Virtus Zevenbergen Technology Fund

4Q23

Market Review

As the December calendar page turns and the last holiday cookie disappears, investors often consider changes to their portfolio allocations and lifestyle driven by the seasonal cycle. 2023 exemplified the challenges inherent in reacting to historical economic data and returns, reaffirming the adage that "past performance is not indicative of future results.” At ZCI, we resisted the Ghosts of Christmas Past and remained resolutely forward-looking, focusing on the actions and goals of company management teams as they navigated an uncertain economic landscape. Much of 2023’s relative outperformance was attributable to portfolio holdings escaping the previous year’s penalty box through diligent expense management and accelerating product momentum. Investors continued to grapple with various factors during the quarter, including consumer resilience, business profit trends, and the implications of macroeconomic and corporate data on future investment returns. Additionally, the Federal Reserve’s December minutes introduced the possibility of interest rate cuts in 2024.

Fund Performance

The Virtus Zevenbergen Technology Fund returned 15.72% (Class I) in the quarter, underperforming the S&P North American Technology Sector Index, which returned 17.17%. The underperformance was due to an underweight to the information technology sector (semiconductors, application software), and an overweight and stock selection within the communication services sector (interactive media & services, interactive home entertainment, advertising). The consumer discretionary sector was a significant contributor to performance (broadline retail).

Microsoft and Advanced Micro Devices were the largest contributors to performance in the quarter.

• Microsoft posted double-digit sales growth and record earnings in the most recent quarter, handily exceeding investor expectations. While still early in the company’s AI monetization efforts, client spend on AI workloads contributed to an acceleration in Azure cloud revenue, which rose 28% year over year. In November, the company’s partnership with OpenAI was in focus as Microsoft introduced its first custom co-designed chip for generative AI just days before a leadership shakeup at the startup. (Ultimately, OpenAI’s CEO Sam Altman retained his role, and Microsoft earned a non-voting board seat, granting greater visibility into the partnership.) Additionally, the company closed its acquisition of Activision Blizzard after a lengthy review process, bolstering Microsoft’s mobile gaming content catalogue. Shares moved higher throughout the quarter, contributing positively to strategy performance.
• Semiconductor company Advanced Micro Devices topped revenue expectations supported by cyclical improvement in global PC markets and enterprise demand for datacenter chips. Propelling share gains further, the company launched its latest MI300 portfolio with improved memory density and bandwidth for applications in generative AI training and inference. While peer NVIDIA retains leadership in the AI chip market today, testimonials for the MI300 series from tech giants Microsoft, Oracle, and Meta Platforms allude to support of multiple viable suppliers in the market. Given widespread demand for AI across many different industries and the pace of technology buildouts, management outlined a total addressable market of $400 billion for its datacenter chip portfolio (more than double prior expectations).

ON Semiconductor and The Trade Desk were the largest detractors from performance in the quarter.

• Supplier of sensor and power management components to auto and industrial end markets, ON Semiconductor reported solid 3Q23 results, but forward guidance disappointed. The company struck a conservative tone on global vehicle sales as consumers grapple with higher loan financing costs, acknowledging a near-term pullback in demand for its high efficiency silicon carbide chips from a single, large electric vehicle manufacturer. While management reiterated confidence in the secular trend for electric vehicles and the company’s ability to grow its silicon carbide business twice the market rate this year (supported by strong design wins), a cyclical recovery will likely be more weighted in the latter half of 2024.
• Founder-led advertising technology platform The Trade Desk reported a strong 3Q23, but shares pulled back on slightly weaker guidance, driven by macro pressures. Large automotive and entertainment customers reduced discretionary spending in view of recent labor strikes while other budgets were paused after escalating conflicts in Israel. TV ad budgets moving to digital channels remains the largest avenue of growth for The Trade Desk. This is complemented by a rapidly growing retail media business with deepening partnerships from the likes of Walmart, Kroger, and Target. While short-term macro trends may continue to be unpredictable, a seasoned executive team and looming 2024 election spend cycle should help navigate the uncertainty.

Perspective

Reminiscent of a Rorschach test, interpretations of the market environment continue to fluctuate, with some seeing uncertainty where others see opportunity. While macroeconomic and geopolitical headlines have long played a role in how investors view the future, the rapidity of the modern news cycle has undoubtedly intensified reactions to market developments. It can be easy to get caught up in the noise, with a seemingly endless supply of commentary tempting many to make short-term decisions at the expense of long-term outcomes. We look forward to the year ahead, welcoming fellow investors to direct attention “back to the basics” of company fundamentals as portfolio holding businesses leverage efficiency improvements and AI integration efforts to drive product advancements and revenue growth. Our investment team is grateful for the conviction and long-term outlook demonstrated by those investing alongside us at ZCI.