The Virtus Small-Cap Sustainable Growth Fund invests in a select group of small-cap growth companies that exhibit a competitive advantage, have strong management and low financial risk, and that are able to grow over market cycles.
Virtus Small-Cap Sustainable Growth Fund
3Q 2016 COMMENTARY
MARKETS — U.S. small-cap stocks surged in the third quarter, with growth small-caps overcoming the losses experienced in the first half of the year. Technology and health care drove market performance as investors’ appetite for risk grew, while defensive sectors lagged, such as utilities and consumer staples.
PORTFOLIO — Given the market trend toward higher risk, lower quality stocks, the Fund with its high-quality focus slightly lagged its benchmark in the quarter. Changes made to the portfolio during the quarter included the purchase of Old Dominion Freight Line and the sale of Heartland Express and Hub Group.
OUTLOOK — The presidential election and prospect of a Fed rate hike in December will create some short-term uncertainty and headwinds for the market, but our outlook continues to be that the U.S. will grow over the next year at 1.5% to 2.5% in GDP, and that corporate earnings growth will drive equity returns of approximately 6% to 8% over the next 12 months.
The U.S. small-cap market advanced sharply during the third quarter. The Russell 2000® Growth Index gained 9.22% during the period, overcoming the decline in the first half of the year, and bringing the year-to-date return for the Index to 7.48%. An aggressive response from global central banks following the U.K.’s “Brexit” vote encouraged investors to embrace riskier securities as reflected in technology (+17.65%) and health care (+13.45%), driven by biotechnology shares, pacing gains. The defensive sectors of consumer staples (-5.06%) and utilities (-3.71%) lagged.
The Fund slightly underperformed the benchmark Russell 2000 Growth Index during the quarter, and significantly outperformed the Index year to date.
Companies that contributed the most to the Fund’s performance during the quarter were Shutterstock and Fox Factory Holding.
Shutterstock’s shares rose as recent business results have shown no erosion in the company’s competitive position with Adobe’s recent entrance into the market.
Fox Factory’s brand position is enabling the company to enjoy pricing power, enter adjacent markets, and expand profitability.
Holdings that contributed the least to performance were The Chefs’ Warehouse and PriceSmart.
The Chefs’ Warehouse is facing challenges integrating a recent acquisition onto its computer system which hurt profitability.
PriceSmart’s results were hurt by weakening currencies and economic conditions in South America.
PURCHASES AND SALES
During the quarter, we purchased Old Dominion Freight Line and sold Heartland Express and Hub Group. Old Dominion Freight Line was founded in 1934 and is the fourth largest less-than-truckload trucking company in the U.S. Less-than-truckload freight is comprised of multiple customers’ shipments per haul, thereby requiring a network of service centers to sort and expedite freight. As one of the largest less-than-truckload carriers, Old Dominion’s high volume of freight per service center enables for low per-unit handling costs which, in turn, attracts more customers’ freight in a virtuous circle. This has enabled Old Dominion to persistently gain market share (which rose from less than 3% in 2002 to over 8% currently) while generating high returns on its invested capital. To fund the purchase of Old Dominion, we sold our stakes in Heartland Express and Hub Group.
As we enter the final quarter of the year, we continue to face the uncertain outcome of the presidential election and the prospect that the Fed will raise interest rates slightly in December. This will create some short-term uncertainty and headwinds for the market, but we recommend staying the course for the long term. Investors have had plenty of time to process the election and the Fed’s outlook for the rate increase, so we do not believe either will have a meaningful impact on equity prices over the long term.
Our outlook continues to be that the U.S. will grow over the next year at 1.5% to 2.5% in GDP, and that corporate earnings growth will drive equity returns of approximately 6% to 8% over the next 12 months.
Class A operating expenses are 1.50% and gross operating expenses are 1.58%. Operating expenses reflect a contractual expense reimbursement in effect through 7/31/2017. Operating expenses do not include indirect expenses incurred by the underlying funds in which the Fund invests.
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® Growth Index is a market capitalization-weighted index of growth-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.
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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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