Virtus Strategic Allocation Series
2Q 2016 COMMENTARY
Equities – During the second quarter, the U.S. equity market continued to be tormented by the tug-of-war between the bulls and bears. While the S&P 500® Index has experienced several rapid swoons and sharp recoveries in the last year and a half, the price level of the Index has remained virtually unchanged. The United Kingdom’s surprising “Brexit” vote at the end of June sent the market into a temporary tailspin, only to quickly recover and make new all-time highs in mid-July. With the Federal Reserve and other world central banks continuing the easy money policy, the bears lack a compelling case for a move lower. Furthermore, bearish sentiment is high, which is not normally a precondition for a significant market decline. The overall market tenor during the quarter was affected by a general move back into defensive areas of the market – i.e., consumer staples, utilities, health care, and telecom – and the recovery in the price of crude oil, which served to propel beaten-down energy stocks higher.
Fixed Income – The broader U.S. bond market, as represented by the Barclays U.S. Aggregate Bond Index, returned 2.21% for the quarter. Despite the volatility and uncertainty surrounding the Brexit vote, spread sectors outperformed U.S. Treasuries as spreads tightened. High yield corporates was the best performing sector, posting its fifth consecutive month of positive returns since the sharp selloff in the early part of 2016. The emerging markets debt sector also performed well. Emerging markets were relatively stable following the Brexit vote, suggesting that the event was less systemic to global financial markets than previous events in recent history. Though greater fallout may yet occur, the emerging markets stand to benefit from a continuation of low U.S. interest rates, easing on the part of major central banks, and their potential to generate income in a yield-starved environment. Outperformance of longer duration assets contributed to the gains in investment grade corporates while dampening the performance of bank loans, which have inherently shorter durations.
During the second quarter, the Series increased 0.84% (Class A NAV), compared with the benchmark composite (60% S&P 500® Index, 40% Barclays U.S. Aggregate Bond Index) which rose 2.37%. The portfolio’s fixed income allocation generated a positive return in the quarter, while the performance of the equity allocation was negative.
Equity Allocation – The negative performance of the equity allocation was largely driven by the Series’ underweight allocations to the materials, consumer staples, utilities, and energy sectors, and stock selection within these sectors. In addition, the portfolio’s exposure to industrials was detrimental to performance, both in terms of the sector overweight and stock selection. The sectors that detracted the most from performance were industrials, health care, and consumer discretionary, while technology provided a modest benefit. The stocks that detracted the most from performance were Goodyear Tire, Alaska Air, and Target, while the stocks that made the largest positive contributions to returns were agricultural processor Archer-Daniels-Midland, a gold miner ETF, and discount retailer Five Below.
Fixed Income Allocation – Our underweight position in U.S. Treasuries and agency mortgage-backed securities benefited performance as most spread sectors outperformed the government sector. Our non-U.S. dollar exposure was aided by fading concerns over China, a more dovish Fed, major central bank easing, and higher commodity prices, which helped to improve global risk sentiment and contributed to U.S. dollar weakness during the quarter. Within the outperforming emerging markets high yield sector, the continued strength of Venezuelan debt during the quarter contributed to the Series’ return. The Series’ exposure to corporate high yield, the quarter’s strongest-performing fixed income sector, also benefited performance. At the same time, although the high yield sector made a positive contribution to overall performance of the Series, our higher quality bias detracted from returns in a period in which lower quality outperformed.
Equities – Although the overall environment during the quarter was relatively quiet and range-bound, the Brexit vote caused a violent sell-off in global stocks, only to be followed by a swift recovery that now leaves U.S. stock averages at all-time highs. As we have discussed in previous commentaries, the performance metrics that have aided many stocks in this market run contrary to our “growth at a reasonable approach” stock picking biases. The market’s manic nature is well illustrated by energy stocks and the beating they took last year, in contrast to the violent move upward these stocks have since seen this year with the recovery in oil prices. Also, during the recent period of tepid economic growth, investors have continued to search for growth at any price, not growth at a reasonable price, while simultaneously using the defensive areas of the market as a “bond proxy” in this very low interest rate environment. While it continues to be a very trying time for our stock selection process, we will continue to eliminate stocks that underperform, and buy stocks that we believe offer a combination of momentum and future consistent growth potential.
Fixed Income – The UK’s decision to leave the EU introduces new uncertainties to the global outlook with broad social, economic, and political implications that will take years to materialize. Although challenges remain in the global environment, a number of positive developments continued to help the credit markets perform well as the second quarter came to a close. Technical conditions in the credit markets also have improved. Against the more positive global backdrop, better economic data in the U.S. have alleviated fears of an impending recession. Our approach to investing in the global credit markets nonetheless requires caution as a number of these positive developments are still fluid situations: negative surprises and further currency devaluations are possible in China, oil likely will remain volatile, and the U.S. dollar could resume its ascent. All eyes will continue to be on the Fed. Though global concerns are a driving factor in its accommodating posture, the central bank has to weigh a host of external concerns against a resilient U.S. economy. We enter the third quarter guided by a modest improvement in the global environment, but also aware of newer risks such as the uncertainty associated with the UK’s vote and a divisive U.S. presidential election.
Benchmark since inception performance is reported from 9/28/1984. Class A operating expenses are 0.98% and gross operating expenses are 1.12%. Operating expenses reflect a contractual expense reimbursement in effect through 4/30/2017.
Average annual total returns reflect the change in share price and the reinvestment of all dividends and capital gains.
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: A composite index consisting of 60% S&P 500® Index and 40% Barclays U.S. Aggregate Bond Index. 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 Barclays U.S. Aggregate Bond Index measures the U.S. investment grade fixed rate bond market. The index is calculated on a total return basis. The indexes are unmanaged, their returns do not reflect any fees, expenses, or sales charges, and they are not available for direct investment.
The commentary is the opinion of the subadvisers. 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.
The investments for the Series are managed by the same portfolio manager(s) who manage one or more of the other funds that have similar names, investment objectives and investment styles as the Series. You should be aware that the Series is likely to differ from the other mutual funds in size, cash flow pattern and tax matters. Accordingly, the holdings and performance of the Series can be expected to vary from those of the other mutual funds.
Shares of the separate Series of Virtus Variable Insurance Trust are sold only through the currently effective prospectuses and are not available to the general public. Shares of the VIT Series may be purchased only by life insurance companies to be used with their separate accounts which fund variable annuity and variable life insurance policies or qualified retirement plans. The performance information for the Series does not reflect fees and expenses of the insurance companies. If such fees and expenses were deducted, performance would be lower.
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.
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.
Foreign & Emerging Markets: Investing internationally, especially in emerging markets, involves additional risks such as currency, political, accounting, economic, and market risk.
Allocation: The fund's exposure to different asset classes may not be optimal for market conditions at a given time. Asset allocation does not guarantee a profit or protect against a loss in declining markets.
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.
Prospectus: For additional information on risks, please see the fund's prospectus.