Ivy Securian Real Estate Securities Fund

Market Sector Update

  • Late-cycle concerns have emerged, putting downward pressure on second quarter economic forecasts. Gross domestic product (GDP) growth estimates for the period have fallen to 1.7% as cost pressures, trade tensions, and global uncertainty take their toll. These factors are pressuring corporate earnings, making a year-over-year decline likely for the second consecutive quarter. On a brighter note, the labor picture remains exceptionally strong, with the unemployment rate at 3.6% its lowest level in nearly 50 years.
  • While the U.S. Federal Reserve’s (Fed) base case calls for growth trending to a slower but more sustainable level, rate cuts are likely if the U.S. economy softens more than expected. Interest rates – here and abroad – are signaling that investors are worried about a slowdown. Investors believe the Fed is entering an easing cycle, at futures have priced multiple cuts over the next year. It’s unusual to see such strong market conviction about the need for easier policy while the Fed continues to temper expectations, guiding to only modest easing this year.
  • All asset classes have performed well to date in 2019 despite slowing growth and fears of a downturn. Ironically, the catalyst for the second quarter rally was growing conviction the Fed will reduce rates in the near term, which would prolong the expansion. Real estate stocks once again delivered positive returns, with the FTSE NAREIT Equity REITs Index, the Fund’s benchmark, up 1.2%.
  • Macroeconomic and interest rate conditions remain favorable for real estate operators, although we are paying careful attention to indicators that suggest a slowdown and possible earnings recession in the second half of the year. Tailwinds from U.S. tax reform, business expansion and positive consumer sentiment have created a solid demand backdrop, allowing real estate investment trusts (REITs ) to improve occupancies and command higher rental rates.

Portfolio Strategy

  • The Fund delivered a positive return for the quarter, but underperformed its benchmark.
  • The Fund’s overall performance for the period is attributed to more defensive positioning of the portfolio. We have held a larger than typical exposure to net lease and health care properties throughout 2019 given our belief that expectations for a “Goldilocks” environment are too optimistic. Net lease and health care companies tend to outperform while interest rates are falling and underperform when rates climb. Our conviction is heightened by the sharp run-up in equity prices into what we believe will be an “earnings recession” this year.
  • Warehouse REITS also proved to be a detractor to relative performance, although modestly. The burgeoning ecommerce activity has produced strong demand for warehouse space, but new supply has begun to outstrip that demand, leading to reduced rental rate and net income growth for the companies. Typically, that combination has resulted in sub-par performance for the equity and we believe a correction is due. We reduced our exposure to warehouse owners after a period of strong performance left these companies with what we believe are unsustainably inflated valuation levels – particularly if the previously mentioned “earnings recession” unfolds across corporate America.
  • Single family rentals (SFR) REITs were the top performing sector in the benchmark for the quarter on a total return basis. Given the overweight, it was also the top positive contributor for the quarter. The expense hiccups from previous quarters for now have stabilized, resulting in a robust same store net operating income growth average of 6.4% for the quarter. With greater comfort with their maturing operational controls, SFR holdings were increased during the quarter, as we feel there continues to be a long runway for growth; both from a steady stream of millennial and retiree demand, and from demonstrated outreach for affordable housing.
  • Retail REITs alsocontributed to performance in the quarter. The portfolio was underweight to both shopping centers and malls in the quarter and both sectors lagged the broader universe. The portfolio remains underweight to the traditional retail group with the belief that store closings and leasing costs will remain elevated and mute returns for the space.
  • Self-storage REITs remain under new supply pressure, causing significant deceleration in revenue growth. Despite the drag on quarterly performance, we remain underweight the sector.
  • Negative stock selection among hotel REITS detracted from the Fund’s relative performance. We remain underweight the group on concerns that increasing labor costs and continued new supply will pressure earnings, while increasing economic headwinds will pressure sentiment towards the space.

Outlook

  • Equity markets remained rock solid for the period, but risks are in play. Geopolitical risks remain high. Increasing labor costs and slowing growth have reset earnings expectations at a lower level. However, we think a strong backdrop for the consumer and favorable Fed policies are enough to keep the economy out of a textbook recession.
  • However, we a being quite vigilant for signs of further macroeconomic data deterioration along with a corporate “earnings recession.” Continued dovish Fed policy should prove favorable for risk assets so long as the date doesn’t deteriorate materially throughout the remainder of the year.
  • With regard to the current commercial real estate cycle, we continue to see stable operating conditions across the sector with few material concerns on the horizon. Bank lending, commercial construction, equity allocations and overall pricing metrics remain much healthier than was often the case in previous cycle peaks. Simply moving into the later stages of this recovery does not mean sector fundamentals will turn negative.
  • The “bondification” of real estate has been bemoaned by many market participants as irrational, but has become current reality. Short-term REIT price movements have been tightly tethered to changes in the 10-Year U.S. Treasury yield for the past five years. While acquiescing to the new normal, we continue to believe that longer-term share price performance will be heavily influenced by macro conditions. Share price support will come from further employment gains and GDP growth while potentially rising borrowing costs, such as a rising 10-year U.S. Treasury yield, or a steepening yield curve could offer resistance.
  • Valuations of private market transactions continue to support REIT valuations, suggesting REITs currently trade at a discount to NAV. REIT pricing compared to broader fixed income and equity markets also looks attractive compared to historic averages. Significant fund raising in real estate private equity funds suggests further support for real estate valuation.

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.

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. It is not possible to invest directly in an index.

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. 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.

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Ivy Mid Cap Income Opportunities

Market Sector Update

  • The stock market ascended during the second quarter 2019 to an all-time high despite significant consternation on the economic growth outlook. Tariffs reentered the vernacular as both China and Mexico were threatened with increases, but by the end of the quarter the increases were repealed. Many developed nations stopped buying products from Huawei, a significant global technology company based in China, further showing strains in Chinese- U.S. relations. The global economy has shown signs of slowing, but it is difficult to decipher how much to attribute to the trade indecision versus other factors. Offsetting these fissures in the economic outlook, the Federal Reserve (Fed) signaled willingness to pivot from a neutral bias toward one appearing more accommodative. This put significant downward pressure on U.S. interest rates and drove other risk assets higher in value, including the stock market. In the second quarter, the Russell Midcap Index, the Fund’s benchmark, increased 4.13% following very strong gains in first quarter. Financials, communication services, industrials, information technology, health care, utilities, consumer discretionary and materials all produced positive returns, keeping with pace the overall market. Consumer staples and energy were the only sectors to trail the benchmark.
  • Long-term interest rates declined more than 40 basis points during the quarter, ending the period at 2.0% on 10-Year US Treasuries. Despite falling yields in the fixed-income market, higher dividend yielding stocks continued to be out of favor. Those stocks with a dividend yield of greater than 2.9% (the top quintile of dividend yield) underperformed the benchmark by 230 basis points. This was a surprise to us given the competitive income that can now be found in the stock market from these big yielders.

Portfolio Strategy

  • The Fund posted a positive return, outperforming its benchmark in the quarter. Sector allocation was a modest positive to relative performance. An underweight in real estate drove the allocation benefit but was slightly offset with a cash position from positive flows into the Fund.
  • The consumer discretionary sector produced the best relative performance in the quarter, despite a significant overweight position to the slightly underperforming sector. Hasbro increased strongly on better-than-expected results with growth reemerging following the liquidation of Toys R Us in 2018. Service Corp., a funeral and cemetery operator, also saw nice gains in the quarter as volumes were better-than-feared following a strong flu-driven event comparison from first quarter 2018.
  • Scotts Miracle-Gro extended its strong performance from last quarter into this quarter and drove outperformance within the materials sector. The company had a very difficult 2018 in its hydroponics business, which has seen a significant improvement in 2019 all while its base business of growing medium and seeds has shown little price elasticity despite significant increases to offset cost pressures. RPM International slightly outperformed in the quarter as management is executing on a plan to drive operational improvement and should produce significant margin expansion.
  • The industrials sector was an area of relative weakness for the Fund during the quarter. Both Rockwell Automation and nVent, an electrical products manufacturer, lagged during the quarter due to concerns about the economic growth outlook. We remain favorable on both companies. Rockwell should continue to benefit from further penetration of industrial automation globally. nVent, a new purchase in the quarter, was recently spun-out of Pentair and we believe the company should see growth accelerate now with greater focus on its own business.

Outlook

  • We continue to watch several key variables to determine positioning. These variables (domestic economic growth, change in interest rates, change in commodity prices and foreign economic growth) have remained consistent and continue to be monitored.
  • While we still expect domestic economic growth in 2019, albeit slower than 2018, we have increased pessimism about the level of growth. We believe the broad uncertainty that has been generated from the ever-changing trade negotiations have likely slowed capital deployment from companies. We expect companies will attempt to accelerate plans to move manufacturing out of China, but don’t expect it to be a significant near-term positive to the U.S. Juxtaposed to the weaker industrials outlook, the consumer economy remains robust with solid wage and job growth and high levels of confidence. We believe the lower interest rate environment can provide more buying power to consumers with the ability to reaccelerate the U.S. housing market.
  • We had been concerned about the increasing interest rates and the unintended consequences that could arise given how low and for how long rates had remained depressed. It appears the Fed has kicked the can down the road for “normalizing” the environment and thereby removing what we felt was one of the biggest risks to this cycle given the likely unnatural things that have occurred in the market due to the extended period rates have remained low. In fact, it appears interest rates will be lowered at least once this year. With this risk removed over the near-term, it should be more constructive for the market. We feel the fund can offer a very competitive income component relative to fixed income markets while providing the potential for income growth and better capital appreciation.
  • We expect that the moderating inflationary pressures driven by commodity prices will surprise the market over the next six months. Many companies push through pricing with a lag relative to costs increases. Over the past 18 months, companies have been combating ever increasing raw materials. Over the next two quarters, we would expect pricing to have caught up to cost inflation, providing margin expansion opportunities for those companies that have pricing power. We expect this to most directly benefit those heavy users of steel, materials and freight as all have seen recent deflation. Oil prices remained fairly stable during second quarter. Tariffs remain a potential headwind but ascertaining the likelihood of implementation seems to be a fool’s errand.
  • Much is still unknown across the globe. It appears China has been attempting to stimulate its economy and we expect we will see this produce accelerating growth over the coming months. As this occurs, it should have follow-on impacts in both Europe and Latin America. Brexit remains a potential risk event, but as the stakes are so high, we continue to expect a moderate outcome versus a more extreme exit. With the near-term removal of higher interest rates given actions by the Fed, it appears the U.S. is still the most stable of the global economies to invest; however, we expect global growth acceleration to closely match the U.S. economy throughout the year. The tactics of President Donald Trump still have the potential to concern the market, but thus far his actions have shown a deep awareness of any damping of the stock market.

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.

Top 10 holdings (%) as of 06/30/2019: Avery Dennison Corp. 3.1, Scotts Miracle-Gro Co. 3.0, Maxim Integrated Products, Inc. 3.0, Service Corp. International 2.9, Hasbro, Inc. 2.9, RPM International, Inc. 2.9, Encompass Health Corp. 2.9, Polaris Industries, Inc. 2.9, Broadridge Financial Solutions 2.8 and Arthur J. Gallagher & Co. 2.8. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It is not possible to invest directly in an index.

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. Investing in mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. The Fund’s emphasis on dividend-paying stocks involves the risk that such stocks may fall out of favor with investors and underperform non-dividend paying stocks and the market as a whole over any period of time. In addition, there is no guarantee that the companies in which the Fund invests will declare dividends in the future or that dividends, if declared, will remain at current levels or increase over time. The amount of any dividend the company may pay may fluctuate significantly. In addition, the value of dividend-paying common stocks can decline when interest rates rise as fixed-income investments become more attractive to investors. This risk may be greater due to the current period of historically low interest rates. The Fund typically holds a limited number of stocks (generally 35 to 50). As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a large number of securities. 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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Kimberly A. Scott, CFA
Nathan A. Brown, CFA

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Ivy Pictet Targeted Return Bond Fund

Market Sector Update

  • The tentative signs of growth recovery saw earlier this year seems to have run out of steam over the quarter. Not only has the escalation of the U.S. and China trade tensions contributed to the worsening in business sentiment, it has also seemed to have affected the mood among U.S. consumers. Employment growth has also slowed and so has inflation.
  • Amid increasing market expectations of rate cuts, the Federal Open Market Committee (FOMC) delivered a dovish message in June. They dropped the “patient” stance from the policy statement, replacing it with an assurance to “act as appropriate” on the back of global growth concerns and muted inflation. They also signaled a strong bias to lower rates this year, although it may not be as imminent and as large as expected by markets.
  • Spread products in Europe, in particular peripheral sovereigns and European subordinated banks, were the two best performers this quarter as the European Central Bank (ECB) was preparing markets for additional asset purchases. Renewed trade tensions and lower oil prices pushed emerging market spreads wider in May. However, spreads tightened back in June after seeing lower bond yields, a depreciating U.S. dollar, higher oil prices as well as an agreement between the U.S. and China on resuming trade talks.
  • The safe haven currencies of the Japanese yen and the Swiss franc were among the best performing currencies this quarter, with most of the gains seen in the “risk-off” environment in May. On the other hand, the “risk-on” proxies of the Australian and the New Zealand dollar underperformed. The British pound was one of the worst performing currencies this quarter reflecting Prime Minister Theresa May’s resignation in May and the top Prime Minister candidates’ harder Brexit stance.

Portfolio Strategy

  • The Fund posted a positive return and outperformed its benchmark in the quarter. Our rates positions, specifically our long duration positions in the U.S. and Germany, were the primary positive contributors to performance. Our spread positions, in both developed and emerging markets, also contributed positively to performance.
  • In developed markets, our holdings in European banks, insurance and properties contributed the most, while in emerging markets, our hard currency sovereign holdings in the Middle East, North Africa and Europe performed the best.
  • Overall, our currency positions had a broadly neutral contribution to performance for the period.

Outlook

  • In the aftermath of the re-initiation of the trade talks between the U.S. and China, markets have breathed a sigh of relief, having feared a trade war that could have toppled the global economy into recession. Global manufacturing and capital expenditure have been weak and central banks seem to be willing to ease policy again to avoid a more protracted slowdown. We believe inflation provides the perfect excuse to ease, as it peaked in the second half of 2018.
  • After the Trump administration managed to re-stimulate the economy last year with a fiscal package, we believe everybody else wants to follow suit, the main condition is that monetary policy remains loose so yield rises and currency appreciations do not offset the effects of the additional government spending.
  • We have reduced our exposure to the front end of the U.S. curve as we believe the market was too quick to price rate cuts by the U.S. Federal Reserve in July, although we still believe the Fed will start cutting rates in September.

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. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Fund may fall as interest rates rise, especially securities with longer maturities. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher rated bonds. The Fund may seek to manage exposure to various foreign currencies, which may involve additional risks. The value of securities, as measured in U.S. dollars, may be unfavorably affected by changes in foreign currency exchange rates or exchange control regulations. Investing in foreign securities involves a number of risks that may not be associated with the U.S. markets and that could affect the Fund's performance unfavorably, such as greater price volatility; comparatively weak supervision and regulation of securities exchanges, fluctuation in foreign currency exchange rates and related conversion costs, adverse foreign tax consequences, or different and/or less stringent financial reporting standards. Mortgage-backed and asset-backed securities in which the Fund may invest are subject to prepayment risk and extension risk. The Fund employs investment management techniques that differ from those often used by traditional bond funds, including a targeted return strategy, and may not always perform in line with the performance of the bond markets. The Fund is also non-diversified and may hold fewer securities than other funds and a decline in the value of these holdings would cause the Fund's overall value to decline to a greater degree than a more diversified fund. The Fund expects to use derivatives in pursuing its investment objective. The use of derivatives presents several risks including the risk that fluctuation in the values of the derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative's value is derived. Moreover, some derivatives are more sensitive to interest rate changes and market fluctuations than others, and the risk of loss may be greater than if the derivative technique(s) had not been used. These and other risks are more fully described in the Fund's prospectus.

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Correlation conundrum: Mixed market signals

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While the correlation between equity and fixed income markets has been sending mixed messages, our panelists believe policymakers are a formidable backstop to help sustain the economic expansion.

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Erik Becker, CFA
Portfolio Manager
Ivy Investment Management Company
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Ben Esty
Portfolio Manager
Ivy Investment Management Company
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Matt Hekman
Portfolio Manager
Ivy Investment Management Company
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While the correlation between equity and fixed income markets has been sending mixed messages, our panelists believe policymakers are a formidable backstop to help sustain the economic expansion.

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Depressed valuations may offer opportunity

Fear of recession has depressed valuations of many economically sensitive businesses. Contrary to popular belief, this may be an opportune time to invest, with the added benefit that many of these businesses have improved their financial strength and operating flexibility.

The first quarter of 2019 marked another period when growth beat value, with most outperformers falling into the paradigms of high-flying growth or so-called safety stocks that offer higher dividends, low volatility and stable earnings. Meanwhile, many of the valuations of traditionally cyclical businesses already appear to be discounting a recession. This has pushed valuation dispersions between the cheapest and most expensive stocks to their widest point since the dot-com internet bubble that ended in 2000.

Valuation dispersion widest since 2005
Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Data provided through 03/31/2019. Source: Sanford C. Bernstein & Co. Dispersion based on price/book, equally-weighted data. Includes largest 1,600 stocks by market capitalization in developed world.

While we can never predict when such a trend will reverse, the historical pattern has been for cyclical shares to become heavily discounted amid fears of a recession, and then outperform once the prospects of a recession become clearer. In our view, valuations in financials, energy, autos and housing-related stocks are currently heavily discounted. While the reasons for their weakness vary by industry, we believe each offers a meaningful investment opportunity.

Is it too early?

In considering the viability of investing in these businesses today prior to a downturn, we evaluated returns relative to the market when bought within 24 months of a recession and then held for three years. Because the global financial crisis (GFC) was such an outlier, we wanted to differentiate its results from what has typically happened around a recession.

Leading into the GFC, it is no surprise that financials did not deliver a positive return over the ensuing three years. However, buy-and-hold investors in consumer discretionary stocks were rewarded for purchasing virtually any time within six to eight months of the crisis.

In more mundane recessions, like the four prior to the GFC, patient investors were rewarded for owning undervalued cyclical stocks.

The following two charts show just how strong the outperformance for financials and consumer discretionary stocks were over the three years surrounding these recessions. In various stages of repair, we also believe that many of these companies are better prepared than in the past for a downturn — even as their valuations imply that the opposite is true.

Forward 36-month relative returns

Prior to recessions 1975 — 2001 vs. global financial crisis

U.S large-cap financials
Chart Showing The cost of missing the market can be significant
U.S. Large-Cap consumer discretionary
Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Source: National Bureau of Economic Research, Empirical Research Partners. Equally-weighted cumulative returns of sector versus capitalizationweighted returns of the largest 750 U.S. stocks by market capitalization.

Financials: Progress yet to be fully rewarded

We believe the distrust created during the GFC has not been fully resolved in investors’ minds, so financials remain heavily discounted as demonstrated in the chart below. Their current valuation relative to the broad market places these stocks in the 97th percentile of the past 45 years, meaning they have only been cheaper 3% of the time. However, given their profitability, capital strength and liquidity, we believe the discount is unwarranted.

U.S. Large-Cap financials relative to the market
Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Source: National Bureau of Economic Research, Empirical Research Partners. Data provided from 01/01/1974 – 03/31/2019. Largest 1,000 U.S. stocks ranked by market capitalization. Ratios of price/book values relative to the equally-weighted broad market data as stated above.

We believe both U.S. and European banks have improved their fundamentals and fortified their balance sheets by:

  • increasing tier-1 core risk-based capital ratios to over 13%, from 7%–8% at the end of 2006
  • raising liquidity ratios in the U.S. by 9%, almost triple pre-crisis level; European banks have similarly improved liquidity management
  • scaling back risk-taking to reduce the likelihood of a major institution upending the system
  • implementing self-help that cut costs, improved governance, focused on higher-return businesses and installed next-generation technology to better serve clients.

These combined actions make the banks much better positioned to weather future credit events or market shocks.

Higher liquidity improves resilience to volatility

Liquidity ratio

Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Source: Federal Deposit Insurance Corporation (FDIC). Data provided from 03/31/2002 – 12/31/2018. Liquidity ratio shows liquid assets (cash, Treasuries and municipals) / tangible assets.

From a credit perspective, we believe the overall environment today remains benign, and non-performing loans are below their historical range. The recent outsized growth in leveraged loans alongside loosening lending standards in this space has raised some concern.

With most loans being packaged and dispersed among institutions and within financial products, the additional risk will be borne across markets. The extent to which investors bear this additional risk remains important and may be accentuated in the event of a downturn.

Exposure to risky loans among banks remains constrained, and we do not believe it warrants their current valuation discounts. As a result of stronger risk management and higher regulatory requirements, banks today turn over their leveraged loan inventory as rapidly as every 60 days, three times faster than before the GFC. We continue to watch for new developments but believe that any problems surrounding these loans will be limited in scope, and the risk of systemic contagion is low.

Investors also penalize the sector as interest rates remain persistently low. The reality is that financials have demonstrated an ability to adapt by raising revenue and restoring earnings. Even with the combination of low interest rates and increased regulatory capital requirements, U.S. banks have restored profitability with return on tangible equity of 15%. European banks face more severe interest rate headwinds than those in the U.S. Banks in Europe also have more restructuring ahead to restore profitability; most expect to resume doubledigit returns on equity over time.

Energy: coming off the bottom

Energy stocks are also at depressed valuations because of concerns centered on the uncertain path for energy prices. On a price-to-book (P/B) basis, they are trading in the 98th percentile of the range relative to the market over the last 44 years. In other words, they have been cheaper on a relative basis in just 12 months out of the last 528. And each time was on the heels of a rapid oil price collapse.

Companies in the sector have taken significant steps to endure this kind of volatility — cutting operating costs and capital spending to restore profits and cash flow. Meanwhile, the downturn in exploration and development accelerated the decline in global oil reserves. Falling at a rate not seen in the last four decades (See chart below), the pace of the fall seems unsustainable. Even with developments in the alternative energy and transportation industries, world oil demand is expected to grow over the next two decades, according to the U.S. Energy Information Administration. The combination of rising demand and depletion will more than offset any reductions from technological advances, and ultimately we believe it will require companies to invest in developing additional reserves.

Oil reserve depletion indicates more capital spending is needed
Chart Showing The cost of missing the market can be significant

Past performance is not a guarantee of future results. Source: Rystad Energy

Oilfield service companies would be central to that development but have been particularly vulnerable of late. The previous chart shows that upstream capital expenditures fell by 44% from their 2014 peak. After having endured sharp declines in revenues (-49%) and margins (-63%), these companies have shown progress. With only a slight improvement in revenues, these companies doubled their margins to 10.4% by 2018 (from 5.1% in 2014) by focusing on cost cutting and supply chain efficiencies. In many cases, they have also shown disciplined capital management by aggressively trimming debt. We believe the more austere approach of these companies should allow them to come through this period as leaner, more efficient operations. With these companies trading near historical lows relative to the market, investors are essentially getting a free option on increased energy capital spending whenever the recovery occurs.

Household durables and autos are also undervalued

Within the consumer discretionary sector, household durables and automobiles have faced a perfect storm. Their natural tendency for a late-stage selloff may have been intensified by headwinds such as trade-related cost increases that are specific to the current cycle. Building product manufacturers and homebuilders have underperformed on slower growth in housing starts and the impact of rising rates on affordability. Costs surrounding materials and transportation have risen substantially since the beginning of 2018, and labor has been tight.

Amid the volatility and rising fears of a recession in 2018, household durables fell by 29% and autos by 34%. After taking a severe battering in the last recession, investors seem to want to steer clear of anything housing or automotive related. While there has been some recovery within housing this year, U.S. large-cap auto and housingrelated stocks continue to trade at a significant discount to the broad market on a P/B basis.

Attractive valuations remain

The market’s continued preference for growth and safety has recently left many of the traditionally cyclical businesses out in the cold. While financials, energy and autos have each been discounted for its own specific reasons, each has been judicious in deploying capital, realigning its business models and maximizing operational efficiencies. Meanwhile, valuations in these segments are all attractive. We believe these businesses are better prepared than in the past for a downturn, and history would suggest this is a good time to invest for the patient shareholder.


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

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. The value of a security believed by the Fund’s manager to be undervalued may never reach what the manager believes to be its full value, or such security’s value may decrease. These and other risks are more fully described in the fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

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Active management: Going beyond the index
Pockets of perceived opportunity

Article Short Summary: 

Fear of recession has depressed valuations of many economically sensitive businesses. Contrary to popular belief, this may be an opportune time to invest.

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- In our view, valuations in financials, energy, autos and housing-related stocks are currently heavily discounted.
- We believe both U.S. and European banks have improved their fundamentals and fortified their balance sheets.
- Energy stocks are also at depressed valuations because of concerns centered on the uncertain path for energy prices.

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Monday, December 16, 2019 - 01:45

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A focus on quality as volatility persists

The budding U.S.-China trade agreement that appeared to be a certainty only weeks ago seems to have stalled. Relations between the countries have hit a setback and the risk of a prolonged standoff has grown. While volatility could persist across global markets in the near term, we remain focused on companies that we believe will benefit from powerful overarching themes in emerging markets. Over a market cycle, we think alpha generation and risk mitigation can be achieved by careful management of country risk.

Country event Portfolio action

U.S.-China relations: The souring relationship is likely to be a negative for China with widespread implications across the globe. It may be somewhat offset by fiscal/monetary stimulus and China’s growth-oriented regulatory environment.

Some industries are more sensitive to trade and the value chain disruptions than others. We began trimming/selling trade-sensitive companies late last year and have continued to take action in an effort to mitigate the growing risks with the situation in China. However, we remain positive that companies within certain themes in China will continue to grow: education, ecommerce, the internet, financial inclusion, health care and others.

India election results: Narendra Modi and his political party, the BJP, won by an overwhelming majority.

We think the election outcome is a significant positive factor for India’s economy and for selected industries that may benefit from the increased infrastructure spending and the likely continued structural reforms. The Fund holds companies that we believe can benefit from increased investment spending and better consumer confidence.

Brazil reforms: Under new President Jair Bolsonaro, Brazil is making steady progress on economic issues.

We have maintained an overweight allocation to Brazil, as we expect its congress and new administration to help the economy achieve long-term structural advancements.

 

Despite near-term concerns and likely volatility across the global equity market, we remain optimistic that long-term fundamentals in emerging markets will offer opportunities via several overarching secular themes. For example, many emerging markets are in the early stages of economic development. Favorable demographics, increasing incomes and improving financial markets can make them attractive for trends related to consumption, productivity growth and innovation. The emerging world in particular offers many high-quality companies that are driving innovation both at home and in global markets.

In addition to long-term drivers, there are other factors that we believe will provide emerging markets with positive support during the current turbulent times:

  • Dovish policy from the U.S. Federal Reserve removes one of the headwinds that emerging market currencies faced in 2018.
  • Many emerging market nations are likely to continue to grow gross domestic product at a healthy pace, despite global growth deceleration. We consider this to be a foundation for wealth creation and the middle class consumption growth that underlies many of the potential investment opportunities.
  • While visibility into future earning is foggy, we think the emerging markets offer better value relative to the U.S. Because the effects of the tax cuts and one-time benefits that accelerated U.S. corporate earnings in 2018 have passed, we believe emerging markets now offer a more favorable risk/reward profile.

An active approach to countries, sectors

We believe the inefficient nature of emerging markets provides the opportunity for the Fund to outperform relative to its benchmark index. Our investment philosophy guides our actions:

  • Top-down analysis of macroeconomic drivers and managing country allocations can be crucial components of alpha generation and risk mitigation when investing in emerging markets equities.
  • Themes, both secular and cyclical, can be more powerful in emerging markets because many of these countries are in the early stages of economic development.
  • Fundamental research is a key element of the process and focuses on finding companies with the potential for earnings growth, attractive relative valuations and perceived quality in areas including corporate governance, strength of their balance sheets and competitive positioning.
  • Investing across the valuation spectrum in both growth and value styles allows the Fund to capitalize on the inefficiencies of emerging market equities, depending on the market cycle.

An analysis of key country allocations in the fund

Country Fund Index Ivy Analysis

China
(including Hong Kong)

30.13%

30.84%

With a prolonged trade war now becoming a likely scenario, we expect China to continue easing its regulatory, monetary and fiscal policies. We think such moves will support its economy. We already see early measures that are benefitting the private sector, personal consumption and infrastructure spending, and we think more actions along these lines are likely. In addition, China has changed its policy priorities from “deleveraging and risk management” to “growth and stability.” It also announced a number of policy changes focused on infrastructure spending, increased access to credit for the private sector, tax cuts and fewer regulations on a variety of industries. China’s markets outperformed all other major indices in first-quarter 2019.

Brazil

16.16%

7.60%

After a record-setting recession, Brazil is in the early stages of a recovery. We think valuations there remain attractive and we believe interest rates will stay low because inflation is under control. We are now seeing evidence the election of Jair Bolsonaro as president will support economic growth. His proreform cabinet has been approved and is seeking to fix the country’s fiscal imbalances by addressing pension reform, which may be met with pushback, but remains necessary. We think that effort will be matched by the privatization of state-owned companies and auctions of infrastructure and selected energy acreage.

India

13.76%

9.53%

We believe India adds an attractive risk profile to the Fund because it is relatively immune to the trade-related headwinds elsewhere in Asia. We continue to find what we believe are attractive secular growth stories in financial services, energy and the consumer space. Prime Minister Narendra Modi has defended his incumbency after taking the country through tough reforms such as demonetization and a goods and services tax. We think the return of a Modi government is positive for India because the country can continue the reforms he laid out in his first term.

Russia

8.20%

3.99%

This remains the cheapest market globally, with what we consider attractive companies at attractive valuations. We think Russia has good standalone fundamentals, such as the current and fiscal accounts as well as its foreign exchange reserves. But the fear of sanctions from the U.S. keeps the country’s risk premium high and valuations low.

As a percent of the Fund’s equity assets as of 05/31/2019 vs. MSCI Emerging Markets Index. Allocations are subject to change and are not intended to represent any past or future investment recommendations.


Ivy Live Replay - Active allocation: A world of ideas

Our Ivy Live panelists discuss the evolving investment landscape, including the recent U.S.-China trade escalation, and ideas to help guide allocation decisions.

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The MSCI Emerging Markets Index is an unmanaged index comprised of securities that represent large- and mid-capitalization companies within emerging market countries. It is not possible to invest directly in an index.

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

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/ dealers.

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Article Related Management: 

Jonas M. Krumplys, CFA
Aditya Kapoor

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Active allocation: A world of ideas

Article Short Summary: 

The risks of a prolonged U.S.-China trade standoff have increased, but we believe long-term fundamentals in emerging markets will offer opportunities.

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Story Highlights: 

- The risks of a prolonged U.S.-China trade standoff have increased. However, we remain optimistic that long-term fundamentals in emerging markets will offer opportunities.
- Over a market cycle, we think alpha generation and risk mitigation can be achieved by careful management of country risk.
- We think emerging markets generally offer better value relative to developed markets, with parts of China, Brazil, India and Russia being particularly attractive.

Expiration Date: 

Monday, December 16, 2019 - 01:30

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Industry veteran Dan Hanson named Chief Investment Officer

Waddell & Reed Financial, Inc. (NYSE: WDR), parent company of Ivy Investment Management Company, named Daniel P. Hanson, CFA, as Chief Investment Officer, filling a key role with a versatile industry veteran and prominent environmental, social and governance (ESG) investor as the firm continues to position itself for future organic and inorganic growth.

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Press Releases

Trade tumult: What's next for U.S.-China trade?

After weeks of build up about a possible trade deal between the U.S. and China this month, negotiations have come to a screeching halt. Trade representatives from both sides have accused the other of unfair practices or reneging on parts of the agreement framework. In response, President Donald Trump increased existing tariffs on $200 billion of Chinese goods from 10% to 25% effective May 10, as well as threatened to place tariffs on all remaining products from China, an estimated $250-$300 billion in goods. China retaliated with the announcement it would raise tariffs on $60 billion in U.S. goods, beginning in June.

As the world’s two largest economies struggle to come to an agreement, there are growing fears that the dispute could escalate. Equity markets sent a clear message to that effect on May 13 with a massive sell off across most indexes in the U.S. and around the world.

Derek Hamilton, global economist with Ivy Investment Management Company, says it’s in the best interests of both the U.S. and China to come to an agreement, but the possibility of a recession intensifies if a stalemate lingers late into the second half of 2019.

“The cost of the increased tariffs on U.S. gross domestic product growth would likely be a couple of tenths of a percent, which the U.S. economy could absorb,” says Hamilton. ”However, the impact to business confidence could be more profound, as capital expenditure plans could wane. Another consideration is the latest proposed tariffs are on goods that are almost all consumer-facing, and companies are likely to pass the cost of the tariffs directly to consumers.”

A hit to consumption at the same time as a decline in business confidence would escalate the risk of a U.S. recession, Hamilton says.

So what’s next? The fluidity of this situation creates ongoing market uncertainty, but Hamilton says Ivy’s base case scenario has not changed. He still expects a trade deal by midyear with a recovery in the global economy in the second half of the year.

“We believe it's going to be rocky for a couple of months, but a deal between U.S. and China could happen sometime in the summer,” he says.


Risks vs. Reality: Are the markets out of step?


Brexit, trade wars and geopolitical intrigue dominate the headlines. Check out this highlight from the recent Ivy Live to hear our take.

Get the full perspective


Past performance is not a guarantee of future results. Investment return and principal value will fluctuate, and it is possible to lose money by investing.

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

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Derek Hamilton

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China still seeks growth while navigating new challenges

Article Short Summary: 

Trade talks between the U.S. and China have stalled. Ivy believes a near-term deal is still in the cards, but a prolonged stalemate heightens the possibility of recession.

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– Trade negotiations between the U.S. and China have come to a halt
– The U.S. and China have increased tariffs on each other's goods
– Ivy believes a near-term deal, while challenging, can still be reached
– However, a prolonged stalemate would devastate the global economy

Expiration Date: 

Saturday, November 16, 2019 - 01:00

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Active allocation: A world of ideas

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Global equity markets regained the ground lost in late 2018, with economic stimulus in China fueling emerging market performance and a newly dovish Fed boosting U.S. equities. Where might the markets go from here? We’ll explore the investment landscape and ideas to guide allocation decisions.

SPEAKERS

Jonas Krumplys, CFA
Portfolio Manager
Ivy Investment Management Company
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Jeff Surles, CFA
Portfolio Manager
Ivy Investment Management Company
View Full Bio

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Article Short Summary: 

Global equity markets regained the ground lost in late 2018, with economic stimulus in China fueling emerging market performance and a newly dovish Fed boosting U.S. equities. Where might the markets go from here? We’ll explore the investment landscape and ideas to guide allocation decisions.

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Saturday, November 16, 2019 - 01:45

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An investor account may only be opened through a registered financial advisor. Once established, your account offers a variety of services designed to simplify the management of your investments. Of course, your financial advisor is your best resource to advise you on account activity and help to ensure that your

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