Strategy Description: The Large Cap Focused Equity strategy seeks long-term growth of capital by identifying companies with earnings growth that the portfolio manager believes have the potential to convert to higher growth rates that will exceed investor expectations. The investment process integrates quantitative research to identify opportunities and risks swiftly, and fundamental analysis to verify sources of unexpected growth. The strategy is managed by Smith Group Asset Management, a 10-member investment team averaging 21 years of experience and 13 years of tenure with the firm. Originally founded in 1995, Smith Group became a part of Cantor Fitzgerald in 2021.

Performance: The –3.0% return of the portfolio outpaced the –3.3% return of the S&P 500 Index and the –3.1% return of the Russell 1000 Growth Index. The portfolio had favorable stock selection in Technology and Consumer Staples versus both benchmarks, while Communication Services and Health Care holdings were the primary headwind to relative performance. The portfolio had positive stock selection and negative sector allocation versus the broad market S&P 500 Index while results were reversed relative to the Russell 1000 Growth Index. (for more detail see page 4-6)

Growth Versus Expectations: A key aspect of the Smith Group investment process is that all portfolios embed an earnings growth premium — the difference between expected and realized earnings growth — that ultimately is reflected in stock prices. In the second quarter, 87% of holdings reported better than expected earnings and 71% reported better than expected revenues. Portfolio holdings had very favorable changes in forward growth expectations as the median forward 12–month earnings growth estimate rose by 1.28% for portfolio holdings relative to a 0.00% increase for the median large cap company. Over the past year, portfolio holdings exceeded their expected growth rates estimated one-year ago by 7.9% while benchmark holdings fell short of expectations as inflation pressures continued to compress margins for many companies. (for more detail see page 3 of PDF)

Smith Group Models: The strategy seeks out stocks with key fundamental characteristics that are consistent with companies exceeding growth expectations. Those characteristics are grouped into models that help us in screening and ranking. Smith Group’s Primary Investment Models showed modest positive returns during the period as the Growth Outlook Model failed to add value while Earnings Quality and Valuation models each showed favorable price discrimination. Growth investment factors were largely negative for the quarter while value factors showed strong performance, especially those value metrics focused on earnings and cash flow. (for more detail see page 10 of PDF)

Earnings Trends: Over the past year, earnings have proven far more robust than we expected and after three quarters of side-ways to slightly down year-over-year reports that saw earnings fall by only 3.4%, earnings appear on an upward trajectory once again with an expected next 12-months rise of 10.2% for the average stock in the S&P 500 Index and an increase of 7.7% for the capitalization-weighted index. If consensus earnings expectations are accurate then the S&P 500 Index is trading at 19.3x forward earnings and the average stock in the index is trading at 18.0x forward earnings.

Market Comment: In July, US equity markets extended the rally that began in October 2022 with the S&P500 index rising 3.2%, lifting the index 30% off the October 2022 lows and a mere 1.8% below the highs of early 2022. But July 31 was the high-water mark for the index as it traded down 6.3% over the next two months and finished down 3.3% for the quarter. Traditionally defensive sectors provided little protection from the market pullback as Consumer Staples and Utilities stocks fell 7.9% and 11.4%, respectively, over August and September. Small Caps fared much worse in the sell-off with the Russell 2000 Index falling 10.6% for the last two months. The average stock in the S&P 500 continues to trail the index by a wide margin, returning 1.9% year-to-date versus 13.1% for the capitalization-weighted index. The Federal Reserve raised the Fed Funds Target another 0.25% in the quarter and the yield on the 10 Yr. Treasury rose 0.72% from 3.86% to 4.58%. Mortgage rates reached a 23-year high at quarter’s end as rates on 30-year fixed mortgages rose to 7.3%. WTI Crude rose 28% to $90.77/bbl. while lithium prices continued their sell-off falling 40% for the quarter and are now down 67% from their December 2022 peak.

Inflation has been receding and the U.S. economy continues a path toward normalization while generally outpacing expectations. The economic outlook for Europe and China is not nearly as sanguine as both regions are either in recession or assuredly headed toward one in short order. The Fed remains in tightening mode, but the transmission mechanism of the long and variable lags of monetary policy appear much more difficult to judge relative to prior rate cycles. Just as the causes of this inflationary spike were unique, the effectiveness of the medicine also seems unique. There is a fairly reasonable chance that the economy is just now starting to feel the effects of monetary policy and if that is the case, then a recession would seem the likely outcome. However, consumers are the most important driver of the U.S. economy, and they appear healthy with real wages rising and consumption showing few signs of slowing. Corporate balance sheets are in good standing with little need for debt issuance to fund growth. Given these tail winds an environment of high-single digit corporate earnings growth and a slowdown but not a crash in the economy seems a reasonably likely outcome. (for more detail see page 11 of PDF)