Market Sector Update

• We believe a recession is here, but it’s not the downturn that investors were expecting. The COVID-19 pandemic has the economy facing what might be the worst downturn since shortly after World War II, but the Federal Reserve (Fed) and U.S. government are using all policy levers to soften the blow. Uncertainty is exceptionally high, placing a premium on a strong framework for assessing new information.
• The Fed re-instituted liquidity facilities developed during the great financial crisis and added a new facility to support the corporate bond market directly. In addition, the federal funds target was virtually cut to 0%. The U.S. Congress is doing its part, too. After passing legislation to fund COVID-9 vaccine research and an additional $104 billion in increased state aid, it passed the Coronavirus Aid, Relief and Economic Security (CARES) Act, an unprecedented $2 trillion bill of support, targeting hard hit segments of the economy.
• The COVID-19 pandemic is driving highly correlated downturns in certain segments of the economy. The outlook is especially daunting for the consumer and certain commercial real estate property sectors primarily retail and hotels. It remains to be determined the long-term impact on office demand, but the co-working business model appears dead and the resulting influx of that space back to landlords will drive up vacancy levels and depress rental rates. In the short-term it is likely that most real estate owners, regardless of property type, will deal with tenant fallout and requests for rent relief and/or lease modifications.

Portfolio Strategy

• The Portfolio delivered a negative return, but outperformed its benchmark for the quarter.
• Favorable sector allocation was the primary driver of the Portfolio’s superior relative performance, although individual stock selection was also a material contributor. The most pronounced drivers of performance included an overweighting to datacenter and cell tower owners, and an underweight to retail and hotel owners. The Portfolio also benefitted from favorable stock selection in the office sector.
• Datacenter and cell tower real estate investment trusts (REITs), which both provide real estate that is essential for those working or learning from home, significantly outperformed the broader REIT index in the quarter. Demand for space remains strong, with enterprise migrations in datacenters and 5G build outs in towers expected to accelerate. We continue to see the communications infrastructure names as attractively valued when considering their growth prospects and defensive lease structures, and the Portfolio remains overweight to this sector.
• Net lease REITs delivered positive performance for the quarter, despite the “risk-on” environment and interest rate headwinds. Driving the segment’s performance were two gaming REITs, which own, but do not operate casinos. We have increased our exposure to these companies as they offer very attractive valuations relative to other net lease REITs.
• The Portfolio’s overweight position to Datacenter REITs hindered performance, but favorable stock selection meant the group was still supportive of relative performance. We continue to see the space as attractively valued when considering its growth prospects and remain overweight to this sector.
• Retail REITs grossly lagged the broader REIT group in the quarter. The shopping center and mall sectors were two of the portfolio’s largest underweight positions, which aided relative performance. While the full magnitude of the COVID- 19 impact on REIT income statements remains to be seen, we expect rental cash flows to be severely impacted for at least the next several quarters and we remain underweight the space.
• The shutdowns and stay-at-home orders that impacted much of the world in March, with many hotel REITs reporting unprecedented drops in occupancy numbers. Stock prices for these companies followed suit and lagged the REIT group significantly. We expect the next several quarters to be challenging for this group. The Portfolio is focused on names with better balance sheets and more defensive demand characteristics.

Outlook

• We believe it’s prudent to acknowledge that the outlook for the economy and commercial real estate is murky at best right now. Indeed, the same could be said for most all portions of the investment landscape. The dramatic decision to essentially shut down the U.S. economy – and worse, the primary engine of its growth: the consumer – as well as the lingering effects of that necessity will likely continue to weigh on real estate equities.
• As for the Portfolio, we were early to react to this downturn and put defensive measures in place in an effort to limit downside participation. We have concentrated our positioning in sectors that we believe will continue hold up relatively well in a tough economic environment – mainly datacenters, cell towers, biotechnology and life sciences offices, as well as single family residential rentals. We have largely stayed away from retail related owners and poorly positioned owners of healthcare facilities.
• Prior to the pandemic outbreak in the U.S. we were unfazed by valuation levels and operations within real estate were solid pretty much across the board. Given time we are confident those conditions will return, but now isn’t the time to go “bottom fishing” in the space. We are sticking with our quality bias in our companies’ property holdings, balance sheets, management teams and operational acumen.

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.

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. The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. 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.