The Virtus Quality Small-Cap Fund invests in a select group of small-cap value companies that exhibit a competitive advantage, have strong management and low financial risk, and are able to grow over market cycles.
Virtus Quality Small Cap Fund
2Q 2016 COMMENTARY
The second quarter was marked by the surprising outcome of the U.K.'s "Brexit" referendum on June 23, which resulted in the decision to leave the European Union. For the subsequent two trading days, the U.S. equity market digested the implications of the vote, with the S&P 500® Index down over 5%. The following three trading days, however, saw the equity market rally nearly reaching the pre-Brexit level by quarter’s end. Similar to other major equity indexes, the Russell 2000® Value Index posted a solid return, up 4.31% for the quarter and 6.08% year to date.
The Fund outperformed the Russell 2000 Value Index in the quarter, 4.70% (Class A NAV) versus 4.31%. Year to date, the Fund also outpaced the benchmark, 10.56% (Class A NAV) versus 6.08%. From a sector perspective, performance in the quarter was driven by strong stock selection in the consumer staples and financial services sectors. Unfavorable stock selection in the materials and processing sector and poor stock selection and an overweight in the producer durables sector detracted from performance.
The companies contributing the most to performance during the quarter were National Beverage and insurance and financial services company Primerica.
The companies that contributed the least to performance in the quarter were restaurant chain Cheesecake Factory and IT outsourcing firm Syntel.
PURCHASES AND SALES
We purchased Thor Industries for the portfolio during the quarter, and we sold Computer Services, First Cash Financial Services, and Questar.
Thor Industries is the second largest manufacturer of recreational vehicles (RVs) in the U.S., with a roughly 35% market share. Large scale allows the company to enjoy significant purchasing power with its suppliers that (based on management’s estimates) translates into a meaningful four percentage points advantage in cost of materials over smaller competitors.
- We exited our position in Computer Services as we saw the company’s core marketplace of smaller size financial institutions suffer from the ongoing industry consolidation driven by rapidly rising regulatory compliance costs.
While we continued to admire First Cash Financial Services’ positioning in Mexico, we saw the company’s U.S. business struggle due to the pawn loan demand reduction that, we believed, was more structural than cyclical in nature.
We also exited our position in Questar after the natural gas company announced its acquisition by Dominion Resources.
We believe the domestic economy will grow at a modest rate in the range of 1.5% to 2.5%, and corporate earnings will grow in the mid-single digit range. Our confidence is growing that oil has finally hit bottom because domestic shale producers and major international oil companies have announced dramatic reductions in capital spending on the order of 40% to 70%. These supply reductions, combined with natural depletion rates, will ultimately reduce excess supply. Importantly, stability in the price of oil and the U.S. dollar will help stabilize reported profits for companies in the S&P 500, which have been sliding downward over the last two years due to the impact of weak oil and a strong U.S. dollar. This stability is needed in order for equity markets to generate returns in line with earnings growth.
As we have experienced thus far this year, it is likely to continue to be a volatile year for financial markets. Repercussions from the U.K.’s Brexit vote to leave the European Union and our own presidential elections are likely to cause continued market volatility. However, we will remain steadfast in our high-quality focus as we have always done through good and bad times over the last three decades.
Class A operating expenses are 1.28%.
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® Value Index
is a market capitalization-weighted index of value-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.
For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return measure that accounts for a variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in an investment 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 fund is derived from a weighted average of the performance figures associated with its 3-, 5-, and 10-year (if applicable) Morningstar Rating metrics. Ratings are for the A Shares as shown only; other share classes bear different fees and expenses, which affect performance.
Load-waived A share star ratings do not include any front-end sales load and are intended for those investors who have access to such purchase terms (e.g., plan participants of a defined contribution plan). Not all A share mutual funds for which Morningstar calculates a load-waived A share star rating may actually waive their front-end sales load. Therefore, Morningstar strongly encourages investors to contact their investment professional to determine whether they are eligible to purchase the A share without paying the front load.
© 2016 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
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.
Not insured by FDIC/NCUSIF or any federal government agency. No bank guarantee. Not a deposit. May lose value.
Distributed by VP Distributors, LLC
, member FINRA and subsidiary of Virtus Investment Partners, Inc.
2019 7-16 © 2016 Virtus Investment Partners, Inc.