Virtus Global Infrastructure Fund
4Q 2016 COMMENTARY
— The Fund posted strong relative performance over the last 12 months, but underperformed broader equity markets and its benchmark in the fourth quarter on the “Trump trade” and the Fed’s move to hike interest rates.ATTRIBUTION
— Security selection was the primary driver of the Fund’s underperformance versus the benchmark during the quarter, with transportation stock selection the biggest detractor.OUTLOOK
— We believe that the sector and regional positioning of the portfolio provides benefits to investors in a volatile market environment with numerous economic and political factors in play.
For the quarter ended December 31, 2016, the U.S. equity market rallied post the surprising presidential election result as a Republican-controlled Congress and White House were viewed as positive for the U.S. economy. Expectations of fiscal stimulus and lower taxes drove the reflation trade resulting in higher bond yields. As was largely anticipated post the election, the Federal Reserve raised the fed funds rate by 25 basis points in December. Other developed world equity markets generally lagged the U.S. due to the uncertain impact of the new administration’s policies, particularly with respect to trade, on the rest of the world. Additionally, concerns regarding economic growth prospects and the potential for political upheaval in many countries have caused global markets to trade cautiously.
For the 12 months ended December 31, 2016, developed world equity markets, as measured by the MSCI World Index, posted positive returns despite multiple challenges. Unexceptional economic outlooks across much of the world and widespread political election uncertainties resulted in significant market volatility. The two major events in the year were the United Kingdom voting to leave the European Union (“Brexit”) and Donald Trump winning the U.S. presidential election. Both outcomes were viewed as unexpected by the market, causing short-lived selloffs followed by strong rallies. The impacts of both events are likely to continue to affect markets in the coming years.
In the fourth quarter, the Fund underperformed the broader world equity market (as measured by the MSCI World Index) and its benchmark as investors rotated out of defensive sectors post the election. Security selection had a negative contribution and was the primary driver of the Fund’s underperformance versus the benchmark during the quarter. Transportation stock selection was the biggest detractor. European toll roads and airports had mixed performance and we generally owned the underperformers. We had overweight positions in the Australia/New Zealand toll roads and airports which underperformed in the quarter due to significant sector rotation out of defensive names and into commodity stocks in that region. The strength of the U.S. dollar also hurt the foreign transportation holdings. U.S. railroads rallied strongly in the quarter post the election. While we had some exposure to railroads, we didn’t own one of the better performers. Positive security selection in energy served as a partial offset. Two portfolio holdings that are not in the benchmark were significant outperformers in the quarter and accounted for most of the positive effect. Stock selection in communications and utilities had negligible impacts.
Sector allocation during the quarter had a modestly negative impact on portfolio performance relative to the benchmark. The primary drivers were our overweight in communications and our underweight in utilities. Communications was the second worst performing sector in the portfolio and utilities were the second best. Energy and transportation provided a modest offset to the negative allocation affect. Regional allocation had a beneficial impact on performance. Positive contributions from an overweight in North American and an underweight in Asia Pacific, were partially offset by the overweight in the poorly performing European region.
The Fund outperformed the broader global equity market (as measured by the MSCI World) and its benchmark over the 12-month period. The outperformance occurred in the first half of the year when the defensive sectors in which we invest outperformed based on loose monetary policies instituted by central bankers across the developed world. Some of that outperformance was given back in the last quarter on the “Trump trade” and the Fed’s move to hike interest rates.
As we enter a new year, we expect equity market performance will remain volatile while the market absorbs the numerous economic and political factors in play. Even though the U.S. economy appears to be gathering strength, the full impact of the new administration’s emerging policy changes are still unknown. Following the increase in the fed funds rate in December 2016, more tightening is likely in 2017, in contrast to the accommodative policies by central banks in other developed markets. Anxiety with respect to Europe is high given the slow pace of the European recovery, upcoming elections in France, Germany, and Italy, quantitative easing by the European Central Bank, and the Brexit transition. Given the uncertainties, we believe that the sector and regional diversity that our strategy provides can offer benefits to investors.
We have positioned the portfolio to reflect our outlook for each of the sectors. The largest overweight in the portfolio is energy given our view that the sector has stabilized following strengthening oil prices. As oil price volatility subsides, we believe the midstream energy stocks in the portfolio will benefit from renewed investor focus on company fundamentals. The current trend toward simplification of corporate structures of the pipeline companies and their limited partnerships has generally been perceived as favorable for the sector. Within the communications sector, we remain comfortable with the overweight position in U.S. and European tower companies as they will benefit from network investment by the carriers to support increased data and video usage.
We are underweight the utility sector but remain positive on the fundamentals of regulated utilities, particularly the U.S.-based gas and water utilities. Large capital spending requirements bode well for those companies with supportive regulation. The potential for further Fed rate hikes in 2017 could increase utility stock volatility. Tax reform could also create some uncertainty for the industry around interest expense deductibility, but overall any reform will likely be neutral for utility companies. The underweight in the transportation sector was driven by railroads where we were cautious on volume trends into year end. However, pricing and volumes could improve in 2017 with increased economic activity. Railroads would also be beneficiaries of tax reform. Our airport and toll road holdings are positioned to benefit from relatively attractive traffic growth in Europe and Asia.
Benchmark life performance is reported from 12/31/2004.
The fund class gross expense ratio is 1.32%.
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 Global Infrastructure Linked Benchmark consists of the FTSE Developed Core Infrastructure 50/50 Index (net), a free float-adjusted market capitalization weighted index that gives participants an industry-defined interpretation of developed market infrastructure companies and adjusts the exposure to certain infrastructure subsectors. The constituent weights are 50% Utilities, 30% Transportation (including capping 7.5% for railroads/railways), and a 20% mix of other sectors including pipelines, satellites, and telecommunication towers. The index is calculated on a total return basis with net dividends reinvested. The index is unmanaged, its returns do no reflect any fees, expenses, or sales charges, and is not available for direct investment. Performance of the Global Infrastructure Linked Benchmark between 9/1/2008 and 9/30/2016 represents a 100% allocation to the MSCI World Infrastructure Sector Capped Index. Prior to 9/1/2008 the allocation consisted of 65% MSCI USA/Utilities Index, 20% MSCI World Telecom Services Index, and 15% MSCI World ex USA/Utilities Index.
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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.
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