Market Sector Update

• The start of 2018 contained a full year’s worth of market excitement in just one quarter. The year started exactly the way 2017 ended as upward momentum continuing unabated and the S&P 500 Index posted its strongest start to the year since 2003. However, volatility reintroduced itself to the market and the index finished the period in negative territory for the first time since 2009, making it the worst first quarter in eight years. So what caused this record stretch of almost no downward volatility to come to an end? Fundamentally, economic growth remains solid as evidenced by continued upward revisions to corporate revenue and earnings estimates, but rapidly rising interest rates and trade war concerns proved too much for the market to handle, especially after such a prolonged period without a broadbased market correction.
• Looking more closely, the recent trend of larger companies outperforming their smaller peers did not hold true in the first quarter, which resulted in micro- and small-caps posting positive returns for the period, but growth’s outperformance of value remained firmly in place, based on broad market indices.

Portfolio Strategy

• The Portfolio outperformed the Russell Microcap Growth Index and Russell 2000 Growth Index (its benchmarks), before the effects of sales charges, for the quarter ended March 31, 2018.
• Returns in the Russell Microcap Growth Index were led by primarily by health care with financials and technology adding modestly to the quarterly returns. The health care sector, which is by far the largest sector in the benchmark at 40%, remains as volatile as ever but does continue to be ripe with innovation and offers excellent opportunities for long term capital appreciation. In regard to financials, investors anticipated the benefit that higher interest rates will have on bank earnings in the coming quarters, which helped push the sector’s return to more than 4% for the quarter. Technology contributed a small positive return and was driven by positive quarterly results and better than expected 2018 guidance. On the negative side, consumer discretionary was the only area of significance that detracted. This area remains difficult to navigate given issues such as online competition and wage inflation.
• Portfolio performance attribution analysis for the quarter indicated that, on a relative basis, stock selection was strong with allocation effect causing a slight headwind. More than 100% of the stock selection benefit came from technology with health care and energy also contributing positively. The industrials sector was the primary detractor while consumer discretionary also held back performance modestly. In regard to sector allocation, there were no meaningful standouts either positively or negatively.
• Companies that had the biggest positive impact on performance in the quarter included 8x8, Inc., Mimecast and Tabula Rasa Healthcare. Each of these companies posted strong financial results and perhaps, more importantly, provided 2018 projections that exceeded investors’ expectations. In terms of performance detractors, Sportsman’s Warehouse, PDF Solutions and Kornit Digital were the three worst performers. While the issues affecting each of these businesses are different, in one particular case some elements were deemed structural and long term in nature; thus, the decision was made to eliminate the position.

Outlook

• Despite investor concerns and the recent pullback from all-time highs, the fundamental economic outlook appears to be solid and the full benefit of tax reform has yet to take hold. We believe everything from corporate earnings, job creation, inflation, credit spreads and interest rates will remain conducive to further economic growth. In addition, both consumer and business confidence remain at levels not seen in more than 10 years.
• Even with the solid near-term outlook, we remain vigilant for signs of overheating. Margin compression is one factor where we are hyper focused. Falling margins are commonly caused by things such as slowing revenue growth and/or rising costs, such as labor and interest expense, and typically signal a weakening economic environment. Thus far it appears that it’s too early to start worrying and we have chosen to use the pullback as an opportunity to add to existing positions and establish positions in new holdings.
• We continue to believe that improvement in micro- and small-cap revenue and earnings will sustain throughout the year, though returns will most likely be tempered by moderating valuations.

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 March 31, 2018, 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 03/31/2018: 8x8, Inc. 5.7, Mimecast Ltd. 4.8, Aerie Pharmaceuticals 4.7, Tabula Rosa HealthCare, Inc. 3.9, AxoGen, Inc. 3.8, MYR Group, Inc. 3.5, Tactile Systems Technology, Inc. 3.3, Cornerstone OnDemand, Inc. 2.8, Intersect ENT, Inc. 2.8 and MGP Ingredients, Inc. 2.8.

The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. The Russell Microcap Growth Index measures the performance of the micro-cap growth segment of the U.S. equity market. The S&P 500 Index is an unmanaged index of common stocks. 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. Market risk for small-sized companies may be greater than that for medium or large companies. Smaller companies are more likely to have limited financial resources and inexperienced management. Stocks of smaller companies, as well as stocks of companies with high-growth expectations reflected in their stock price, may experience volatile trading and price fluctuations. Furthermore, when the economy enters a recession, there tends to be a “flight to quality,” which may exacerbate the increased risk and greater price volatility normally associated with smaller companies. The Portfolio’s performance may be more susceptible to a single economic, regulatory, or technological occurrence than if it had a more diversified investment portfolio. The Portfolio may invest in Initial Public Offerings (IPOs), which can have a significant positive impact on the Portfolio’s performance that may not be sustainable. 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. 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.