NOTICE: 2019 Capital Gains Available. View PDF here.

Mid Cap Core Equity Fund Commentary

4Q 2019

The Fund’s Institutional share class returned 5.74% in the fourth quarter, compared with the Russell MidCap® Index1, the Fund’s benchmark, which returned 7.06%.

How did stocks fare overall?

U.S. gross domestic product1 (GDP) annualized growth continued at a muted 2.1% in the third quarter of 2019, up slightly from the second quarter’s reading of 2.0%. Forecasts call for GDP growth to slow down to roughly 1.7% in the fourth quarter of 2019 and first quarter of 2020 and then pick back up to the 2.0% level. Leading indicators had another difficult quarter as the Institute for Supply Management indices1 and Conference Board Leading Economic Indicators1 extended their slowdown that began in late 2018. Businesses and consumers remain divided on their outlooks. While business confidence and sentiment have pulled back to more cautious levels, consumers appear to be more optimistic. The combination of a strong job market, healthy consumer balance sheets, and low inflation has helped to keep consumer spending elevated.

The Federal Open Market Committee’s accommodative stance in 2019 and the corresponding three 0.25% cuts to the federal funds rate during the year also served to pull down mortgage rates in the second half of the year. This led to a major rebound in housing affordability, existing home sales, and housing starts. In addition to support from the U.S. Federal Reserve Board (the Fed), some resolution on Brexit was found and the announcement of a “Phase One” U.S. trade deal with China reversed the consensus outlook from slower growth and a potential recession to a pickup in growth and a renewed expansion. This shift in perspective helped to move markets higher and contributed to a resurgence of cyclical themes while defensive areas lagged.

Stocks had a strong fourth quarter. Emerging market equities led the way, followed by U.S. stocks, and then other developed markets. Within U.S. markets, outperformance came from the tails of the market-cap spectrum as small- and mega-cap stocks had larger returns than large- and mid-cap stocks. Growth stocks generally did better than value stocks for the quarter and the year, though Apple muddied the waters somewhat. Apple, which returned more than 80% during the year, has the largest weight in cap-weighted, large-cap indices. Standard & Poor’s classified Apple as a “value” stock in 2019 while Russell included it in the Russell 1000® Growth Index. This led to a wide performance differential when comparing S&P 500 Value Index1 versus Growth and Russell 1000® Value Index1 versus Growth.

Defensive, higher-yielding sectors—utilities, real estate, and staples—underperformed as market sentiment improved in the fourth quarter. Information technology was the leading sector for the year, propelled even higher in December after the trade deal with China was announced. The health care sector also benefited as the political focus shifted onto other issues in the fourth quarter.

The fourth quarter started out on a shaky note but quickly recovered, rising steadily higher throughout November and December as investor sentiment turned more optimistic. Risk aversion, as evidenced by narrowing credit spreads and declining equity volatility, moved to multi-year lows in the quarter. After a number of misfires on trade talks with China, the announcement of the Phase One deal clearly took many investors by surprise. While previous trade announcements had only a short-lived impact on the market’s outlook, the Phase One deal took root and remained center stage for the rest of the quarter. This bolstered more cyclical sectors and those companies with greater exposure to China. In contrast, defensive styles and sectors lagged behind. Getting the timing correct in regards to when the Phase One agreement would be announced and gauging the importance that the market would attach to it was exceedingly difficult. As mentioned previously, trade negotiations had gone through a number of false starts. Knowing when Phase One would finally come through was impossible to predict, and knowing how much the market would buy into it added further complexity. The position of the Fed and the U.S.-China trade status completely reversed over the past 12 months. The extreme pivots and the market’s swift and volatile reactions were difficult to navigate, especially for managers that may have limits on turnover and tax consequences. The upcoming 2020 U.S. presidential race will no doubt gain attention going forward. However, for now markets appear satisfied that the macroeconomic headwinds to growth have been offset by accommodative central bank policy and the promise of the U.S.-China trade deal.

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 on an overweight to technology, energy, and financials while we had an underweight to utilities, communication services, and healthcare. Energy stocks benefited from the cyclical shift, which made our overweight in this sector additive to performance. While large-cap technology did very well, mid-cap tech delivered roughly average performance, so the technology overweight was a wash. The underweight to healthcare was the most detrimental to relative performance as those stocks made large gains, reflecting the changing political backdrop. Overall, in the fourth quarter, the return from our sector allocations relative to the benchmark was negative (around -0.18%).**

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 overall they added around 0.20%. Other, smaller risk exposures netted each other out. The drop in market risk aversion and the quick shift back to cyclical, higher-risk market segments had a negative impact on our stock picks within sectors—primarily within technology and software—which ended up detracting around 0.49% versus the benchmark. Cash holdings and large transactions into and out of the fund also created a sizable drag on performance. Overall, we underperformed the benchmark by roughly 1.32% for the quarter.

An overweight to the energy sector and an underweight to consumer discretionary helped the Fund's relative performance the most. The stock of Fortinet (2.97% of investments), a cybersecurity company, rose 39.1% during the quarter, as it continued to produce strong financial results and had steady price appreciation. Allegion (1.07%), a Dublin-based security device and service company, had a solid fourth quarter, rebounding 20.2% after a third-quarter selloff as it benefited from the Phase One U.S.-China trade deal. Align Technology (0.84%), a medical device maker, soared 54.2% in the quarter, rebounding from a third-quarter selloff after some patent infringement litigation was settled in its favor.** On the other hand, our overweight to the industrials sector and an underweight to healthcare hurt relative performance the most. The stock of Hasbro (0.82%), an entertainment and toy company, fell 11.0% in the fourth quarter after a major miss on its third-quarter earnings. Online retailer Etsy (0.70%) fell short of expectations and its stock declined by 21.6% in the fourth quarter. ServiceMaster (0.69%), a residential and commercial cleaning, restoration, and pest control company, missed its earnings expectations and reduced its forward guidance, resulting in a 30.8% quarterly loss.**

What is your outlook?

Macroeconomic data in the U.S. had mixed results in the fourth quarter. Manufacturing surveys and purchasing manager indices continued to decline but housing-related industries had positive results. The job market, wages, and consumer activity also stayed strong during the quarter. The divergence between the outlook of businesses and business owners, on the one hand, and consumers remains, with businesses much less optimistic. However, positive sentiment has overtaken the market with expectations of a cyclical rebound. Previously, we anticipated a rebound late in the first or second quarter of 2020 and, from a macroeconomic perspective, we think that the data will improve.

The market’s shift to such a positive outlook happened much sooner than we anticipated. However, while we think riskier, cyclical stocks will perform better on the margins, the magnitude of the differences going forward may be smaller. Because the market anticipates a rosier growth environment in 2020, the risks are that a policy error or geopolitical event could stall out the recovery. Considering how much less risk aversion is present in markets than even three months ago, we are constructive on markets and cyclical themes but also aware that negative events could quickly offset the balance. This is an environment where we will be trying to find higher quality, risk-managed companies in the value and cyclical space. Risk management will be crucial over the next six to 12 months.

The announcement of the Phase One deal with China and the shift in market sentiment happened sooner than we had anticipated. While we have leaned on growth and profitability themes for a number of quarters based upon expectations that macroeconomic data would slow further, the outlook has changed enough that we will shift away from a defensive posture to opportunities in the more cyclical areas of the market. Should the macroeconomic data continue to improve, then there will likely be a rebound in more beaten-down, value names while growth stocks trading at higher multiples could stagnate. The portfolio will remain focused on high quality, profitable ideas but cyclical themes such as value will grow in importance.**

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.

**
Portfolio composition is subject to change.
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 2020, 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. © 2020 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
1

Definitions

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. Gross Domestic Product (GDP) measures the market value of the goods and services produced by labor and property within the respective country/economic region. 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. Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. S&P 500 Value Index measures the performance of the largecapitalization value sector in the US equity market. It is a subset of the S&P 500 Index and consists of those stocks in the S&P 500 Index exhibiting the strongest value characteristics. The indexes are unmanaged and does not reflect the fees and expenses associated with a mutual fund. An investor cannot invest directly in an index.

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 12/31/2019 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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