Virtus Global Infrastructure Fund
2Q 2016 COMMENTARY
The Fund posted positive performance in the second quarter of 2016, significantly outperforming broader equity markets and also outpacing the global infrastructure benchmark.
Stock selection across all sectors in which the Fund invests — utilities, communications, energy, and transportation — was beneficial to the strategy and the primary driver of the outperformance relative to the benchmark.
The Fund’s strong performance in a quarter characterized by global volatility and uncertainty demonstrates the benefits that may result from having an allocation to the global infrastructure asset class.
For the second quarter of 2016, developed world equity markets generally treaded water for the better part of the period as numerous concerns resurfaced. In the U.S., economic growth continued to be underwhelming and renewed worries about the jobs market seems to have put the Federal Reserve back on hold with respect to interest rates. Tepid economies in much of the rest of the world also kept investors on edge during the period. After the United Kingdom (U.K.) voted to leave the European Union (known as “Brexit”) on June 23, global markets experienced severe volatility throughout the remainder of the quarter.
The last 12 months have been challenging for the broader global equity markets. During the second half of 2015, global markets were concerned about the Fed’s tightening timetable as the U.S. economy showed some improvement but most developed economies struggled. Fears that global economic growth was slowing sent commodity prices, including oil, into a downward spiral. After the Federal Reserve finally increased the federal funds rates in December, the new year began with the broader U.S. equity market (as measured by the S&P 500® Index) falling dramatically, and many of the developed equity markets followed the U.S. market’s path. Global growth concerns, oil weakness, and the dollar’s strength all weighed on risk assets. For the latter half of the first quarter and into the second, sentiment improved with global equities and oil rallying. The mood turned sour at quarter’s end as the reality of Brexit hit the markets.
During the second quarter, the Fund posted positive absolute performance of 6.54% (Class A NAV), outperforming the benchmark return of 5.35%. Compared to the broader world equity market (as measured by the MSCI World Index), the strategy significantly outperformed, as defensive stocks rallied on economic concerns and lower-for-longer interest rates. Security selection across all sectors contributed and was the primary driver of outperformance versus the benchmark during the quarter. The strongest selection effect came from the utility sector, followed by communications. Our focus on U.S. regulated utility companies continues to pay off in the current uncertain market environment. Stock selection in communications was supportive mainly driven by the overweight in the U.S. tower stocks and underweight in the poorly performing European telecommunications companies, partially offset by an overweight in the satellite companies. The selection contributions from transportation and energy were modest.
Sector allocation had a modestly negative impact on portfolio performance versus the benchmark during the period, primarily due to our overweight in transportation. This was the weakest performing sector in the benchmark as Brexit had a substantial downward influence on the European transportation names. Partially offsetting the adverse sector allocation was a positive effect from an underweight in communications as its performance lagged both energy and utilities. Regional allocation was immaterial as the positive contribution from the overweight in North America, the best performing region, was mostly offset by the negative impact from Asia and Europe.
Over the past 12 months, the Fund significantly outperformed its benchmark and the broader developed world markets as investors sought safe havens amidst the backdrop of uncertainty. Positive stock selection in the utilities, transportation, and communications sectors drove the outperformance relative to the benchmark, with only a modest negative offset by energy stock selection. Sector allocation had no impact as the positive effect of the overweight in utilities and transportation, combined with the underweight in the social services sector, was offset by being slightly overweight energy and underweight communications.
As we enter the second half of the year, we expect equity market performance will remain mixed and volatile given the persistence of several factors, among them: questions surrounding the strength of the U.S. economy; actions by central banks; the slow pace of a eurozone recovery; implications of Brexit for the U.K. and the European Union; U.S. politics; and global terrorism concerns. Given the uncertainties around the world, we are sticking to our core investment themes. We believe that our strategy provides ample diversity across both sectors and regions, and during these times, our focus on developed markets is central to achieving relatively attractive risk-adjusted returns. We remain confident that in the current environment the portfolio is well positioned to provide an opportunity for growth with a steady income stream.
Utilities – During the quarter, we reduced our utilities overweight slightly but continue to have a positive view on U.S. regulated companies. The U.S. operating environment remains constructive as robust capital spending needs are being largely supported by state regulatory commissions. Additionally, we are invested in select European utilities that have long-term regulatory plans in place, providing both visibility and stability. We continue to avoid utilities with significant exposure to the competitive power business given excess capacity and power price concerns.
Communications – We have a large underweight in communications, which is partially due to ongoing concerns around the wireless market for U.S. integrated telecommunications companies. Given current valuation levels in the U.S., we increased the underweight even further in the quarter. While European telecommunications fundamentals have shown some improvement, upside from M&A now appears limited. Post the Brexit selloff, valuations for the large-cap European incumbents are generally more interesting, but apprehension around the economic impact keeps 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 – We added to our energy holdings during the period, moving the sector to an overweight. After a prolonged period of negative price action, we have turned more positive on energy. While the worst of the oil price crisis seems to be over, there may be continued volatility in energy-related stocks over the short term. We believe that the midstream energy companies (pipelines, gatherers, and processors) in the portfolio are somewhat insulated from oil price movements given multi-year contracts and regulatory agreements. Additionally, the energy companies in the portfolio are underpinned by solid fundamentals with visible dividend support.
Transportation – Our favorite sector and largest overweight continues to be transportation. Our Australian and European holdings in this sector continue to benefit from an increase in global business and leisure travel. Long-term concession agreements with government authorities, attractive cash flows, and stable or growing dividends support our overweight investment thesis. Post Brexit, we will be monitoring traffic trends in Europe closely to see if there is any lasting impact to the European and U.K. economies.
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 MSCI World Infrastructure Sector Capped Index. This is a market capitalization weighted index that measures performance of global infrastructure companies by capturing broad and diversified opportunities across telecommunication, utilities, energy, transportation and social infrastructure sectors. The telecommunication infrastructure and utilities sector each represent one-third of the index weight, while energy, transportation and social infrastructure sectors have a combined weight of the remaining one-third of the index. Performance of the Global Infrastructure Linked Benchmark prior to 9/1/2008 represents an allocation consisting of 65% MSCI USA/Utilities Index, 20% MSCI World Telecom Services Index, and 15% MSCI World ex USA/Utilities Index. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and it is not available for direct investment.
The S&P 500® Index
is a free-float market capitalization-weighted index of 500 of the 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.
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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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