Market Sector Update

• We have been concerned that the COVID-19 shutdown will have long lasting implications for certain real estate sectors, particularly hotels and retail. The initial shock was worse than many expected with hotel occupancies falling to near 20%; and thousands being closed altogether. Retail landlords saw rental collections plummet to approximately 30% for malls and 65% for grocery-anchored shopping centers. As the economy reopened these levels have risen but remain very depressed. A resurgence of the virus will continue to weigh on revenue streams for many property types, particularly without additional unemployment stimulus.
• While real estate investment trusts (REITs) stocks failed to keep pace with the broader market recovery, a 12% return for the FTSE NAREIT Equity REITs Index, the Portfolio’s benchmark, was welcomed relief after the first quarter. Regardless of fundamental headwinds, second quarter property sector performance can be summarized by the following: first quarter’s laggards were second quarter’s big winners. The Fed’s policy actions, along with fiscal stimulus resulted in an uncontested “risk on” environment.

Portfolio Strategy

• The Portfolio posted a positive return for the quarter, but lagged its benchmark for the period.
• Office REITs underperformed the benchmark, but selection decisions within the sector aided the Portfolio’s relative performance. A long-held overweight position in a biotechnology/life science owner was a sizable outperformer, as the company continues to benefit from owning an A+ portfolio of buildings with a highly attractive tenant roster. Near complete avoidance of New York City (NYC) office owners also benefitted the Portfolio. In addition, we reduced our holdings in west coast focused office owners as conditions in that region have deteriorated.
• Multi-family REITs performed in the middle-of-the-pack for the period amid increasing worry over the fundamental outlook for several key markets across the countrys. Our positioning reflects concern for high-rise urban properties in general in the post-COVID-19 era, especially given rent control/eviction bans in states such as California and New York. The overall concerns over these issues has proven beneficial for single family rentals (SFRs) as they own primarily suburban housing and are poised to continue seeing strong rental demand. The manufactured housing segment shares many of the SFR advantages, and has long been an overweight within the Portfolio. Each of the above experienced high rent collections – mid-to-high 90% – throughout the quarter, in stark contrast to many other property sectors.
• 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.
• Datacenter and tower REITs, which were some of the top performers in first quarter, lagged for the period. The Portfolio’s overweight position to these groups detracted from benchmark-relative performance in the quarter, while stock selection enhanced performance. Demand for space remains strong, with enterprise migrations in datacenters and 5G build outs in towers expected to accelerate. At the same time, edge and cloud computing, mobile data usage growth and artificial intelligence are all expected to provide tailwinds to demand for the foreseeable future. We remain overweight to this segment.
• After dramatically lagging in the previous period, retail REITs were a top performer for the quarter, with both mall and shopping center REITs soundly beating the broader category. Retail REITs have been a prime beneficiary to investor response to reopening. We continue to have concerns over tenant health in the space, especially in light of recent COVID-19 flare ups and accelerating retailer bankruptcy announcements. We remain underweight to both groups as we expect a prolonged struggle for landlords and tenants alike.

Outlook

• The U.S. officially entered a recession in the first quarter, and we believe this downturn is likely to be far deeper, but shorter, than the Great Financial Crisis. This monumental downturn has met by an equally epic policy response. It’s not clear where the economy and markets would settle out without the $2 trillion in spending under the CAREs Act and the Fed’s bond buying. Investors, with little historical context to draw on, are falling back on a hopeful view. We’re not as certain and are concerned that the recovery may be stymied as the nation struggles to control outbreaks and Congress tentatively dials down fiscal support.
• As for the Portfolio, we were early to react to this downturn and put defensive measures in place to protect shareholders. While second quarter results were not particularly compelling, we believe our current positioning reflects the reality of a difficult economic recovery. We have concentrated our positioning in sectors that we believe will continue hold up relatively well in a tough economic environment – mainly data centers, cell towers and SFRs. We have largely stayed away from retail related owners and poorly positioned owners of health care and net-leased facilities.
• We believe the prudent thing to do for shareholders is to be vigilant to the risks of these companies present and weigh the opportunities that a recovery may provide. We will continue to stick with a 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 June 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.