In the first quarter of 2013, the Portfolio’s stock holdings had a strong absolute gain but underperformed the Russell 1000 Index. Both stock selection and sector positioning detracted somewhat from relative results, particularly an underweight to the surging Consumer Staples sector.
Among the Portfolio’s major stock contributors were holdings in the Energy and Consumer Staples sectors. Energy holding Pioneer Natural Resources (up 16.6% for the quarter) rose in concert with improving commodity prices. In Consumer Staples, Walgreen (up 29.7%) advanced on robust earnings and recent successful partnerships. Also within Consumer Staples, Church & Dwight (up 21.2%) benefited from solid volume growth. Another key contributor was Financials holding IntercontinentalExchange (up 31.7%), which was buoyed by optimism surrounding its proposed acquisition of New York Stock Exchange operator NYSE Euronext.
Leading detractors included stock selections in the Consumer Discretionary, Industrials, and Information Technology sectors. In Consumer Discretionary, Ulta Beauty (down 17.3%) traded lower on disappointing earnings and the resignation of its CEO. Industrials holding Deere (up 0.1%) moved sideways on slumping grain prices. In the Information Technology sector, F5 Networks (down 8.3%) slipped as its security initiatives failed to impress and a senior sales executive resigned.
An allocation to high-yield bonds during a quarter when high-yield securities outperformed investment-grade debt helped the fixed-income portion of the Portfolio outpace its bond market benchmark, the Barclays U.S. Credit Index (which does not include high-yield bonds). The Portfolio’s high-yield holdings generally tend to be on the higher end of the high-yield credit quality range. As of December 31, 2012, high-yield bonds accounted for 5.78% (not including non-rated bonds) of the net assets of the Portfolio’s fixed-income allocation.
A short duration2 relative to the Barclays U.S. Credit Index also helped the relative performance of the Portfolio’s bond allocation. This conservative interest-rate positioning helped cushion the negative effects of a slight increase in interest rates during the quarter. As of the beginning of the first quarter, the Portfolio’s duration was 5.82 years while the duration of the Barclays U.S. Credit Index was 7.05 years.
During the quarter, the portfolio managers continued to selectively add asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) to the Portfolio. These structured bonds should increase the diversification level of the Portfolio and potentially help offset the negative impact of a sustained sell-off in the corporate bond market, should one occur.
High-yield, high risk bonds, which are rated below investment grade, can involve a substantial risk of loss because they have a greater risk of issuer default and are subject to greater price volatility than investment-grade bonds.