Market Sector Update

• Mid-cap growth stocks, as measured by the Russell Midcap Growth Index (Portfolio’s benchmark), lost 20.04% in the first quarter of 2020. This was a swift reversal from what was a very strong 2019 for the category, marking the end of a 10+ year bull market. The selling that overcame almost all markets in the last half of the quarter was indiscriminate, as the global coronavirus pandemic presented considerable uncertainty about the health of humans and of economies worldwide. Risk was reduced broadly, but even more significantly by investors who were particularly vulnerable to the leverage they had built into their investment approaches. It is the strain on these investors that often drives the market to excess, making the turmoil palpable for all, reinforcing downside pressure in the market. The forced selling eventually subsides, and new information becomes available to help investors make rational decisions about the future. It is in such market environments that our strategy – our core process and philosophical approach to investing – strives to serve well those who entrust us with their money. Our approach emphasizes quality business models and balance sheets, both of which are important business attributes always, but especially when the integrity of economies and the companies that function within those economies are at risk. Our willingness and ability to take a long-range view to investing in strong companies with durable growth outlooks helps the Portfolio during the storm and the wherewithal to reposition into opportunities we have been considering yet wanted to buy at more reasonable valuations.

Portfolio Strategy

• Although the Portfolio returned negative double-digit performance in the quarter, it outperformed the index for the period and significantly led the index on a trailing 12-month basis. Outperformance within the index came from consumer staples, real estate, health care, information technology, and, to a minor extent, materials. Most are generally defensive sectors with respect to the consistency of demand within their businesses. Energy, consumer discretionary, communication services, industrials and financials all underperformed the index in the quarter. Relative outperformance within the Portfolio came from within industrials, health care, communication services and information technology. Our consumer discretionary performance was neutral to relative performance, and our materials, energy, real estate, financials and consumer staples sectors contributed negatively to relative performance in the quarter.
• Our industrials, health care and communications services sectors drove much of the performance in the quarter. Our industrials names made the strongest contribution to relative performance in the quarter. We were overweight this underperforming group, but stock selection shone, and our names performed well versus both the index and the sector within the index. Our health care stocks delivered against both the index, and the health care sector within the index. A number of our names actually gained value in the quarter. In communication services, Electronic Arts performed well, contributing significantly to the Portfolio’s relative performance in the quarter.
• Performance of our consumer discretionary names was neutral to the index in the quarter. Stock selection was helpful to performance, but the Portfolio was overweight this underperforming sector, the impact of which offset most of the benefit of stock selection. A slight negative currency effect related to our exposure to Burberry was the final offset to stock selection. Most of the Portfolio’s consumer discretionary holdings performed well, but a number of names lost significant value as the cloud of coronavirus-related non-essential business closures began to cast a wide and dark shadow across the U.S. economy.
• Materials made the largest negative contribution to relative performance in the quarter, as one stock, Axalta Coating Systems produced the overwhelming share of the underperformance from the group. This automotive and industrials coatings company has struggled in recent years due to economic weakness in China and Europe, and tariff-related issues. Energy names were quite weak in the quarter, as disagreement about oil production targets within OPEC on top of greatly diminished worldwide oil demand caused a steep sell-off in the price. Our energy exposure detracted from relative performance, completely based on stock selection, as we were able to contain the damage with an underweight exposure to the sector. We had no exposure to the outperforming real estate sector in the quarter, which detracted from relative performance. The sector’s performance within the index was supported by its largest constituent. Our financials and consumer staples exposures were both negative to relative returns in the quarter, in about equal measure. In financials, two of our bank names struggled as interest rates declined precipitously as the coronavirus-related economic crisis unfolded, and credit issues became a threat. Hershey Company, a holding in consumer staples, outperformed both the index and the sector within the index. However, we were sufficiently underweight this group – which held up well in the quarter – to post a negative contribution to overall portfolio return. Cash and cash equivalents, which averaged less than 2% in the quarter, contributed 0.05% to relative performance, while equity options detracted by 0.07%.

Outlook

• We are beginning to see some global progress in the health care battle against the virus, but the damage to world economies will require an ongoing assessment that likely delivers more bad news before much good news develops. Our framework for economic growth and progress in the markets hinges on that of our global macroeconomic team, whose forecast for the U.S. includes a better than 20% decline in second quarter gross domestic product (GDP) growth before a recovery that begins in third quarter 2020 and continues into 2021 at a modest pace of growth. The outlook is that the U.S. economy will recoup the lost 2020 GDP, actual plus expected growth, only as we turn the calendar into 2022, somewhat more than a year and a half from today. The forecast is subject to change, depending largely on the course and duration of the pandemic in the U.S. and the ultimate impact on small- and medium-size businesses. The result of all of this will be a market that continues to be very volatile. Active managers should find opportunity to invest in companies that will survive and thrive exiting this crisis. While there will be phases in the market when the worst performing, lower quality stocks have strong moves to the upside relative to the overall market, these phases tend to be short-lived and capped at prices and valuations that reflect the limited outlook of many companies. Beyond the uncertainty we see diminished dividends and stock buyback programs as further limiting market appreciation. Our approach to investing in high-quality growth companies has generally performed well in both strong and weak markets. We expect our focus on strong balance sheets will remain important as economic stress presents challenges to many businesses. Further, our companies have durable growth opportunities that should allow them to deliver earnings independent of stock buyback-derived earning-per-share growth. We will continue to focus on strong and differentiated durable growth opportunities, increasing our allocation to existing exposures where possible at suddenly much more attractive prices, adding new stocks where price action has made names of interest much more reasonable to buy, and exiting positions where challenges old or new seem unlikely to resolve themselves satisfactorily relative to our investment thesis and within our time horizon.

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 March 31, 2020, 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 03/31/2020: CoStar Group, Inc. 3.8, Electronic Arts, Inc. 3.5, Chipotle Mexican Grill, Inc. 3.1, Tractor Supply Co. 3.0, DexCom, Inc. 2.8, MarketAxess Holdings, Inc. 2.8, Teradyne, Inc. 2.6, Fastenal Co. 2.5, TransUnion 2.5 and Monolithic Power Systems, Inc. 2.5.

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.

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

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. 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.