Ivy VIP Corporate Bond

Market Sector Update

  • The second quarter saw a continuation in the risk-on environment from the first quarter, however the period was marked by a moderate sell-off in risk assets in May as trade tensions resurfaced.
  • Despite the risk-on environment, U.S. Treasuries continued to rally. This was due to the anticipation of the Federal Reserve (Fed) cutting its benchmark interest rate, as well as falling interest rates across the globe. The market was pricing in a greater than 60% chance of one or more 25 basis points (bps) rate cuts by year end at the end of the first quarter. That has shifted to the market pricing in a nearly 60% chance of three or more 25 bps cuts by year end.
  • The macroeconomic data, as well as the expectations for Fed easing, caused the 2-year yield to decline 51 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.
  • After a significant rise of over 7% in the first quarter, high yield returned a more modest 2.5% as Treasury rates fell and the spread on the index fell from 391 bps to 377 bps. Leveraged loans returned 1.58%, continuing to lag behind high yield as loans don’t benefit from falling Treasury yields, and the asset class saw outflows in the quarter.
  • Overall fundamentals for the investment grade universe continue to weaken, especially as the expansion is in its 11th year. The growth in revenues and earnings before interest, tax, depreciation and amortization (EBITDA) (excluding commodity sectors) were up 3.2% and 2.6% in the first quarter of 2019, a deceleration versus 4.5% and 4.3% in the fourth quarter of 2018, respectively.
  • Investment grade issuance was $291 billion in the quarter, down 14% year over year. Issuance, net of maturities, was up 14% year over year, however net supply growth for the first half of the year remained down 9% versus the first half of 2018. Merger and acquisition (M&A) related funding has declined this year to $106 billion in the first half of 2019 versus $143 billion in first half 2018. BBB issuance is 40% of year-to-date supply, down slightly from 43% of full-year supply in 2018.

Portfolio Strategy

  • The Portfolio had a positive return, but underperformed its benchmark, the Bloomberg Barclays U.S. Credit Index. The benchmark returned approximately 4%, which was driven primarily by falling rates as well as the benchmark’s spread tightening from 113 bps to 109 bps.
  • The Portfolio further reduced its duration relative to the benchmark, but the difference remains modest. Benchmark duration rose 0.2 year to 7.4 years at quarter-end. Higher duration means higher price volatility for a given change in spreads.
  • Overall risk positioning in the Portfolio remained relatively constant in the quarter with no material changes to exposures to the various ratings categories.
  • The largest changes in sector positioning were increases in the communications and technology sectors and decreases in the financial and consumer cyclical sectors.

Outlook

  • The second half of the year has two large factors that likely drive asset performance – Fed policy and trade policy. While the end of the second quarter saw a commitment by the U.S. to hold off on additional tariffs with China while talks resume, we did see an increase in tariff rates to 25% from 10% on $200 billion of imports into the U.S. from China as well as other trade frictions, most notably being restrictions on Huawei. This has already begun to and will continue to weigh on global growth. More importantly, the uncertainty over the trade relationship between the U.S. and China may dampen confidence and investment going forward.
  • The Fed has indicated they are likely to ease, but the pace of easing will have a material impact on asset prices. The market is pricing in a nearly 60% chance of three or more cuts by year end, a pace which we believe to be slightly too aggressive although we do anticipate the Fed easing. We believe macroeconomic data will continue to show a softening trend and will likely fall short of expectations in the second half due to trade policy uncertainty, Brexit and geopolitical concerns.
  • We believe credit spreads should widen for the second half of 2019 due to a few factors. First, macroeconomic data points are likely to underwhelm relative to consensus. Secondly, fundamentals in investment grade remain stretched with corporate balance sheets at their most levered levels post-crisis. Lastly, duration in investment grade marketplace continues to rise.
  • The technical backdrop for spreads remains relatively positive. We believe net supply should be materially lower than last year due to smaller M&A volume and tax changes reducing the incentive to issue debt. However, we expect a higher amount of total fixed income issuance principally from U.S. deficit funding. On the demand side, we see the trends modestly supportive of spreads. Mutual fund flows remain robust and are likely to continue in the near future, but overall yields in the market have compressed, which may reduce demand.
  • Given our expectation for modest widening of spreads in 2019, we believe our conservative positioning relative to the benchmark is appropriate. We will be opportunistic in our credit selection and overall positioning to take advantage of the opportunities and dislocations as they present themselves.

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 Bloomberg Barclays U.S. Credit Index measures the investment grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related bond markets, including a non-corporate component of non- U.S. agencies, sovereigns, supranationals and local authorities. 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 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 Portfolio's prospectus. Not all funds or fund classes may be offered at all broker/ dealers.

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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Mark Beischel
Susan K. Regan

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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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Zachary Shafran
Bradley Warden

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Ivy VIP Natural Resources

Market Sector Update

  • Global equity markets posted modestly positive returns on the broad indexes. The energy and materials sectors were mixed with slightly positive returns for materials and slightly negative returns for energy during the quarter. Energy underperformed the broader equity markets, while materials were more in line.
  • After rebounding strongly in the first quarter, crude oil prices declined slightly with West Texas Intermediate, the U.S. benchmark, declining about 3% and Brent crude oil declining about 6%.
  • Toward the end of the quarter, OPEC signaled that it intended to extend its policy that was agreed to in December 2018 to maintain oil production cuts of approximately 1.2 million barrels per day (bpd). OPEC’s primary goals are to balance the oil market and keep inventories at a targeted level, which will support prices.
  • OPEC has found it necessary to reduce production because of the continued growth of U.S. production. Despite U.S. producers seeking to increase free cash flow by moderating capital expenditures, U.S. oil production again grew in the quarter. According to the U.S. Energy Information Administration, U.S. oil production in the second quarter grew by approximately 1.5 million bpd from the second quarter of 2018.
  • Other commodity prices were mixed in the quarter. Iron ore prices were up about 26% because of supply disruptions, while copper prices declined about 7% on decelerating demand trends.

Portfolio Strategy

  • The Portfolio posted a negative return for the quarter and slightly underperformed the return of its benchmark.
  • The five greatest equity detractors to the Portfolio's performance relative to the benchmark were Halliburton Co., RPC Inc., Newmont Mining, WPX Energy Inc. and Centennial Resource Development, Inc.
  • The five greatest equity contributors to relative performance were BHP Group plc, Barrick Gold Corp., Rio Tinto plc, Occidental Petroleum Corp. and Canadian Pacific Railway Limited.
  • The Portfolio’s exposure to the energy sector remained stable from the prior quarter, ending at about 66% of equity assets. The remaining sector exposure was composed of materials, industrials and chemicals.
  • In general, we seek to own companies in the Portfolio with low-cost positions, strong balance sheets and the ability to grow profitably with high returns on capital. We also seek to own companies exposed to favorable trends in their respective commodities and sub-sectors.

Outlook

  • We expect OPEC production cuts to remain in place for the second half of the year and possibly longer. Non-OPEC oil production is expected to grow enough to satisfy global oil demand growth and could possibly exceed it. This would require additional cuts from OPEC to balance the market. U.S. production growth is expected to decelerate but still grow in excess of 1 million bpd in 2019.
  • Global demand for commodities is expected to slow as the market seeks clarity on the resolution of U.S. Federal Reserve policy and U.S. trade policy. Positive results on these two issues could lead to an improvement in global growth and commodity demand.
  • Energy equities continue to price-in a lower oil price than the current spot price, and it is expected that this gap will eventually converge.

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 06/30/2019: Chevron Corp., 6.03%; BHP Group PLC, 4.83%; Rio Tinto PLC, 4.65%; Phillips 66, 4.60%; EOG Resources, Inc., 4.58%; Halliburton Co., 4.19%; Concho Resources, Inc., 4.07%; Diamondback Energy, Inc., 3.87%; Valero Energy Corp., 3.77%; Marathon Petroleum Corp., 3.71%.

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. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. 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 natural resources can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments; and the cost assumed by natural resource companies in complying with environmental and safety regulations. Investing in physical commodities, such as gold, exposes the Portfolio to other risk considerations such as potentially severe price fluctuations over short periods of time. The Portfolio may use a range of derivative instruments in seeking to hedge market risk on equity securities, increase exposure to specific sectors or companies, and manage exposure to various foreign currencies and precious metals. Such hedging involves additional risks, as the fluctuations 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. These and other risks are more fully described in the 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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David P. Ginther, CPA
Michael T. Wolverton, CFA

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Where are the financial markets headed in the next 12 months? Rather than focus on unknowns, advisors and investors are better off looking at opportunities and implications. What can we learn from what we know at this point?

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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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Matthew A. Hekman
Mark Beischel
Susan K. Regan

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Ivy VIP Asset Strategy

Market Sector Update

  • The quarter was defined by a marked turn in central bank policy. Global central banks abruptly turned dovish, with the president of the European Central Bank (ECB) expressly foretelling additional easing during a policy speech in mid- June. This was followed by dovish rhetoric from the U.S. Federal Reserve (Fed) and several emerging market central banks cut interest rates.
  • The changes caused interest rates globally to drop – in some cases to record low levels. The 10-year U.S. Treasury fell toward 2% and yields in Europe fell precipitously, with 10-year points on multiple euro-denominated curves falling into negative territory. The Bank of Japan indicated that its yield curve control, which had been targeting 10-year yields around 0%, no longer had a lower boundary. Roughly $13 trillion of debt globally had negative yields at quarter-end.
  • The market started fully pricing-in rate cuts by the Fed and ECB before the end of the summer, with additional rate cuts from the Fed by year end. Credit spreads rallied as the market started to expect that quantitative-easing programs could be restarted and central bank balance sheets expanded.
  • Equities generally welcomed the dovish tilt by central banks and added to first-quarter performance, despite softening economic data. Softer data from the Institute for Supply Management and on capital goods as well as uneven employment data added to concerns about the global economy. Chinese equities were a notable underperformer, even as the G20 Summit meeting in late June prompted a temporary truce in ongoing trade tensions between the U.S. and China.
  • Gold was a big beneficiary during the quarter of the tilt in central bank policy and rose to its highest level since mid- 2013. Other commodities such as oil, gas and copper did not perform well, as weakening economic data hurt prices. The one exception was iron ore, which benefited from several mine closures which constrained supply.
  • Through all of this, the U.S. dollar remained fairly stable as expectations of lower U.S. rates were offset by dovishness of other central banks and weakening economic data.

Portfolio Strategy

  • The Portfolio had a strong positive return during the quarter and outperformed its all-equity benchmark. Gold was the best-performing asset class. The equity portfolio outpaced the benchmark, while the fixed income portfolio slightly lagged the benchmark.
  • Within the equity portfolio, performance was driven largely by stock selection, especially in the technology, industrials, consumer staples and health care sectors. Qualcomm was one of the Portfolio’s strongest performers, driven by its settlement with Apple, Inc. We felt the likelihood of that result was underappreciated by the market. We trimmed that position after the event. Microsoft Corp., which we also trimmed, continued to contribute as well.
  • Within industrials, the Portfolio’s tilt toward aerospace and defense continued to provide a tailwind given renewed rumblings in the Middle East as well as further Chinese activity in the South China Sea. In addition, Schneider Electric SE (France) and Larsen & Toubro (India) added to the sector’s performance.
  • On the negative side, Philip Morris International suffered along with its industry after standout first-quarter performance, and Glencore International plc continued to underperform mining peers because of low iron ore exposure and nagging regulatory issues. While the performance of Asia-Pacific holdings exceeded the benchmark, the Portfolio’s position in China Unicom Ltd., a mobile and fixed-line operator, detracted amid concerns about higher capital expenditures, which we think are overblown.
  • The fixed income portfolio lagged the benchmark but still provided positive returns for the quarter. Global interest rates rallied, which helped holdings in longer-duration Treasuries and investment-grade fixed income positions. The investment-grade credit positions were helped by the rally in spreads, which also benefited high yield and emerging market fixed income exposure in the Portfolio. The one detractor was in the bank loan holdings, which generally underperformed as the market shifted towards pricing-in Fed rate cuts.
  • Gold rose more than 9% and again reinforced the large position in the Portfolio as a risk diversifier against global macro risks and central bank policy that is intended to combat them. We tend not to place too much emphasis on technical factors, but it is noteworthy that gold has broken through persistent resistance to rise above $1,400 per ounce.

Outlook

  • While we were expecting further support from global central banks, the timing and magnitude of the dovish tilt was not expected. We thought the shift would be more gradual, especially given the fact that the Fed was hiking interest rates as recently as December and the ECB just started trying to normalize policy.
  • Uncertainty remains elsewhere in the global backdrop with tariffs and trade wars representing a wildcard with an unpredictable outcome, despite the apparent truce that was agreed to during the G20 meeting.
  • As a result we have been operating near the bottom end of our risk budget of 70-90% of the expected risk of the benchmark and expect to remain there for the foreseeable future. We are exploring how to adjust the nature of some of our risk-diversifying assets. Given very low interest rates, we are increasingly uncomfortable holding a number of assets that we have traditionally held to diversify risk, mainly long-duration Treasuries. We are exploring replacements mainly in the mortgage market, which could provide similar diversification without exposing the Portfolio to as much interest-rate risk.
  • Our outlook on the global economy remains subdued and we are skeptical about a recovery in the second half of the year, as many had predicted. As a result, risk in the equity portfolio has been reduced and we have slightly taken down credit risk in the fixed income portfolio.

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 06/30/2019: Microsoft Corp., 3.13%; Airbus SE, 2.22%; Nestle S.A., Registered Shares, 1.90%; Wal-Mart Stores, Inc., 1.83%; Fiserv, Inc., 1.83%; AIA Group Ltd.,&br;1.58%; Adobe, Inc., 1.56%; Visa, Inc., Class A, 1.51%; Pfizer, Inc., 1.36%; Sampo plc, A Shares, 1.33%.

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. The Portfolio may allocate its assets among different asset classes of varying correlation around the globe. The Portfolio's Equity Sleeve typically holds a limited number of stocks (generally 50 to 70). As a result, the appreciation or depreciation of any one security held by the Fund may have a greater impact on the Portfolio’s NAV than it would if it invested in a larger number of securities. 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. The Portfolio’s Diversifying Sleeve includes fixed-income securities, that are subject to interest-rate risk and, as such, the net asset value of the Portfolio may fall as interest rates rise. Investing in high-income 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. The Portfolio may seek to hedge market risk via the use of derivative instruments. Such investments involve additional risks. Investing in commodities is generally considered speculative because of the significant potential for investment loss due to cyclical economic conditions, sudden political events, and adverse international monetary policies. Markets for commodities are likely to be volatile and the Portfolio may pay more to store and accurately value its commodity holdings than it does with the Portfolio’s other holdings. These and other risks are more fully described in the 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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W. Jeffery Surles, CFA

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Ivy VIP Value

Market Sector Update

  • 2019 started with a sharp “hockey stick” recovery in the equity markets. Throughout the second quarter, market jitters reemerged as mixed signals from the economy caused the Federal Reserve (Fed) to press its dovish tilt. Just six months ago, the market expected three interest rate hikes this year. Now, the market is anticipating the Fed will actually cut rates twice before year-end, as growth both inside and outside the U.S. has slowed.
  • The Institute for Supply Management (ISM) Purchasing Managers Index has gone from over 60 in the summer of 2018 to 51.7 in July 2019. While anything above 50 is expansionary, the slowdown is apparent. Extreme weather trends have made noise in the numbers, but the uncertainty caused by trade wars and tariffs have started to reveal a noticeable impact.

Portfolio Strategy

  • The Portfolio posted a positive return, slightly underperforming the Russell 1000 Value Index (Portfolio’s benchmark) during the quarter. Some good stock picks in Qualcomm, Metlife and Citigroup were hampered by the weak performance of a few other names.
  • State Street, the worst performer in the quarter, became inexpensive in mid-2018 when investors reacted negatively to the company’s announced purchase of Charles River Development (maker of investment management software). While we believe the purchase of Charles River has a good chance of eventually adding value, the pressure in the base business continued at an unacceptable pace. We saw no near-term solution and thus sold the position during the quarter.
  • Qualcomm, the best performer in the quarter, is a developer of digital telecommunication products that enable cellular communications. This stock was purchased in the second half of 2018 while the company was embroiled in a lawsuit with Apple over cellphone chip sales. The companies reached an agreement on future business in mid-April and the stock quickly soared over 50%. We sold our position in early May as the stock became fully valued.
  • The worst-performing sectors were industrials, consumer discretionary and financials. Industrials performance was weighed down by our holdings in Spirit AeroSystems, where the Boeing 737 Max issues put pressure on exposed aerospace suppliers. While the Boeing concerns are ongoing, we still view Spirit as a high-quality supplier and think the issues should be resolved in the next few quarters.
  • The best-performing sectors overall were information technology, energy and real estate. The Portfolio was equal weight energy versus the benchmark. Energy Transfer Partners, Valero and Phillips 66 were our largest holdings in the sector. While we continue to believe these names are the best way to be positioned within the energy sector, sometimes performance comes from avoiding pitfalls. Not owning Exxon and Occidental, which underperformed in the quarter, added to the sector’s return relative to the benchmark.
  • Our strategy does not attempt to make sector calls, rather focusing primarily on stock selection. We overweight or underweight sectors based on individual stock opportunity, with some limits to control risk or volatility. The Portfolio is overweight financials and consumer discretionary, where we find value and yield. In these areas, we have been able to find what we believe are good companies with repeatable business models generating high rates of free cash flow, and low stock prices relative to our estimation of each company’s true intrinsic value. The Portfolio is underweight utilities and health care, due to lack of compelling ideas.

Outlook

  • The U.S. economy has enjoyed a long successful run from the end of the 2008 recession. There was an additional boost with the tax cut in early 2018. Recent economic data supports the idea of a slowing economy but does not yet support the concept of a recession. The ISM Purchasing Managers Index is one data point we are watching closely. The trends have slowed but are still indicating economic expansion. The Fed is in a difficult spot, now faced with the prospect of cutting interest rates to keep the economic expansion going.
  • While the economic forces listed above are clearly important factors, our first approach is from the company level. We seek to find quality, growing companies whose stocks are trading below what we consider their intrinsic values. This is often due to short-term negative factors, and we become larger owners of a company if we feel those negatives are about to dissipate. We continue to search for and make investments one company at a time to seek to benefit clients over the long run.

The opinions expressed are those of the Portfolio’s manager 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 % of net assets as of 06/30/2019: Walmart Stores, Inc. 4.6, Citigroup, Inc. 4.5, Bank of America Corp. 4.4, Comcast Corp. 4.4, Pfizer, Inc. 4.3, Broadcom Corp. 3.8, Phillips 66 3.6, Philip Morris International, Inc. 3.3, CVS Caremark Corp. 3.1 and MetLife, Inc. 3.1.

The Russell 1000 Value Index is an unmanaged index comprised of securities that represent the large-cap sector of the stock market. 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. The value of a security believed by the Portfolio’s manager to be undervalued may never reach what the manager believes to be its full value, or such security’s value may decrease. Investing in companies in anticipation of a catalyst carries the risk that certain of such catalysts may not happen or the market may react differently than expected to such catalysts, in which case the Portfolio may experience losses. The securities of many companies may have significant exposure to foreign markets as a result of the company’s operations, products or services in those foreign markets. As a result, a company’s domicile and/or the markets in which the company’s securities trade may not be fully reflective of its sources of revenue. Such securities would be subject to some of the same risks as an investment in foreign securities, including the risk that political and economic events unique to a country or region will adversely affect those markets in which the company’s products or services are sold. Not all funds or fund classes may be offered at all broker/dealers. 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 Growth

Market Sector Update

  • Market strength continued in the quarter as equities posted positive returns, adding to sizable gains in first quarter. The Portfolio’s benchmark, the Russell 1000 Growth Index, was up approximately 21.5% year-to-date. Equities across all capitalization ranges and all styles had positive gains during the quarter. Growth styles continued to outperform relative to value styles while mid-cap returns were more mixed across styles.
  • The Federal Reserve (Fed) remained supportive. During the quarter, markets began to price in at least one rate cut as early as July, with small odds of a more aggressive, larger cut. The Fed continued to signal a willingness to cut rates to offset the impacts from global slowing/trade pressures or to further stimulate the U.S. in the hopes of inciting some level of inflation. Investors have responded positively to a more dovish stance by the Fed.
  • It was another noisy quarter for global trade. There was a temporary tariff spat with Mexico during the quarter that resolved quickly. However, the bigger news was the building expectation for easing trade tensions between the U.S. and China that ultimately ended with a temporary “trade truce” between the countries during June’s G20 Summit. The news was welcomed by the market but also anticipated.
  • Economic data remained mixed. Employment and housing remain supportive in the U.S. while manufacturing data around the globe has weakened, with many countries moving into contraction territory.
  • From a factor perspective, momentum (price returns and relative strength) and quality (return on equity and return on assets) outperformed during the quarter. Quality has been a strong performer for entire year. Underperforming factors included value (price to sales and price to book) and risk (beta and variability of earnings).

Portfolio Strategy

  • The Portfolio posted a positive return, outperforming its benchmark during the quarter. Performance benefited from strong stock selection across several sectors, including information technology, industrials, health care, financials, consumer discretionary and consumer staples. The communications services sector was the only notable detractor to performance.
  • Information technology posted strong relative contribution to performance through significant overweight positions in VeriSign, Visa and Broadridge Financial Solutions. Performance also benefited from continued strength in overweight software names, Microsoft and Adobe.
  • Industrials was another notable positive contributor to performance as investors remained attracted to the strong late-cycle growth prospects from both CoStar Group and Verisk Analytics, both overweight positions.
  • Health care saw strength in a few stock-specific names, including Zoetis, which continues to benefit from its slow, steady and stable growth in the animal health sector. Illumina was a relative outperformer as investors gained incremental confidence in strong second half growth. The Portfolio also benefited from underweight exposure to the large-cap biotechnology and pharmaceutical sectors, both of which performed poorly during the quarter.
  • Financials was additive due to strong performance from CME Group as volatility moved higher in April. Consumer discretionary benefited from an overweight to Ferrari as investors continued to appreciate the company’s strong new car launch slate and stronger price realization.
  • The notable detractor during the quarter was communications services. The Portfolio was overweight Alphabet, which underperformed, and was underweight Facebook, which outperformed. The Portfolio also was negatively impacted by lack of exposure to Disney, which was strong in the quarter due to investor excitement over Disney’s new video streaming service.

Outlook

  • Easing rates likely due to slower growth. As illustrated by strong market gains, investors seem to be taking bad news as good news. The inference is that the Fed rate cuts are to be viewed as an attempt to further accelerate growth in order to incite some level of inflationary pressures. Another view of potential cuts, one we see as more probable, is to counter weakening trends in the U.S. driven by years of Fed rate hikes and slowing global growth.
  • The U.S.-China “trade truce” is hardly a resolution. This latest news of “kick the can” simply implies that trade will continue to be a source of volatility in the second half of 2019. We see the trade dispute as having serious long-term ramifications on allocation of capital and business investment. We believe it is difficult for companies to have confidence in a long-range plan without knowing the rules of engagement with respect to global trade.
  • Financial tightening is still hanging around. The impact of the nine rate hikes, plus quantitative tightening, working through the system is yet to be fully digested and should result in continued slowing in back half 2019. We foresee earnings risk and negative revisions ahead.
  • Growth scarcity trade is in effect, for now. We believe as growth slows investors will continue to favor high quality, highly visible, durable growth names. We believe if earnings encounter sharper negative revisions in the second half of the year there may be more opportunity to look for cyclical exposure for the Portfolio before 2020.

The opinions expressed are those of the Portfolio’s manager 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 % of net assets as of 06/30/2019: Microsoft Corp. 8.7, Amazon.com, Inc. 5.1, Visa, Inc. 4.9, Apple, Inc. 4.6, Alphabet, Inc. 4.2, CME Group, Inc. 3.8, Zoetis, Inc. 3.1, PayPal, Inc. 3.1, Verisk Analytics, Inc. 3.0 and Adobe, Inc. 3.0.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. 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. Investing in companies involved primarily in a single asset class (large cap) may be more risky and volatile than an investment with greater diversification. 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. Not all funds or fund classes may be offered at all broker/dealers. 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 Core Equity

Market Sector Update

  • For the second quarter of 2019, the S&P 500 Index, the Portfolio’s benchmark, returned a respectable 4.3%. The second quarter’s strongest market sectors were financials, materials, and information technology, while energy, real estate and utilities performed the worst. Year-to-date performance favors information technology, consumer discretionary and industrials. However, the defensive sectors have held their own despite the market gains over the past six months.
  • The strong equity market move on a year-to-date basis must be taken in context with an unusually low starting point following the fourth quarter 2018. As of June 30, the S&P 500 Index is essentially in line with levels at the end of last September, making it a highly volatile nine months for equities.
  • One of the catalysts to the market rally earlier this year was rising optimism that the U.S. and China would make solid progress toward a trade deal. That optimism faded in May when President Donald Trump announced the U.S. would increase the tariff rate on $200 billion in Chinese imports from 10% to 25%. Discussions between Trump and China President Xi Jinping at the G20 Summit in June were more hopeful, with the U.S. essentially announcing a trade cease-fire and lessening restrictions on Huawei Technologies Co. Ltd., China’s crown jewel technology company.

Portfolio Strategy

  • The Portfolio delivered a positive return for the quarter and outperformed its benchmark.
  • Individual stock selection, primarily within information technology and financials sector, drove performance while stock selection within the consumer discretionary sector and a modest allocation to cash slightly detracted from relative performance.
  • Over the past quarter, we have reduced or eliminated positions in several names that benefitted from strong secular growth, but that also increased to questionable valuation levels. In addition, we have materially decreased the Portfolio’s weighting of high-growth holdings over the past few quarters as their valuation levels have increased relative to the broad market.

Outlook

  • The continual back-and-forth between China and the U.S. has served to increase the level of macro uncertainty. Business leaders have responded by becoming more guarded in their outlook and capital expenditure plans, leading to reduced industrial activity. This reduction may not hurt the overall U.S. economy which is driven primarily by consumer-led activity, but industrial ups and downs are consequential to S&P 500 Index earnings growth.
  • During the U.S. Federal Reserve’s (Fed) June meeting it became increasingly obvious the Fed has shifted to a more dovish tilt. Futures markets have priced in a cut to the federal funds rate at the July meeting. In addition, probabilities built into market pricing suggest that investors believe the Fed will cut a total of 75 basis points from the current target rate of 2.5%.
  • Policy makers elsewhere have also become more dovish, with central banks in Europe stuck on a ”lower for longer” interest rate policy and China introducing both monetary and fiscal easing. Given such widespread global easing, it would not be surprising for growth rates to improve in many parts of the world by year-end
  • Any movement higher in global economic momentum, we believe, could serve as a catalyst for many areas of the market that have been left behind in 2019’s stock market rally. We are increasingly searching for more “value” oriented ideas within that market while keeping core positions in many long-term winners that benefit from secular/sustainable business drivers.

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.

Gus C. Zinn, CFA, served as a portfolio manager and the strategy until Dec. 3, 2018.

The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. It is not possible to invest directly in an index.

Risk factors: Because the Portfolio is generally invested in a small number of stocks, the performance of any one security held by the Portfolio will have a greater impact than if the Portfolio were invested in a larger number of securities. Although larger companies tend to be less volatile than companies with smaller market capitalizations, returns on investments in securities of large capitalization companies could trail the returns on investments in securities of smaller companies

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 Municipal High Income Fund

Market Sector Update

  • The high yield municipal curve performed well during the quarter. Both the long end and front end of the curve performed the best for the quarter, while the middle of the curve underperformed. Notably, the 1-year bond returned 2.73% while 20- and 30-year maturities returned 2.73% and 3.08%, respectively.
  • Market participants believe the Federal Reserve (Fed) will cut rates in July or September of this year, which has resulted in short rates performing consistently with the longer end of the curve. It is clear the Fed is very concerned about the negative effects of global trade tariffs and geopolitical risks on the economy along with prospects of slower growth. Overall, we believe the short and long ends of the municipal curve are richly valued relative to Treasuries.
  • Puerto Rico bonds continued to perform well for the quarter, returning 3.06%, which was a result of restructuring the island’s sales-tax-backed debt. However, we continue to be wary of Puerto Rico bonds. The restructuring of the general obligation bonds, which constitute the largest amount of debt outstanding, is headed to court. The concern is the 2012 and 2014 debt could be invalidated as unconstitutional, which means it is possible investors could see a total loss on their investments. While we feel this is unlikely, we believe the bonds are trading at higher prices than any possible recovery. Except for the sales-tax bonds, we still believe Puerto Rico bonds are “dead money,” meaning investors will receive no income from the bonds for the foreseeable future. We would be remiss if we pursued an investment with a high likelihood of offering no income.
  • Debt issuance was higher in the first half than a year earlier, but remained lower than historical norms. We are confident that supply will rise in the remainder of the year which could put some pressure on interest rates.
  • The rally in rates from the first quarter continued during the second quarter. We remain less constructive on the high yield municipal space as new issues come to market with historically low absolute yields and weak collateral for investors. Broadly, we have turned more bearish on the credit market as spreads hover near the lows of 2007.

Portfolio Strategy

  • The Fund had a positive return for the quarter, but underperformed its benchmark. The Fund’s underweight in the tobacco sector and Puerto Rico bonds detracted, while the Fund’s short duration versus the benchmark hampered performance.
  • The Fund’s duration is 73% of its benchmark, which is closer to the benchmark than the previous quarter. We have been actively seeking attractive opportunities in the new issue market in A- to AA-rated bonds, which we believe offer more relative value with spreads at historically tight levels. This has marginally increased the duration of the Fund, however we remain defensively positioned from a duration standpoint.
  • The Fund has been reducing exposure to non-rated bond, ending the quarter with an approximately 24% allocation. Non-rated bond spreads are at record lows, so we feel it is prudent to own more liquid rated bonds to provide us the opportunity to exploit credit widening.
  • Approximately 3% of non-rated bonds in the Fund are pre-refunded, which means the bonds are highly liquid despite being non-rated. The Fund holds roughly 9% pre-refunded bonds, which provides ample liquidity to exploit investment opportunities as interest rates rise and credit spreads widen. We plan on continuing to hold pre-refunded bonds in the Fund as a source of additional liquidity. Likewise, with book yields above 6%, the allocation allows us to continue to provide a stable and attractive dividend yield.
  • We favor revenue bonds over tax-backed debt. We think revenue bonds provide higher yields and better diversification from the general tax and pension issues affecting many municipalities. While general obligations have fared well in Chapter 9 bankruptcies, this trend changed following Detroit’s bankruptcy and we expect the same outcome in the Title IV filing in Puerto Rico.

Outlook

  • We believe the strength in the high yield municipal market should continue in the near term. Municipal bond funds have seen 25 weeks of positive inflows and low levels of issuance have resulted in positive results. We believe demand for municipal bonds will stay consistent with normal levels, but we do expect issuance to increase substantially in the second half of the year which may lead to slightly higher rates.
  • We will look for opportunities with more defensive structures as interest rates continue to hover near historically low levels and credit spreads remain tight. We believe it makes sense to remain shorter duration relative to the benchmark as the sector seems fully priced.
  • We expect the Fed to cut interest rates in July or September by 25 basis points. We are concerned about potential global trade wars with China and the European Union and the impact on the global economy. While trade tensions clearly are a concern, we do not feel a recession is likely this year.
  • We believe investors will continue to search for tax-exempt yield even after the tax legislation was passed. We view the tax cuts as favoring lower-income brackets, but with the top tax rate at 37% we believe municipal bonds remain highly attractive.
  • Going forward, we believe supply should increase about 20% from 2018 levels; however we believe the demand is strong enough to handle the increase. One consistent concern is the consolidation of assets into a select few high yield municipal bond funds. With three firms controlling a significant percentage of high yield municipal assets, a potential market disruption may cause an issue if investors decided to redeploy capital into other asset classes. We feel if that was to occur we are well positioned to redeploy capital at more attractive spreads and lengthen duration quickly.

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.

Risk factors: The value of the Fund's shares will change, and you could lose money by investing. 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. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). Exempt interest dividends the Fund pays may be subject to state and local income taxes. The portion of the dividends the Fund pays that is attributable to interest earned on U.S. government securities generally is not subject to those taxes, although distributions by the Fund to its shareholders of net realized gains on the sale of those securities are fully subject to those taxes. The municipal securities market generally, or certain municipal securities in particular, may be significantly affected by adverse political, legislative or regulatory changes or litigation at the Federal or state level. 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 Limited-Term Bond Fund

Market Sector Update

  • Yields across the U.S. Treasury curve fell substantially during the quarter. The yield on the 2-year U.S. Treasury note fell 50 basis points (bps) to 1.76%, while the 5-year U.S. Treasury note fell 46 bps to 1.77% at the end of the quarter. The front end of the yield curve is particularly flat and slightly inverted as the 3-year note ended the quarter at 1.71%.
  • The first half of the year saw the Federal Reserve (Fed) shift its strategy from rate hikes to “patience” in the first quarter, then Chairman Jerome Powell pivoted toward rate cuts at the June Federal Open Market Committee (FOMC) meeting. Uncertainty about the trade environment and tariffs and global growth were key concerns. President Donald Trump raised the tariff rate from 10% to 25% on $200 billion imports from China in early May.

Portfolio Strategy

  • The Fund had a positive return, but slightly underperformed relative to its benchmark for the quarter.
  • The Fund is underweight U.S. Treasuries, overweight corporate bonds, and maintains an allocation to mortgagebacked securities, primarily commercial mortgage-backed securities. During the quarter we reduced the Fund’s cash position and added to all three of the asset classes.
  • The Fund's duration, which is a measure of the sensitivity of bond prices to changes in interest rates, is roughly 90% of the benchmark.

Outlook

  • The current economic expansion is now the longest on record. It is clear the Fed wishes to keep promoting this expansion. Inflation is in check – the Consumer Price Index, Producer Price Index and Personal Consumption Expenditure Deflator all remain under 2%. The lack of inflation provides the Fed the room to cut rates should it be deemed necessary.
  • Expectations are rising for a rate cut of at least 25 bps at the July FOMC meeting. The influx of data ahead of the meeting could shift expectations. May’s employment report was weak with nonfarm payroll number posting a gain of just 75,000 jobs. However, there will be another employment report and the first reading on second-quarter gross domestic product before the next Fed meeting.
  • We believe fixed income should perform well for the foreseeable future. The Fed rate hikes are behind us and the potential for cuts lies ahead, both of which should support performance. In dealing with slower growth in Europe, the European Central Bank said it will do “whatever it takes” to help deliver positive growth to the economies of Europe. While domestic interest rates are low, they are negative far out on the yield curve in Europe. For example, the 10-year German bund yielded -33 bps at the end of June.
  • Many market participants are debating the Fed’s reason for cutting rates. Some believe it is an insurance cut aimed at helping to extend the expansion, while others think the cut is due to an impending economic recession. While we know expansions do not last forever, our view is that a recession is unlikely in the near term.

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.

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 rate rise. These and other risks are more fully described in the Fund's prospectus.

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Susan K. Regan

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Quarterly Fund Commentary

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