Virtus Multi Strategy Target Return Fund
2Q 2016 COMMENTARY
The second quarter started with risk assets extending their gains from the mid-February lows, and ended with a dramatic spike in volatility, large currency moves, and a flight to safety market environment triggered by the U.K.'s June 23 Brexit decision to leave the European Union.
The Fund remained on track with its aim of managing volatility to a target of less than half that of global equities.
The greatest drivers to the Fund’s performance in the quarter were credit and currency-based strategies.
The performance of risk assets generally improved in the beginning of the second quarter, extending their gains from the mid-February lows. Financial market advancement coincided with positive economic data flowing from China, which benefited from the country’s recommitment to growth announced earlier in the year. Elsewhere, manufacturing data were constructive in emerging and developed countries alike. These events contributed to a rally in commodity prices.
Midway through the quarter, Federal Reserve rate hike expectations were repriced into the market. Ultimately, the U.S. dollar delivered a strong recovery which adversely impacted emerging market currencies and debt. Also through the middle of the quarter, modest growth in the eurozone was supported by stable progress in Germany and France, while Japan continued to struggle with a deteriorating inflation outlook.
The tail end of Q2 2016 was overwhelmingly dominated by the EU referendum and subsequent decision by the U.K. to separate from the 28-state union. This June 23 decision resulted in a dramatic spike in volatility, large currency moves, and a flight to safety market environment.
The Fund returned -0.10% (Class A NAV) for the second quarter, which compares to 0.07% for the U.S. Treasury federal funds rate. Since inception on July 20, 2015, the Fund has observed an annualized volatility of 3.89% compared to 15.41% for the MSCI ACWI (local currency).
The greatest drivers to the Fund’s performance in the quarter were credit and currency-based strategies. Of particular significance, our long Australian and Korean rates strategies, as well as long positions in U.S. high yield credit and commercial mortgage-backed securities were all strong performers. Notable strategies that detracted from the Fund’s performance included our short German 10-year bund position and long equity exposure to Europe. Over the course of the last three months, we have selectively added to the overall risk of the portfolio, however, the Fund is constructed with a diversity of themes designed to deliver returns under a range of scenarios.
April —The Fund delivered a positive return as market sentiment stabilized. Prior changes in the Fund, which reflect our anticipation for prolonged accommodative monetary policy and global reflation, added to performance. Notably, exposure to Japanese and European stocks, as well as European and US inflation, were positive drivers. Our exposure to the US dollar, reduced compared to the beginning of the year, detracted modestly to offset the returns of various profitable equity and credit strategies. In April, we added a strategy to benefit from a steepening in the US yield curve.
May —The Fund was broadly flat in May. Duration-based and long inflation strategies detracted from performance as the portfolio experienced gains in equities and our long US dollar position. Aggregate portfolio risk was increased during May through exposure to global stocks. Additionally, the portfolio management team initiated a trade to short the Canadian dollar against the US dollar and a long Korean government bond strategy. We expect these strategies to support the performance of the portfolio should markets experience an increase in global risk-aversion.
June — June proved to be a challenging month for the Fund. A number of risk-reducing strategies, as well as exposure to equities via options, served to dampen losses during a volatile month, but not enough to prevent a small loss in the portfolio. Many of the gains were defensive in nature, such as volatility strategies, while detractors were largely our broad equity exposure. Government bond positions in Poland and South Africa were added to the Fund as well as an increase in exposure to emerging market stocks. Also added was a strategy designed to benefit from our negative outlook on European financials credit, in the event of continued stress in that sector of the credit market.
The most significant event for global markets leading up to June 23 was undoubtedly the outcome of the U.K. referendum. The vote to leave the EU came as a surprise to most, with opinion polls and betting agencies having had the odds in favor of remain in the days leading up to the vote. As such, the modest risk rally into June 23 rapidly reversed, with sterling assets hit hardest. The effect was felt across global markets, with equities selling off sharply and a flight to quality driving global government bonds yields lower and the U.S. dollar higher. The conclusion of this event provides an unambiguous reminder that nobody can predict the future.
The uncertainty facing the U.K. will continue as political changes are developing. We believe that the uncertainty created by the decision to leave the EU is enough to thrust the U.K. into a mild recession. Our central scenario is that the Bank of England will intervene, most likely by lowering interest rates and participating in asset purchases, but this will not be adequate enough to counteract adverse consumer sentiment and subsequent fall in business investment. Ultimately, this leaves the British pound vulnerable and likely to decline.
The U.S. economy has shown signs of resilience, albeit growth has been at a moderate pace. We expect the U.S. economy to continue growing at a healthy rate, supported by household consumer spending with tighter labor markets and rising inflation. Additionally, recent positive manufacturing survey data reinforces our conviction and alleviates some of the concerns deriving from the previous month’s non-farm payroll figure.
In the eurozone, manufacturing has recently surprised to the upside. Germany and Italy experienced the most meaningful increases whereas France has failed to keep pace. Consumer sentiment continues to improve within the region accompanied by a decline in unemployment. Inflation in the region is now decisively positive as recent headline readings ascended towards core inflation. We trust that the European Central Bank will continue with accommodative monetary policy and might consider extending their QE program. This course of action should benefit European equities and drive inflation higher.
We maintain that if properly managed, China’s efforts committed towards growth will be sufficient in preventing a “hard landing.” Consequently, we envision a gradual rebase lower for their currency. Elsewhere in Asia, Japan has endured a strengthening yen and successive deterioration in inflation. However, as Japanese Prime Minister Shinzo Abe has attained a majority after the Upper House election, we believe that he should be able to proceed with constitutional reform and implement a coordinated fiscal and monetary response.
Benchmark since inception performance is reported from 7/31/2015.
Class A operating expenses are 1.80% and gross operating expenses are 2.26%. Operating expenses reflect a contractual expense reimbursement in effect through 2/28/2017.
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.