Virtus ETF Trust II

 

VIRTUS DUFF & PHELPS CLEAN ENERGY ETF

VIRTUS NEWFLEET ABS/MBS ETF

VIRTUS NEWFLEET HIGH YIELD BOND ETF

VIRTUS SEIX SENIOR LOAN ETF

VIRTUS TERRANOVA U.S. QUALITY MOMENTUM ETF

Table of Contents

 

Shareholder Letter (unaudited)

September 2022

Dear Shareholder:

On behalf of Virtus ETF Advisers LLC (the “Adviser”), I am pleased to present the shareholder report for the Virtus ETF Trust II (the “Trust”) for the annual fiscal period ended July 31, 2022.

The Adviser is part of Virtus Investment Partners, a distinctive partnership of boutique investment managers singularly committed to the long-term success of individual and institutional investors.

The report provides financial statements and portfolio information for the following funds within the Trust:

•Virtus Duff & Phelps Clean Energy ETF (VCLN) – This fund commenced operations on August 3, 2021 and seeks to generate capital appreciation by investing in clean energy companies.

•Virtus Newfleet ABS/MBS ETF (VABS)

•Virtus Newfleet High Yield Bond ETF (BLHY)

•Virtus Seix Senior Loan ETF (SEIX)

•Virtus Terranova U.S. Quality Momentum ETF (JOET)

On behalf of the Adviser and our fund Sub-Advisers, thank you for your investment. If you have questions, please contact your financial adviser, or call 1-888-383-0553. For more information about the funds and the other ETFs we offer, we invite you to visit our website, www.virtusetfs.com.

Sincerely,

William Smalley
President

Virtus ETF Trust II

This material must be accompanied or preceded by the prospectus.

Management’s Discussion of Fund Performance (unaudited)

July 31, 2022

Virtus Duff & Phelps Clean Energy ETF (VCLN)

How did the markets perform during the period from the Fund’s inception on August 3, 2021, through July 31, 2022?

For most of the fiscal year, the global clean energy market, as measured by the performance of the S&P Global Clean Energy Index, experienced volatility due to several macroeconomic factors. Chief among these were global supply chain disruptions, rising interest rates to combat inflationary headwinds, the war in Ukraine, and uncertainty about U.S. clean energy policy. Importantly, these factors not only impacted the global clean energy market, they also affected the broader U.S. equity market, as measured by the S&P 500^® Index, which was down 5.26% from the Fund’s inception date through July 31, 2022.

Encouragingly, however, a significant positive announcement for the clean energy sector was made in the final days of July 2022, when U.S. Senator Joe Manchin indicated his support for a federal climate bill, which would later become the Inflation Reduction Act. This was a notable shift, especially after several prior months of failed negotiations had left most policymakers, investors, and companies with little to no confidence that a comprehensive federal clean energy policy could be achieved. As evidence of the importance of this announcement, the S&P Global Clean Energy Index rose 9.7% in the final two days of July.

What factors affected the Fund’s performance during its fiscal year?

From its inception on August 3, 2021, through July 31, 2022, the Fund’s total return based on net asset value (NAV) was -3.76%. The Fund’s total return based on market price was -3.48%. For the same period, the S&P Global Clean Energy Index (net) returned -2.14%.

Sector allocation had a neutral impact on Fund performance, while stock selection had a slightly negative impact. The Fund’s top contributors to relative performance from a sector perspective were the information technology and energy sectors. Within the information technology sector, overweight positions in Enphase Energy and SolarEdge Technologies were top contributors. Within the energy sector, an underweight position in Aemetis was a top contributor.

The Fund’s largest detractors from relative performance from a sector perspective were the industrials and utilities sectors. Within the industrials sector, the Fund’s overweight positions in TPI Composites and ITM Power were the primary detractors. Within the utilities sector, an underweight position in Consolidated Edison was the primary detractor.

The preceding information is the opinion of the investment adviser and sub-adviser. Any such opinions are subject to change at any time based upon market or other conditions and should not be relied upon as investment advice. Statements of fact are from sources considered reliable, but the investment adviser makes no representation or warranty as to their completeness or accuracy. Past performance is no guarantee of future results, and there is no guarantee that market forecasts will be realized.

Performance as of 7/31/2022

 

*Total return calculated for a period of less than 1 year is not annualized

(1)The S&P Global Clean Energy Index (net) is designed to measure the performance of companies in global clean energy-related businesses from both developed and emerging markets, with a target constituent count of 100, calculated on a total return basis with net dividends reinvested. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment.

(2)Commencement of operations on August 3, 2021.

Performance data quoted represents past performance and past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance data may be higher or lower than actual data quoted. Returns do not reflect the deduction of taxes a shareholder would pay on Fund distributions or the redemption of Fund shares. For the most current month-end performance data please visit www.virtusetfs.com or call toll free (800) 243-4361. Market price returns are based on the mid-point of the highest bid and lowest offer for Fund shares as of the scheduled close of regular trading on the New York Stock Exchange Arca (“NYSE”), ordinarily 4:00 p.m. Eastern time, on each day during which the NYSE is open for trading, and do not represent the returns an investor would receive if shares were traded at other times.

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.

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Clean Energy Industry: Developments in the clean energy segment could adversely affect the price and valuations of portfolio holdings. These developments include swift price and supply fluctuations caused by events relating to international politics, the success of project development and tax and other governmental regulatory policies. There could also be weak demand for clean energy company products or services, the obsolescence of existing technology or short product cycles, and falling prices and profits due to the supply of, and demand for, oil and gas along with competition from new market entrants.

Limited Number of Investments: Because the portfolio has a limited number of securities, it may be more susceptible to factors adversely affecting its securities than a portfolio with a greater number of securities.

Non-Diversified: The portfolio is not diversified and may be more susceptible to factors negatively impacting its holdings to the extent the portfolio invests more of its assets in the securities of fewer issuers than would a diversified portfolio.

Foreign & Emerging Markets: Investing in foreign securities, especially in emerging markets, subjects the portfolio to additional risks such as increased volatility, currency fluctuations, less liquidity, and political, regulatory, economic, and market risk.

Market Volatility: The value of the securities in the portfolio may go up or down in response to the prospects of individual companies and/or general economic conditions. Price changes may be short- or longterm. Local, regional or global events such as war, acts of terrorism, the spread of infectious illness or other public health issue, recessions, or other events could have a significant impact on the portfolio and its investments, including hampering the ability of the portfolio’s manager(s) to invest the portfolio’s assets as intended.

Exchange Traded Funds: The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities.

Market Price/NAV: Shares of ETFs often trade at a discount to their net asset value, which may increase investors’ risk of loss. At the time of sale, an investor’s shares may have a market price that is above or below the Fund’s NAV.

No Guarantee: There is no guarantee that the Fund will meet its objective.

Prospectus: For additional information on risks, please see the Fund’s prospectus. The Fund may not be suitable for all investors.

Value of a $10,000 Investment Since Inception at Net Asset Value

The chart above represents historical performance of a hypothetical investment of $10,000 over the life of the Fund, assuming reinvestment of distributions. Past performance does not guarantee future results.

Virtus Duff & Phelps Clean Energy ETF (continued)

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Virtus Newfleet ABS/MBS ETF (VABS)

How did the markets perform during the fiscal year ended July 31, 2022?

Performance over the 12-month period was defined by the large move higher in interest rates and the Federal Reserve’s (the Fed’s) changing policy actions from quantitative easing (QE) to quantitative tightening (QT). The yield on the US Treasury 2 year note rose from 0.21% to 2.89% during the period. The Fed’s target interest rate went from 0.25% to 2.5% over the course of four rate hikes. The Fed also began its balance sheet reduction plan. There was nowhere to hide in the fixed income markets, as the Bloomberg U.S. Aggregate Bond Index returned -9.12% while the securitized component of the Index returned -6.76%.

The economy, as measured by gross domestic product (GDP) over the fiscal year, continued its post-pandemic recovery, generating third-quarter 2021 and fourth-quarter 2021 GDP gains of 2.1% and 6.9%, respectively, in the first half of the fiscal year. The economy slowed in response to the Fed’s rate hikes in the second half of the fiscal year, experiencing negative first-quarter 2022 and second-quarter 2022 GDP results of -1.6% and -0.9%, respectively.

Unemployment levels remained at record lows, which buoyed consumer performance. Consumer prices rose steadily while the market saw record prices for autos, housing, and rents. In turn, credit performance within the securitized markets remained strong as asset price inflation buttressed securitized deal structures. Despite the increases in asset valuations, securitized bond prices could not keep pace with rapidly higher interest rates and fears of recession and stagflation.

What factors affected the Fund’s performance during its fiscal year?

The securitized market experienced excellent credit performance, but interest rate duration was the real driver of returns for the Fund and entire bond market. The Fund’s net asset value return through July 31, 2022, was -4.12%, versus a total return of -4.05% for the ICE BofA 1-3 Year A-BBB US Corporate Index, the Fund’s benchmark.

Positive contributors to the Fund’s returns included cash, select holdings in “whole business deal” securities, including one issued by Taco Bell, and a short duration higher coupon aircraft-backed security leased to Emirates Airline.

Primary detractors from the Fund’s relative performance included longer duration holdings, including a student loan-backed security issued by Navient, as well as more interest rate-sensitive residential mortgage-backed securities issued by Angel Oak Mortgage Trust and Verus Securitization Trust.

The preceding information is the opinion of the investment adviser and sub-adviser. Any such opinions are subject to change at any time based upon market or other conditions and should not be relied upon as investment advice. Statements of fact are from sources considered reliable, but the investment adviser makes no representation or warranty as to their completeness or accuracy. Past performance is no guarantee of future results, and there is no guarantee that market forecasts will be realized.

Performance as of 7/31/2022

 

(1)The ICE BofA 1-3 Year A-BBB US Corporate Index measures performance of U.S. corporate bond issues rated A through BBB, inclusive (based on an average of Moody’s, S&P and Fitch), with a remaining term to final maturity less than 3 years. The index is calculated on a total return basis. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment.

(2)Commencement of operations on February 9, 2021.

Performance data quoted represents past performance and past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance data may be higher or lower than actual data quoted. Returns do not reflect the deduction of taxes a shareholder would pay on Fund distributions or the redemption of Fund shares. For the most current month-end performance data please visit www.virtusetfs.com or call toll free (800) 243-4361. Market price returns are based on the mid-point of the highest bid and lowest offer for Fund shares as of the scheduled close of regular trading on the New York Stock Exchange Arca (“NYSE”), ordinarily 4:00 p.m. Eastern time, on each day during which the NYSE is open for trading, and do not represent the returns an investor would receive if shares were traded at other times.

MBS and ABS Risks: MBS and ABS may be less liquid than other bonds, and may be more sensitive than other bonds to the market’s perception of issuers and creditworthiness of payees, particularly in declining general economic conditions when concern regarding mortgagees’ ability to pay (e.g., the ability of homeowners, commercial mortgagees, consumers with student loans, automobile loans

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

or credit card debtholders to make payments on the underlying loan pools) rises, which may result in the Fund experiencing difficulty selling or valuing these securities. MBS and ABS issued by participants in housing and commercial real estate finance, as well as asset-backed markets generally, have experienced extraordinary weakness and volatility at various times in recent years, and may decline quickly in the event of a substantial economic or market downturn.

Fixed Income Securities Risks: Risks of investments in fixed income securities include, without limitation, credit risk, interest rate risk, liquidity risk, maturity risk and prepayment risk. These risks could affect the value of investments in which the Fund invests, possibly causing the Fund’s share price and total return to be reduced and fluctuate more than other types of investments.

Credit Risk: The value of fixed income securities is dependent on the creditworthiness of their issuers. A deterioration in the financial condition or credit rating of an issuer, changes in the market’s perception of the issuer’s financial strength, or a deterioration in general economic conditions may have an adverse effect on the value of the investment and may cause an issuer to fail to pay principal and interest when due.

Interest Rate Risk: The value of the Fund’s fixed income investments will generally vary inversely with the direction of prevailing interest rates. In general, rising interest rates will negatively impact the price of a fixed rate debt instrument and falling interest rates will have a positive effect on price. Risks associated with rising interest rates are heightened given that interest rates in the U.S. are near historic lows. Adjustable rate instruments also react to interest rate changes in a similar manner, although generally to a lesser degree (depending, however, on the characteristics of the reset terms, including the index chosen, frequency of reset and reset caps or floors, among other factors). Interest rate sensitivity is generally more pronounced and less predictable in instruments with uncertain payment or prepayment schedules.

Exchange Traded Funds: The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities.

Market Price/NAV: Shares of ETFs often trade at a discount to their net asset value, which may increase investors’ risk of loss. At the time of sale, an investor’s shares may have a market price that is above or below the Fund’s NAV.

No Guarantee: There is no guarantee that the Fund will meet its objective.

Prospectus: For additional information on risks, please see the Fund’s prospectus. The Fund may not be suitable for all investors.

Value of a $10,000 Investment Since Inception at Net Asset Value

The chart above represents historical performance of a hypothetical investment of $10,000 over the life of the Fund, assuming reinvestment of distributions. Past performance does not guarantee future results.

Virtus Newfleet ABS/MBS ETF (continued)

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Newfleet High Yield Bond ETF (BLHY)

How did the markets perform during the Fund’s fiscal year ended July 31, 2022?

The high yield market had two distinct periods of performance during the fiscal year. In the latter part of 2021, the high yield market generated positive total returns with mostly stable spreads. However, early 2022 saw negative performance, as both rising Treasury yields and widening credit spreads hurt returns. The high inflation data that arrived in early 2022, combined with the Russian invasion of Ukraine, were key drivers of this performance. The high inflation data led the market to price in aggressive actions by the Federal Reserve (the Fed) to tighten monetary policy via interest rate hikes, which led to lower economic growth expectations. The conflict in Ukraine led to a spike in energy prices – further pressuring inflation – with a particular impact in Europe.

Investors continued to evaluate the likelihood of a recession driven by the Fed’s actions to stamp out inflation. Rising recession risks led investors to become more cautious about lending to firms that are exposed to the consumer. Housing-related industries also repriced, as rising interest rates typically impact the housing market. In a related theme, consumer demand shifted from physical goods to services during the period, impacting the retail, leisure, lodging, and entertainment industries. Bonds of oil and gas firms generally outperformed as commodity prices rose due to the Russia-Ukraine war, along with lingering COVID-19 effects. From a ratings perspective, CCC-rated securities, which are considered higher risk, underperformed during the year, which was not surprising given the overall widening in credit spreads.

What factors affected the Fund’s performance during its fiscal year?

For the 12 months ended July 31, 2022, the Fund generated a total return of -8.29% (net asset value), versus a total return of -8.03% for the Bloomberg U.S. High-Yield 2% Issuer Capped Bond Index, the Fund’s benchmark.

The high yield market experienced poor performance over the 12-month period, as both risk-free rates and credit spreads moved higher due to the Fed tightening financial conditions and the outbreak of war in Europe.

Underperformance versus the Fund’s benchmark was largely due to the Fund’s overweight to CCC-rated securities, which underperformed during the period, and from poor selection within the capital goods and energy industries. These detractors were partially offset by an out-of-index allocation to floating rate loans, which outperformed, and from carrying cash in a market that had negative overall performance.

The preceding information is the opinion of the investment adviser and sub-adviser. Any such opinions are subject to change at any time based upon market or other conditions and should not be relied upon as investment advice. Statements of fact are from sources considered reliable, but the investment adviser makes no representation or warranty as to their completeness or accuracy. Past performance is no guarantee of future results, and there is no guarantee that market forecasts will be realized.

Performance as of 7/31/2022

   

(1)The Bloomberg U.S. High-Yield 2% Issuer Capped Bond Index is a market capitalization-weighted index that measures fixed rate non-investment grade debt securities of U.S. and non-U.S. corporations. No single issuer accounts for more than 2% of market cap. The index is calculated on a total return basis. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment.

(2)The Fund commenced operations on December 5, 2016.

Performance data quoted represents past performance and past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance data may be higher or lower than actual data quoted. Returns do not reflect the deduction of taxes a shareholder would pay on Fund distributions or the redemption of Fund shares. For the most current month-end performance data please visit www.virtusetfs.com or call toll free (800) 243-4361. Market price returns are based on the mid-point of the highest bid and lowest offer for Fund shares as of the scheduled close of regular trading on the New York Stock Exchange Arca (“NYSE”), ordinarily 4:00 p.m. Eastern time, on each day during which the NYSE is open for trading, and do not represent the returns an investor would receive if shares were traded at other times.

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Fixed Income Securities: Risks of investments in fixed income securities include, without limitation, credit risk, interest rate risk, liquidity risk, maturity risk and prepayment risk. These risks could affect the value of investments of the Fund, possibly causing the Fund’s share price and total return to be reduced and fluctuate more than other types of investments.

Mortgage-Backed and Asset-Backed Securities: Mortgage-backed and asset-backed securities are subject to the general fixed income risks described above. Mortgage-backed and asset-backed securities may be less liquid than other bonds, and may be more sensitive than other bonds to the market’s perception of issuers and creditworthiness of payees.

Junk Bonds or High Yield Securities: High yield securities are generally subject to greater levels of credit quality risk than investment grade securities. The retail secondary market for these “junk bonds” may be less liquid than that of higher-rated fixed income securities, and adverse conditions could make it difficult at times to sell these securities or could result in lower prices than higher-rated fixed income securities. These risks can reduce the value of the Fund’s shares and the income it earns.

Foreign Securities: Investments in foreign securities involve the risk of possible adverse changes in investment or exchange control regulations or currency exchange rates, expropriation or confiscatory taxation, limitation on the removal of cash or other assets of the Fund from foreign markets, political or financial instability, or diplomatic and other developments which could affect such investments. Further, foreign securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility. These risks are generally greater in emerging markets.

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.

Loan Participation and Assignment: The principal risk associated with acquiring loan participation interests and assignments is the credit risk associated with the underlying corporate borrower. There is also a risk that there may not be a readily available market for loan participation interests or assignments and, in some cases, this could result in the Fund disposing of such securities at a substantial discount from face value or holding such securities until maturity.

Exchange Traded Funds: The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities.

Market Price/NAV: Shares of ETFs often trade at a discount to their net asset value, which may increase investors’ risk of loss. At the time of sale, an investor’s shares may have a market price that is above or below the Fund’s NAV.

No Guarantee: There is no guarantee that the Fund will meet its objective.

Prospectus: For additional information on risks, please see the Fund’s prospectus. The Fund may not be suitable for all investors.

Virtus Newfleet High Yield Bond ETF (continued)

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

​Virtus Newfleet High Yield Bond ETF (continued)

Value of a $10,000 Investment Since Inception at Net Asset Value

The chart above represents historical performance of a hypothetical investment of $10,000 over the life of the Fund, assuming reinvestment of distributions. Past performance does not guarantee future results.

​

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Virtus Seix Senior Loan ETF (SEIX)

How did the fixed income markets perform during the Fund’s fiscal year ended July 31, 2022?

•     Fixed income markets continued to rebound from COVID-19, with areas that were likely to benefit from the reopening of society outperforming through April of 2022. Fundamental improvement remained strong, which resulted in credit spreads tightening and an active new issue calendar. The Russian invasion of Ukraine in February of 2022 caused a temporary pause, but at first was taken lightly by the markets. Flows into the leveraged loan market initially gained momentum owing to expectations of a moderate rise in interest rates and the belief that inflationary pressures, while persistent, would fade in towards the end of the reporting period.

•     A global Russian oil embargo, acceptance that the Russia–Ukraine conflict would likely continue for a long time, and new awareness about Ukraine’s importance to the global food supply helped accelerate inflationary pressures. Economic indicators jumped to four-decade highs during the second quarter of 2022. In the second quarter of 2022, the market perception of inflation changed from a gradual but persistent factor to a rapidly escalating issue. Subsequently, the U.S. Federal Reserve (the Fed) began an aggressive tightening program to drive inflation down toward its target of 2%, and the market quickly switched modes from managing a slowdown to preparing for a recession.

•     During the 12-month period, bank loans, which are floating rate instruments, outperformed other fixed income alternatives including high yield securities, investment grade corporate credit, and Treasuries due to rising interest rates. Credit rating upgrades continued to outnumber downgrades, although the pace shifted late in the second quarter of 2022. Default rates remained low, but began to increase modestly toward the end of the period, due to tightening lending standards. From a credit quality perspective, higher quality loans outperformed lower quality after a sharp correction in the second quarter. Until that point, lower quality credit had outperformed.

What factors affected the Fund’s performance during its fiscal year?

•     For the 12 months ended July 31, 2022, the Fund generated a total return of -1.93% (net asset value) versus a total return of -0.86% for the Credit Suisse Leveraged Loan Index, the Fund’s benchmark. The Fund’s relative overweight position to high yield, which was not in the benchmark, and to B-rated credit more than offset relative underweighting to the lowest quality segment of the loan market and split BB-rated credit. The Fund’s high yield bond position was negatively impacted by rising rates as well as widening credit spreads. Excluding the high yield exposure, the Fund’s bank loan positions underperformed the benchmark by 0.13%.

•     From a sector allocation perspective, the Fund’s relative overweight positions in consumer durables, aerospace, and consumer non-durables detracted from performance while relative underweights to utility, gaming & leisure, and information technology contributed to performance.

•     Overall security selection detracted from relative performance. Negative selection in metals & mining, chemicals, and retail detracted from performance while positive security selection in information technology, consumer non-durables, and automotive contributed to performance.

The preceding information is the opinion of the investment adviser and sub-adviser. Any such opinions are subject to change at any time based upon market or other conditions and should not be relied upon as investment advice. Statements of fact are from sources considered reliable, but the investment adviser makes no representation or warranty as to their completeness or accuracy. Past performance is no guarantee of future results, and there is no guarantee that market forecasts will be realized.

Performance as of 7/31/2022

 

(1)The Credit Suisse Leveraged Loan Index is a market-weighted index that tracks the investable universe of the U.S. dollar denominated leveraged loans. The index is calculated on a total return basis. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment.

(2)Commencement of operations on April 24, 2019.

Performance data quoted represents past performance and past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance data may be higher or lower than actual data quoted. Returns do not

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

reflect the deduction of taxes a shareholder would pay on Fund distributions or the redemption of Fund shares. For the most current month-end performance data please visit www.virtusetfs.com or call toll free (800) 243-4361. Market price returns are based on the mid-point of the highest bid and lowest offer for Fund shares as of the scheduled close of regular trading on the New York Stock Exchange Arca (“NYSE”), ordinarily 4:00 p.m. Eastern time, on each day during which the NYSE is open for trading, and do not represent the returns an investor would receive if shares were traded at other times.

Fixed Income Securities: Risks of investments in fixed income securities include, without limitation, credit risk, interest rate risk, liquidity risk, maturity risk and prepayment risk. These risks could affect the value of investments of the Fund, possibly causing the Fund’s share price and total return to be reduced and fluctuate more than other types of investments.

Junk Bonds or High Yield Securities: High yield securities are generally subject to greater levels of credit quality risk than investment grade securities. The retail secondary market for these “junk bonds” may be less liquid than that of higher-rated fixed income securities, and adverse conditions could make it difficult at times to sell these securities or could result in lower prices than higher-rated fixed income securities. These risks can reduce the value of the Fund’s shares and the income it earns.

Foreign Securities: Investments in foreign securities involve the risk of possible adverse changes in investment or exchange control regulations or currency exchange rates, expropriation or confiscatory taxation, limitation on the removal of cash or other assets of the Fund from foreign markets, political or financial instability, or diplomatic and other developments which could affect such investments. Further, foreign securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility. These risks are generally greater in emerging markets.

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.

Loan Participation and Assignment: The principal risk associated with acquiring loan participation interests and assignments is the credit risk associated with the underlying corporate borrower. There is also a risk that there may not be a readily available market for loan participation interests or assignments and, in some cases, this could result in the Fund disposing of such securities at a substantial discount from face value or holding such securities until maturity.

Exchange Traded Funds: The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track.The costs of owning the ETF may exceed the cost of investing directly in the underlying securities.

Market Price/NAV: Shares of ETFs often trade at a discount to their net asset value, which may increase investors’ risk of loss. At the time of sale, an investor’s shares may have a market price that is above or below the Fund’s NAV.

No Guarantee: There is no guarantee that the Fund will meet its objective.

Prospectus: For additional information on risks, please see the Fund’s prospectus. The Fund may not be suitable for all investors.

Virtus Seix Senior Loan ETF (continued)

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Virtus Seix Senior Loan ETF (continued)

Value of a $10,000 Investment Since Inception at Net Asset Value

The chart above represents historical performance of a hypothetical investment of $10,000 over the life of the Fund, assuming reinvestment of distributions. Past performance does not guarantee future results.

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

Virtus Terranova U.S. Quality Momentum ETF (JOET)

How did the markets perform during the fiscal year ended July 31, 2022?

U.S. equities faced challenging headwinds during the first half of 2022, as investors feared that a recession would be forthcoming due to rising inflation. In addition, the energy shock that resulted from the Russia-Ukraine conflict added stress to the financial system. This prompted the Federal Reserve (the Fed) to raise interest rates more aggressively than previously anticipated. Historically high inflation and more stringent monetary conditions weighed on both the consumer and business confidence. This resulted in concerns that economic growth and potential stagflation would impact stocks. As a result, the market posted two back-to-back quarterly declines for the first time since 2015. The S&P 500^® Index entered a bear market, recording its largest decline for the first half of a year since 1970. The U.S. economy contracted by an annualized 1.6% in the first quarter of 2022, a sharp slowdown from the 6.9% growth rate seen in the fourth quarter of 2021.

What factors affected the Fund’s performance during its fiscal year?

For the 12 months ended July 31, 2022, the Fund’s total return based on net asset value (NAV) was -9.27%. For the same period, the Terranova U.S. Quality Momentum Index returned -8.97%.

Positive contributors to Fund performance included positions in the energy sector, semiconductor devices, and steel production. Pioneer Natural Resources, ConocoPhillips, and EOG Resources are involved in the exploration and production of crude oil, natural gas, and NGLs (natural gas liquids). Advanced Micro Devices (AMD) produces semiconductor products and devices. AMD offers products such as microprocessors, embedded microprocessors, chipsets, graphics, video, and multimedia products, and supplies them to third-party foundries. Nucor engages in the manufacturing of steel and steel products. It operates through the following segments: Steel Mills, Steel Products, and Raw Materials. It is also North America’s largest recycler of scrap metal and a leading scrap broker.

Detractors from Fund performance included Shopify, Meta Platforms, Moderna, Etsy, and EPAM Systems. Shopify operates a cloud-based commerce platform designed for small and medium-sized businesses. Its software is used by merchants to run business across all sales channels, including web, tablet, and mobile storefronts. Shopify was impacted by over-expansion during the pandemic which proved not to be sustainable in the second quarter of 2022. Meta Platforms engages in the development of social media applications. It builds technology that helps people connect, find communities, and grow businesses. Meta’s shares weakened as the company gave revenue forecasts that missed estimates amid a slowdown in user growth and increased competition. Etsy operates an online marketplace that offers handmade products such as shoes, clothing, bags, and accessories. Etsy also builds custom websites and offers a payment processing service. Etsy, along with other e-commerce companies like Shopify, declined as investors anticipated weaker earnings, which deepened concerns that the pace of online shopping may have slowed. EPAM Systems engages in the provision of software product development and digital platform engineering services. The company was impacted by the conflict in Ukraine as it had large production capacity in Ukraine, Belarus, and Russia. The Fund no longer held shares in Shopify, Meta Platforms, Moderna, Etsy, and EPAM Systems at the fiscal year-end on July 31, 2022.

The preceding information is the opinion of the investment adviser. Any such opinions are subject to change at any time based upon market or other conditions and should not be relied upon as investment advice. Statements of fact are from sources considered reliable, but the investment adviser makes no representation or warranty as to their completeness or accuracy. Past performance is no guarantee of future results, and there is no guarantee that market forecasts will be realized.

Performance as of 7/31/2022

 

(1)The Terranova U.S. Quality Momentum Index is an equally weighted index designed to provide diversified exposure to quality momentum large-cap equities listed in the United States. 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 is not available for direct investment.

(2)Commencement of operations on November 17, 2020.

Performance data quoted represents past performance and past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance data may be higher or lower than actual data quoted. Returns do not reflect the deduction of taxes a shareholder would pay on Fund distributions or the redemption of Fund shares. For the most

Management’s Discussion of Fund Performance (unaudited) (continued)

July 31, 2022

current month-end performance data please visit www.virtusetfs.com or call toll free (800) 243-4361. Market price returns are based on the mid-point of the highest bid and lowest offer for Fund shares as of the scheduled close of regular trading on the Nasdaq Stock Market(“Nasdaq”), ordinarily 4:00 p.m. Eastern time, on each day during which the Nasdaq is open for trading, and do not represent the returns an investor would receive if shares were traded at other times.

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.

Momentum Factor Investing: Momentum investing is subject to the risk that the securities may be more volatile than the market as a whole. There may be periods when the momentum style of investing is out of favor and therefore, the investment performance of the portfolio may suffer.

Passive Strategy/Index Risk: A passive investment strategy seeking to track the performance of the underlying Index may result in the portfolio holding securities regardless of market conditions or their current or projected performance. This could cause the portfolio’s returns to be lower than if the portfolio employed an active strategy.

Exchange Traded Funds: The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track.The costs of owning the ETF may exceed the cost of investing directly in the underlying securities.

Market Price/NAV: Shares of ETFs often trade at a discount to their net asset value, which may increase investors’ risk of loss. At the time of sale, an investor’s shares may have a market price that is above or below the Fund’s NAV.

No Guarantee: There is no guarantee that the Fund will meet its objective.

Prospectus: For additional information on risks, please see the Fund’s prospectus. The Fund may not be suitable for all investors.

Value of a $10,000 Investment Since Inception at Net Asset Value

The chart above represents historical performance of a hypothetical investment of $10,000 over the life of the Fund, assuming reinvestment of distributions. Past performance does not guarantee future results.

Virtus Terranova U.S. Quality Momentum ETF (continued)

Shareholder Expense Examples (unaudited)

 

We believe it is important for you to understand the impact of costs on your investment. All funds have operating expenses. As a shareholder of the Virtus Duff & Phelps Clean Energy ETF, Virtus Newfleet ABS/MBS ETF, Virtus Newfleet High Yield Bond ETF, Virtus Seix Senior Loan ETF and Virtus Terranova U.S. Quality Momentum ETF (each, a “Fund”) you may incur two types of costs: (1) transaction costs, which include brokerage commissions that you pay when purchasing or selling shares of the Fund; and (2) ongoing costs, which include advisory fees and other fund expenses, if any. The following example is intended to help you understand your ongoing costs (in dollars and cents) of investing in a Fund and to compare these costs with the ongoing costs of investing in other funds. The examples are based on an investment of $1,000 invested at the beginning of the period and held throughout the entire period (February 1, 2022 to July 31, 2022).

Actual expenses

The first line under each Fund in the table below provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line for your Fund under the heading entitled “Expenses Paid During Period” to estimate the expenses you paid on your account during this period.

Hypothetical example for comparison purposes

The second line under each Fund in the table provides information about hypothetical account values and hypothetical expenses based on each Fund’s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not each Fund’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in each Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs, such as brokerage commissions paid on purchases and sales of Fund shares. Therefore, the second line under each Fund in the table is useful in comparing ongoing Fund costs only and will not help you determine the relative total costs of owning different funds.

In addition, if these transactional costs were included, your costs would have been higher.

 

(1)Assuming 5% return before expenses.

(2)Annualized expense ratios reflect expenses net of waived fees or reimbursed expenses, if applicable.

(3)Expenses are calculated using each Fund’s annualized expense ratio, multiplied by the average account value for the period, multiplied by 181/365 (to reflect the six-month period).

Schedule of Investments — Virtus Duff & Phelps Clean Energy ETF

July 31, 2022

Schedule of Investments — Virtus Duff & Phelps Clean Energy ETF (continued)

July 31, 2022

The following table summarizes valuation of the Fund’s investments under the fair value hierarchy levels as of July 31, 2022.

Schedule of Investments — Virtus Newfleet ABS/MBS ETF

July 31, 2022

Schedule of Investments — Virtus Newfleet ABS/MBS ETF (continued)

July 31, 2022

Schedule of Investments — Virtus Newfleet ABS/MBS ETF (continued)

July 31, 2022

Schedule of Investments — Virtus Newfleet High Yield Bond ETF

July 31, 2022

Schedule of Investments — Virtus Newfleet High Yield Bond ETF (continued)

July 31, 2022