAML US High Yield Index. Meanwhile, leveraged loans have returned 1.03% and 6.67% for the quarter and YTD, respectively.
• Bond yields reached their YTD low of 6.25% in September before increasing into quarter end, finishing at 6.39%. Leveraged loans were mixed as the quarter ended with a pick-up in issuance, lighter withdrawals and broader market volatility.
• Lower rated bonds underperformed throughout the quarter compared to middle and higher rated tiers. The U.S.- China trade war continues to create instability in the high yield market and this uncertainty has informed the demand in higher quality/higher rated debt.
• High yield fund flows were mixed throughout the quarter with a net inflow of $2.8 billion. Leveraged loans ended the quarter with $7.37 billion of outflows. Loan funds reported their twelfth consecutive outflow in September, albeit this month was the lowest outflow of the year at $0.7 billion. The last four quarters rank among the eight largest quarterly outflows on record.
• The high yield universe had strong new issuance in the quarter with $68 billion of new bonds. September’s $31 billion of new issuance was the highest month in two years. Refinancing leads among the use of proceeds. In terms of ratings, BB accounted for the highest volume of new issuance. Energy and health care have the highest level of new issue volume YTD with $24.7 billion and $20.2 billion, respectively.
• Leveraged loan new issues increased in September, posting the second largest total volume this year. In the quarter, $92.5 billion of new loans priced, making it the highest quarter of the year. Similar to bonds, refinancing was the main use of proceeds.
• High yield spreads finished the quarter at 475 basis points (bps), compared to 461 bps at the end of the second quarter.

Portfolio Strategy

• The Portfolio had a positive return, but underperformed the benchmark.
• The Portfolio’s allocation across asset classes remained steady, ending the quarter at 64% bonds, 21% loans, 6% other and 9% cash. The Portfolio’s weighting by rating category is 16% BB, 46% B, 24% CCC, as measured by Standard and Poor’s. The quality breakdown of our loan portfolio is 17% first lien and 6% second lien.
• Leveraged loans continue to offer attractive yields relative to their seniority in the capital structure. First-lien loans are the largest loan category and are the most senior debt in the capital structure. In times of stress and volatility, loans offer the potential for more stability and outperformance as compared to high yield debt and equity.
• As we assess the market uncertainty around tariffs and trade, we have become more cautious about the risks we are taking. The outperformance of BB rated bonds YTD has mostly been rate driven as the 10-year U.S. Treasury yield has moved from 2.68% at the beginning of the year to 1.67% at the end of the third quarter. We continue to view our loan portfolio as a replacement for our exposure in the BB category and, therefore, has underperformed YTD. The yield pick-up in loans relative to expensive BB rated paper reinforces our allocation to leveraged loans, especially as the 10-year U.S. Treasury yield continues to decline.
• Compared to the all-bond benchmark, as well as our peer group, we are underweight high yield bonds. This detracted from our performance as bank loans underperformed the index. The allocation to loans has been the largest detractor from performance, for reasons outlined above. Additionally, credit selection in our loan portfolio in the mining, oil & gas and retail sectors detracted from performance. Conversely, the selection effect of our bond portfolio has outperformed our peers YTD.

Outlook

• President Donald Trump’s trade tariffs, an impeachment inquiry by the House of Representatives, slowing global growth and weak business confidence continue to weigh on the markets ahead of continued negotiations in October between the U.S. and China. We believe the president needs a deal (big or small) with China to head off a recession, which we believe is likely if the next round of tariffs is put in place.
• On the flip side, the strong labor market continues to help consumer confidence, the Federal Reserve and global central banks are easing and providing stimulus which in turn has continued to help sectors such as housing and building materials. Assuming we are correct in our expectation of some form of trade deal, with high yield spreads at around 500 bps, we think credit investors have a favorable setup into year end and 2020.
• As always, our focus when evaluating investments is 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.