QUARTERLY REPORT
| Not FDIC Insured No Bank Guarantee May Lose Value |
August 31, 2018 |
FUND DISTRIBUTIONS AND MANAGED DISTRIBUTION PLAN
The Board of Directors (“the Board,” or the ”Directors”) of Virtus Total Return Fund Inc. (“the Fund”) adopted a Managed Distribution Plan (the “Plan”) which provides for the Fund to make a quarterly distribution rate of $0.361 per share. Under the terms of the Plan, the Fund seeks to maintain a consistent distribution level that may be paid in part or in full from net investment income, realized capital gains, and a return of capital, or a combination thereof.
If the Fund estimates that it has distributed more than its income and capital gains in a particular period, a portion of your distribution may be a return of capital. A return of capital may occur, for example, when some or all of the money that you invested in the Fund is paid back to you. A return of capital distribution does not necessarily reflect the Fund’s investment performance and should not be confused with “yield” or “income.”
To the extent that the Fund uses capital gains and/or return of capital to supplement its investment income, you should not draw any conclusions about the Fund’s investment performance from the amount of the Fund’s distributions or from the terms of the Fund’s Managed Distribution Plan.
The amounts and sources of distributions reported in Section 19(a) notices of the Investment Company Act of 1940 are only estimates and are not being provided for tax reporting purposes. The actual amounts and sources of the amounts for tax reporting purposes will depend upon the Fund’s investment experience during the remainder of its fiscal year and may be subject to changes based on tax regulations. The Fund will send shareholders a Form 1099-DIV for the calendar year that will tell you how to report distributions for federal income tax purposes.
The Board may amend, suspend or terminate the Managed Distribution Plan at any time, without prior notice to shareholders, if it deems such action to be in the best interest of the Fund and its shareholders.
Information on the Fund is available through the closed-end fund section on the web at www.Virtus.com. Section 19(a) notices are posted on the website at: https://www.virtus.com/our-products/closed-end-fund-details/ZF.
MESSAGE TO SHAREHOLDERS
Dear Virtus Total Return Fund Inc. Shareholder:
Enclosed is the quarterly report for the Virtus Total Return Fund Inc. (ZF) for the period ended August 31, 2018.
For the three months ended August 31, 2018, the fund’s net NAV increased 2.80%, including $0.3610 in reinvested distributions, and its market price increased 0.61%. The options overlay strategy contributed 1.29% to the fund’s NAV return during the period.
During the same period, the fund’s composite benchmark, consisting of 60% FTSE Developed Core Infrastructure 50/50 Index (net) and 40% Bloomberg Barclays U.S. Aggregate Bond Index, increased 1.83%, including reinvested dividends. Performance of the composite’s underlying indices over this period included a loss of 0.28% for the equity index and a gain of 0.02% for the fixed income index.
We announced in October that Rampart Investment Management has been appointed a subadviser to manage the fund’s options overlay strategy and that Rampart’s Chief Investment Officer, Warun Kumar, was added as a portfolio manager to the fund. Mr. Kumar previously managed the strategy through Newfleet Asset Management. Additional information is contained in the press release located on the fund’s web page at www.virtus.com.
On behalf of Virtus Investment Partners and our affiliated portfolio managers, I thank you for your investment. Should you have any questions or require support, the Virtus customer service team is ready to assist at 1-866-270-7788 or through the closed-end fund section of our website, www.virtus.com.
Sincerely,
George R. Aylward
President, Chief Executive Officer, and Trustee
Virtus Total Return Fund Inc.
October 2018
Performance data quoted represents past results. Past performance is no guarantee of future results and current performance may be higher or lower than performance shown above. Any market index referenced herein is unmanaged; its returns do not reflect any fees, expenses, or sales charges; and is not available for direct investment.
2
MESSAGE TO SHAREHOLDERS (Continued)
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.
Options Overlay: The options overlay strategy may not be successful in achieving its objective of increasing distributable income while limiting the risk of loss and, in periods of significant moves in the S&P 500® Index, has resulted and, in the future, may result in losses for investors.
Foreign Investing: Investing internationally involves additional risks such as currency, political, accounting, economic, and market risk.
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.
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.
ABS/MBS: Changes in interest rates can cause both extension and prepayment risks for asset- and mortgage-backed securities. These securities are also subject to risks associated with the repayment of underlying collateral.
Leveraged Loans: Loans may be unsecured or not fully collateralized, may be subject to restrictions on resale and/or trade infrequently on the secondary market. Loans can carry significant credit and call risk, can be difficult to value and have longer settlement times than other investments, which can make loans relatively illiquid at times.
Leverage: When a fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded.
Market Price/NAV: At the time of purchase and/or sale, an investor’s shares may have a market value that is above or below the fund’s NAV, which may increase the investor’s risk of loss.
Fundamental Risk of Investing: There can be no assurance that the Fund will achieve its investment objectives. An investment in the shares of the Fund is subject to the risk of loss of principal; shares may decrease in value.
3
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
| Portfolio Holdings Summary Weightings | ||||||||
| The following table presents the portfolio holdings within certain sectors as a percentage of total investments net of written options at August 31, 2018.
|
| |||||||
| Common Stocks |
61 | % | ||||||
| Utilities |
27 | % | ||||||
| Industrials |
17 | |||||||
| Energy |
11 | |||||||
| All other Common Stocks |
6 | |||||||
| Corporate Bonds and Notes |
18 | % | ||||||
| Financials |
4 | |||||||
| Energy |
4 | |||||||
| All other Corporate Bonds and Notes |
10 | |||||||
| Leveraged Loans |
6 | |||||||
| Mortgage-Backed Securities |
5 | |||||||
| Foreign Government Securities |
4 | |||||||
| Other |
6 | |||||||
|
|
|
|||||||
| Total |
100 | % | ||||||
|
|
|
|||||||
See Notes to Schedule of Investments
4
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
5
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
6
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
7
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
8
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
9
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
10
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
11
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
12
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
13
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
14
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
15
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
16
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
17
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
18
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
19
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
20
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
21
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
See Notes to Schedule of Investments
22
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
Open Purchased Options contracts as of August 31, 2018, were as follows:
| Description of Options | Number of Contracts |
Contract Notional Amount |
Strike Price(1) |
Expiration Date |
Value | |||||||||||||||
| Call Options |
||||||||||||||||||||
| S&P 500® Index |
409 | $ | 122,700 | $ | 3,000 | 9/4/18 | $ | 2 | ||||||||||||
| S&P 500® Index |
554 | 165,646 | 2,990 | 9/5/18 | 5 | |||||||||||||||
| S&P 500® Index |
132 | 39,534 | 2,995 | 9/7/18 | 3 | |||||||||||||||
| S&P 500® Index |
442 | 133,926 | 3,030 | 9/10/18 | 1 | |||||||||||||||
| S&P 500® Index |
603 | 182,709 | 3,030 | 9/12/18 | 2 | |||||||||||||||
| S&P 500® Index |
132 | 40,128 | 3,040 | 9/14/18 | 7 | |||||||||||||||
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| 20 | ||||||||||||||||||||
|
|
|
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| Put Options |
||||||||||||||||||||
| S&P 500® Index |
409 | 110,430 | 2,700 | 9/4/18 | 9 | |||||||||||||||
| S&P 500® Index |
554 | 150,688 | 2,720 | 9/5/18 | 33 | |||||||||||||||
| S&P 500® Index |
132 | 36,168 | 2,740 | 9/7/18 | 12 | |||||||||||||||
| S&P 500® Index |
442 | 121,771 | 2,755 | 9/10/18 | 56 | |||||||||||||||
| S&P 500® Index |
603 | 166,428 | 2,760 | 9/12/18 | 94 | |||||||||||||||
| S&P 500® Index |
132 | 36,432 | 2,760 | 9/14/18 | 33 | |||||||||||||||
|
|
|
|||||||||||||||||||
| 237 | ||||||||||||||||||||
| Total Purchased Options |
|
$ | 257 | |||||||||||||||||
|
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|
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Open Written Options contracts as of August 31, 2018, were as follows:
| Description of Options | Number of Contracts |
Contract Notional Amount |
Strike Price(1) |
Expiration Date |
Value | |||||||||||||||
| Call Options |
||||||||||||||||||||
| S&P 500® Index |
409 | $ | 120,042 | $ | 2,935 | 9/4/18 | $ | (7 | ) | |||||||||||
| S&P 500® Index |
554 | 162,322 | 2,930 | 9/5/18 | (57 | ) | ||||||||||||||
| S&P 500® Index |
132 | 38,874 | 2,945 | 9/7/18 | (13 | ) | ||||||||||||||
| S&P 500® Index |
442 | 131,274 | 2,970 | 9/10/18 | (24 | ) | ||||||||||||||
| S&P 500® Index |
603 | 179,393 | 2,975 | 9/12/18 | (42 | ) | ||||||||||||||
| S&P 500® Index |
132 | 39,468 | 2,990 | 9/14/18 | (9 | ) | ||||||||||||||
|
|
|
|||||||||||||||||||
| (152 | ) | |||||||||||||||||||
|
|
|
|||||||||||||||||||
| Put Options |
||||||||||||||||||||
| S&P 500® Index |
409 | 113,089 | 2,765 | 9/4/18 | (12 | ) | ||||||||||||||
| S&P 500® Index |
554 | 154,012 | 2,780 | 9/5/18 | (25 | ) | ||||||||||||||
| S&P 500® Index |
132 | 36,828 | 2,790 | 9/7/18 | (16 | ) | ||||||||||||||
| S&P 500® Index |
442 | 124,423 | 2,815 | 9/10/18 | (134 | ) | ||||||||||||||
| S&P 500® Index |
603 | 169,745 | 2,815 | 9/12/18 | (253 | ) | ||||||||||||||
| S&P 500® Index |
132 | 37,092 | 2,810 | 9/14/18 | (54 | ) | ||||||||||||||
|
|
|
|||||||||||||||||||
| (494 | ) | |||||||||||||||||||
| Total Written Options |
|
$ | (646 | ) | ||||||||||||||||
|
|
|
|||||||||||||||||||
Footnote Legend:
| (1) | Strike price not reported in thousands. |
See Notes to Schedule of Investments
23
VIRTUS TOTAL RETURN FUND INC.
SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
($ reported in thousands)
The following table provides a summary of inputs used to value the Fund’s investments as of August 31, 2018 (See Security Valuation Note 2A in the Notes to Financial Statements):
| Total Value at August 31, 2018 |
Level 1 Quoted Prices |
Level 2 Significant Observable Inputs |
Level 3 Significant Unobservable Inputs |
|||||||||||||
| Debt Securities: |
||||||||||||||||
| Asset-Backed Securities |
$ | 7,099 | $ | — | $ | 7,099 | $ | — | ||||||||
| Corporate Bonds and Notes |
59,320 | — | 59,320 | — | * | |||||||||||
| Foreign Government Securities |
11,517 | — | 11,517 | — | ||||||||||||
| Leveraged Loans |
19,160 | — | 19,160 | — | ||||||||||||
| Mortgage-Backed Securities |
16,146 | — | 16,146 | — | ||||||||||||
| U.S. Government Securities |
6,405 | — | 6,405 | — | ||||||||||||
| Equity Securities: |
||||||||||||||||
| Common Stocks |
198,300 | 186,998 | 11,302 | — | ||||||||||||
| Preferred Stocks |
3,251 | 515 | 2,736 | — | ||||||||||||
| Rights |
1 | — | — | 1 | ||||||||||||
| Money Market Mutual Fund |
4,000 | 4,000 | — | — | ||||||||||||
| Purchased Options |
257 | 160 | 97 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total Investments before Written Options |
$ | 325,456 | $ | 191,673 | $ | 133,782 | $ | 1 | ||||||||
|
|
|
|
|
|
|
|
|
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| Liabilities: |
||||||||||||||||
| Written Options |
$ | (646 | ) | $ | (646 | ) | $ | — | $ | — | ||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total Investments Net of Written Options |
$ | 324,810 | $ | 191,027 | $ | 133,782 | $ | 1 | ||||||||
|
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|
|
|
|
|
|
|
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* Amount is less than $500.
Securities held by the Fund with an end of period value of $7,176 were transferred from Level 2 to Level 1 based on our valuation procedures for non-U.S. securities. There were no other transfers between Level 1, Level 2, or Level 3 related to securities held at August 31, 2018.
Some of the Fund’s investments that were categorized as Level 3 were valued utilizing third party pricing information without adjustment. Such valuations are based on unobservable inputs. A significant change in third party information could result in a significantly lower or higher value of Level 3 investments.
Management has determined that the amount of Level 3 securities compared to total net assets is de minimis; therefore, the rollforward of Level 3 securities and assumptions are not shown for the period ended August 31, 2018.
See Notes to Schedule of Investments
24
VIRTUS TOTAL RETURN FUND INC.
FINANCIAL HIGHLIGHTS (Unaudited)
AUGUST 31, 2018
(Reported in thousands except for the per share amounts)
| Total Net Assets | Net Asset Value per share |
|||||||||||||||
| Beginning of period: November 30, 2017 | $ | 289,580 | $ | 13.45 | ||||||||||||
| Net investment income (loss)* |
$ | 5,486 | $ | 0.25 | ||||||||||||
| Net realized and unrealized gain (loss) on investments |
(30,355 | ) | (1.41 | ) | ||||||||||||
| Dividends from net investment income and distributions from net long-term and short-term capital gains** |
(23,314 | ) | (1.08 | ) | ||||||||||||
|
|
|
|
|
|||||||||||||
| Net increase (decrease) in net assets/net asset value |
(48,183 | ) | (2.24 | ) | ||||||||||||
|
|
|
|
|
|||||||||||||
| End of period: August 31, 2018 |
$ | 241,397 | $ | 11.21 | ||||||||||||
|
|
|
|
|
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| * | Calculated based on average shares outstanding. |
| ** | Please note that the tax status of our distributions is determined at the end of the taxable year. However, based on interim data as of August 31, 2018, we estimate that 20.2% of distributions will represent net investment income, 7.3% will represent long-term capital gains and 72.5% will represent return of capital. Also refer to inside front cover for information on the Managed Distribution Plan. |
See Notes to Schedule of Investments
25
VIRTUS TOTAL RETURN FUND INC.
NOTES TO SCHEDULE OF INVESTMENTS
AUGUST 31, 2018 (Unaudited)
Note 1—Significant Accounting Policies
The Trust is an investment company that follows the accounting and reporting guidance of Accounting Standards Codification Topic 946 applicable to Investment Companies.
The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements and, for derivatives, included in Note 2 below. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates, and those differences could be significant.
| A. | Security Valuation |
Security valuation procedures for the Fund, which include nightly price variance, as well as back-testing items such as bi-weekly unchanged price, monthly secondary source and transaction analysis, have been approved by the Board of Directors of the Fund (the “Board”, or the “Directors”). All internally fair valued securities are approved by a valuation committee appointed by the Board (the “Valuation Committee”). The Valuation Committee is comprised of certain members of management as identified to the Board and convenes independently from portfolio management. All internally fair valued securities are updated daily and reviewed in detail by the Valuation Committee monthly unless changes occur within the period. The Valuation Committee reviews the validity of any model inputs and any changes to the model. Fair valuations are reviewed by the Board at least quarterly.
The Fund utilizes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The Fund’s policy is to recognize transfers between levels at the end of the reporting period.
| • Level 1 – | quoted prices in active markets for identical securities (security types generally include listed equities). |
| • Level 2 – | prices determined using other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). |
| • Level 3 – | prices determined using significant unobservable inputs (including the Valuation Committee’s own assumptions in determining the fair value of investments). |
A description of the valuation techniques applied to the Fund’s major categories of assets and liabilities measured at fair value on a recurring basis is as follows:
Equity securities are valued at the official closing price (typically last sale) on the exchange on which the securities are primarily traded or, if no closing price is available, at the last bid price and are categorized as Level 1 in the hierarchy. Restricted equity securities and private placements that are illiquid, or are internally fair valued by the Valuation Committee, are generally categorized as Level 3 in the hierarchy.
Certain non-U.S. securities may be fair valued in cases where closing prices are not readily available or are deemed not reflective of readily available market prices. For example, significant events (such as movement in the U.S. securities market or other
26
VIRTUS TOTAL RETURN FUND INC.
NOTES TO SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
regional and local developments) may occur between the time that non-U.S. markets close (where the security is principally traded) and the time that the Fund calculates its net asset value (“NAV”) (at the close of regular trading on the New York Stock Exchange (“NYSE”), generally 4 p.m. Eastern time) that may impact the value of securities traded in these non-U.S. markets. In such cases the Fund fair values non-U.S. securities using an independent pricing service which considers the correlation of the trading patterns of the non-U.S. security to the intraday trading in the U.S. markets for investments such as ADRs, financial futures, exchange-traded funds, and certain indexes, as well as prices for similar securities. Such fair valuations are categorized as Level 2 in the hierarchy. Because the frequency of significant events is not predictable, fair valuation of certain non-U.S. common stocks may occur on a frequent basis.
Debt securities, including restricted securities, are valued based on evaluated quotations received from independent pricing services or from dealers who make markets in such securities. For most bond types, the pricing service utilizes matrix pricing that considers one or more of the following factors: yield or price of bonds of comparable quality, coupon, maturity, current cash flows, type, and current day trade information, as well as dealer-supplied prices. These valuations are generally categorized as Level 2 in the hierarchy. Structured debt instruments, such as mortgage-backed and asset-backed securities, may also incorporate collateral analysis and utilize cash flow models for valuation and are generally categorized as Level 2 in the hierarchy. Pricing services do not provide pricing for all securities and therefore indicative bids from dealers are utilized which are based on pricing models used by market makers in the security and are generally categorized as Level 2 in the hierarchy. Debt securities that are internally fair valued by the Valuation Committee are generally categorized as Level 3 in the hierarchy.
Claims are valued by brokers based on pricing models that take into account, among other factors, both cash and non-cash assets. The valuation is derived from expected cash flow of the claims and the non-cash assets, which include all real estate, private equity or other securities within the estate. To the extent that these inputs are observable, the values of the claims are categorized as Level 2. To the extent that these inputs are unobservable, the values are categorized as Level 3.
Listed derivatives, such as options, that are actively traded are valued based on quoted prices from the exchange and are categorized as Level 1 in the hierarchy. Over-the-counter derivative contracts, which include forward currency contracts and equity-linked instruments, do not require material subjectivity as pricing inputs are observed from actively quoted markets and are categorized as Level 2 in the hierarchy.
Investments in open-end mutual funds are valued at NAV. Investments in closed-end funds are valued as of the close of regular trading on the NYSE each business day. Both are categorized as Level 1 in the hierarchy.
A summary of the inputs used to value the Fund’s net assets by each major security type is disclosed at the end of the Schedule of Investments for the Fund. The inputs or methodologies used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.
| B. | When-issued Purchases and Forward Commitments (Delayed-Delivery) |
The Fund may engage in when-issued or forward commitment transactions. Securities purchased on a when-issued or forward commitment basis are also known as delayed
27
VIRTUS TOTAL RETURN FUND INC.
NOTES TO SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
delivery transactions. Delayed delivery transactions involve a commitment by the Fund to purchase or sell a security at a future date (ordinarily up to 90 days later). Delayed delivery enables the Fund to lock in what is believed to be an attractive price or yield on a particular security for a period of time, regardless of future changes in interest rates. The Fund records delayed delivery securities on the trade date. The Fund maintains collateral for the securities purchased. Securities purchased on a when-issued or forward commitment basis begin earning interest on the settlement date.
| C. | Leveraged Loans |
The Fund may invest in direct debt instruments which are interests in amounts owed by a corporate, governmental, or other borrower to lenders or lending syndicates. Leveraged Loans are generally non-investment grade and often involve borrowers that are highly leveraged. The Fund may invest in obligations of borrowers who are in bankruptcy proceedings. Leveraged loans are typically senior in the corporate capital structure of the borrower. A loan is often administered by a bank or other financial institution (the “lender”) that acts as agent for all holders. The agent administers the terms of the loan, as specified in the leveraged loan. The Fund’s investments in loans may be in the form of participations in loans or assignments of all or a portion of loans from third parties. When investing in loan participations, the Fund has the right to receive payments of principal, interest and any fees to which it is entitled only from the lender selling the loan participation and only upon receipt by the lender of payments from the borrower. The Fund generally has no right to enforce compliance with the terms of the leveraged loan with the borrower. As a result, the Fund may be subject to the credit risk of both the borrower and the lender that is selling the leveraged loan. When the Fund purchases assignments from lenders it acquires direct rights against the borrower on the loan.
The Fund may invest in multiple series or tranches of a loan, which may have varying terms and carry different associated risks. Leveraged loans may involve foreign borrowers and investments may be denominated in foreign currencies. Direct indebtedness of emerging countries involves a risk that the government entities responsible for the repayment of the debt may be unable, or unwilling, to pay the principal and interest when due.
The leveraged loans have floating rate loan interests which generally pay interest at rates that are periodically determined by reference to a base lending rate plus a premium. The base lending rates are generally LIBOR, the prime rate offered by one or more U.S. banks or the certificate of deposit rate. When a leveraged loan is purchased the Fund may pay an assignment fee. On an ongoing basis, the Fund may receive a commitment fee based on the undrawn portion of the underlying line of credit portion of a leveraged loan. Prepayment penalty fees are received upon the prepayment of a leveraged loan by a borrower. Prepayment penalty, facility, commitment, consent and amendment fees are recorded to income as earned or paid.
Note 2—Derivative Financial Instruments and Transactions
Disclosures about derivative instruments and hedging activities are intended to enable investors to understand how and why the Fund uses derivatives, how derivatives are accounted for, and how derivative instruments affect the Fund’s results of operations and financial position. Summarized below are such disclosures and accounting policies for each specific type of derivative instrument used by the Fund.
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VIRTUS TOTAL RETURN FUND INC.
NOTES TO SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
| A. | Options contracts |
An options contract provides the purchaser with the right, but not the obligation, to buy (call option) or sell (put option) a financial instrument at an agreed-upon price. The Fund pursues an option income strategy whereby it purchases and sells out-of-the money puts and calls, creating an options spread designed to generate a consistent level of option cash flow which should result in additional yield. The Fund is subject to equity price risk in the normal course of pursuing its investment objectives.
When the Fund purchases an option, it pays a premium and an amount equal to that premium is recorded as an asset. When the Fund writes an option, it receives a premium and an amount equal to that premium is recorded as a liability. The asset or liability is adjusted daily to reflect the current market value of the option. Holdings of the Fund designated as collateral for outstanding written options are noted in the Schedule of Investments.
If an option expires unexercised, the Fund realizes a gain or loss to the extent of the premium received or paid. If an option is exercised, the premium received or paid is recorded as an adjustment to the proceeds from the sale or the cost basis of the purchase. The difference between the premium and the amount received or paid on effecting a closing purchase or sale transaction is also treated as a realized gain or loss.
The risk in writing call options is that the Fund gives up the opportunity for profit if the market price of the security increases and the option is exercised. The risk in writing put options is that the Fund may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying options is that the Fund pays a premium whether or not the option is exercised. The use of such instruments may involve certain additional risks as a result of unanticipated movements in the market. Writers (sellers) of options are normally subject to unlimited risk of loss, as the seller will be obligated to deliver or take delivery of the security at a predetermined price which may, upon exercise of the option, be significantly different from the then-market value. However, the Fund may limit its risk of loss when writing an option by purchasing an option similar to the one that is sold, except for the fact it is further “out of the money.”
The Fund invested in derivative instruments during the fiscal period in the form of writing put/call options and buying put/call options on the S&P 500® Index. The primary risk associated with these derivative instruments is equity risk.
For the period ended August 31, 2018, the average daily premiums paid by the Fund for purchased options were $474, and the average daily premiums received by the Fund for written options were $973.
Note 3—Illiquid and Restricted Securities
($ reported in thousands)
Investments are generally considered illiquid if they cannot be disposed of within seven days in the ordinary course of business at the approximate amount at which such securities have been valued by the Fund. Additionally, the following information is also considered in determining liquidity: the frequency of trades and quotes for the investment, whether the investment is listed for trading on a recognized domestic exchange and/or whether two or more brokers are willing to purchase or sell the security at a comparable price, the extent of market making activity in the investment and the nature of the market for investment.
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VIRTUS TOTAL RETURN FUND INC.
NOTES TO SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
Restricted securities are not registered under the Securities Act of 1933, as amended (the “1933 Act”). Generally, 144A securities are excluded from this category, except where defined as illiquid.
The Fund will bear any costs, including those involved in registration under the 1933 Act, in connection with the disposition of such securities.
The Fund held securities considered to be illiquid at August 31, 2018, with an aggregate value of $1 representing 0.0% of the Fund’s net assets.
At August 31, 2018, the Fund did not hold any securities that were restricted.
Note 4—Credit Risk and Asset Concentrations
In countries with limited or developing markets, investments may present greater risks than in more developed markets and the prices of such investments may be volatile. The consequences of political, social or economic changes in these markets may have disruptive effects on the market prices of these investments and the income they generate, as well as the Fund’s ability to repatriate such amounts.
High-yield/high-risk securities typically entail greater price volatility and/or principal and interest rate risk. There is a greater chance that an issuer will not be able to make principal and interest payments on time. Analysis of the creditworthiness of issuers of high-yield/high-risk securities may be complex, and as a result, it may be more difficult for the Adviser and/or subadviser to accurately predict risk.
The Fund may invest a high percentage of its assets in specific sectors of the market in the pursuit of its investment objective. Fluctuations in these sectors of concentration may have a greater impact on the Fund, positive or negative, than if the Fund did not concentrate its investments in such sectors.
The Fund borrows through its line of credit for the purpose of leveraging its portfolio. While leverage presents opportunities for increasing the Fund’s total return, it also has the effect of potentially increasing losses. Accordingly, any event which adversely affects the value of an investment held by the Fund would be magnified to the extent the Fund is leveraged.
Note 5—Regulatory Matters and Litigation
From time to time, the Fund, the Fund’s Adviser and/or subadvisers, and/or their respective affiliates may be involved in litigation and arbitration as well as examinations and investigations by various regulatory bodies, including the SEC, involving compliance with, among other things, securities laws, client investment guidelines, laws governing the activities of broker-dealers and other laws and regulations affecting their products and other activities. At this time, the Adviser believes that the outcomes of such matters are not likely, either individually or in aggregate, to be material to these financial statements.
Note 6—Recent Accounting Pronouncement
In March 2017, the Financial Accounting Standards Board issued an Accounting Standards Update, ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities (the “ASU”) which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. The ASU does not require any accounting change for debt securities held at a discount; the discount continues to be amortized to maturity. The ASU is effective for fiscal years, and interim periods within those
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VIRTUS TOTAL RETURN FUND INC.
NOTES TO SCHEDULE OF INVESTMENTS (Continued)
AUGUST 31, 2018 (Unaudited)
fiscal years, beginning after December 15, 2018. At this time, management is evaluating the implications of these changes on the financial statements.
Note 7—Subsequent Events
Management has evaluated the impact of all subsequent events on the Fund through the date the Schedule of Investments was filed, and has determined that the following subsequent event requires recognition or disclosure in these Notes to Schedule of Investments.
Effective October 15, 2018, Rampart Investment Management, an investment management affiliate of Virtus Investment Partners that specializes in options strategies, has been appointed as an additional investment subadviser to manage the existing options overlay strategy on the Fund. Warun Kumar, chief investment officer, Rampart, who previously managed the strategy through Newfleet Asset Management, has been added as a portfolio manager to the Fund.
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CERTIFICATION
The Fund’s Chief Executive Officer (“CEO”) will file the required annual CEO certification regarding compliance with the NYSE’s listing standards no more than 30 days after the Fund’s annual shareholder meeting. The Fund has included the certifications of the Fund’s CEO and Principal Financial Officer required by Section 302 of the Sarbanes-Oxley Act in the Fund’s Form N-CSR filed with the SEC for the period of this report.
KEY INFORMATION
Shareholder Relations: 1-866-270-7788
For general information and literature, as well as updates on net asset value, share price, major industry groups and other key information.
REINVESTMENT PLAN
The Automatic Reinvestment and Cash Purchase Plan (the “Plan”) offers shareholders a convenient way to acquire additional shares of the Fund. Registered holders will be automatically placed in the Plan. If shares are held at a brokerage firm, contact your broker about participation in the Plan.
REPURCHASE OF SECURITIES
Notice is hereby given in accordance with Section 23(c) of the 1940 Act that the Fund may from time to time purchase its shares of common stock in the open market when Fund shares are trading at a discount from their net asset value.
PROXY VOTING INFORMATION (FORM N-PX)
The Adviser and subadvisers vote proxies relating to portfolio securities in accordance with procedures that have been approved by the Fund’s Board. You may obtain a description of these procedures, along with information regarding how the Fund voted proxies during the most recent 12-month period ended June 30, free of charge, by calling toll-free 1-866-270-7788. This information is also available through the SEC’s website at http://www.sec.gov.
FORM N-Q INFORMATION
The Fund files a complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. Form N-Q is available on the SEC’s website at http://www.sec.gov. Form N-Q may be reviewed and copied at the SEC’s Public Reference Room. Information on the operation of the SEC’s Public Reference Room can be obtained by calling toll-free 1-800-SEC-0330.
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VIRTUS TOTAL RETURN FUND INC.
101 Munson Street
Greenfield, MA 01301-9668
This report is transmitted to the shareholders of Virtus Total Return Fund Inc. for their information. This is not a prospectus, circular, or representation intended for use in the purchase of shares of the Fund or any securities mentioned in this report.
