Investment Update - Ivy Mid Cap Income Opportunities Fund


Investment Update – Ivy Mid Cap Income Opportunities Fund

Commentary as of May 10, 2021

What is the background of the Ivy Mid Cap Income Opportunities Fund?

Kim Scott: The genesis of the Ivy Mid Cap Income Opportunities Fund lies within the Ivy Mid Cap Growth Fund. The Ivy Mid Cap Growth Fund invests in high-quality companies we believe have long runways for growth. In our view, these types of companies are profitable and have strong balance sheets.

Over time, we realized something special was going on within the mid-cap growth universe, particularly among companies considered core growers. We noticed that some of these companies were not only growing faster than the U.S. economy and many of their large-cap brethren, but they were also returning capital to shareholders in the form of dividends. In addition to paying dividends, these companies were also growing their earnings and the cash flows that they could use to grow those dividends. This observation led to the idea of a strategy that could generate current income, income growth, and possibly capital appreciation. Thus, the Ivy Mid Cap Income Opportunities Fund was born.

Nathan Brown: The two most important factors within the Ivy Mid Cap Income Opportunities Fund are income and growth. In this Fund, we want to own companies that are not only paying dividends but are also growing those dividends supported by organic earnings growth.

We strive to build a portfolio that generates mid-to-high single-digit dividend growth. As such, since its inception in 2014 until 2020, the Fund delivered an average annual payout growth in the high single digits. During the pandemic, when revenues evaporated for many firms, we were pleasantly surprised to see many of our investments in the portfolio grow their dividends at a faster pace than expected. Two examples include Tractor Supply, which recently grew its dividend by 30%, and Packaging Corporation of America, which recently grew its dividend by 20% and is now yielding 3%.

Finally, like the Ivy Mid Cap Growth Fund, the Ivy Mid Cap Income Opportunities Fund is not a growth at any price strategy. We are valuation-sensitive investors who seek to invest in companies when we believe the valuation is right, providing an opportunity for capital appreciation.

The Ivy Mid Cap Income Opportunities Fund holds between 35-50 equally weighted stocks in the portfolio. Could you discuss the rationale behind equally weighting the holdings in the portfolio? Is the portfolio still actively managed?

Nathan: We want every investment within the portfolio to represent the strategy of the Fund. We don’t want to barbell the portfolio with high payout ratio names with no growth on one end, and low/no payout names that have rapid growth on the other end. We seek to rebalance the portfolio at least quarterly, which forces us to maintain conviction in all portfolio names by either re-purchasing stocks that have lost market value or by cutting losses and moving on to other investments, if needed.

Even with an equally weighted portfolio, the Fund is still actively managed. Since inception, the Fund’s active share has been above 90%. (Active share is a measure of the percentage of stock holdings in a mutual fund portfolio that differs from the holdings of that fund’s benchmark index. The Ivy Mid Cap Income Opportunities Fund’s benchmark is the Russell Midcap® Index.)

Over the course of 2020 and year to date, could you discuss how the Fund has performed relative to your expectations? Also, did the management team make any significant portfolio changes during 2020?

Nathan: Irrespective of the market cycle, our objective is to provide our investors with total return through current income, income growth, and capital appreciation opportunities. Over a market cycle, we seek to generate an average high single-digit to low double-digit annual return. In 2020, we produced a high-single digit return for the Fund, which given the backdrop of the pandemic, was well within our expectations.

In 2020, as the pandemic spread, revenues and, in return, liquidity for many companies evaporated. Early into the year, we identified five companies whose liquidity conditions, in our view, could be greatly impacted by the pandemic. Two of those companies were energy pipelines. Last year, as oil demand fell, we determined these companies might not have the same economics as we previously thought and that they might struggle to maintain their dividend levels. Out of caution, we exited our positions in these investments. There were other companies where we assessed that dividends may be impacted by the pandemic. We worked closely with the managements of these companies to learn more about their current situations. Following those conversations, we determined the business models of these companies should remain robust and they should be able to return to their previous dividend levels by the end of 2021, so we have held tight on those positions in the portfolio.

There have been other investments whose business models and ability to generate cash have been stronger than anticipated. For example, American Campus Communities, the largest owner, manager, and developer of high-quality student housing communities in the U.S., has maintained its dividends despite the challenges of the pandemic and many colleges being forced to pivot to online curriculum. The occupancy rate for student housing has continued at a high level (near 90%) as students have wanted to be near their colleges rather than taking classes, although virtual, from their parents’ basements.

So, while we have made changes along the fringes in the portfolio, by and large, through the pandemic, the portfolio has remained the same.

Given the current rising interest rate environment, what is your outlook for the Fund?

Nathan: Generally, we expect dividend payers to perform well when interest rates go down, which in our view, should lead to higher demand for income-paying equity investments. However, there was an anomaly in dividend payers’ performance as they weren’t rewarded with lower interest rates in 2020. Contrary to our expectations, the dividend-paying group has been performing well in 2021 as interest rates are rising. So, to wrap up, we want to say, irrespective of the interest rate environment, we will continue to focus on building a portfolio that has the potential to generate a total return through current income, income growth, and opportunities for capital appreciation.

Top 10 holdings as a % of net assets as of 03/31/2021: Snap-On Inc. 3.0, Broadridge Financial Solutions, Inc. 3.0, Tractor Supply Co. 2.9, Stanley Black & Decker, Inc. 2.9, Garmin Ltd. 2.9, Clorox Co. 2.9, Watsco, Inc. 2.9, Cracker Barrel Old Country Store, Inc. 2.9, American Campus Communities, Inc. 2.9, and Packaging Corporation of America, 2.8.

Past performance is no guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through May 2021, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance, and time horizon.

The views expressed represent the investment team’s assessment of the market environment as of May 2021, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

Risk factors: Ivy Mid Cap Growth Fund - The value of the Fund’s shares will change, and you could lose money on your investment. Investing in mid-cap growth stocks may carry more risk than investing in stocks of larger more well-established companies. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus. Ivy Mid Cap Income Opportunities Fund - The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Investing in mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. The Fund’s emphasis on dividend-paying stocks involves the risk that such stocks may fall out of favor with investors and underperform non-dividend paying stocks and the market as a whole over any period of time. In addition, there is no guarantee that the companies in which the Fund invests will declare dividends in the future or that dividends, if declared, will remain at current levels or increase over time. The amount of any dividend the company may pay may fluctuate significantly. In addition, the value of dividend-paying common stocks can decline when interest rates rise as fixed-income investments become more attractive to investors. This risk may be greater due to the current period of historically low interest rates. The Fund typically holds a limited number of stocks (generally 35 to 50). As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a large number of securities. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.

The Russell Midcap Index measures the performance of the mid-cap segment of the US equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It is not possible to invest directly in an index. All information is based on Class I shares. Class I shares are only available to certain investors.

Natural or environmental disasters, such as earthquakes, fires, floods, hurricanes, tsunamis, and other severe weather-related phenomena generally, and widespread disease, including pandemics and epidemics, have been and can be highly disruptive to economies and markets, adversely impacting individual companies, sectors, industries, markets, currencies, interest and inflation rates, credit ratings, investor sentiment, and other factors affecting the value of the Fund’s investments. Given the increasing interdependence among global economies and markets, conditions in one country, market, or region are increasingly likely to adversely affect markets, issuers, and/or foreign exchange rates in other countries. These disruptions could prevent the Fund from executing advantageous investment decisions in a timely manner and could negatively impact the Fund’s ability to achieve its investment objective. Any such event(s) could have a significant adverse impact on the value and risk profile of the Fund.

Investing involves risk, including the possible loss of principal.

Significant Event On December 2, 2020, Waddell & Reed Financial, Inc. (WDR), the parent company of Ivy Investment Management Company, the investment adviser of the Ivy Funds, and Macquarie Management Holdings, Inc., the U.S. holding company for Macquarie Group Limited’s U.S. asset management business (Macquarie), announced that they had entered into an agreement whereby Macquarie would acquire the investment management business of WDR (“the Transaction”). The Transaction closed on April 30, 2021. The Ivy Funds, as part of Delaware Funds by Macquarie, are now managed by Delaware Management Company and distributed by Delaware Distributors, L.P.

Ivy Mid Cap Growth Fund and Ivy Mid Cap Income Opportunities Fund investment manager, Delaware Management Company (Manager), may permit its affiliates, Macquarie Investment Management Global Limited (MIMGL) and Macquarie Funds Management Hong Kong Limited, to execute Fund security trades on behalf of the Manager. The Manager may also seek quantitative support from MIMGL.

All third-party marks cited are the property of their respective owners.

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