Amid the noise, will tech's run continue?

Strong start, but unknowns persist

The rebound in equities in 2019 has been led by the information technology sector, similar to the past few years. The bounce-back within technology has been widespread, regardless of market capitalization or subsector. However, recent turmoil surrounding U.S.- China trade relations, as well as reported antitrust investigations into four of the largest tech companies have led to an uptick in volatility.

Despite the ebb and flow of U.S and China trade discussions, we remain optimistic of an eventual agreement in the second half of 2019. This action is in the long-term best interests of both countries and we believe that progress towards an agreement would be supportive of financial markets.

The technology sector is also facing implications from the U.S. government’s alleged antitrust investigation into four of the largest technology companies – Apple, Amazon, Facebook and Alphabet. The results of this action won’t be known for months, if not years, so we are assessing the situation in a long-term context. Our belief is that the underlying reason these companies have been successful is because they create products and services people demand. While short-term noise may increase, we believe the long-term secular opportunities created by these companies continue to be attractive.

Seeking innovation beyond tech

We pursue an actively managed, risk-controlled portfolio of investments in what we deem attractive companies: Those with innovation-driven differentiation and sustainable levels of profitability and growth that operate within three key sectors of the economy, including technology, health care and applied science and technology. Our approach of focusing on technology companies as well as those that use science and technology as agents of change is a key differentiator of the Fund versus its peers.

While trade tension and government investigations may create unknowns, the secular drivers of technology and health care are diverse and growing. We believe we are at a unique crossroads as innovation in science and technology converge at an unprecedented pace. In fact, wide-ranging innovation is enabling and impacting nearly every industry across the globe. We view this innovation-driven disruption as a positive in the fact that it is helping create new industries and investable opportunities.

With that in mind, the following analysis highlights key growth drivers for technology and health care, how the Fund is positioned to take advantage of these opportunities, and our outlook moving forward.

Sector Fund Benchmark Ivy’s Analysis

Information Technology

61%

73%

Semiconductors
Semiconductors have long been a key allocation within the Fund as we believe the emergence of new secular growth opportunities should continue to support above-market returns for the space. We believe semiconductors should be driven by emerging growth areas, such as the Internet of Things (IoT), autos, machine learning, 5G, industrial and data centers. The IoT is one growth driver expected to have meaningful impact in the coming years. In fact, Intel estimates that roughly 200 billion “smart devices” will make up the IoT by 2020, up from 15 billion in 2015. Data expected to be generated from these devices is reflected in Graph 1 below.

Financial Technology
The proliferation of mobile payments and widespread use of card-based payments are promising secular trends for processors of payment transactions. Business Insider Intelligence estimates mobile payment growth to reach $357 billion by 2021, accounting for 45% of e-commerce sales. We continue to be optimistic on the future of this space.

Health Care

16%

0%

In our view, health care, notably biotechnology and pharmaceuticals, is among the greatest innovators and early adopters of new science and technology. We believe the next few years should be particularly constructive for biotechnology stocks and we have added several names in this area, as we expect significant innovation and economic returns.

Gene Therapy
In particular, we are monitoring revolutionary advances in gene therapy, a cutting-edge technique to create and administer medicine. Much of it started with mapping the human genome 18 years ago, which was a seminal event. While it was exciting, no one could afford gene sequencing due to computing power limitations – the cost exceeded $1,000,000 roughly 10 years ago. With the technology and vast quantity of information now available, it can be done more cheaply and accurately, as shown in Graph 2 below.

Inexpensive gene sequencing allows companies to dig deeper into genetics and find ways to treat patients based on their individual genomes. Gene therapy involves administering a medicine that has been pre-engineered to selectively impact particular cellular genetics in a single dose to patients. By influencing specific genes, cells may be “reprogrammed” to recognize particular cancers or other damaging diseases. Despite the inherent risks of gene therapy, we believe there is upside for leading companies to offer significant returns.

As a percent of the Fund’s equity assets as of 06/30/2019 vs. S&P North American Technology Index.

Graph 1. Data demand means opportunity for semis

The Fund’s overweight position in semiconductors is supported by secular growth drivers, including future data creation.

Chart Showing DATA DEMAND MEANS OPPORTUNITY FOR SEMIS
Graph 2. Innovation transforming gene therapy

Gene therapy has benefited from rapid innovation, which has driven the cost of gene sequencing to roughly $1,000 per sequenced genome.

Chart Showing INNOVATION TRANSFORMING GENE THERAPY

Source: National Human Genome Research Institute (NHGRI)

Cautious optimism going forward

While we are highly cognizant of moves in the market, our three- to five-year timeline for investing allows us to take a longer term approach. We believe many stocks in the information technology space remain relatively wellpositioned going forward. We are constantly evaluating the technology supply chain and demand signals coming from key technology end-markets. We believe the rebound within the sector should continue for the remainder of 2019.

On the health care front, we believe the demand for quality health care should drive growth within biotechnology, health care information technology systems and pharmaceuticals. We think the next few years should be particularly constructive for biotechnology stocks. We believe there will be improvement in capital spending trends, and we are looking for a continuation of an active mergers-and-acquisition environment.

As always, we continue to monitor the macroeconomic environment, but our focus remains primarily on securityspecific fundamental research. We believe this attention to bottom-up research, coupled with the innovation and transformation under way across the globe, should continue to provide investment opportunities for the Fund.


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Past performance is no guarantee of future results. The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Because the Fund invests more than 25% of its total assets in the science and technology industry, the Fund’s performance may be more susceptible to a single economic, regulatory or technological occurrence than a fund that does not concentrate its investments in this industry. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market. In addition, the Fund’s performance may be more volatile than an investment in a portfolio of broad market securities and may underperform the market as a whole, due to the relatively limited number of issuers of science and technology related securities. Investment risks associated with investing in science and technology securities, in addition to other risks, include: operating in rapidly changing fields, abrupt or erratic market movements, limited product lines, markets or financial resources, management that is dependent on a limited number of people, short product cycles, aggressive pricing of products and services, new market entrants and obsolescence of existing technology. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers. Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.

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While trade tension and government investigations may create unknowns, the secular drivers of technology and health care are diverse and growing. We believe we are at a unique crossroads as innovation in science and technology converge at an unprecedented pace, which is creating new investable opportunities.

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- Despite concerns over U.S.-China trade relations and possible U.S. government antitrust investigations into Big Tech, the technology sector has led the market’s gains in 2019.
- Data aggregation, data analytics, the Internet of Things (IoT), migration toward cloud computing, 5G are key themes the Fund is positioned to take advantage of going forward.
- The Fund is overweight semiconductors. We believe the emergence of new secular growth opportunities should continue to support above-market returns.
- Gene therapy and personalized therapies are areas of groundbreaking research and innovation that we believe will provide significant opportunities for investment.

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A defensive tilt in market uncertainty

A look back

After a good start to the year, the Fund has been affected by volatility in 2019, with year-todate performance adversely impacted by poor performance during May. Over the month, the risk-off environment stemming from deteriorating trade negotiations between the U.S. and China led to nondiscriminatory selling of equities considered sensitive to trade regardless of fundamentals. With that backdrop, cyclical sectors underperformed more defensive-oriented sectors. Despite the Fund maintaining a relatively neutral allocation between cyclicals and defensives, stock selection in the energy, industrials, financials and consumer discretionary sectors negatively impacted performance during the selloff. The Fund underperformed its Morningstar Foreign Large Blend category peers by nearly 2% in May. For reference, the Fund outperformed its benchmark and category average (ranking in the 39th percentile of its peer group) from January through April.

Over the course of the year, the Fund has faced headwinds resulting from its relative value investment philosophy. Growth stocks have outperformed value stocks for the year to date by a significant margin. For example, the MSCI EAFE Growth Index has outperformed the MSCI EAFE Value Index by more than 700 basis points. As shown in the chart below, the Fund currently places in the bottom third of its Morningstar Foreign Large Blend category when measured by its Morningstar Value- Growth score. That score evaluates value factors (i.e. price/book, price/sales, project price/earnings, etc.) and growth factors (i.e. long-term projected earnings growth, sales growth, cash flow growth, etc.) to determine either a value or growth tilt. Higher scores indicate a greater growth orientation, and as the chart makes clear, the Fund’s value tilt relative to peers has been prevalent over the past several years.

A tilt towards value
Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Data provided from 04/30/2014 through 05/31/2019. Source: Morningstar Direct. A score of less than 50 indicates a value tilt relative to peers.

Over the trailing three-year period, several factors have presented meaningful headwinds:

  • Growth significantly outperformed value. Given our relative value process, we would typically expect this market environment to be more challenging for the Fund.
  • Poor stock selection in a short list of select holdings was highlighted by the significant decline of Teva Pharmaceuticals Industries Ltd. in August 2017.
  • Energy prices declined during the fourth quarter of 2018 and the Fund maintained a significant overweight allocation.
  • The Fund was affected by the risk-off environment in May 2019.

The view ahead

Shifts in central bank policy, the rise of nationalism, the Brexit saga and trade negotiations — particularly between the U.S. and China — are standout issues affecting the current economic environment. Going forward, we believe geopolitics will continue to have a meaningful impact on asset values across the world. The question remains: How much longer will the cycle extend uninterrupted by looming risks? We continue to seek stocks that exhibit more defensive characteristics. As trade tensions have escalated between the U.S. and China, the Fund has shifted to a slightly more defensive posture.

Despite the challenges, we believe pockets of opportunity exist. In our view, there are attractive valuations in cyclicals and value-oriented stocks, including in emerging markets and China in particular.

At a fundamental level, we continue to be focused on companies with perceived sustainable competitive advantages, safe/high dividend yields and strong balance sheets. We have sold or trimmed holdings where relative valuation is not as attractive as well as several cyclical holdings that could be impacted by global trade issues. For example, AP Moller Maersk, a global shipping conglomerate, was trimmed during May as it is directly tied to global trade. While we still like the underlying fundamental trends in this industry and believe they are trading at attractive valuations, we feel the next twelve months have more risks than opportunities. We believe Wuliangye Yibin Co. Ltd, a Chinese spirits company, is still well positioned to capture the Chinese consumers’ propensity to buy high-end spirits, but have trimmed the holding into relative strength. We added Dollarama Inc., a Canadian dollar store company, during the month. Dollar stores generally are defensive and Dollarama is also positioned to grow as it expands store count and increases the average price of items in its stores. We believe we were able to buy Dollarama at an attractive relative valuation.

We have increased the Fund’s cash allocation to 8-10%. We are utilizing cash to offset some of the higher beta exposures in the portfolio.

This active approach has served us well over the long term. As shown below, the Fund has a strong track record of success, performing well relative to its benchmark, the MSCI EAFE Index, and its Morningstar Foreign Large Blend peers over the long term.

Seeks long-term outperformance relative to index and peers
Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Data provided from 04/02/2007 (Class I share inception date) through 05/31/2019. Charts above reflect batting averages (monthly rolling return data) for the Class I shares of the Fund over the time periods shown. Source: Morningstar Direct.

High conviction ideas

As we move forward, our highest convictions include:

  • Energy — As we move through 2019, the Fund maintains an approximately 11% allocation to energy compared to a 6% allocation for the benchmark. While oil prices have declined, we believe our holdings in the sector are priced as if oil was considerably lower than its current price. Many companies have been focused on improving their balance sheets and cash flow. With that backdrop, we think there are many attractively valued stocks and believe these holdings offer considerable upside. Seven Generations Energy Ltd., a Canadian holding that has weighed on the portfolio, has been executing on its strategy and we believe is positioned to rebound. As a result, we would expect the Fund to perform well if energy prices rise.
  • Information technology — We believe companies within this sector provide relative growth opportunities in industries like semiconductors and hardware storage, or stable growth opportunities in companies focused on information technology services and/or software development. SAP SE, a German software company developing enterprise software for businesses, has been successful maintaining its legacy business as well as growing its cloud-based software platform.
  • Emerging markets (China) — We remain constructive on emerging markets as we move through 2019. In an effort to support the economy for the remainder of the year, we expect China to continue to add fiscal stimulus, lower the reserve requirement ratio and be constructive on regulatory policy. Chinese holding Wuliangye Yibin Co. Ltd. has been a standout performer in the portfolio. Despite a setback during the fourth quarter of 2018 on global trade/GDP growth fears, the stock strongly recovered in 2019 and has been resilient through the most recent period of volatility. Fundamentally, its high revenue and income growth potential (30– 40% growth expectations in 2019) is propelled by increasing demand for premium spirits as wealth grows in China. With 100% of the company’s sales in China, we believe the firm is less sensitive to ongoing trade war concerns. We ended May with an approximately 11% allocation to emerging markets, with more than 8 percentage points of that allocation invested in China.

Overall, the Fund is now more defensively positioned. We believe the portfolio’s tilt towards low relative valuations and increased cash allocation should lower volatility of Fund returns and cushion returns during times of market stress.

Fund Performance

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Past performance is no guarantee of future results. The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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.

Risk factors: 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. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

Top 10 equity holdings as a percent of net assets as of 05/31/2019: Nestle S.A., Registered Shares 3.0%, Total S.A. 2.8%, Roche Holdings AG, Genusscheine 2.8%, SAP AG 2.4%, Airbus SE 2.3%, Tokio Marine Holdings, Inc. 1.9%, Unilever plc 1.9%, Orange S.A. 1.8%, Subaru Corp. 1.7% and Ferguson plc 1.7%.

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Catherine Murray

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Seeking durable quality in a volatile market
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We have shifted the portfolio slightly more defensive, while maintaining exposure to areas we believe should participate in market upside.

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- The Fund’s value tilt has been a headwind to relative performance as growth-oriented equities have outperformed their value-oriented peers by a significant margin over the past several years.
- In our view, there are attractive valuations in cyclicals and value-oriented stocks, including in emerging markets and China in particular.
- While we are hopeful geopolitical unrest is temporary, we have shifted the portfolio slightly more defensive, while maintaining exposure to areas we believe should participate in market upside.

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Ivy Securian Core Bond Fund

Market Sector Update

  • Strong labor markets and a near record expansion are facing off against persistently weak inflation, decelerating growth and a possible earnings recession. Despite the U.S. economy’s stronger-than-expected gross domestic product (GDP) growth in the first quarter, data have been mostly disappointing in the second quarter.
  • Late cycle concerns, such as cost pressures, trade tensions and global uncertainty have taken their toll. These factors are pressuring corporate earnings, making a year-over-year decline likely for the second quarter in a row. On a brighter note, the labor picture remains exceptionally strong with the unemployment rate at 3.6% as of June 30, the lowest in nearly 50 years.
  • All asset classes have performed well to date in 2019 despite slowing growth and fears of a downturn. Ironically, the catalyst for the second quarter rally was increasing conviction that the U.S. Federal Reserve (Fed) will cut rates in the near term, prolonging the expansion.
  • Treasury bonds on the other hand seem to be pricing in an alarming slowdown. Yields fell across the curve with the 2-year U.S. Treasury Note leading the way down 50 basis points (bps), leaving it as 1.76%. This compares to a yield of 2.09% on the 3-month U.S. Treasury Bill, which is more directly tied to the federal funds rate. The 10-year U.S. Treasury Note yield fell 40 bps and now sits at 2.01%.
  • Corporate bonds produced very strong absolute returns and strong returns relative to Treasuries and structured securities. The high-grade sector has produced year to date returns of nearly 10%, with high grade- and high yieldcredit returning 4.48% and 2.45% in the second quarter, respectively. Excess returns for investment grade were over 1% in the quarter and have reached almost 4% year to date relative to Treasuries. Performance has been led by longerdated bonds in sectors considered less defensive, and more heavily indebted, such as telecommunications, subordinated banking, food and beverage and autos.

Portfolio Strategy

  • The Fund had a positive return for the quarter that was slightly less than the return of its benchmark.
  • The Fund’s overall exposure to corporate bonds increased very modestly during the quarter. We added exposure in the communications sector for the first time in a while; we have grown more comfortable with the deleveraging plans of the large wireless providers. We also increased exposure to the banking and utility sectors as we continue to see these as more defensive in nature relative to most industrial sectors. Exposure to the industrials sector fell, mostly in consumer cyclicals and energy.
  • In terms of interest rate exposure, the portfolio remains most exposed to credits in the utilities, insurance, energy and financials relative to the benchmark. The largest underweights in the corporate space are in communication services, information technology, capital goods and consumer non-cyclicals.
  • Structured exposure fell as a percentage of the Fund’s net asset value during the second quarter, primarily in assetbacked securities (ABS), non-agency mortgage-backed securities (MBS) and commercial-mortgage backed securities (CMBS.) We invested in Agency MBS as this sector remains very liquid and relatively attractive to Treasuries. The portfolio remains overweight ABS, CMBS and non-Agency MBS.
  • The relative overall duration of the Fund rose during the quarter and finished the period slightly short of its benchmark.

Outlook

  • We expect growth to slow but remain positive and close to potential in the second half of the year. While we don’t see an immediate catalyst for a recession and still believe it’s some time off, the economy’s margin of error is slim. While it’s almost certain that second quarter growth will mark a record for the longest U.S. economic expansion on record, market participants are clamoring for the Federal Reserve to cut rates to extend the run.
  • Event risk is elevated, heightening potential downside. The market seems increasingly dependent on the Fed navigating this softer patch perfectly. With market expectations so far ahead of the Fed’s rate guidance, a rate cut is likely to be a necessary condition for continued performance rather than a pleasant surprise. However, if the Fed commits to a path of “insurance cuts” geared to head off slower growth and promote inflation, the economy could extend its run.
  • We expect the Fed to begin to ease in the second half of 2019. The question will be if it’s fast enough and large enough to act as a tailwind for the markets. With some risk of a policy mistake and higher volatility, we are tempering our enthusiasm and maintaining what we consider a more defensive posture relative to our historical risk exposures.

The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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.Past performance is not a guarantee of future results.

All information is based on Class I shares.

The Bloomberg Barclays U.S. Aggregate Bond Index is a market capitalization-weighted index, representing most U.S. traded investment grade bonds. It is not possible to invest directly in an index.

Duration is a measure of a security's price sensitivity to changes in interest rates. A fund with a longer average duration generally can be expected to be more sensitive to interest rate changes than a fund with a shorter average duration.

Risk factors: 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. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. These and other risks are more fully described in the Fund's prospectus. Not all funds or fund classes may be offered at all broker/ dealers.

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Ivy IG International Small Cap Fund

Market Sector Update

  • International small-cap equities delivered a positive return during the second quarter, building on the positive momentum from the first quarter. While initially softer due to global trade tensions, equity markets recovered through June following more dovish comments from the U.S. Federal Reserve (Fed) and the European Central Bank (ECB), further reinforcing the easing bias among global central banks.
  • Economic data was mixed over the quarter. While employment data remains encouraging, U.S. survey data indicates deterioration in business conditions and expected future activity. Data in the European Union showed some signs of improvement, albeit data from Germany remains generally weak.
  • Despite a lack of political progress in the U.K. and the resignation of Prime Minister Theresa May, U.K. equities were resilient and posted marginally positive returns for the quarter though lagged performance across other regions. Japanese equities underperformed over the quarter as trade tensions and a stronger yen weighed on performance.
  • The strongest performing sectors for the period were information technology, utilities and real estate, while energy, consumer staples and consumer discretionary underperformed. Oil markets were weaker over the quarter with Brent crude falling by 2.80%. Bond yields moved lower with the U.S. 10-year Treasury yield approaching 2.0%, while the benchmark German 10-year bund yield marked new lows at -0.33%.

Portfolio Strategy

  • The Fund produced positive performance and outperformed its benchmark for the period. At the country level, stock selection in the U.K., Japan and Ireland contributed to relative performance, while stock selection in Sweden, Germany and South Korea detracted from relative performance.
  • Top relative individual contributors to performance for the period included Games Workshop Group plc, a U.K.-based leisure products company; Future plc, a U.K.-based media company; and Taiyo Nippon Sanso Corp., an industrial gas company based in Japan. Top relative individual detractors to performance for the period included Ryohin Keikaku Co. Ltd., a Japanese-based multiline retail company; Premier Oil Plc, a U.K.-based oil, gas and consumable fuels company; and Hyundai Marine & Fire Insurance Co. Ltd., a Korean-based insurance company.
  • Several new positions were added in the Asia-Pacific region over the quarter. A position in Stanley Electric Co. Ltd., a manufacturer of automobile headlamps, was added for its perceived strong position as a producer of LED lighting. We believe the company will continue to generate growth as penetration of LED technology grows due to its improved visibility and lower power consumption. MISUMI Group, Inc. was also added, a maker of small-batch customized pressed die and plastic mold products. Combined with the company’s unique online retail offering, we believe MISUMI gives the Fund exposure to the early-stage recovery of the machine tool cycle and as a long-term structural growth business. Over the quarter, several positions were sold including Maxell Holdings Ltd., which announced a significant special dividend and share repurchase following a campaign of shareholder activism. However, we believe the future prospects for the operating business are less appealing. Long-held positions in Japan (Maruichi Steel Tube Ltd., NGK Spark Plug Co. Ltd. and Nifco, Inc.) and Australia (Spark Infrastructure Group and Carsales.com Ltd.) were also sold.
  • Within Europe, we initiated a position in Domino’s Pizza Group Plc. We believe this is a mispriced high-quality franchisee business. We believe the company is a market leader in the delivered food market, with strong brand awareness, high returns and cash generation.
  • We also added Barco N.V., which we feel is a market leader across the niche activities of cinema projection, wireless meeting rooms and health care display.

Outlook

  • While equity markets have recovered strongly in 2019, we believe corporate results and management commentary will be key as we enter the second half of the year. Given the strong performance to date in 2019, the market is unlikely to look through any disappointment or downward revisions of earnings expectations.
  • Japan remains intent on raising its consumption tax from 8% to 10% in October, and while we feel this is a policy error, consumption and consumption stocks in Japan have reacted negatively well in advance of the tax hike. As a result, we believe these domestic-demand sectors are now very attractive.
  • With a temporary trade war truce having been called at the June G20 meeting in Osaka, Japan, we believe attention will turn to what progress can be made in bilateral talks between the U.S. and China. Critical to this will be what concessions are made for China’s telecom equipment giant Huawei to purchase critical components from U.S. manufacturers and whether it remains on the so-called "entity list." While it is difficult to forecast this outcome, incentives remain for both sides to reach a deal, particularly as the November 2020 U.S. election draws nearer.
  • Central bank policy in most major economies is likely to remain supportive and with valuations of cyclical stocks attractive relative to their defensive, quality counterparts, we remain cyclically inclined in our positioning but flexible to change this view should conditions change.

  • The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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. Past performance is not a guarantee of future results.

    Effective Feb. 21, 2019, Ivy IG International Small Cap Fund was renamed Ivy International Small Cap Fund. Additionally, the name of the sub-adviser changed from I.G. International Management Limited to Mackenzie Investments Europe Limited. Mackenzie Investments Europe Limited delegates to its subsidiary, Mackenzie Investments Asia Limited, for additional portfolio management responsibilities. References to Mackenzie Investments Europe Limited include both entities.

    Top 10 equity holdings as a percent of net assets as of 06/30/2019: SCSK Corp. 2.5%, Teleperformance SE 2.0%, Sixt SE 1.9%, TechnoPro Holdings, Inc. 1.8%, ARTERIA Networks Corp. 1.8%, Matsumotokiyoshi Holdings Co. Ltd. 1.8%, Alstom 1.8%, Steadfast Group Ltd. 1.8%, Manulife U.S. REIT 1.8% and Zeon Corp. 1.8%.

    All information is based on Class I shares.

    Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in small-cap stocks may carry more risk than investing in stocks of larger more well-established companies. The value of a security believed by the Fund’s manager to be undervalued may never reach what the manager believes to be its full value, or such security’s value may decrease. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

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Ivy Apollo Strategic Income Fund

Market Sector Update

  • Rising political conflicts and uncertainty weighed on business sentiment leading to below trend growth in gross domestic product (GDP) in the second quarter.
  • The macro environment has softened with growth slowing in the U.S., Europe and China. The escalating trade dispute with China and weakening fundamentals has left central bankers set to ease policy in response, with many taking a sharp turn from hawkish to dovish. By switching their focus from tight labor markets and accelerating wage growth to slowing economies and softening inflation expectations, policymakers are trying to create a backdrop for lower volatility.
  • In the U.S., the market has priced two to three rate cuts from the Federal Reserve (Fed) in the remainder of 2019. The European Central Bank (ECB) has signaled its willingness to cut rates and potentially restart its purchase of corporate bonds. In China, the government has started to implement a new round of policy initiatives to stimulate growth.
  • The normalization of the Fed’s balance sheet is also winding down as the Fed slows the pace to a level it considers consistent with efficient and effective policy implementation.
  • The yield curve inverted as the market reduced expectations of the Fed’s tightening policy and overall expectations for slower global growth. The 10-year U.S. Treasury declined 40 basis points and the 2-year Treasury declined 51 basis points.
  • Trade tensions continued during the quarter, but the G20 Summit in late June provided an opportunity for the U.S. and China to call a temporary truce in an effort to return to the negotiating table.

Portfolio Strategy

  • The Fund had a positive return in the quarter that was slightly less than the return of its benchmark and its Morningstar peer group average.
  • The market’s reaction to the potential global easing in monetary policy led to a rally in both short- and long-duration Treasuries.
  • The U.S. dollar slightly weakened over the quarter against developing market currencies as the Japanese yen and euro gained 2.79% and 1.38%, respectively. The global bond strategy sleeve’s 100% U.S. dollar exposure hurt performance relative to the Fund’s Morningstar peers.
  • We continue to seek opportunities to reduce volatility in the Fund. In addition, we maintained our longstanding lowduration strategy to gain a higher degree of certainty about companies in which we can invest.
  • The Fund also continued to hold a higher level of liquidity in the quarter. We will be opportunistic in allocating that capital as we find dislocations in the market.

Outlook

  • We expect most major economies to grow at a slower pace during the remainder of the year compared to last year. Global manufacturing and service sector businesses have reported weaker conditions than in recent times.
  • The U.S. budget deficit is expected to rise to $1.0 trillion (4.7% of GDP) in 2019 from structural forces that have deteriorated by a much greater amount than the offsetting cyclical improvement.
  • Trade war rhetoric and complicated political concerns including Brexit, potential European auto tariffs and the start of U.S. presidential debates are likely to mean that global interest rates and credit markets will continue to be volatile in the near term.
  • We believe trade also will continue to be a risk factor going forward. There still is the potential for more tariffs, followed by retaliatory action that might impact companies’ capital investment plans. That, in turn, could continue to affect markets, stocks and ultimately consumer and business confidence.
  • In our view, fundamentals in the credit markets remain stretched, with balance sheets still levered. The slowing in global growth is a concern and makes us cautious about the outlook for credit spreads. We think technicals in credit can be supported with investor expectations that the ECB will resume corporate bond purchases.
  • Given our expectation for a modest widening of spreads in the second half of the year, we believe our conservative positioning relative to the benchmark is appropriate. We will remain opportunistic with credit selection and overall positioning.

The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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. Past performance is not a guarantee of future results.

All information is based on Class I shares.

The Fund is managed by Ivy Investment Management Company. The total return strategy is sub-advised by Apollo Credit Management, LLC.

Risk factors: The value of the Fund's shares will change, and you could lose money on your investment. Although asset allocation among different sleeves and asset categories generally tends to limit risk and exposure to any one sleeve, the risk remains that the allocation of assets may skew toward a sleeve that performs poorly relative to the Fund's other sleeves, or to the market as a whole, which would result in the Fund performing poorly. While Ivy Investment Management Company (IICO) monitors the investments of Apollo Credit Management (Apollo) in addition to the overall management of the Fund, including rebalancing the Fund's target allocations, IICO and Apollo make investment decisions for their investment sleeves independently from one another. It is possible that the investment styles used by IICO or Apollo will not always complement each other, which could adversely affect the performance of the Fund. As a result, the Fund's aggregate exposure to a particular industry or group of industries, or to a single issuer, could unintentionally be larger or smaller than intended. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Fixed-income securities are subject to interest rate risk and, as such, the net asset value of the Fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

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Ivy Pictet Emerging Markets Local Currency Debt Fund

Market Sector Update

  • The Fund's benchmark, the JP Morgan GBI-EM Global Diversified Index, gained 5.6% with most of the gains seen in June and coming from stronger local bond prices.
  • Argentina dropped 5%, but gained 22% in June, disguising most of its earlier losses as industrial production started declining again. Brazil gained 7.4% and we believe the expected pension reform will help fiscal savings, though economic data moderated. Colombia gained 3.2%, impacted by the sharp move lower in oil and coal prices. Mexico was up 6.1%, almost all from local bond prices given a central bank now likely to cut rates.
  • Russia gained 10.4%, with interest rates cut by 25 basis points (bps) and while growth slowed, external sector balances remained strong. Turkey gained 10.1% and the currency weakened, but was more than offset by local bond prices supported by lower inflation and a dovish central bank. The Philippines gained 6.8%, mostly from local bond prices as inflation declined and interest rates were cut by 25 bps.

Portfolio Strategy

  • The Fund posted a positive return but underperformed the benchmark for the quarter. Our current strategy continues to be overweight local rates where we believe yields look attractive, such as in Russia, or where the central bank is now likely to cut interest rates such as in Mexico. The dovish U.S. Federal Reserve (Fed) with interest rate cuts on the horizon is also a key factor.
  • Conversely, markets where inflation may surprise on the upside and fundamentals on the downside may result in selective opportunities to move underweight. Hungary is a key example where inflation pressures are building.
  • We continue to look for the perceived right entry point to selectively move overweight emerging market currencies that have improving growth and fundamentals. We expect more idiosyncratic moves over the coming months which will result in our implementing more relative value plays with overweights versus underweights to certain markets.

Outlook

  • We expect global data and growth to remain weak, but believe emerging market growth is holding up better than developed market growth, which is more late cycle. U.S. growth is expected to soften with an increasingly dovish Fed with interest rate cuts well priced in and this could continue to be supportive for some emerging market local rate markets. While less optimism over growth is normally not supportive for currencies, a favorable growth differential would be supportive while valuations look appealing compared to their long-term equilibrium levels.
  • We believe emerging market inflation remains low on average and the outlook remains favorable given output gaps are not yet closed in most countries.
  • In local rates, we see select Asian countries, Mexico, Peru and Russia with a dovish bias offering opportunities to be overweight while eastern Europe is more likely to have a bias towards tighter policy should the economic environment in Europe improve. To be sure, this is still a sovereign investment-grade asset class, yielding over 5.5%, with potential returns from currencies.

  • The opinions expressed are those of the Fund’s managers regarding Class I shares and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through March 31, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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. Past performance is not a guarantee of future results.

    The JP Morgan GBI-EM Global Diversified is an unmanaged index that tracks the performance of emerging market debt. It is not possible to invest directly in an index.

    Effective December 2018, Wee-Wing Ting, portfolio manager, left the firm to pursue other opportunities.

    All information is based on Class I shares.

    Risk factors: As with any 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. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise, especially securities with longer maturities. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The Fund may seek to manage exposure to various foreign currencies, which may involve additional risks. The value of securities, as measured in U.S. dollars, may be unfavorably affected by changes in foreign currency exchange rates or exchange control regulations. Investing in foreign securities involves a number of risks that may not be associated with the U.S. markets and that could affect the Fund’s performance unfavorably, such as greater price volatility; comparatively weak supervision and regulation of securities exchanges, fluctuation in foreign currency exchange rates and related conversion costs, adverse foreign tax consequences, or different and/or less stringent financial reporting standards. Sovereign debt instruments are also subject to the risk that a government or agency issuing the debt may be unable to pay interest and/or principal due to cash flow problems, insufficient foreign currency reserves or political concerns. Risks of credit-linked notes include those risks associated with the underlying reference obligation, including but not limited to market risk, interest rate risk, credit risk, default risk and foreign currency risk. The buyer of a credit-linked note assumes the risk of default by the issuer and the underlying reference asset or entity. If the underlying investment defaults, the payments and principal received by the Fund will be reduced or eliminated. Also, in the event the issuer defaults or there is a credit event that relates to the reference asset, the recovery rate generally is less than the Fund’s initial investment, and the Fund may lose money. The use of derivatives presents several risks including the risk that fluctuation in the values of the derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Moreover, some derivatives are more sensitive to interest rate changes and market fluctuations than others, and the risk of loss may be greater than if the derivative technique(s) had not been used. Derivatives also may be subject to counterparty risk, which includes the risk that a loss may be sustained by the Fund as a result of the insolvency or bankruptcy of, or other non-compliance by, another party to the transaction.These and other risks are more fully described in the Fund's prospectus.

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Ivy VIP Global Bond

Market Sector Update

  • Rising political conflicts and uncertainty weighed on business sentiment leading to below trend gross domestic product (GDP) growth during the quarter. The macro environment softened with growth slowing in the U.S., Europe and China. The escalating trade war concerns between the U.S. and China left central banks set to ease policy in response to weakening data. Policy makers took a sharp turn from hawkish to dovish with the weakening fundamentals.
  • In the U.S., the market has priced two to three rate cuts by the Federal Open Market Committee for the remainder of 2019. In Europe, the European Central Bank (ECB) has signaled its willingness to cut rates and potentially restart its purchase of corporate bonds. And finally, in China, the government has started to implement a new round of policy initiatives in an effort to stimulate growth.
  • The normalization of the U.S. Federal Reserve’s (Fed) balance sheet is also winding down as the Fed slows down the pace of decline in the balance sheet to a level consistent with believed efficient and effective policy implementation.
  • The yield curve inverted as the market brought down expectations of the Fed’s tightening policy and overall expectations of a slower global growth environment. The 10-year U.S. Treasury declined 40 basis points while the 2- year U.S. Treasury declined 51 basis points.
  • By switching their focus from tight labor markets and accelerating wage growth to slowing economies and softening inflation expectations, policymakers are trying to create a backdrop for lower volatility.

Portfolio Strategy

  • The Portfolio had a positive return and performed in line with its benchmark for the quarter. The market’s reaction to the potential global ease in monetary policy led to a rally in both short- and long-duration Treasuries.
  • The U.S. dollar slightly weakened over the quarter against developed market currencies as the yen and euro gained 2.79% and 1.38%, respectively. The Portfolio’s 97.5% U.S. dollar exposure hurt performance relative to peers.
  • We continue to seek opportunities to reduce volatility in the Portfolio. Additionally, we are maintaining a low duration strategy for the Portfolio as we feel it allows us a higher degree of certainty involving those companies in which we can invest.
  • We continue to focus on maintaining proper diversification for the Portfolio. We continue to hold a higher level of liquidity (patient capital) because of structural changes in the capital markets. We will be opportunistic in allocating that capital when we believe dislocations in the market arise.

Outlook

  • We expect most major economies to grow at a slower pace for the remainder of the year. Global manufacturing and service sector businesses report weaker conditions today than in recent times.
  • Trade war rhetoric and complicated political concerns like the ongoing Brexit saga, European auto tariffs and the U.S. presidential debates will likely mean that global interest rates and credit markets will continue to exhibit volatility in the near term. We believe trade will continue to be a risk factor going forward. There is the potential for more tariffs, followed by retaliatory action that might impact company capital investment plans. A negative feedback loop might impact markets, stocks and ultimately consumer and business confidence.
  • Fundamentals in the credit markets continue to remain stretched with balance sheets remaining levered. Softer global growth is concerning and leads us to be cautionary on the outlook for credit spreads. Technicals in credit can be supported with investors’ expectations that the ECB will resume corporate bond purchases.
  • Given our expectation for modest widening of spreads during the second half of 2019, we believe our conservative positioning relative to the benchmark is appropriate. We will be opportunistic about our credit selection and overall positioning to take advantage of perceived opportunities and dislocations as they present themselves.
  • The U.S. Federal budget deficit is expected to rise to $1.0 trillion (4.7% of GDP) in 2019 from structural forces which have deteriorated by a much greater amount than the offsetting cyclical improvement.

The opinions expressed are those of the Portfolio’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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. Past performance is not a guarantee of future results.

Diversification and asset allocation are investment strategies that attempt to manage risk within your portfolio but they do not guarantee profits or protect against loss in declining markets.

Risk factors: The value of the Portfolio’s shares will change, and you could lose money on your investment. International investing involves additional risks including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Portfolio may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. These and other risks are more fully described in the Portfolio’s prospectus.

Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.

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Ivy VIP Science and Technology

Market Sector Update

  • Strong market performance in the first quarter of 2019 continued through the second quarter. The reasons for this strong continuation were the consistently dovish rhetoric by the Federal Reserve (Fed) on likely future interest rate cuts and late-quarter optimism around the China trade dispute as President Donald Trump made several conciliatory comments. While U.S. and China economic data continued to weaken through the quarter, the Fed’s actions and positive trade negotiation meetings supported the constructive equity environment.
  • The S&P North American Technology Index, the benchmark for the Portfolio, increased nearly 5% in the quarter after the roughly 20% increase in the first quarter of 2019.
  • The technology sector saw positive performance across the spectrum again in quarter, with the software and IT services sub-sectors as the stand-out performers.

Portfolio Strategy

  • Similar to the first quarter of 2019, the Portfolio had a positive return and significantly outperformed the benchmark during the second quarter. Stock selection within information technology was the primary driver of outperformance. Cypress Semiconductor was the top individual relative contributor, while allocations to Universal Display Corp. and Euronet Worldwide, Inc. also contributed to outperformance.
  • The Portfolio’s underweight in some of the largest benchmark constituents, namely Amazon.com, Inc., Visa Inc., and Mastercard Inc., was a drag during the period. The impact of the underweight positions was more than offset by the outperformance in the Portfolio.
  • The Portfolio’s allocation to health care, a sector absent from the benchmark, slightly detracted on a relative basis during the second quarter.

Outlook

  • The constant pace of innovation continues to be the key supportive factor for the technology and health care sectors. While we are highly cognizant of moves in the market, our three- to five-year timeline for investing allows us to take a longer-term approach. For example, technology is increasingly critical for companies to gain competitive advantages. Data aggregation, data analytics, migration towards cloud computing, semiconductors – all are key areas we are positioned to take advantage of going forward. We still expect cloud computing capital expenditures to bounce back in the remainder of 2019, though likely at a rate lower than we expected earlier in the year.
  • We continue to be optimistic on semiconductors. The space has contributed strongly to information technology performance over the past couple years and we believe the emergence of new secular growth opportunities, such as autos, machine learning and ubiquitous connectivity will continue to support above-market returns in the sector. While we remain constructive on semiconductors, we expect some level of volatility that we believe will create compelling new opportunities for the Portfolio over the longer term.
  • We are carefully monitoring the technology supply chain and demand signals coming from key technology endmarkets. Huawei’s addition to the U.S. “entity list” during the quarter created volatility within the supply chain, but relatively positive commentary from Trump in his meeting with President Xi Jinping of China reversed most of the initial negative equity reactions. The U.S.-China geopolitical risk remains, but we are optimistic on the trajectory of these relations along with an expected rebound in technology spending in the next few quarters.
  • Our exposure in biotechnology remains a key area of innovation within health care and an area where we expect our holdings to outperform over the coming quarters. Gene therapy and personalized advanced therapies are the areas of groundbreaking research and innovation that should provide significant opportunities for investment.

The opinions expressed are those of the Portfolio’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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. Past performance is not a guarantee of future results.

Top 10 equity holdings as a percent of net assets as of 6/30/2019: Microsoft Corp. 10.1%, Euronet Worldwide, Inc. 6.4%, Aspen Technology, Inc. 5.4%, WNS (Holdings) Ltd. ADR 5.1%, Universal Display Corp.: 5.1%, Vertex Pharmaceuticals, Inc. 4.8%, Apple, Inc. 4.7%, ACI Worldwide, Inc. 4.5%, Alibaba Group Holding Ltd. ADR 3.9%, Cerner Corporation 3.8%.

The S&P North American Technology Sector Index is a modified-capitalization weighted index representing U.S. securities classified under the GICS® technology sector and internet retail sub-industry. It is not possible to invest directly in an index.

Risk factors: The value of the Portfolio’s shares will change, and you could lose money on your investment. Because the Portfolio invests more than 25% of its total assets in the science and technology industry, the Fund’s performance may be more susceptible to a single economic, regulatory or technological occurrence than a fund that does not concentrate its investments in this industry. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market. In addition, the Portfolio’s performance may be more volatile than an investment in a portfolio of broad market securities and may underperform the market as a whole, due to the relatively limited number of issuers of science and technology related securities. Investment risks associated with investing in science and technology securities, in addition to other risks, include: operating in rapidly changing fields, abrupt or erratic market movements, limited product lines, markets or financial resources, management that is dependent on a limited number of people, short product cycles, aggressive pricing of products and services, new market entrants and obsolescence of existing technology. These and other risks are more fully described in the Portfolio's prospectus.

Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.

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Ivy VIP Balanced

Market Sector Update

  • Domestic markets continued to rally in the second quarter of 2019 despite a disappointing breakdown in trade negotiations between the U.S. and China which introduced some volatility intra-quarter.
  • The S&P 500 Index, the Porfolio’s equity benchmark, advanced 4% with financials, information technology, materials and consumer discretionary sectors leading the way. Ten of the 11 sectors posted a positive return for the quarter, with energy being the only sector with a negative return.
  • The macroeconomic data, as well as the expectations for U.S. Federal Reserve (Fed) easing, caused the 2-year yield to decline 51 basis points (bps) to 1.75% and the 10-year yield to decline 40 bps to 2%. The spread between the 10-year U.S. Treasury note and the 3-month U.S. Treasury bill, which last quarter turned negative for the first time since 2007, remains negative or inverted.Historically, an inverted yield curve has implied a forthcoming recession, but the time lag can be significant. Another yield curve measure, the spread between the 10-year U.S. Treasury Note and the 2-year U.S. Treasury Note steepened from 14 bps to 25 bps in the quarter, a small indicator that the Fed will rekindle growth expectations with rate cuts.
  • The Portfolio’s fixed income benchmark, the Bloomberg Barclays U.S. Government/Credit Index, increased 3.5% during the quarter, as the Treasury market rallied due to an expectation that the Fed would begin to reduce the federal funds rate. Options markets are currently pricing in a 100% probability of a 25 bps rate cut at the Fed’s July meeting and a 63% probability of another 25 bps of cuts through the remainder of 2019. In addition, investment Grade credit spreads tightened by four bps during the quarter and contributed modestly to the benchmark’s positive return.

Portfolio Strategy

  • The Portfolio had a positive return in the quarter that was slightly less than the return of its benchmark, but in-line with its Morningstar peer group average.
  • The equity portion of the Portfolio benefitted from an overweight position to the financials sector and strong stock selection in the information technology and financials sectors, which positively impacted relative performance.
  • With regard to the fixed income portion, the Portfolio’s relative underweight of corporate credit negatively impacted performance in the quarter as credit spreads tightened. The Portfolio’s duration now stands at approximately 93% of the benchmark.

Outlook

  • As we look ahead, global economic growth is very likely to decelerate over the next several months, but we expect it to remain positive. As we have previously highlighted, individual and corporate tax reform was a meaningful positive for the domestic economy which, along with lighter regulation and a generally more business-friendly political climate, was supportive for growth.
  • However, the uncertainties around political, monetary and trade policies have been stubbornly persistent and are likely to linger for most of this year. While we believe domestic economic growth will continue, the lagged effects of tighter monetary policy and waning benefits from fiscal stimulus will be a headwind.
  • As a result, we are closely watching inflation rates and inflation expectations which have been modest, and must remain so, in order to allow our central bank to respond to slower growth. We have been encouraged by the Fed’s recent shift toward an easing bias with cuts to the federal funds rate expected in the near future.
  • While we continue to monitor macroeconomic forces and trends, we maintain an emphasis on finding high quality, growing companies whose securities are trading at a reasonable valuation with visible catalysts to drive relative outperformance over the next 12 months. This approach has served investors well over time, and our confidence in it has not waned.

The opinions expressed are those of the Portfolio's managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary 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. Past performance is not a guarantee of future results.

The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-cap U.S. equity market. The index includes 500 of the top companies in leading industries of the U.S. economy. It is not possible to invest directly in an index.

The Bloomberg Barclays U.S. Government/Credit Index measures the performance of U.S. dollar-denominated United States Treasuries, government-related, and investment-grade U.S. corporate securities that have a remaining maturity of greater than or equal to one year. In addition, the securities have $250 million or more of outstanding face value and are fixed-rate and non-convertible securities. It is not possible to invest directly in an index.

Risk factors: The value of the Portfolio's shares will change, and you could lose money on your investment. An investment in the Portfolio is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed-income securities are subject to interest rate risk and, as such, the net asset value of the Portfolio may fall as interest rates rise. The lower-rated securities in which the Portfolio may invest may carry greater risk of nonpayment of interest or principal then higher-rated bonds. In addition to the risks typically associated with fixed-income securities, loan participations in which the Portfolio may invest carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loan participations may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. The Portfolio's emphasis on dividend-paying stocks involves the risk that such stocks may fall out of favor with investors and underperform nondividend 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 Portfolio 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 Portfolio typically holds a limited number of stocks (generally 45 to 55). As a result, the appreciation or depreciation of any one security held by the Portfolio will have a greater impact on the Portfolio's net asset value than it would if the Portfolio invested in a large number of securities. The value of a security believed by the Portfolio's managers to be undervalued may never reach what the manager believes to be its full value, or such security’s value may decrease.

Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.

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Susan K. Regan

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