Market Sector Update

• While trailing the broad market indices in the third quarter, real estate investment trusts (REITs) stocks as measured by the FTSE NAREIT Equity REITs Index, the Portfolio’s benchmark, returned nearly 12% during the period.
• As expected, the Federal Reserve (Fed) unveiled its new inflation policy framework while reiterating its goals of maximum employment and price stability. The new guidance indicates that interest rate hikes are unlikely to happen until realized inflation reaches 2%, which isn’t expected to occur for some time. Policymakers want to see enough job growth to fully absorb labor slack, even if that means the economy runs “hot” before raising rates.
• This move reflects the Fed’s view that the benefits of job gains are distributed more broadly as the economy approaches full employment. Investors believe the new policy factors in a 1-2% overshoot of the 2% target to ensure the economy reaches full employment. Real rates are likely to remain depressed in this scenario.
• The devasting impact of the COVID-19 pandemic on the Main Street economy has individuals and companies carefully examining how we live, work and play. Many of these decisions have yet to fully mature, while the collective society waits for a safe, scalable vaccine. Until then – or until such time as the market becomes convinced that a vaccine is imminent – many real estate property sectors are expected to struggle.

Portfolio Strategy

• The Portfolio posted a positive return and outperformed its benchmark for the quarter.
• The Portfolio’s performance was due to favorable sector allocation and stock selection across a number of property types. We continued to structure the Portfolio toward sectors that have been relatively less affected by the pandemic fallout, including data centers, industrial warehouses and single-family rentals (SFR).
• Office REITs underperformed the benchmark, but our underweight to the segment, particularly those with east and west coast focused portfolios, was the largest driver of the Portfolio’s relative performance. With “work from home” (WFH) arrangements remaining in place, the amount of companies delaying or cancelling their return to a normalized office environment has grown significantly. Several well-known research firms have reduced their forecast for future office demand, with suggestions of 20% rental declines likely amid surging vacancy levels post-pandemic. As such, we have reduced our exposure to office REITs.
• Multi-family REIT landlords have done a commendable job of securing rental payments from existing tenants, although longer term fears of urban out-migration, particularly metro New York and San Francisco, spooked investors. The story was mirror image for SFR REITs, which outperformed the index for the quarter.
• Self-storage was the worst performer in the index for the quarter, which fits with the return reversal trend discussed above. The segment has faced an overbuilt condition for several quarters, but is still considered a “defensive” property type and thus substantially outperformed in first quarter. Occupancy has held up remarkably well, though a freeze on delinquent tenant auctions, stay-at-home orders and financial priorities were all likely tailwinds in that regard. As the country re-opens these could revert to headwinds, even as new supply continues to deliver. The Portfolio’s underweight to the sector was additive to performance.
• After a relative rebound last quarter, enthusiasm for retail REITs cooled during the period, with shopping center REITs the worst-performing subsector and mall REITs not faring much better. We continue to have concerns over tenant health in the space, especially in light of recent shutdowns related to COVID-19 flare ups. We remain underweight to both groups as we expect continued store closures to weigh on the space. Our underweight position significantly aided performance in the quarter.
• Net lease REITs performed marginally better than the broader space in the quarter, with favorable stock selection acting as a tailwind to the Portfolio’s performance. Gaming REITs benefitted from better than expected rent collections and improving tenant fundamentals, while retail-focused net lease names also saw improving collections. The Portfolio continues to hold an overweight position to the net lease gaming names, with positive views on the security of their rent streams and earnings growth prospects.

Outlook

• While the early recovery has been V-shaped and faster than expected, it’s questionable whether the momentum is self-sustaining at this point. The recession is likely to be the shortest on record after a 31% annualized quarterly decline in real Gross Domestic Product (GDP) in second quarter, which was the deepest quarterly downturn ever. Policy support focused on Main Street has been effective in delivering relief to battered consumers and affected businesses. While expanded unemployment benefits had been an early tailwind, without another stimulus package, a weaker consumer could quickly become a headwind. The consensus for GDP growth in the third quarter is about 25%, which still leaves the economy far below where it was in 2019. We expect economic activity to shrink by 4-5% for the full year and unemployment to remain elevated at between 7-8% at year end.
• The big question on investors’ minds is whether we’ll see growth slow more than expected as the fiscal stimulus dwindles and the “new normal” comes into view. Another stimulus package would help hold the line until we have a vaccine. Until then, corporate earnings, particularly in travel and leisure, remain under significant pressure. As the pandemic drags on and businesses refocus on long term prospects, we expect further restructuring and less positive labor market momentum.
• Against a backdrop of continued uncertainty, growing corporate and government borrowing have reduced the resilience of the economy to an unexpected shock. An effective vaccine would be a game changer. However, the timing – and the public’s faith in the process – are key uncertainties. Our political system seems less responsive than ever to growing imbalances that could threaten longer run growth prospects. The lack of any consensus in even defining the nation’s most pressing problems has hurt the outlook for the economy and the markets. We expect continued volatility until the U.S. presidential election is settled – potentially well past election day.

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, 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.

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.