Ivy Apollo Strategic Income Fund

Market Sector Update

  • The first two months of quarter were strong as the U.S.–China trade deal was finally signed in January. Business confidence was improving and optimistic. Job growth was solid; beating expectations and the unemployment rate was at a historical low. The stock market reached new records with consumer confidence elevated. The outlook for 2020 was for stable global growth.
  • Unfortunately, the rise of COVID-19, which began in late-November 2019 and spread throughout China, Asia, Europe and ultimately the U.S. in early-March, has dramatically impacted the overall picture for global growth, capital markets and financial stability. This macro-environment led to an immediate decline in global gross domestic product (GDP) output, massive job losses and enormous reductions of wealth.
  • The fiscal and monetary responses have been massive with the Federal Reserve (Fed) cutting rates to zero, and providing U.S. dollar liquidity to other central banks, money market funds and corporate credit. It also started unlimited quantitative easing with large purchases of U.S. Treasuries and mortgage-backed securities. The Fed’s balance increased by $1 trillion in a week. Most central banks have indicated they will respond as needed to maintain operations and avoid dysfunctional financial markets during this crisis and it is clear that they will keep policy extremely accommodative as their economies recover. The monetary response has been just as impressive. The $2.0 trillion spending bill passed the Senate and House of Representatives after last minute negotiations – ultimately it should help bridge the effects of “social distancing.”
  • The sharp contraction in economic activity stemming from COVID-19 and the related shutdown is assumed to be temporary. Uncertainties dominate, but the baseline assessment is the acute stage of the health crisis has largely ended in China and will begin to ease in advanced countries by late- April to early-June. Recoveries in different nations will depend mainly on their performances prior to the pandemic and whether factors that supported or detracted from economic performance will change. The downside risk is that the pandemic extends longer and there is an extended period of getting back to normal activities, which lowers the overall economic activity and GDP drifts sideways from depressed second-quarter levels rather than a “V” shaped recovery.

Portfolio Strategy

  • The Fund underperformed its benchmark and Morningstar peer group for the quarter. Most of the underperformance was attributable to the Fund’s exposure to credit. The Fund’s exposure to lower quality CCC credits, as well a securities priced off of LIBOR, had a negative impact on the Fund. CCC credits underperformed due to their significant reliance on a strong U.S. economy. Securities that are priced off short-term interest rates underperformed as the Fed cut its policy rates by 125 basis points in order to ease funding pressures. Concerns of a global recession due to the COVID- 19 pandemic have led to a dramatic decrease in confidence, consumption and business investment. These concerns spilled into the credit markets, which witnessed large spikes in credit spreads to levels not seen since the 2008 global financial crisis.
  • With concern of a global recession, the U.S. dollar strengthened over the quarter against developed market currencies as the pound and euro gained 6.3% and 1.6%, respectively. The Fund’s 99.25% U.S. dollar exposure enhanced its performance relative to peers.
  • We continue to seek opportunities to reduce volatility in the Fund. Additionally, we are maintaining a low-duration strategy for the Fund as we feel it allows us a higher degree of certainty involving those companies in which we can invest. With the dramatic increase in credit spreads, we are taking this dislocation to allocate our portfolio out of higher quality U.S. Treasuries and credit into higher yielding credit. The Fund allocated 2.5% from the Global Bond Strategy sleeve to the High Income Strategy sleeve. Current weightings are 47.5% in the Global Bond Strategy sleeve, 32.5% in the High Income Strategy sleeve, and 20% in the Total Return Strategy sleeve.
  • We continue to focus on maintaining proper diversification for the Fund. 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

  • The U.S.’s sizable fiscal packages provide much needed income support for sidelined workers and financial support for businesses facing interrupted product demand and cash flows. However, the packages are not fiscal stimulus that will generate stronger growth.
  • China was weak going into the crisis; its domestic demand had slowed sharply. Business fixed investments had decelerated materially, while growth in gross capital formation had been propped up by government infrastructure investment. Consumer and business debt levels were very high, which reduced the government’s flexibility to stimulate more.
  • Most emerging markets were not well positioned going into the pandemic. Poor economic performances have harmed finances. In some Latin American countries, misguided policies and poor leadership have created turmoil that had contributed to capital flight. Debt levels are relatively high, and in special cases like Turkey, are burdened by large amounts of U.S. dollar-denominated debt levels that are costly to service as their currencies weaken versus the dollar.
  • The other concern with emerging markets is the dramatic decline in the price of oil. This impact has dramatically reduced overall budgets in OPEC, Russia, Nigeria, Brazil, Mexico and other nations.
  • Finally, the tilt away from globalization that has been underway for about half of the decade is likely to be reinforced. We believe new factors stemming from COVID-19 will fuel the move further away globalization, which will change complex international supply chains, higher tariffs and potentially increased barriers to immigration.

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 March 31, 2020, 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 impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

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 VIP Securian Real Estate Securities

Market Sector Update

  • We believe a recession is here, but it’s not the downturn that investors were expecting. The COVID-19 pandemic has the economy facing what might be the worst downturn since shortly after World War II, but the Federal Reserve (Fed) and U.S. government are using all policy levers to soften the blow. Uncertainty is exceptionally high, placing a premium on a strong framework for assessing new information.
  • The Fed re-instituted liquidity facilities developed during the great financial crisis and added a new facility to support the corporate bond market directly. In addition, the federal funds target was virtually cut to 0%. The U.S. Congress is doing its part, too. After passing legislation to fund COVID-9 vaccine research and an additional $104 billion in increased state aid, it passed the Coronavirus Aid, Relief and Economic Security (CARES) Act, an unprecedented $2 trillion bill of support, targeting hard hit segments of the economy.
  • The COVID-19 pandemic is driving highly correlated downturns in certain segments of the economy. The outlook is especially daunting for the consumer and certain commercial real estate property sectors primarily retail and hotels. It remains to be determined the long-term impact on office demand, but the co-working business model appears dead and the resulting influx of that space back to landlords will drive up vacancy levels and depress rental rates. In the short-term it is likely that most real estate owners, regardless of property type, will deal with tenant fallout and requests for rent relief and/or lease modifications.

Portfolio Strategy

  • The Portfolio delivered a negative return, but outperformed its benchmark for the quarter.
  • Favorable sector allocation was the primary driver of the Portfolio’s superior relative performance, although individual stock selection was also a material contributor. The most pronounced drivers of performance included an overweighting to datacenter and cell tower owners, and an underweight to retail and hotel owners. The Portfolio also benefitted from favorable stock selection in the office sector.
  • Datacenter and cell tower real estate investment trusts (REITs), which both provide real estate that is essential for those working or learning from home, significantly outperformed the broader REIT index in the quarter. Demand for space remains strong, with enterprise migrations in datacenters and 5G build outs in towers expected to accelerate. We continue to see the communications infrastructure names as attractively valued when considering their growth prospects and defensive lease structures, and the Portfolio remains overweight to this sector.
  • Net lease REITs delivered positive performance for the quarter, despite the “risk-on” environment and interest rate headwinds. Driving the segment’s performance were two gaming REITs, which own, but do not operate casinos. We have increased our exposure to these companies as they offer very attractive valuations relative to other net lease REITs.
  • The Portfolio’s overweight position to Datacenter REITs hindered performance, but favorable stock selection meant the group was still supportive of relative performance. We continue to see the space as attractively valued when considering its growth prospects and remain overweight to this sector.
  • Retail REITs grossly lagged the broader REIT group in the quarter. The shopping center and mall sectors were two of the portfolio’s largest underweight positions, which aided relative performance. While the full magnitude of the COVID- 19 impact on REIT income statements remains to be seen, we expect rental cash flows to be severely impacted for at least the next several quarters and we remain underweight the space.
  • The shutdowns and stay-at-home orders that impacted much of the world in March, with many hotel REITs reporting unprecedented drops in occupancy numbers. Stock prices for these companies followed suit and lagged the REIT group significantly. We expect the next several quarters to be challenging for this group. The Portfolio is focused on names with better balance sheets and more defensive demand characteristics.

Outlook

  • We believe it’s prudent to acknowledge that the outlook for the economy and commercial real estate is murky at best right now. Indeed, the same could be said for most all portions of the investment landscape. The dramatic decision to essentially shut down the U.S. economy – and worse, the primary engine of its growth: the consumer – as well as the lingering effects of that necessity will likely continue to weigh on real estate equities.
  • As for the Portfolio, we were early to react to this downturn and put defensive measures in place in an effort to limit downside participation. We have concentrated our positioning in sectors that we believe will continue hold up relatively well in a tough economic environment – mainly datacenters, cell towers, biotechnology and life sciences offices, as well as single family residential rentals. We have largely stayed away from retail related owners and poorly positioned owners of healthcare facilities.
  • Prior to the pandemic outbreak in the U.S. we were unfazed by valuation levels and operations within real estate were solid pretty much across the board. Given time we are confident those conditions will return, but now isn’t the time to go “bottom fishing” in the space. We are sticking with our quality bias in our companies’ property holdings, balance sheets, management teams and operational acumen.

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 march 31, 2020, 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 FTSE NAREIT Equity REITs Index is designed to present investors with a comprehensive family of REIT performance indexes that spans the commercial real estate space across the U.S. economy. The FTSE NAREIT Equity REITs index contains all Equity REITs not designated as Timber REITs or Infrastructure REITs. 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.

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

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. 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. Because the Fund invests more than 25% of its total assets in the real estate industry, the Fund may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. 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.

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 Natural Resources Fund

Market Sector Update

  • Global equity markets posted negative returns on the broad indexes. The energy and materials sectors also posted negative returns and underperformed the broader equity market. Materials outperformed the energy sector.
  • Crude oil prices declined significantly in the quarter with West Texas Intermediate crude oil, the U.S. benchmark, down about -67% and Brent oil down about -61%. A perfect storm hit the oil market as demand significantly weakened due to the COVID-19 pandemic, coupled with a policy change from OPEC to supply more oil to the market. This shift in policy occurred when OPEC and Russia were unable to agree on extending existing production cuts. The result was a dramatically oversupplied market for oil that is straining inventory storage around the world.
  • The severe decline in oil prices in the quarter caused producers around the world, notably in the U.S., to slash capital expenditures and growth outlooks. The U.S. shifted from growth mode to contraction mode as many domestic producers announced plans to cut activity from 30-50% for the full year in 2020. With the oil price dropping below the cash costs of operation in some areas, some producers have elected to completely stop activity in the near term.
  • Other commodity prices moved lower in the quarter with iron ore prices down by about 4% and copper prices down by about 20%. Iron ore prices held up relatively well due to tight controls on supply by the largest suppliers.

Portfolio Strategy

  • The Fund outperformed the return of its benchmark, the S&P North American Natural Resources Sector Index, but posted a negative return for the quarter. Outperformance was partially driven by an underweight in the energy sector, an overweight in materials, and strong stock performance relative to the index in solar, precious metals, other metals and chemicals.
  • The five greatest equity contributors to relative performance were overweight positions in Canadian Pacific Railway, Barrick Gold Corp., Rio Tinto plc, Schlumberger and Occidental Petroleum.
  • The five greatest equity detractors to relative performance were TC Energy Corp., Enbridge Inc., Newmont Corp., Chevron Corp. and WPX Energy Inc.
  • The Fund’s exposure to the energy sector decreased significantly from the prior quarter, ending at about 33% of equity assets. The decrease was due to reduction in exposure and depreciation of equity. The remaining sector exposure was composed of materials, solar, industrials, utilities and chemicals. The Fund also increased its cash position to around 11% given the significant uptick in market volatility and unprecedented market conditions.
  • In general, we seek to own companies in the Fund 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

  • Due to the open-ended nature of the COVID-19 pandemic, it is unclear when exactly demand for oil and other commodities will return to previous levels. With large parts of the world economy grinding to a standstill, demand is expected to be significantly below trend until businesses begin to increase operations.
  • In order to match lower demand conditions, supply of oil and other commodities is expected to be drastically cut also. However, the supply cuts are likely to be slower than the demand reduction, which should result in increasing inventories for much of the remaining year. Persistent oversupply will likely continue to keep commodity prices near cash costs of operation or the marginal cost of new supply until more supply growth is needed to meet demand.
  • After several years of expansion in the U.S. energy industry, we are likely headed for a contraction that could last for many months. Much higher oil prices will be needed for the industry to return to growth. It is expected that this will not occur until demand recovers to a level where more supply from U.S. producers is needed. If OPEC continues its increasing market share strategy, U.S. oil supply growth will likely not be needed until 2021.

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 March 31, 2020, 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 03/31/2020: Barrick Gold Corp. 5.9, Phillips 66 3.9, Canadian Pacific Railway Ltd. 3.6, Union Pacific Corp. 3.3, Rio Tinto plc 3.3, Valero Energy Corp. 3.2, Galp Energia SGPS S.A., Class B 2.7, Marathon Petroleum Corp. 2.6, Air Products and Chemicals, Inc. 2.6, and BHP Group plc 2.6.

The S&P North American Natural Resources Sector Index represents U.S.-traded securities in the energy and materials sectors, excluding the chemicals industry, and steel sub-industry. It is not possible to invest directly in an index. All information is based on Class I shares.

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

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. 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 Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. The Fund 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. Not all funds or fund classes may be offered at all broker/ dealers.

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David P. Ginther, CPA
Michael T. Wolverton, CFA

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