Virtus Multi-Strategy Target Return Fund
3Q 2016 COMMENTARY
MARKETS — Global financial markets broadly improved at the beginning of the third quarter, supported by the accommodative monetary policy of central banks. Emerging markets bonds and equities benefited from a late-quarter rally in commodities, while European banks and Japanese equities were under pressure.
PORTFOLIO — The Fund's performance was positive in July, led by a number of long equity strategies, led by Japan and emerging markets. Returns were also positive in August, driven by credit strategies in emerging markets and North American high yield. September presented many challenges, however, and the Fund was adversely impacted by long Japanese equities, short U.S. biotech stocks, and a number of rates and currency strategies. Although these losses were partly offset by gains in the long U.S. and European inflation, emerging market rates, and emerging market equity strategies, the Fund ended the quarter down slightly.
OUTLOOK — We continue to prefer risk-seeking assets over bonds, including North American equities, on the basis of continued household real income and earnings growth, and emerging markets equities, based on reasonable valuations and improvements in forward earnings expectations. Within fixed income, we continue to see value in high yield and emerging market debt, in particular local currency.
Financial markets broadly improved at the beginning of the third quarter, continuing the trend observed shortly after the U.K.’s “Brexit” referendum in late June. Contributing to the recovery in global sentiment was the extended accommodative monetary response of policymakers which served to support global risk assets.
The middle of the quarter was characterized by a docile financial market environment. With fears of a “hard landing” for China’s economy and commodity price collapse subsiding, the search for yield increased and purchases of emerging market government bonds accelerated.
Commodities largely advanced towards the end of the quarter. Emerging market bonds and equities were beneficiaries of this rally. European banks continued to be under pressure, as well as Japanese equities. The latter is a result of the ineffectiveness of the efforts by the Bank of Japan’s (“BOJ”) to stimulate inflation and growth within its economy and restore confidence in financial markets.
The Fund returned -0.42% (Class A NAV) during the quarter ended September 30, 2016. Since its inception on July 20, 2015, the Fund has observed annualized volatility of 3.74% compared to 14.81% for the MSCI All Country World Index (ACWI), in local currency.
July — Fund performance was positive, aided by gains in a number of the long equity strategies, led by Japan and emerging markets. Positive contributions were also the result of the long emerging market and long North American high-yield credit strategies. The performance gains were offset by losses in the volatility and select short equity strategies. Aggregate exposure to the U.S. dollar was adjusted by replacing the long U.S. dollar versus short Singapore dollar strategy, with a long U.S. dollar versus short New Zealand dollar strategy.
August — The Fund’s returns were again positive, driven by credit strategies in emerging markets and North American high yield. These positions were supplemented by the positive performance from the long U.S. commercial mortgage-backed securities (CMBS) and U.S. inflation strategies. Detracting from performance were losses in equities and foreign currency exchange, with the long South African rand exposure experiencing the greatest decline. During the month, the long Mexican government credit strategy was modified by funding from Canadian dollars versus the previous funding in U.S. dollars. This action was taken to protect the strategy against the potential adverse impact of the U.S. economic and political situation.
September —The Fund faced numerous challenges and was adversely impacted by long Japanese equities, short U.S. biotech stocks, and a number of rates and currency strategies. The losses were partly offset by performance gains in the long U.S. and European inflation, emerging market rates, and emerging market equity strategies. During the month we introduced steepener positions (a type of interest rate swap) in the Australian and Korean rates markets, which reflect our expectation that global reflationary pressure will start to appear through steeper curves. We also added a long position in Israeli rates. We closed our relative value equity strategy between the S&P 500® Index and Russell 2000® Index, as valuation differentials between these two asset classes no longer supported the strategy. Finally, we reduced our Japanese equity exposure in the lead-up to the BOJ meeting, reflecting our change in view on further near-term monetary stimulus in Japan.
Global monetary policy accommodation has extended throughout 2016, with the Federal Reserve further delaying increasing rates and the European Central Bank (“ECB”), BOJ, and the Bank of England (“BOE”) all undertaking quantitative easing, and several other central banks reducing policy rates. Inflation remains low in most countries, but there is now evidence that, with the exception of Japan, it is moving slowly higher.
As the U.S. recovery continues to mature, indications are for a gradual rise in interest rates over the course of the next two years. We continue to believe that the strength of the U.S. economy, accompanied by higher inflation, warrants tighter monetary policy by the Fed.
The pace of the eurozone recovery remains modest, despite the extended policy stimulus from the ECB. We expect a steady increase in the region’s inflation measures as it currently remains too low. Progress on structural reforms has been mixed and the very low trend growth rate in the region may well fall further.
The U.K., on the other hand, has embarked on the long road to European Union exit. Growth will be negatively impacted in our view and in the short-term inflation will spike higher, reflecting the weakness of the currency (sterling).
Japan appears to be at yet another critical juncture. The limits of monetary policy seem to have been reached and although the BOJ has clearly stated that it will continue to offer policy support until its inflation target has been breached, the policy efforts have effectively been handed to the fiscal authorities.
We continue to prefer risk-seeking assets over bonds. Within equities, we favor North American equities on the basis of continued household real income and earnings growth. We also favor emerging markets equities based on reasonable valuations and improvements in forward earnings expectations. Within fixed income, we are conscious that many credit spreads have contracted significantly but in the global hunt for yield we still favor credit. We continue to see value in high-yield and emerging market debt, in particular local currency.
Benchmark since inception performance is reported from 7/31/2015.
Class A operating expenses are 1.69% and gross operating expenses are 2.27%. Operating expenses reflect a contractual expense reimbursement in effect through 3/1/2017. Operating expenses do not include indirect expenses incurred by the underlying funds in which the Fund invests.
Average annual total returns reflect the change in share price and the reinvestment of all dividends and capital gains. Net Asset Value (NAV) returns do not reflect the deduction of any sales charges. POP (Public Offering Price) performance reflects the deduction of the maximum sales charge of 5.75%. A contingent deferred sales charge of 1% may be imposed on certain redemptions within 18 months on purchases on which a finder’s fee has been paid.
Performance data quoted represents past results. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. Investment return and principal value will fluctuate so your shares, when redeemed, may be worth more or less than their original cost. Please visit Virtus.com for performance data current to the most recent month-end.
Index: The Federal Funds Rate is the interest rate paid on overnight loans made between depository institutions. This index is the weighted average of rates on brokered trades and represents the arithmetic mean of all daily rates for a given month. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment.
Aviva Investors Americas LLC (AIA) is the named subadviser to the Virtus Multi-Strategy Target Return Fund and utilizes the services of Aviva Investors Global Services Limited (AIGSL) and its other affiliates (collectively, Aviva Investors) to manage the Fund. These affiliates are Participating Affiliates as that term is used in relief granted by the SEC. The listed investment professionals are associated with AIGSL.
The portfolio managers utilize derivatives to implement the majority of the fund’s investment strategies. Considering each investment strategy’s contribution to overall risk may present a clearer picture of how the fund is positioned relative to each investment’s market value. Risk is defined as volatility, as calculated by FinAnalytica, and is a one month annualized standard deviation, which measures dispersion of returns. It may not be indicative of future risk, and is not a predictor of returns.
The commentary is the opinion of the subadviser. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
Equity Securities: The market price of equity securities may be adversely affected by financial market, industry, or issuer-specific events. Focus on a particular style or on small or medium-sized companies may enhance that risk.
Foreign & Emerging Markets: Investing internationally, especially in emerging markets, involves additional risks such as currency, political, accounting, economic, and market risk.
Credit & Interest: Debt securities are subject to various risks, the most prominent of which are credit and interest rate risk. The issuer of a debt security may fail to make interest and/or principal payments. Values of debt securities may rise or fall in response to changes in interest rates, and this risk may be enhanced with longer-term maturities.
High Yield-High Risk Fixed Income Securities: There is a greater level of credit risk and price volatility involved with high yield securities than investment grade securities.
Derivatives: Investments in derivatives such as futures, options, forwards, and swaps may increase volatility or cause a loss greater than the principal investment.
Leverage: When a fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded.
Counterparties: There is risk that a party upon whom the fund relies to complete a transaction will default.
Portfolio Turnover: The fund's principal investments strategies will result in a consistently high portfolio turnover rate. A higher portfolio turnover rate may indicate higher transaction costs and may result in higher taxes when fund shares are held in a taxable account.
Prospectus: For additional information on risks, please see the fund's prospectus.