Virtus Global Infrastructure Fund
3Q 2016 COMMENTARY
- MARKETS — The third quarter of 2016 was generally good for developed world equity markets. Within the infrastructure sectors, utilities and communications gave back some of the strong performance achieved during the first half of the year, energy rallied on potential OPEC oil production cuts, and several transportation stocks performed well, influenced positively by traffic numbers from European toll roads and Asia/Pacific airports.
- PORTFOLIO — The Fund has posted strong relative performance over the last 12 months, though lost ground during the third quarter primarily due to declines in utilities and communications. For the quarter, the Fund’s absolute performance was mostly unchanged; however, it underperformed broader equity markets and also lagged its benchmark
- OUTLOOK — We expect to see continued volatility in equity markets as the year draws to a close, influenced by pivotal elections in France, Italy, and the U.S., as well as the potential for a Fed rate hike. Despite these uncertainties, we remain confident that the income the Fund pays to shareholders will be supported by the dividends generated by the companies within the portfolio.
For the quarter ended September 30, 2016, developed world equity markets generally benefited from a post Brexit rally which was achieved early in the period as central banks remained accommodative. Toward the latter part of the quarter, stocks treaded water as investors grappled with monetary policy and political election concerns. In the U.S., apprehension surrounding the presidential election outcome and increasing Federal Reserve rate hike speculation gave pause. In Europe, subdued growth prospects, political and economic uncertainties, and concerns about bank stability were the focus.
At the sector level, utilities and communications gave back some of the strong performance achieved during the first half of the year. Energy rallied after OPEC agreed to oil production cuts, and several transportation stocks performed strongly due to solid traffic numbers from European toll roads and Asia/Pacific airports. The Fund significantly underperformed developed market equities and underperformed its benchmark as investors rotated out of defensive sectors due to strong relative performance and growing interest rate concerns.
Over the last 12 months, developed world equity markets posted strong returns even though there were multiple challenges. Stocks managed to move forward despite tepid economic outlooks and political election uncertainties. Market volatility was enhanced by a short-lived, broad-based, Brexit-related selloff, which was followed by a strong relief rally as central bankers reiterated intentions to continue with monetary easing policies. In Europe, most stock markets finished the period in positive territory with the notable exception being Italy. Italian stocks were negatively impacted by concerns over a constitutional referendum (a vote is currently scheduled for early December) in which voters will decide the future structure of the government. The current prime minister, viewed by many as constructive toward commerce and markets, has pledged to resign if the reform measures are rejected.
U.S. stock markets ended the period among the strongest performers in the developed world. After enhanced volatility leading into the Fed’s 25 basis point Fed funds rate increase in December 2015, U.S. stocks moved upward as expectations for further rate hikes diminished, Brexit fears were forgotten, and OPEC reached an agreement on oil production cuts.
During the quarter, after several ups and downs, the Fund’s absolute performance was mostly unchanged. The Fund underperformed its benchmark and the broader world equity market (as measured by the MSCI World Index). Security selection had a negative contribution and was the primary driver of the Fund’s underperformance versus the benchmark. Utility selection was the biggest detractor. Portfolio performance was particularly impacted by the sell-offs of several gas and water utility stocks which we own. Stock selection in both communications and energy also detracted, as we were overweight the energy stock with the worst performance during the quarter, while in communications we had a large overweight in a U.S. tower stock that performed poorly. Transportation was the only sector with a positive security selection effect.
Sector allocation had a positive impact on portfolio performance relative to the benchmark. The primary drivers were our overweight in energy, which was the top performing sector, and our underweight in communications which lagged both energy and transportation. The utilities sector posted the weakest performance, and it was the largest detractor given our overweight position. Regional allocation had a slightly negative impact on performance. Positive contributions from an overweight in North America and an underweight in Africa/Middle East were more than offset by the negative impacts stemming from underweights in Asia Pacific and Europe.
Over the past 12 months, the Fund outperformed both developed market equities and its benchmark. The outperformance can be partially attributed to the defensive sectors in which we invest being supported by the “lower for longer” interest rate policies instituted by central bankers across the developed world. The primary contributor to the Fund’s outperformance versus the benchmark was stock selection in utilities and transportation. Utilities in several countries were buoyed by accommodative central bank policies. The Fund was overweight U.S. utilities, which sold off prior to the Fed’s December 2015 rate hike, but rebounded strongly during the second quarter when investors sensed a less hawkish Fed. However, utilities lost ground during the final quarter as investors rotated out of defensive names due to strong relative performance and the return of rising interest rate concerns.
Transportation, which was the Fund’s largest overweight, was its top performing sector for the year and contributed significantly to outperformance versus the benchmark. Transportation stocks were driven upward by strong air passenger demand and toll road usage. Communications was a slightly negative detractor to performance versus the benchmark mainly due to exposure to the satellite companies. Energy sector performance had a neutral impact on relative performance over the course of the year. Weak stock selection was offset by an overweight sector allocation. After a dismal start, energy was the Fund’s strongest sector over the final 3 quarters as oil prices stabilized and the stocks reacted positively to the OPEC oil production cuts agreed to September.
As we enter the fourth quarter, we expect to see continued volatility in equity markets. The outcomes of political elections in France, Italy, and the U.S. will be pivotal to investor sentiment toward equities. In the U.S., the Fed is on watch for a potential interest rate rise, most likely in December. Given the uncertainties, we believe that the sector and regional diversity that our strategy provides can continue to offer benefits to investors. We remain confident that the income the Fund pays to shareholders will be supported by the dividends generated by the companies within the portfolio.
Utilities — Our utility overweight is primarily a result of our positive view on U.S. regulated companies. We are particularly attracted to U.S.-based gas and water utilities, as the large capital spending needs bode well for those companies with supportive regulation. The cautionary note is the potential for a Fed rate hike before year-end. We expect utility stock volatility leading up to a rate hike, but believe that the fundamental investment cases for the companies in which we invest remain strong.
Communications — We had a large underweight in communications, which is partially due to ongoing concerns around the wireless market for U.S. integrated telecommunications companies and valuations. European telecommunications fundamentals have shown pockets of improvement, but the stocks continue to be weighed down by uncertainty surrounding the Eurozone economy, keeping us underweight for now. We remain comfortable with the overweight position in U.S. tower companies as they will benefit from network investment by the carriers to support increased data and video usage. The portfolio benefits from the attractive dividend yields provided by communications companies, which are generally well supported by cash flows.
Energy — The OPEC oil production cuts agreed to in September provided a boost to most energy-related stocks, including the mid-stream energy companies in which we invest. During the quarter, we added to our energy overweight position. We believe that as oil price volatility subsides, our mid-stream energy stocks will benefit from a renewed investor focus on company fundamentals.
Transportation — Transportation remains our largest overweight. We like the long-term concession agreements, the strong cash flows, and the dividends. Our airport and toll road companies are positioned to benefit from relatively attractive traffic growth. However, we have turned more cautious on Northern European hub airports as passenger loads have been adversely impacted by terrorism concerns. The final quarter of the year will be a key barometer as holiday travel is an important indicator of consumer sentiment.
Benchmark life performance is reported from 12/31/2004.
Class A operating expenses are 1.22%.
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.
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 Investing: Investing internationally involves additional risks such as currency, political, accounting, economic, and market risk.
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.
Income: Income received from the fund may vary widely over the short- and long-term.
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