The Virtus Capital Growth Series offers a concentrated portfolio that focuses on companies with growth rates believed to exceed the general market.
Virtus Capital Growth Series
3Q 2016 COMMENTARY
The Series outperformed the Russell 1000® Growth Index during the third quarter. For the quarter, the portfolio benefited from strong stock selection in the consumer discretionary sector and strong stock selection and an overweight in the information technology sector, while negative stock selection in health care and an overweight in consumer staples detracted from performance.
Holdings that contributed the most to performance during the quarter were Facebook and Alibaba.
Facebook continues to grow advertising revenue and take share in the online digital marketing space. The company delivers an unprecedented global reach of 20% of the earth’s population to advertisers in a very measureable (return on investment) way. Monetization of this audience has barely scratched the surface of its long-term potential. Despite reaching a revenue run rate greater than $25 billion, Facebook’s second quarter growth rate accelerated again to 59%. Ad revenue soared as mobile monetization continued to rapidly improve and user engagement remained incredibly robust.
Alibaba’s two marketplaces, Taobao and Tmall.com, combine to form the largest online commerce company in the world by gross merchandise value (GMV). In recent quarters, GMV growth has reaccelerated and improved mobile monetization (better now than desktop) and has led to even faster growth in revenue. Management has laid out a number of social commerce initiatives to further improve mobile monetization over time. Alibaba’s marketplaces have significant network effects and the company is fostering the ecosystem with investments in payments and logistics partnerships.
Holdings that contributed the least to performance were Bristol-Myers Squibb Company and Monster Beverage.
To this point, Bristol-Myers has dominated the initial immuno-oncology (I/O) market, securing a market share over 80%. The company is working on combination therapies with a very broad set of checkpoint inhibitors which we believe will provide a more comprehensive and sustainable treatment for cancer. However, a failed trial in first-line lung cancer (based more on trial design than on drug effectiveness) and positive results from competitors have led analysts to adjust assumptions for Bristol’s ultimate market share and pricing power.
Quarterly results for Monster Beverage remain erratic as the company continues transitioning its global distribution agreements to Coke bottlers, the majority of which should be completed by the end of the year. Once the Coke bottler transition is complete, we believe this new partnership will accelerate Monster’s domestic and international sales resulting in many years of profitable growth ahead. As a result, we remain owners of the business.
PURCHASES AND SALES
During the quarter, we purchased Activision Blizzard and Westinghouse Air Brake Technologies, and we sold Apple, Fleetmatics Group, and Fortive.
Activision Blizzard is a creator of miniature social networks wrapped around the gaming experience. Social networks are great businesses because they have sticky and high margins and they have low capital intensity and strong recurring revenue. Activision’s core competency is creating gaming franchises that are incredibly immersive with a distinct social aspect that leads to a long tail of in-game purchases and/or subscriptions.
Westinghouse Air Brake Technologies is a leading provider of highly-engineered products and services to the rail-car industry. It manufactures brakes, electronics, and other specialty equipment that improve the safety and efficiency of locomotives and rails cars. Industry dynamics are attractive with large barriers to entry, which has resulted essentially in a duopoly between Westinghouse and Knorr-Bremse.
We sold Apple as it is facing a material slowdown in China which threatens one of the company’s largest drivers of growth over the last few years. Further, the iWatch has not taken off as well as some expected and iPad unit sales have moderated.
Fortive was spun out of Danaher in July and is the more classically cyclical and industrial segments of the former Danaher so we exited our small position.
Fleetmatics agreed to be acquired by Verizon at a 40% premium to the previous day’s closing price. We sold our fully valued shares to fund other purchases.
As we enter the final quarter of the year, investors face a multitude of uncertainties in the short term that could lead to market volatility, including the upcoming presidential election and prospects that the Fed will raise interest rates. However, we do not believe either will have a meaningful impact on equity prices over the long term. It is important to remember that even the president of the United States has limits to his/her power with checks and balances from the legislative and judicial branches of our government. Additionally, future interest rate increases by the Fed are intended to “normalize” rates and give the Fed more room to maneuver in the future, and are not intended to shut down an overheated economy. We believe the best solution for investors is to focus on high-quality securities which should generate favorable returns amid rising markets and provide downside protection in more volatile periods.
Class A operating expenses are 1.03% and gross operating expenses are 1.20%. Operating expenses reflect a contractual expense reimbursement in effect through 4/30/2017.Average annual total returns reflect the change in share price and the reinvestment of all dividends and capital gains. 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 monthend. Index: The Russell 1000® Growth Index is a market capitalization-weighted index of growth-oriented stocks of the 1,000 largest 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. 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. The investments for the Series are managed by the same portfolio manager(s) who manage one or more of the other funds that have similar names, investment objectives and investment styles as the Series. You should be aware that the Series is likely to differ from the other mutual funds in size, cash flow pattern and tax matters. Accordingly, the holdings and performance of the Series can be expected to vary from those of the other mutual funds. Shares of the separate Series of Virtus Variable Insurance Trust are sold only through the currently effective prospectuses and are not available to the general public. Shares of the VIT Series may be purchased only by life insurance companies to be used with their separate accounts which fund variable annuity and variable life insurance policies or qualified retirement plans. The performance information for the Series does not reflect fees and expenses of the insurance companies. If such fees and expenses were deducted, performance would be lower.
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.
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