NOTICE: 2019 Capital Gains Available. View PDF here.

Mid Cap Core Equity Fund Commentary

3Q 2019

The returns presented reflect fee waivers that have been in effect during the applicable periods. Without such waivers, the total returns would have been lower. Currently, contractual fee waivers are in effect from December 26, 2018 through December 31, 2019.

The Fund’s Institutional share class returned -0.13% in the third quarter, compared with the Russell MidCap® Index1, the Fund’s benchmark, which returned 0.48%.

How did stocks fare overall?

Positive economic growth continued in the second quarter of 2019 though gross domestic product1 (GDP) growth decreased to 2.0% from the first-quarter reading of 3.1%. Forecasts call for U.S. GDP growth to remain at or below 2% through the end of 2021. The Institute for Supply Management indices1 and Conference Board Leading Economic Indicators1 pointed to an ongoing slowdown that began in late 2018. Concurrently, companies have pushed back against rising employment costs and salaries by hiring less aggressively, although employee confidence remains high, as reflected by the growing number of quits in the job market.

Sentiment appears to be divided, with businesses pulling back to a neutral stance, while consumers still appear to be enthusiastic about the economy. The Federal Open Market Committee (FOMC) cut the federal funds rate twice—by 0.25% each time—in the third quarter, in July and again in September. While being noncommittal on additional rate cuts, the Fed indicated that it would be prepared to act in the event of a further economic downturn. Speculation regarding future actions by the U.S. and foreign central banks has had a significant influence on equity market returns, a theme that is likely to persist. Trade and tariff issues have also contributed to market volatility as optimism ebbs and flows over U.S. trade deals with China and other nations.

It was a mixed bag for stocks in the third quarter as large-cap U.S. equities posted modest returns while other developed markets were slightly negative. U.S. small caps were next on the spectrum, followed by emerging markets, which underperformed. Within the U.S., large-cap growth stocks edged out large-cap value by a slim margin, but value stocks performed better in the mid-cap and small-cap segments. Defensive, higher-yielding sectors, including utilities, real estate, and staples, tended to perform better while cyclical, commodity-sensitive sectors, such as materials and energy, lagged. Healthcare, which is often considered more defensive, was a notable exception as the political rhetoric surrounding the 2020 presidential election has kept downward pressure on drug companies and health care providers.

The third quarter followed the pattern that we saw in the second quarter. Investor risk aversion started out at a fairly low level, jumped midway through August, and then calmed again in September. This led to positive returns in July, a pullback in August, and generally positive returns again in September. While more defensive styles and sectors performed better in July and August, September had some sharp reversals beneath the surface, even though the overall equity market returns were rather muted. Bond yields, which had come down to multi-year lows in August, suddenly surged in early September on greater optimism surrounding economic growth. For equities, this news was counter to the consensus positioning that had heavily favored high-growth, momentum stocks over high-beta1, value, and small caps. As a result, when investors raced to shift to the new outlook, high-momentum stocks drastically underperformed while deep-value, previously heavily shorted stocks outperformed significantly in just a few short days. Defensive sectors—utilities, real estate, and consumer staples—still outperformed cyclical areas—materials and energy—for the quarter as a whole, but September was full of surprises.

Many of the issues that the market had struggled with in the first half of the year lingered on through the third quarter. Tariffs and trade policy, Fed actions, central bank activities in Europe and Asia, and the U.S. presidential race continue to be the main focus of investors’ attention. These issues are largely dependent upon the words and actions of a rather limited set of individuals, which makes navigating them a complex task. Markets as a whole appear to be anticipating slower growth going forward, but there remain a number of other sources of volatility that investors have to deal with.

What factors influenced the Fund’s performance?

From a market cap perspective, we are in line with the benchmark. As to sectors, our approach this quarter leaned primarily on overweights to technology and industrials while we had an underweight to utilities, communication services, and materials. Technology and industrials had positive returns in the third quarter, but utilities outperformed significantly. As a result, the overweight to technology and industrials added to performance but the underweight to utilities made it difficult to keep up with the benchmark. Overall, in the third quarter, our return from sector allocations relative to the benchmark was negative (around -0.13%).**

From a style perspective, we held stocks that had some positive price momentum, higher profitability metrics, and lower leverage. These higher-quality characteristics had mixed results but, combined, they added around 0.15%. Other, smaller-risk exposures also contributed, with style allocation adding around 0.20%. The combination of ongoing trade disputes, increased volatility in oil markets, and the sharp thematic reversal in September had a negative impact on our stock picks within sectors, which ended up detracting around 0.34% versus the benchmark.

Overweights to industrials and technology helped the Fund's relative performance the most. A Semiconductor toolmaker benefited from a more positive outlook for a U.S.-China trade deal and improved analyst sentiment for its stock, and gained 23.7% for the quarter. A financial information management systems and services firm rose 13.6% on a positive earnings report and analyst upgrades. A uniform supplier, which makes employee uniforms and other business support products, gained 13%, supported by a tailwind of lower unemployment, and increased hiring.**

On the other hand, our overweight to the consumer discretionary sector and an underweight to materials hurt relative performance the most. An internet infrastructure and domain name company, saw its stock fall 9.8% as increased government scrutiny and the potential for greater regulation weighed on its prospects. An independent oil and natural gas company fell 23.1% during the quarter, hurt by the drop in oil and gas prices. An oil exploration and production company had its stock tumble 26.7% for the same reason.**

What is your outlook?

The macroeconomic backdrop both in the U.S. and globally slowed again in the third quarter. A surprising uptick in housing activity may have been due to a decline in prevailing mortgage rates. However, regional and national purchasing managers indices have retreated significantly. There appears to be a growing divergence between the outlook of businesses/business owners and consumers. On the one hand, businesses are wary of a continued slowdown in growth and they may have grown weary of the persistent uncertainty regarding trade and tariffs. They are also showing signs of pulling back on hiring. Consumers, on the other hand, appear to be much more confident about the economy and the job market in the months ahead.

Our outlook tends to align better with the business outlook in that we expect that growth will deteriorate somewhat over the next three to six months. During this period, we believe that themes surrounding growth, profitability, and quality will continue to outperform. However, we do anticipate that a rebound is likely in the late first quarter or second quarter of 2020, which would benefit riskier, cyclical stocks. We will be looking to shift to those themes gradually over the next few months but, for now, we expect volatility to continue within equity markets and we expect more muted returns over the next few months.

We have been leaning on growth and profitability themes for a number of quarters in anticipation that the macroeconomic data would slow and that those characteristics would help protect the portfolio in the event of a more severe market downturn. If an economic rebound were to occur as we anticipate, in the first or second quarter of 2020, then having a portfolio that is too defensive could cause us to lag the market. With that thought in mind, we have begun to pay closer attention to cyclical areas of the markets and/or beaten-down value stocks that would likely benefit should that shift occur. While the portfolio is still focused on high-quality, profitable ideas at the moment, it is likely that we will begin to gradually shift towards cyclical themes such as value late in 2019 or early in 2020 in anticipation of an economic upturn.

**
Portfolio composition is subject to change.
Each Lipper Mutual Funds average is an equally weighted average of the mutual funds within their respective investment objectives, adjusted for reinvestment of capital gain distributions and income dividends.
1

Definitions

Gross Domestic Product (GDP) measures the market value of the goods and services produced by labor and property within the respective country/economic region. Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole, beta is used in the capital asset pricing model, which calculates the expected return of an asset based on its beta and expected market returns. Conference Board Leading Economic Index is an American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables. ISM Manufacturing Index (ISM) is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM monitors employment, production, inventories, new orders, and supplier deliveries. A composite diffusion index monitors conditions in national manufacturing and is based on the data from these surveys. Russell MidCap® Index measures the performances of the 800 smallest companies in the Russell 1000® Index. The index is unmanaged and does not reflect the fees and expenses associated with a mutual fund. An investor cannot invest directly in an index.

Past performance does not guarantee future results. The performance data quoted represents past performance and current returns may be lower or higher. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. To obtain performance information current to the most recent month end, call 800-762-7085 or visit us at www.cavanalhillfunds.com.

The Lipper Mutual Funds Average is an equally weighted average of the mutual funds within their respective Lipper classification, adjusted for reinvestment of capital gains distributions and income dividends. Lipper ratings are not intended to predict future results, and Lipper does not guarantee the accuracy of this information. More information is available at www.lipperweb.com. Thomson Reuters Copyright 2019, All Rights Reserved.
Morningstar rankings are based on a fund’s average annual total return relative to all funds in the same Morningstar category. Fund performance used within the rankings, reflects certain fee waivers, without which, returns and Morningstar rankings would have been lower. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100.
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An investor should consider a fund’s investment objectives, risks and charges and expenses carefully before investing or sending money. This and other important information about an investment company can be found in the fund’s prospectus. To obtain a Cavanal Hill Funds prospectus or summary prospectus, please call 800-762- 7085 or visit us at www.cavanalhillfunds.com. Please read it carefully before investing.

Cavanal Hill Investment Management, Inc. is an SEC registered investment adviser and a wholly-owned subsidiary of BOKF, NA, a wholly-owned subsidiary of BOK Financial Corporation, a financial holding company (“BOKF”). BOKF, NA serves as the custodian for the Cavanal Hill Funds. Cavanal Hill Investment Management, Inc. provides investment advice, administration and other services for the Funds and receives a fee for providing such services as fully described in the prospectus. The Funds are distributed by Cavanal Hill Distributors, Inc., a registered Broker/Dealer, member FINRA and wholly-owned subsidiary of BOKF. SEC registration does not imply a certain level of skill or training. Bank of Oklahoma and its affiliates Bank of Arkansas, Bank of Albuquerque, Bank of Texas, Bank of Arizona, Mobank and Colorado State Bank and Trust offer investment management and administrative services nationally and administer more than $35 billion in assets for numerous clients, including foundations and endowments, and high-net-worth individuals.
Commentary provided is for the period ended 9/30/2019 is designed to provide a frame of reference and does not constitute investment advice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. The opinions expressed herein reflect the judgment of the authors at this date and are subject to change without notice and are not a complete analysis of any sector, industry or security. This document contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates, and projections about the Cavanal Hill Funds, the securities and credit markets and the economy in general. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “plans,” “projects,” variations of such words and similar expressions are intended to identify such forwardlooking statements. Management judgments relating to and discussion of the value and potential future value or performance of any security, group of securities, type of security or market segment involve judgments as to expected events and are inherently forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what is expressed, implied, or forecasted in such forward-looking statements. The potential realization of these forward-looking statements is subject to a number of limitations and risks, which are described in the Funds’ prospectuses, and investors or potential investors, are cautioned to review the Funds’ prospectuses, and the description of such risks. Neither the Funds nor the Funds’ investment adviser, Cavanal Hill, undertake any obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events or otherwise.

MUTUAL FUNDS AND OTHER INVESTMENTS: NOT FDIC INSURED • MAY LOSE VALUE • NO BANK GUARANTEE

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