The Virtus Small-Cap Sustainable Growth Fund invests in a select group of small-cap growth companies that exhibit a competitive advantage, have strong management and low financial risk, and that are able to grow over market cycles.
Virtus Small-Cap Sustainable Growth Fund
4Q 2016 COMMENTARY
MARKET — Small-cap stocks ended 2016 with a strong finish, surging in the fourth quarter to outpace large-cap stocks for the year.
PERFORMANCE — The Fund outperformed the benchmark for the quarter and the year. Omega Flex and The Chefs' Warehouse were the top performing holdings for the quarter.
OUTLOOK — Looking to the year ahead, there is a fair amount of economic uncertainty as the country awaits the arrival of the new administration. If the policy changes put forward by the president-elect come to fruition, we believe the economy and equity markets stand to benefit.
The U.S. small-cap market advanced sharply during the fourth quarter. In particular, the Russell 2000® Index gained 8.83%, bringing its year-to-date rise to 21.31%. The Russell 2000® Growth Index gained 3.57% during the quarter, bringing its rise for the year to 11.32%.
The U.S. election was one of the most significant economic events of 2016, as it turned some sector losers into winners, and vice versa. In the Russell 2000 Growth Index, utilities (+10.50%), financial services (+10.42%), and producer durables (+9.94%) all increased sharply during the quarter. Other sectors, including health care (-6.66%), and energy (-1.21%), lagged in the quarter.
The Fund outperformed its benchmark, the Russell 2000 Growth Index, during the quarter, and significantly outperformed the benchmark in 2016.
Holdings that contributed the most to performance during the quarter were Omega Flex and The Chefs' Warehouse:
- Omega Flex outperformed in the quarter due to improving residential construction prospects. We continue to believe that the company’s solid competitive position, in a niche market, will allow them to capitalize on a strengthening construction environment.
- The Chefs’ Warehouse’s quarterly results were in line with expectations after the company reported very disappointing results in the first half of 2016. Chefs’ sales have increased meaningfully, along with many other small-cap stocks, following the election.
Holdings that contributed the least to performance were Shutterstock and Ellie Mae:
- Shutterstock’s share price rebounded in previous quarters as concerns about the competitive threat from Adobe’s new stock photo offering abated. Softness in Shutterstock’s most recent quarterly results was due to changes the company made to some of its subscription plans, in addition to distractions caused by the upgrade of their technology infrastructure.
- Ellie Mae reported very strong results, both in terms of generating healthy productivity from its existing customers and booking new seats. However, the stock has been very negatively impacted by the recent rise in interest rates and the fear this will challenge refinancing.
PURCHASES AND SALES
During the quarter, we made no complete purchases or sales from the portfolio.
As we peer into 2017, we believe there is more than a usual amount of economic uncertainty. President-elect Trump has no public office track record for us to assess and judge how effective he will be in getting changes accomplished. It does seem highly likely that some form of corporate and personal tax reform, partial ACA repeal, increased infrastructure spending and less regulatory burden for many businesses will occur over the next two years. However, the timing of these changes is unclear. If these events were to occur, we believe the economy should accelerate and grow in the 2.5% to 3.5% range for the next couple of years. We also believe that the S&P 500 EPS growth should pick up from the low single-digit range to the mid-to-high single-digit growth range as economic growth increases over the next year.
The fund class gross expense ratio is 1.54%. The net expense ratio is 1.51%, which reflects a contractual expense reimbursement in effect through 7/31/2017. This ratio reflects the direct and indirect expenses paid by the Fund.
The net expense ratio minus the indirect expenses incurred by the underlying funds in which the Fund invests is 1.50%.
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 Russell 2000® Growth Index is a market capitalization-weighted index of growth-oriented stocks of the smallest 2,000 companies in the Russell Universe, which comprises the 3,000 largest U.S. companies. The index is calculated on a total return basis with dividends reinvested. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and it is not available for direct investment.
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.
Limited Number of Investments: Because the fund has a limited number of securities, it may be more susceptible to factors adversely affecting its securities than a less concentrated fund.
Industry/Sector Concentration: A fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated fund.
Prospectus: For additional information on risks, please see the fund's prospectus.
The Morningstar RatingTM for funds, or "star rating", is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.
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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.
Please carefully consider a Fund’s investment objectives, risks, charges, and expenses before investing. For this and other information about any Virtus mutual fund, contact your financial representative, call 1-800-243-4361, or visit Virtus.com for a prospectus or summary prospectus. Read it carefully before investing.