Market Sector Update

• Mid-cap growth stocks, as measured by the Russell Midcap Growth Index (Portfolio’s benchmark), were down in the third quarter following strong returns in the prior two quarters. Year-to-date, the index has yielded a return of 25.2%.
• Top absolute performing sectors in the index were real estate, consumer staples and materials, indicating a fairly sizable rotation to defensive sectors in a risk-off move in the markets. Energy was once again the worst performing sector despite relatively stable commodity prices and a refinery attack in Saudi Arabia that disabled significant capacity. After multiple quarters of strong results, health care was the weakest contributor to the index.
• The market could be looking toward potential political outcomes in 2020 and the financial ramification of some policies. For the quarter, the more economically sensitive sectors were mixed in the growth index with materials, industrials and consumer discretionary producing positive returns and financials, information technology and communication services producing negative returns.
• The beginning of August saw a fairly dramatic selloff in the markets, with a significant change in market leadership, albeit for a very short period. Many pundits wondered aloud if it was the beginning of a structural change in the market, possibly caused by the broad geopolitical rhetoric and economic news flow. The market, however, returned to a relatively calm stance for the remainder of the quarter, though never really gaining a solid footing for growth. With so much uncertainty, corporations are sitting on the sidelines relative to production, choosing to wait for clearer economic direction. While the Federal Reserve (Fed) provided an “insurance interest rate cut” in the quarter, it wasn’t enough to re-engage market participants.

Portfolio Strategy

• The Portfolio posted a slight positive return in the third quarter, performing better than its benchmark. Stock selection drove most of the outperformance.
• Consumer discretionary continues to be the biggest sector overweight in the Portfolio. While this overweight position was slightly beneficial, stock selection was a drag on performance for a second quarter in a row, particularly in specialty retail and auto components. In luxury goods, Burberry was a strong contributor in the quarter as the brand announced solid second quarter earnings with solid forward guidance on the brand’s new designer lines. Lululemon Athletica, Inc. was another positive overweight in the quarter as the athleisure apparel company beat street estimates for second quarter earnings and saw continued growth from e-commerce and men’s apparel. Underperformance in consumer discretionary came partially from an overweight position in Tractor Supply Company, which pulled back in the quarter due to macro concerns and questions around the viability of sales initiatives.
• Health care added to performance for the quarter, with biotech Seattle Genetics leading the way. The strong stock performance came from a positive second quarter earnings announcement coupled with positive early and later stage results for oncology therapies in its pipeline. Animal health company Zoetis was also a standout for the quarter, with continued strong revenue and earnings growth in both the companion and production animal categories.
• Information technology was an underweight in the quarter, and while the allocation affect was a slight negative, stock selection more than offset the underweight drawdown of the sector on the portfolio due in large part to overweight positions in Guidewire and Tyler Technologies. Tyler Technologies continues its upward trend as the leading provider of technology management solutions for the public sector, and its migration to a subscription based SaaS provider should allow for continued growth in the future. Guidewire was essentially flat two months into the quarter, when it announced a solid quarter that demonstrated impressive cloud momentum and 81% of sales were subscription based. Subscription-based models provide for more predictable and profitable recurring revenue; both positives for the business model.
• The Portfolio’s cash exposure continues to be at the low-end of our normal range but provided incremental help to performance in the quarter. A small options exposure also added to performance on the quarter.

Outlook

• The broad U.S. equity market continues its quarterly moderating return profile, based largely on trade war concerns and the ultimate effect the impasse will have on global and domestic gross domestic product (GDP) growth. The ramifications of the trade impasse coupled with political and geopolitical uncertainties appear to be bleeding through to company management decisions relating to capital expenditure decisions and productivity. While we appreciate that many of the world’s economies are challenged and we continue to watch for any signs of inflection in those economies, we believe the impact of any inflection may be muted until things become settled in the U.S.
• As expected, the Fed implemented an interest rate cut in third quarter as an “insurance measure” against a potential economic slowdown due to tariffs. Although there is much rhetoric around a resolution to the trade wars, near-term confidence in the economy and corporate profits continues to be uncertain in the quarter, with decelerating earnings growth once again the talk of the markets.
• Continuing the trend from the second quarter, higher debt companies within the benchmark outperformed lower debt companies. During the quarter, the market received its first interest rate cut since December 2008. While it appears there may be one to two more cuts before the end of 2019, we think the environment for companies to add leverage is not the same as it was in the past cycle of cuts post the global financial crises. We don’t expect the trend of higher debt companies outperforming lower debt companies to continue.
• While the Portfolio represents an economically constructive point of view, our approach is essentially balanced based on stock selection as opposed to overt sector allocations. It continues to express a more economically constructive and optimistic view, with a more assertive pro-growth, less defensive stance.
• We remain steadfast in our approach, maintaining that stock selection drives performance. However, if need be, we will prudently apply a macro overlay by utilizing more defensive sector exposure, cash and/or portfolio hedging. We continue have no exposure to real estate and energy, which represent a combined 4.2% of the benchmark.

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 Sept. 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.

Top 10 equity holdings as a % of net assets as of 09/30/2019: CoStar Group, Inc. 3.5, Chipotle Mexican Grill, Inc. 3.1, Electronic Arts, Inc. 2.7, Zoetis, Inc. 2.7, TransUnion 2.5, Keysight Technologies, Inc. 2.4, Tractor Supply Co. 2.4, Teradyne, Inc. 2.4, Edwards Lifesciences Corp. 2.3 and ServiceNow, Inc. 2.2.

The Russell Midcap Growth Index measures the performance of the mid-cap growth segment of the U.S. equity universe. 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. Investing in mid-cap growth stocks may carry more risk than investing in stocks of larger more wellestablished companies. 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. Not all funds or fund classes may be offered at all broker/dealers. 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.