Market Sector Update

• Smaller companies added to first quarter gains over the past three months, and also outperformed their large-cap peers, based on broad market indices.
• Small-cap company outperformance has now occurred in each of the past four months, which in and of itself is not that significant; however, the magnitude is. Over this four-month period small caps, based on the Russell 2000 Growth Index are outperforming large caps, based on the S&P 500 Index, by the largest margin since 2010. This performance differential is almost certainly a result of increasing rhetoric about tariffs and fears of a global trade war erupting. On the surface, it would appear a trade war would be less of an impact for smaller companies as they commonly generate a lower percentage of revenue and earnings from overseas compared to large caps.

Portfolio Strategy

• In the quarter ended June 30, 2018, the Portfolio outperformed its benchmarks, the Russell Microcap Growth Index and Russell 2000 Growth Index.
• In the second quarter, every sector but one posted positive returns in the Russell Microcap Growth Index, which is indicative of the broad-based strength. In what has been a reoccurring theme in the recent past, the index continued to be fueled by its two largest sectors – healthcare and technology. Broadly speaking, these sectors benefited from a powerful combination of strong financial results, innovative new products, as well as multiple expansion.
• The industrials and consumer discretionary sectors also produced solid gains for the index in the quarter. In the past, companies in these two sectors commonly paid some of the highest tax rates; thus, the passage of tax reform has enabled them to generate significant year-over-year growth in after tax cash flow and earnings. Lastly, as previously mentioned, there was no real drag on the index’s performance. Materials was the worst performing sector and it was down only slightly during the period.
• Performance attribution analysis for the quarter reveals that the Portfolio benefited from both allocation effect and stock selection. From an allocation standpoint, performance was aided by the technology sector since the Portfolio carries an overweight position, and it was one of the strongest performing areas in the index. Additionally, the Portfolio’s underweight position in financials also helped given this area of the market underperformed during the period.
• Stock selection provided an outsized benefit during the second quarter due primarily to the Portfolio’s health care holdings. Despite being underweight the sector, the Portfolio’s holdings appreciated meaningfully more than the index’s, which resulted in significant outperformance in the second quarter. Technology holdings also added to the selection benefit. On the negative side, stock selection in the energy sector created a modest headwind.
• Companies that had the biggest positive impact on performance in the quarter included Tabula Rasa Healthcare, Tactile Systems Technology and Axogen. Each of these companies have unique, innovative products that provide them with strong competitive positions in very large, underpenetrated end markets. In terms of performance detractors, the Portfolio benefited from having very few holdings that performed poorly. GTT Communications and Mercury Computer Systems were the only two laggards in the quarter. In both instances this weakness came after posting sizable gains over the past 18-24 months.

Outlook

• Looking forward, as we enter the second half of the year, it appears that business fundamentals remain favorable and the prospect for robust earnings growth is still intact. However, as valuation multiples continue to march higher, especially for smaller healthcare and technology companies, it would increasingly appear that the marketplace recognizes this forecasted growth. After posting strong absolute and relative returns in the quarter, we have trimmed some of our stronger performers, which is providing us fresh capital to seek out new investments. While it is anyone’s guess which direction the market is headed in the short term, we remain ready to capitalize on any pullback that could occur due to something such as the escalating global trade conflict.

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, 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 06/30/2018: 8x8, Inc. 5.3, Aerie Pharmaceuticals 5.2, Tabula Rosa HealthCare, Inc. 4.9, Mimecast Ltd. 4.9, Tactile Systems Technology, Inc. 4.7, AxoGen, Inc. 4.0, MYR Group, Inc. 3.2, Kornit Digital Ltd. 3.1, EVO Payments, Inc. 3.1 and Cornerstone OnDemand, 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.