Market Sector Update

• The big story in the first quarter was a continued shift to strategies that are poised to capitalize on better growth this year. This propelled strong returns for previous laggards like small caps, cyclical stocks and value strategies. Real estate stocks were no different, with an elongation of the rotation that started in December 2020 as a result of the Pfizer vaccine announcement. Simply put, last year’s losers continue to be the winners so far this year. Hotels and retail, last year’s laggards, widely outstripped real estate investment trust (REIT) returns.
• The economy built on fourth quarter momentum and accelerated early this year. The Federal Reserve (Fed) and President Joe Biden’s administration are doubling down on policy support to make sure the economy takes off. New relief measures and a clearer path to lifting restrictions laid the foundation for the fastest expected growth in decades.
• Despite the forecast for eye-popping growth, the Fed is steadfast in its commitment to keep a lid on rates until there is clear evidence of full employment and realized inflation. Members of the Federal Open Market Committee (FOMC) predict this process will take at least two years. Policymakers expect easy money to spur investment and better productivity, increasing sustainable growth. This risks an overshoot, but Fed officials are confident in their ability to slow the economy with available monetary tools if needed.
• While longer interest rates have risen on faster growth, the current movement isn’t alarming. Long-term rates rose while short rates remained anchored near zero, in line with Fed guidance. Long-term expectations remain in check, near the Fed’s 2% target. The recent increase in rates isn’t enough to slow the economy and reflects expectations for a return to normal growth and inflation in years to come.

Portfolio Strategy

• Despite a quarter characterized by deep-value, smaller-cap stocks being in favor, the Portfolio outperformed the FTSE NAREIT Equity REIT Index. We found quality names trading at significant discounts, which offset the drag from the Portfolio’s otherwise larger cap, growth-biased profile. Favorable decisions were a move to overweight senior housing, retail and hotel owners. The most significant drags on performance came from not owning last year’s laggards, such as New York City office owners and Net Lease companies. Five companies out of the index that fall into this esoteric group caused a 0.5% drag on performance.
• Office stocks were the biggest detractors to performance in the quarter. Many office stocks returned 15%-25%. Investors flocked to beaten up office names and have come to embrace the notion that office usage isn’t dead. We agree that offices are not obsolete but believe that work-from-home will alter office demand and operating costs in significant ways.
• With vaccinations beginning, investors could finally estimate a trough in senior housing occupancies and look forward to resumed earnings growth. With occupancies hovering in the high-70% to low-80%, these companies have an attractive runway for future earnings growth.
• Retail REITs were a top performer with the mall and shopping center subsectors leading. While tenant health took a step back in 2020, valuation in the space was very compelling entering the quarter and increasing optimism led to outperformance in the quarter. The portfolio had a substantial overweight to the retail space entering the period, but valuations became less compelling as the quarter progressed and we are underweight malls and shopping centers. Additionally, hotel REITs were one of the largest beneficiaries of vaccine rollouts and economic reopening. A combination of an overweight to the sector and favorable stock selection aided relative performance in the quarter. We remain overweight the space.
• Datacenter and tower REITs, which were some of the top performers in 2020, lagged the broader REIT sector. Neither sector contributed significantly to relative performance, but as valuations became more compelling in the period, the Portfolio shifted to an overweight by the end of the quarter. We continue to see strong growth prospects for this space.

Outlook

• We must consider whether the beneficiaries of the reopening have run too far, too fast. We believe some have and we made several portfolio changes to reflect our conviction that high quality, larger cap growth stocks will again be favored as we move through the balance of the year. Recent fiscal and monetary policies are unprecedented. The levels of fiscal support and easy money already in place are each considerable. Together, these policies – and proposed programs - are taking us into the unknown. The economy is poised for takeoff with plenty of liquidity as an accelerant. We’re likely to exceed pre-pandemic trend growth by the end of this year, and new businesses are forming at a rapid pace. For now, the potential benefits to the economy, and more importantly, to people, seem to outweigh the risks. But it would be imprudent to think that there isn’t a potential downside as well.
• While it appears a real estate recovery has begun alongside the economic recovery, we doubt all property types will return to pre-pandemic cash flow levels in lockstep. Those with short duration lease profiles such as apartments, single family rentals, and self-storage should fare well in a rising inflation environment. Others, such as retail and hotels may take years before they reach 2019 earnings.
• The pandemic accelerated trends that were already in place and put a spotlight on those with strong and bleak futures. Work-from-home is here to stay, and demand for office space and business travel will likely face a long recovery; as will bricks and mortar retail. Meanwhile, we believe strongly in “new economy” sectors such as data centers and cell towers. Although we selectively exploited several obvious public market pricing anomalies, we have largely avoided companies that we believe are more exposed to these post-pandemic trends. We have continued to focus the portfolio’s positioning to take advantage of those we believe will recover and thrive in a post-COVID-19 world.
• REIT stocks remain attractively valued, particularly against the backdrop of Fed actions, improving economic growth, and forever low interest rates. The environment could be attractive in which the 10-year U.S. Treasury rate remains range-bound, coupled with steadily improving economic growth. New vaccine-resistant strains, and higher 10-year U.S. Treasury rates represent two primary risks that could cause the group to deliver uninspiring returns in 2021.

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, 2021, 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.

The FTSE NAREIT Equity REITs Index is designed to present investors with a comprehensive family of REIT performance indexes that spans the commercial real estate space across the U.S. economy. The FTSE NAREIT Equity REITs index contains all Equity REITs not designated as Timber REITs or Infrastructure REITs. 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 Fund's shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. Because the Fund invests more than 25% of its total assets in the real estate industry, the Fund may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. These and other risks are more fully described in the fund'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.