Virtus Multi-Strategy Target Return Fund
4Q 2016 COMMENTARY
PORTFOLIO — The Fund had a strong quarter, showing little reliance on the overall direction of broad markets to deliver its return, finishing up 3.53% (Class I), well ahead of both the MSCI All Country World Index (net), which rose 1.19% (in U.S. dollars), and the Bloomberg Barclay’s U.S. Aggregate Bond Index, which was down 2.98%. A combination of market, opportunistic, and risk-reducing strategies contributed to the performance over the course of the quarter.
MARKETS — Risk aversion was the immediate reaction in global asset markets to the surprise victory by Donald Trump, quickly giving way to an expectation that his key economic policy proposals of lower taxes and increased spending would fuel a much more reflationary environment. Global yield curves steepened and the U.S. and other equity markets advanced whereas vulnerabilities in emerging market fixed income and currency assets were realized.
OUTLOOK — Looking ahead, we favor diverse exposure to North America, Europe, and emerging markets equities. Within fixed income, we continue to see credit spreads tightening and given the potential duration risk in a rising yield environment, we prefer high yield credit. We continue to maintain a bias that is long the U.S. currency as we expect the U.S. dollar to continue to be supported by widening interest rate differentials with the rest of the world.
Global yield curves steepened in the beginning of the fourth quarter accompanied by a rise in market-based measures of inflation compensation. This behavior, in our view, is reflective of receding deflationary concerns and is the result of continued moderate global growth, commodity price stabilization, and monetary policy remaining accommodative. The U.S. presidential election became the dominant theme surrounding the November 8 results.
Risk aversion was the immediate reaction in global asset markets to the surprise victory by Donald Trump, however, this rapidly gave way to an expectation that his key economic policy proposals of lower taxes and increased spending would fuel a much more reflationary environment. Subsequently, global yield curves steepened and the U.S. and other equity markets advanced whereas vulnerabilities in emerging market fixed income and currency assets were realized. The quarter concluded on a strong note for global equities as the rally continued attributed to greater expectations for global growth and inflation, while the recent trend higher in global yields paused.
The Fund was up 3.53% (Class I share) in the quarter, showing little reliance on the direction of markets to deliver its return, compared with the MSCI All Country World Index (net), which rose 1.19% (in U.S. dollars), as well as the Bloomberg Barclay’s U.S. Aggregate Bond Index, which was down 2.98%. Since its inception on July 20, 2015, the Fund has observed annualized volatility of 3.28% compared to 13.19% for the MSCI All Country World Index (ACWI), in local currency, over the same period. A combination of market, opportunistic, and risk-reducing strategies contributed to the Fund's performance over the course of the quarter.
- October — A broad range of strategies contributed to the Fund’s overall positive performance in October. A number of the equity strategies gained, led by long Europe and short U.S. biotech. Positive contributions were also the result of the short German bunds, long U.S. and European inflation, developed market curve steepening, and currency strategies. These gains were partly offset by losses in credit. We took the opportunity to benefit from a more stable outlook for commodity prices by initiating a strategy of being long global resource stocks. We also collected profits and closed our short pound sterling position against the U.S. dollar, while adding a short position in the Japanese yen against the U.S. dollar.
- November — November delivered a small positive return for the Fund, driven by the strategies that benefited from a more reflationary market environment. Positive contributions came from the U.S. and Japanese equities, rate strategies (short German bunds, long U.S. inflation, and positions in U.S. and Australian rates that benefited from a steeper yield curve), and foreign exchange strategy (short Japanese yen). These gains were offset by losses in emerging market equities and local currency debt, as well as our short U.S. biotech stocks strategy. We increased our exposure to the reflation theme by adding to our long U.S. inflation strategy and our strategy anticipating rising yields in longer-dated Australian bonds, which reflected our view that President-elect Trump would pursue more reflationary policies. Prior to the election we closed our long position in the Mexican peso against the Canadian dollar, given the asymmetric downside risk of the strategy in the event of a Trump victory.
- December — Positive performance in December resulted from gains made across a range of strategies. Long positions in European equities and global resource companies contributed as well as our long U.S. dollar strategies against the Korean won and Chinese renminbi. Additionally, our strategies of being long South African and Indonesian government bonds were profitable as U.S. rates stabilized.
Global monetary policy accommodation is being extended into 2017, with the European Central Bank (ECB), Bank of Japan (BoJ) and the Bank of England (BoE) all continuing quantitative easing, and several other central banks reducing policy rates. While inflation remains low in most countries, the U.S. has shown signs of higher inflation and we expect the Federal Reserve (Fed) to embark on a tighter monetary policy stance as a result.
As the U.S. economy continues its recovery, the election of Donald Trump as president has the potential to further stimulate the reflationary environment through infrastructure spending and tax cuts. We therefore continue to believe that the strength of the U.S. economy, accompanied by higher inflation, warrants our expectations for the Federal Open Market Committee to raise rates three more times in 2017 and multiple times in 2018.
The pace of eurozone recovery is showing encouraging signs but remains modest despite the extended policy stimulus from the ECB. We believe we are still far away from a rise in Euro policy rates as we expect a steady but slow increase in the region’s inflation measures.
The U.K. economy has been resilient since the Brexit vote but we believe we are still in the early stages, as business investment could significantly slow given the uncertainty. We expect growth to be negatively impacted and a weaker currency (sterling) to lead to higher short-term inflation.
Japan’s inflation outlook remains challenged to reach its two percent target. As expectations of any further stimulus from the BoJ are low, the onus is now on the government to pursue reflationary policies in order to help the economy reach this goal. We expect weakening in the yen to persist into 2017, which could reduce some of the pressure on the BoJ and the government to engage in further supportive policies.
Within equities, we favor diverse exposure to North America, Europe, and emerging markets. North America in particular should continue to benefit from U.S. growth, together with supportive Trump policies. Within fixed income, we continue to see credit spreads tightening and, given the potential duration risk in a rising yield environment, we retain a preference for high yield credit. We continue to maintain a bias long the U.S. dollar as we expect it will continue to be supported by widening interest rate differentials with the rest of the world.
Benchmark since inception performance is reported from 7/31/2015.
The fund class gross expense ratio is 2.02%. The net expense ratio is 1.45%, which reflects a contractual expense reimbursement in effect through 3/1/2017. This ratio reflects the direct and indirect expenses paid by the Fund.
The net expense ratio minus the indirect expenses incurred by the underlying funds in which the Fund invests is 1.44%.
Average annual total returns reflect the change in share price and the reinvestment of all dividends and capital gains. Class I shares have no sales charge and therefore their returns do not reflect the deduction of a sales charge, which if applied, would reduce the performance quoted. Fees and expenses vary among share classes and other share classes do carry sales charges. Class I shares are offered primarily to eligible institutional investors who purchase the minimum amounts required and may not be available to all investors. For performance of other share classes, please visit www.virtus.com.
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.