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

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Brexit, trade wars and geopolitical intrigue dominate the headlines. Yet, U.S. business confidence remains high while stocks continue to climb and P/E levels suggest less global risk. We explore this Goldilocks scenario to determine investment opportunities, as well as bears to avoid.

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Derek Hamilton
Global Economist
Ivy Investment Management Company
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Jonas Krumplys, CFA
Portfolio Manager
Ivy Investment Management Company
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Sarah Ross, CFA
Portfolio Manager
Ivy Investment Management Company
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Brexit, trade wars and geopolitical intrigue dominate the headlines. Yet, U.S. business confidence remains high while stocks continue to climb and P/E levels suggest less global risk. We explore this Goldilocks scenario to determine investment opportunities, as well as bears to avoid.

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Q2 Outlook<br> Global economy is slow out of the gates

Activity in segments of the global economy moderated throughout the first quarter of 2019 as policy risks and decelerating trade continued to hamper growth. The overall sluggish pace of economic expansion, particularly in the eurozone, has led us to recast our global growth forecast. However, we believe headway on a number of key issues could lead to a rebound later this year.

U.S. steady in slowing global economy

We have revised our global gross domestic product (GDP) growth forecast to 3.3%, down slightly from our outlook as the year began. While we project U.S. growth around 2.5%, the waning effect of tax cuts and fiscal stimulus, the trade dispute between the U.S. and China and tighter monetary policy by the Federal Reserve (Fed) continues to weigh on economic activity.

The ongoing trade standoff between the world’s two largest economies has been a drain on both and each wants a resolution. We believe a new trade agreement between the U.S. and China will be announced in the next few months, especially as President Donald Trump eyes reelection next year.

The Fed indicated it will likely leave rates unchanged this year because of weaker global growth and tepid inflationary pressure. In a surprising move, Fed Chairman Jerome Powell also announced plans to halt the Fed’s program of reducing bonds and mortgage-backed securities holdings on its balance sheet in September. These actions could help minimize a more meaningful slowing in U.S. economic growth.

The yield curve has continued to flatten in the U.S., with portions of the curve already slightly inverted. While an inversion in the yield curve has been a precursor to every modern-era recession, this is just one indicator of economic trajectory. We do not see a downturn in the U.S. economy on the horizon.

Eurozone GDP performance has been surprisingly poor so far in 2019, although it already had been weakened by the general slowdown in global growth and ongoing trade burdens. A number of local issues, including the lack of a plan for the U.K. to leave the European Union (EU), growing unrest in France over fuel taxes and rising prices generally, and the lagging effects of government mandates on automobiles in Germany have stymied growth in the region. The European Central Bank’s (ECB) response to this weakness has been to delay its plans to raise interest rates from the third quarter of 2019 to early 2020 and to add a new round of liquidity to the banking system. The lackluster economic performance in the first quarter prompted us to downgrade our 2019 eurozone GDP forecast to 1.2%.

Global growth continues at a sluggish pace
Chart Showing Global growth continues at a sluggish pace

Source: Ivy Investments. Chart shows Ivy 2018, 2019 forecasts of annual gross domestic product growth, all based on purchasing power parity. Past performance is not a guarantee of future results. The gross domestic product growth forecasts are current through April 2019, and subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.

When — and how — will Brexit end?

Nearly three years after the U.K.’s initial referendum, Brexit has become a political quagmire and a drag on its economy. The U.K. Parliament through early April had failed to pass a withdrawal agreement despite three attempts, leaving an already wounded Prime Minister Theresa May in further political limbo as momentum to reevaluate the “divorce” has grown.

While we continue to believe the U.K. will ultimately leave the EU with agreements that keep the two somewhat connected on key issues, the possibility of a “hard Brexit” — where the U.K. leaves the EU without a deal to clarify trade, its status with the Republic of Ireland and other issues — cannot be ruled out. Parliament’s failure to pass any Brexit legislation suggests the odds of calls for early elections have increased. We believe the thought of a change in government — especially one led by Jeremy Corbyn, the far-left leader of the Labour Party — and the increasing likelihood that the departure deadline could be significantly extended is likely to send jitters through the markets.

In our view, it is highly likely that the U.K. will fall into recession if a hard Brexit becomes reality. Such a result could send negative repercussions throughout the EU.

Emerging markets poised for a rebound

After battling through multiple headwinds in 2018 that spilled over into the first quarter of this year, emerging markets appear ripe for improvement. Along with its trade turmoil with the U.S., China has felt pressures from its decision to reduce the pace of debt accumulation in the economy. The deceleration in economic growth has caused the government to introduce fiscal stimulus, including infrastructure spending, tax cuts and stronger credit growth.

In addition, China’s property market recently has shown signs of weakness, but cities continue to move away from purchase restrictions, which we think will limit downside risks in the sector. We continue to believe that looser policy and the potential for a trade deal with the U.S. could result in stronger economic growth in China in the second half of 2019.

In India, the central bank recently reduced interest rates in response to slower growth. The upcoming presidential election will determine whether the coalition government of Prime Minister Narendra Modi can earn another term, which we believe could be a key factor in India’s long-term growth potential.

Following a record-setting recession, Brazil is showing signs of recovery as markets have strengthened in anticipation of pension reform, one of several fiscal reforms championed by new president, Jair Bolsonaro. While the legislation still faces an uphill battle to gain lawmakers’ approval, we believe pension reform could be passed sometime later this year.

Currency markets looking upward

Currency markets were mixed in the first quarter, with the U.S. dollar modestly stronger on average. The dollar’s strength came despite the Fed’s revised position on rate hikes for the remainder of 2019. While a lack of support from higher interest rates might normally be expected to undermine the dollar, the focus in currencies has shifted from interest rates to worries about global growth. That change has benefited the dollar as it tends to appreciate during times of uncertainty.

However, we expect the dollar to weaken marginally as global growth picks up throughout the year. Among developed market currencies, the pound shows potential for appreciation, assuming a Brexit accord is agreed upon in the very near term. The euro also could appreciate as growth in the eurozone begins to rebound.

The Fed’s more dovish stance on rate hikes and a weakening U.S. dollar could bode well for some emerging market currencies. We anticipate any trade agreement between the U.S. and China will include language prohibiting currency manipulation, stabilizing the yuan versus the dollar in the near term. However, we believe an uptick in economic growth in places like China and Europe will be necessary before there are any meaningful currency rallies among other emerging markets.


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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Risk factors: Investment return and principal value will fluctuate, and it is possible to lose money by investing. 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 a fixed income security 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. Investments in real estate may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. Debt securities, like mortgage-backed securities and asset-backed securities, are subject to additional risks due to their exposure to interest rate risk. Changes in interest rates can cause the value of these securities to be more volatile than other fixed-income securities and may magnify the effect of the rate increase on the price of such securities.

Past performance is not a guarantee of future results. 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 current through April 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.

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The global economy was sluggish through the first quarter of 2019. Get Ivy's view on key issues that have slowed growth and the possibility of a rebound later in the year.

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- U.S. steady in slowing global economy
- When – and how – will Brexit end?
- Emerging markets poised for a rebound
- Currency markets looking upward

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Moving to a defensive position for uncertain times

A combination of asset classes may offer lower volatility — a concern for many investors today. The Fund’s sleeve structure allows us to blend three complementary fixed-income strategies while adjusting allocations as needed, based on market conditions and our outlook. In the current environment, that means taking a more defensive position.

We think low interest rates are likely to continue in the foreseeable future, based on the “dovish” policies of major central banks, slower economic growth worldwide and a market dealing with uncertainty about a wide range of issues:

  • Central bank policy: Both the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) have turned to more accommodative interest rate policies in the last three months. Europe’s loss of economic momentum was a key factor for the ECB, which cut its 2019 eurozone economic growth forecast to an annual rate of 1.1% from 1.7%. We do not expect the ECB to raise interest rates until at least March 2020. The ECB committed to providing liquidity to credit markets until 2023 through its targeted longer-term refinancing operations (TLTRO), which is a source of funding for European financial institutions. We believe Fed and ECB policies reflect the global economy, including an expectation that the U.S. is in the later stages of an economic cycle.
  • Slower global growth: Market participants widely are forecasting slower global economic growth in 2019; Ivy estimates the global growth rate this year at 3.4%.
  • Trade dispute: China’s slowing economy and the U.S.-China trade war have raised many concerns about the direction of the world’s no. 2 economy. While there is no resolution yet to the trade dispute, we think a deal ultimately could add economic stimulus, help growth inside and outside both countries, and boost business and consumer confidence. In our view, a deal thus could help prolong the current cycle.
  • Direction of dollar: The strong U.S. dollar was a global market factor in 2018. The Fed’s prediction of no rate hikes in 2019 and one in 2020 will likely cause the dollar to weaken against high yielding emerging market currencies as investors search for yield continues. Lacking a major change in global growth, the dollar should be range bound against developed currencies ( euro, yen and pound) as these countries deal with their own idiosyncratic issues.
  • North Korea: There is concern that the U.S. is losing traction on any agreement to eliminate nuclear weapons.
  • Political uncertainty: Distractions already are developing as we face the 2020 U.S. election campaigns. In addition to the presidential election, there will be voting on all 435 seats in the House of Representatives, 34 of the 100 Senate seats and a wide range of state and local elections.

Against this backdrop, credit spreads have been somewhat volatile but remain compressed. We believe the more dovish Fed — compared with its position at the beginning of 2018 — will keep a lid on credit spreads, and we think the high income sector offers value in certain sectors.

We have chosen to position the Fund defensively in this environment and in general are seeking to move to higher quality securities and longer duration overall.

Philosophy and process

Unlike single-sector funds, the Fund seeks to capture the return opportunities and risk mitigation potential of a diversified mix of fixed-income securities. It invests across a range of factors, including credit, liquidity and complexity, and combines sleeves of three fixed-income strategies.

We believe a portfolio that spans the fixed-income credit spectrum can offer higher return potential from high-yield, high-risk bonds and non-traditional credit vehicles, while using highly rated investment-grade bonds to provide fund liquidity. Flexible sleeve allocations allow for adjustments based on market conditions and our outlook, potentially creating an opportunity to mitigate risk exposure, volatility and overall Fund duration.

The Fund’s stated objective is to seek to provide a high level of current income, with capital appreciation a secondary objective. While income is not guaranteed, the Fund has continued to capture a competitive yield for shareholders. We consider it a defensive fund and have positioned it for an uncertain economic environment.

A closer look at each sleeve

Strategy Sleeve Allocation Allocation at 02/28/2019

Global Bond

Flexible  10–70%

47.5%

High Income

Flexible  10–70%

32.5%

Total Return

Target   20%

20.0%

  • Global bond strategy: Decisions are based on factors including fundamental global themes, such as country analysis, issuer analysis, including domicile, performance and credit history across economic cycles; and issue analysis, including maturity, quality and denomination. We invest primarily in a diversified portfolio of bonds of foreign and U.S. issuers.
  • High income strategy: We focus on bottom-up credit work to find companies we think can outperform throughout a business cycle. We dig into the details of the business models, covenants and competitive advantages as part of our investment decision. While doing the bottom-up analysis, we don’t turn a blind eye to the business cycle or credit spreads, and want to be sure we can be compensated for the risks we take. We ypically hold names throughout the cycle, don’t want to rely on timing the big macro calls and tend to stay away from highly cyclical sectors.
  • Total return strategy: The Fund’s sub-adviser, Apollo Credit Management, manages this sleeve. It provides access to the full breadth of the credit markets, including some nontraditional credit securities. Such securities may not have been accessible to all investors in the past, especially within a mutual fund. Apollo can explore the market for nontraditional opportunities, partner with banks to lend money to smaller companies, or underwrite loans for a select entity — all as part of seeking to generate yield while keeping duration low. As with the other sleeves, it is a long-only strategy. The managers do not pursue derivativeoriented transactions.

Near-term outlook

We see some opportunity now among emerging markets and Brazil in particular, based on reform programs announced by the new presidential administration there. Conversely, Mexico’s new administration has raised some troubling issues that make it less attractive to us now. We also have an ongoing concern about the risk of potential sanctions on Russia and what that could mean for its debt.

In the U.S., we think slower economic growth is likely for the first half of 2019 and we expect the dollar to remain strong. We also do not expect the Fed to raise interest rates this year. However, U.S. economic growth still is above trend, with healthy real income growth and an elevated personal savings rate that we think can insulate against the negative wealth affect from the lower stock market late in 2018.

Labor markets continue to expand, which has kept consumer confidence near cycle highs and supported strong spending growth. But we think trade will continue to be a risk factor going forward. There is a potential for more tariffs followed by retaliatory action that could impact the capital investment plans of many companies. That raises the risk of what we would consider a negative feedback loop that could affect all markets and ultimately consumer confidence.


Late cycle factor risks


An increasingly volatile environment has raised questions about the stock market’s ability to sustain its historic bull run. Our Ivy Live panel shared their views on the subject.

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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.

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

Diversification cannot guarantee a profit or protect against loss in a declining market. It is a method to manage risk.

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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A combination of asset classes may offer lower volatility – a concern for many investors today. The Fund’s sleeve structure allows a blend of three fixed-income strategies.

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- We think low interest rates are likely to continue, based on the “dovish” policies of major central banks.
- In general, we are moving to higher quality securities and longer duration in the Fund.
- We consider it a defensive fund and have positioned it for an uncertain economic environment.

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Ivy Global Equity Income Fund

Market Sector Update

  • Equity market performance was largely positive during the quarter. Hopes for an improved global trade environment, along with increased confidence around favorable monetary policy, offset deteriorating hard economic data. Hard data has softened progressively over the course of the year as the impact of tariffs and other aspects of the U.S.-China trade war have taken a toll on growth. Additionally, the uncertainty around the short- and long-term implications of a new long-term global trade paradigm appear to be causing marginal weakening in hiring and spending.
  • Markets have been propped up to some degree by the prospects for an aggressive monetary response to weakening conditions, with both the U.S. Federal Reserve (Fed) and European Central Bank making sharp shifts toward much more accommodative policies in response to the aforementioned slowdown. Against this tailwind, the outlook on trade resolution was less favorable for most of the quarter. Markets gave back roughly half of their year-to-date gains during the month of May as the outlook for some sort of trade agreement worsened. However, the quarter finished on a strong note as positive news with respect to a freeze on additional tariffs and progress on other areas emerged from the G20 Summit in Japan.
  • From a sector perspective, performance was mixed regarding pro-cyclical and stable sectors. Within the Fund’s benchmark, financial stocks were the strongest performers, with insurance companies being the most positive driver of performance in the sector. Industrials also outperformed on prospects for improved activity. Utilities were a strong performer, as was communication services, which was driven by the media components of this sector rather than the telecom constituents. Health care and real estate underperformed, as did energy on weak crude price dynamics.

Portfolio Strategy

  • The Fund posted positive performance and performed in line with its benchmark for the quarter. Stock selection during the period was favorable, while sector allocation was a drag on relative performance. Geographic allocation was a positive relative contributor to performance, while currency positioning (a by-product of stock selection and sector/country decisions) was a drag on relative performance.
  • Regarding sector allocation, the Fund’s underweight position in real estate was the largest positive relative contributor to performance. The Fund’s overweight allocation to energy and health care, as well as being underweight financial services were negative relative return drivers.
  • Stock selection in industrials, health care, consumer staples, materials and energy all contributed favorably to relative performance. Stock selection in communication services and information technology were both relative return headwinds. Lockheed Martin Corp., Wal-Mart Stores, Inc., Citigroup, Inc., LVMH Moet Hennessy – Louis Vuitton and Nestle S.A. were the most significant individual contributors to relative performance. Intel Corp., British American Tobacco plc, Philip Morris International, Inc., Taiwan Semiconductor Manufacturing Co. Ltd. and CNOOC Ltd. were the largest individual negatives with respect to relative performance.
  • From a geographic allocation perspective, the Fund’s underweight position in Japan, along with favorable stock selection, more than offset the impact of being underweight the yen. The Fund’s overweight position in Europe, along with positive stock selection in that region helped relative performance. Stock selection in North America was a solid positive contributor to results, while stock selection in Asia ex Japan was a drag to relative performance.
  • Our investment approach remains steadfastly focused on investing in perceived high-quality businesses with favorable near and intermediate fundamentals, generally rising dividends and attractive valuations. This approach is consistent across sectors and regions. The core of our approach is based on stock selection as the key driver of portfolio inclusion and construction.
  • Global growth has moderated due to trade concerns, as well as normalization of certain aspects of fiscal and monetary policy. One of the most noteworthy aspects of market performance over the past several quarters has been the violent risk-on/risk-off episodes that have occurred. We have attempted to take advantage of these episodes by adding to or establishing positions in companies that fit our key investment criteria when we believe those shares are reflecting excessive company-specific pessimism or overblown macro fears. We are particularly focused on businesses that we believe can deliver reasonable results in a slowing environment. From a broader portfolio construction point of view, we believe it as a bit of a fool’s errand to shift portfolio positioning in response to the latest tweets or headlines on trade or the latest perturbations with respect to monetary policy. This has been our view for several quarters and remains our view at present.

Outlook

  • Global growth has clearly slowed over the past several quarters, in part due to trade uncertainty but also due to a return to trend from artificial stimulus (the U.S. in particular). This slowdown has been felt most sharply in Asia and Europe, while economic expansion in the U.S. has been slightly more resilient. Despite this softness, optimism about improving trade relations abounds after a truce was reached between President Donald Trump and Chinese President Xi Jinping at the G20 Summit in June. In our view, this optimism is reflected not only in stock prices but also in corporate guidance and forward earnings estimates. This quality is most pronounced in the U.S., and less so in Europe, Japan and Asia.
  • Directionally, this sense of relief may be correct, though much work remains before there is an end to current trade hostilities. Additionally, if a deal is reached it is not entirely clear this event would be sufficient to drive a reacceleration of growth needed to meet earnings expectations and support current valuations.
  • Our low-conviction, base view is that progress will be made, and a period of stability is likely to follow. In this case, we find some of the most intriguing opportunities to be outside the U.S. at present, given current expectations, coupled with current valuation differentials.

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.

Top 10 equity holdings as a percent of net assets as of 06/30/2019: Royal Dutch Shell plc, Class A 4.1%, Lockheed Martin Corp. 3.5%, Nestle S.A., Registered Shares 3.4%, Pfizer, Inc., 3.3%, Taiwan Semiconductor Manufacturing Co. Ltd. 3.3%, Total S.A. 3.3%, AstraZeneca plc 2.8%, Citigroup, Inc. 2.8%, Samsung Electronics Co. Ltd. 2.8% and Tokio Marine Holdings, Inc. 2.8%.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Dividend-paying investments may not experience the same price appreciation as non-dividend paying instruments. Dividend-paying companies may choose to not pay a dividend or the dividend may be less than expected.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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Christopher J. Parker

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Ivy Focused Value NextShares

Market Sector Update

  • The end of 2018 saw the return of stock volatility as equity markets took a sharp late year fall. This pullback, however, was followed immediately by a back and forth recovery to start 2019.
  • The stocks that led the decline in December were the first to recover in January, providing a painful sting to investors who decided the selloff was a signal to position portfolios more defensively. Following a complacent 2017, large market swings have returned and have elevated fear amongst investors. Global growth has appeared to slow, and the Federal Reserve (Fed) has taken notice, halting further interest rate hikes for 2019.

Portfolio Strategy

  • The Fund had a positive single-digit absolute return but underperformed the Russell 1000 Value Index (its benchmark) during the quarter, primarily due to individual stock selection.
  • As a concentrated Fund, it exhibits higher volatility in returns over the short term, in pursuit of longer-term gains. The Fund also paid a quarterly dividend of 20 cents per share, which is a 3.96% annual dividend yield based on its quarterend net asset value of $20.18.
  • Weakness in a varied selection of areas hurt overall performance. CVS Health Corp., the America’s largest drugstore chain, completed the acquisition of Aetna, and lowered its earnings outlook. Initial guidance after a merger is always risky, but we believe when the dust settles this stock could be notably higher and continue to hold. AbbVie stock performance fell during the quarter as investors continued to worry over whether or not, Humira, the company’s biggest selling drug, was going generic. We think the company’s pipeline of new drugs will provide a positive surprise. PBF Energy, Inc., an oil refiner, also hampered performance. On the positive side, The Chemours Company, a chemical company, rallied, followed closely by Synchrony Financial.
  • We focus primarily on stock selection and avoid making sector calls. We overweight or underweight sectors based on individual stock opportunity, with some limits to control risk or volatility. We are overweight financials, consumer discretionary and materials, where we find both 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 (the cash a company generates after cash outflows to support operations and maintain its capital assets), and low stock prices relative to our estimation of each company’s true intrinsic value.
  • The Fund is underweight consumer staples, industrials and utilities. We simply do not find many attractive investments in these sectors at this time although we are constantly on the lookout for opportunities.

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. We believe the recent economic data supports the idea of a slowing economy early in the year but a re-acceleration later. The Fed has indicated a pause in interest rate hikes, and many wonder if it is not just a pause, but a cessation. Other macro events to watch are the trade negotiations with China, the lapping of last year’s tax cut, job creation and inflation. We a cautiously optimistic that the Fed has done a good job with raising rates and believe the risk of a near-term recession is low.
  • We think recent economic data supports the idea of a slowing economy but does not yet support the concept of a shrinking economy (recession). The current challenge will be for the Fed to tighten money policy back up, yet not slow the economy into contraction. The recent pause in interest rate hikes for 2019 indicates it is not an easy task – slowing the economy and inflation via rate hikes is a difficult job. We liken it to stepping on a rolling egg to stop it without breaking it. History shows a high probability of failure, if interest rates rise too much thus helping to create a recession. This is something we will watch carefully.

The opinions expressed are those of the Fund’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 March 31, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon. Past performance is not a guarantee of future results.

IVY000224 07/31/2019

Top 10 holdings (%) as of 03/31/2019: American Capital Agency Corp. 5.8, PBF Energy, Inc. 5.5, Phillips 66 5.1, Prudential Finanical, Inc. 5.0, MetLife, Inc. 4.9, Gilead Sciences, Inc. 4.2, Pfizer, Inc. 4.2, Gap, Inc. (The) 4.1, International Business Machines Corp. 4.1 and International Paper Co. 4.1.

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 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. 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. 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 Fund 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. 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.

Ivy Nextshares are a new type of fund. NextShares funds have a limited operating history and may not be available at all broker/dealers. There is no guarantee that an active trading market for NextShares funds will develop or be maintained, or that their listings will continue or remain unchanged.

About NextShares: Shares of NextShares funds are normally bought and sold in the secondary market through a broker, and may not be individually purchased or redeemed from the fund. In the secondary market, buyers and sellers transact with each other, rather than with the fund. NextShares funds issue and redeem shares only in specified creation unit quantities in transactions by or through Authorized Participants. In such transactions, a fund issues and redeems shares in exchange for the basket of securities, other instruments and/or cash that the fund specifies each business day. By transacting in kind, a NextShares fund can lower its trading costs and enhance fund tax efficiency by avoiding forced sales of securities to meet redemptions. Redemptions may be effected partially or entirely in cash when in-kind delivery is not practicable or deemed not in the best interests of shareholders. A fund’s basket is not intended to be representative of the fund’s current portfolio positions and may vary significantly from current positions. As exchange-traded securities, NextShares can operate with low transfer agency expenses by utilizing the same highly efficient share processing system as used for exchange-listed stocks and ETFs. Trading prices are linked to the NextShares next-computed NAV and will vary by a market-determined premium or discount, which may be zero; may be above, at or below NAV; and may vary significantly from anticipated levels. Purchase and sale prices will not be known until the NextShares NAV is determined at the end of the trading day. NextShares do not offer the opportunity to transact intraday based on current (versus end-of-day) determinations of a fund’s value. Limit orders can be used to control differences in trade prices versus NAV (cost of trade execution), but cannot be used to control or limit execution price. Buying and selling NextShares may require payment of brokerage commissions and expose transacting shareholders to other trading costs. Frequent trading may detract from realized investment returns. The return on a shareholder’s NextShares investment will be reduced if the shareholder sells shares at a greater discount or narrower premium to NAV than he or she acquired the shares.

NextSharesTM is a trademark of NextShares Solutions LLC. All rights reserved. Used with permission.

Ivy NextShares funds are managed by Ivy Investment Management Company and are distributed by ALPS Distributors, Inc.

ALPS Distributors, Inc., NextShares Solutions LLC, and Ivy Investment Management Company or Ivy Distributors, Inc. (or their affiliates) are all unaffiliated companies.

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Matthew Norris

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Quarterly Fund Commentary

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Ivy Focused Growth NextShares

Market Sector Update

  • It was a quarter of reversals. Equities performed strongly and reversed a significant portion of the losses realized during the prior quarter. Equities across all capitalization ranges and all styles had significant gains during first quarter 2019. Growth styles outperformed value styles while mid caps outperformed both small and large. The Russell 1000 Growth Index, the Fund’s benchmark, increased by approximately 16% in the quarter.
  • The Federal Reserve (Fed) was a big source of the optimism that developed during the quarter. Post what was perceived to be policy error during fourth quarter 2018, the Fed moved quickly to ease tightening financial conditions. Actions taken included stepping back from quantitative tightening (balance sheet reduction) and taking a more dovish position regarding future interest rate hikes.
  • In response to these actions from the Fed, yields across the yield curve (a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates) moved lower and the yield curve spread (10-year minus 2-year Treasuries) flattened slightly. Investors perceived the reduction in rates across the yield curve as helpful for solving the problem of tight financial conditions.
  • On the trade tariffs front, there was building hope during the quarter that China and the U.S. were on a path to agreement. Companies with high foreign sales exposure, those that experienced a difficult year in 2018, benefited from this more optimistic sentiment.
  • The net positive is that several of the most prominent worries during 2018 were mitigated during first quarter 2019, sending volatility lower and market multiples higher. Despite near-term earnings risk based on weak global growth, there were building expectations for an acceleration in earnings growth later in 2019.
  • In another reversal of fourth quarter 2018 performance, a period in which all sectors in the index ended in negative territory, first quarter 2019 closed with all sectors in positive territory, including strength in information technology and real estate and relative underperformance in financials and energy.
  • From a factor perspective, risk and quality outperformed during the quarter. Underperforming factors included value and pockets of momentum.

Portfolio Strategy

  • The Fund posted strong absolute double-digit returns, outperforming its benchmark during the period. Performance benefited from strong stock selection in industrials, consumer discretionary and communication services. An underweight position in consumer staples, along with an overweight position in information technology, also contributed to performance. The main offset was driven by stock selection in financials.
  • The industrials sector was a notable positive contributor to performance. Strong growth momentum from CoStar Group propelled the stocks in the sector higher and offset minimal negative impact from cyclical names, such as Caterpillar. Consumer discretionary benefited from stock selection with strength in V.F. Corp., bouncing from recent concern related to the sustainability of the company’s Vans shoe segment growth. The Fund also benefited from zero exposure to Tesla, which underperformed in the quarter. Communications services strength was driven by Electronic Arts, a video game developer that impressed markets with a surprise game launch during the quarter that was met with much enthusiasm. The portfolio also benefited from no exposure to The Walt Disney Company, a sizeable benchmark name that underperformed.
  • The strong positive relative drivers were offset by performance in financials. Specifically, CME Group was a significant detractor to performance as the gains realized in 2018 related to an increase in volatility partly reversed as volatility in the markets ebbed.

Outlook

  • We are cautious in returning to the narrative that the economy/equity markets will exit from the recent period of volatility and stress back on the same bull market trade as before. We are concerned economic conditions will remain tight and that a more cautious narrative is warranted and not currently being reflected. The Fed has stepped back from further tightening but the impact from past interest rate hikes will remain in the system. We believe investors must ask if the repositioning of the Fed policy is an attempt to further accelerate the economy or a response to increasing, latecycle risks to global growth.
  • We think the concerns around trade tariffs have also been swept away too quickly as investors have just moved to anticipation of a clear resolution. Several questions still linger and it is an unknown if a deal will bring full closure. We worry the uncertainty already created regarding global supply chains will be hard to unwind. Excesses appear to be difficult to find as consumer debt, manufacturing inventories, corporate debt coverage and excess business investment, just aren’t apparent this cycle. We think the implication could be a growth deceleration with no recession or a shallow recession looming on the horizon.
  • The Fund will remain tilted toward high quality, profitable growth as we believe the controversy regarding the growth outlook will remain, if not increase. In the current environment of sentiment swings between pro-growth and growth fears, it is important to stress risk management to avoid mistakes given the high failure rate of large-cap growth companies.

The opinions expressed are those of the Fund’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 March 31, 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon. Past performance is not a guarantee of future results.

IVY000223 07/31/2019

Top 10 holdings (%) as of 03/31/2019: Microsoft Corp. 8.4, Alphabet, Inc. 6.9, MasterCard, Inc. 6.1, PayPal, Inc. 5.5, Amazon.com, Inc. 5.4, Zoetis, Inc. 5.0, Adobe, Inc. 4.9, Visa, Inc. 4.6, Intuit, Inc. 4.5 and CoStar Group, 3.9.

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.

Co-portfolio Manager Daniel P. Becker, CFA, left the firm effective April 12, 2018.

Risk factors: The value of the Fund’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 Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.

Ivy Nextshares are a new type of fund. NextShares funds have a limited operating history and may not be available at all broker/dealers. There is no guarantee that an active trading market for NextShares funds will develop or be maintained, or that their listings will continue or remain unchanged.

About NextShares: Shares of NextShares funds are normally bought and sold in the secondary market through a broker, and may not be individually purchased or redeemed from the fund. In the secondary market, buyers and sellers transact with each other, rather than with the fund. NextShares funds issue and redeem shares only in specified creation unit quantities in transactions by or through Authorized Participants. In such transactions, a fund issues and redeems shares in exchange for the basket of securities, other instruments and/or cash that the fund specifies each business day. By transacting in kind, a NextShares fund can lower its trading costs and enhance fund tax efficiency by avoiding forced sales of securities to meet redemptions. Redemptions may be effected partially or entirely in cash when in-kind delivery is not practicable or deemed not in the best interests of shareholders. A fund’s basket is not intended to be representative of the fund’s current portfolio positions and may vary significantly from current positions. As exchange-traded securities, NextShares can operate with low transfer agency expenses by utilizing the same highly efficient share processing system as used for exchange-listed stocks and ETFs. Trading prices are linked to the NextShares next-computed NAV and will vary by a market-determined premium or discount, which may be zero; may be above, at or below NAV; and may vary significantly from anticipated levels. Purchase and sale prices will not be known until the NextShares NAV is determined at the end of the trading day. NextShares do not offer the opportunity to transact intraday based on current (versus end-of-day) determinations of a fund’s value. Limit orders can be used to control differences in trade prices versus NAV (cost of trade execution), but cannot be used to control or limit execution price. Buying and selling NextShares may require payment of brokerage commissions and expose transacting shareholders to other trading costs. Frequent trading may detract from realized investment returns. The return on a shareholder’s NextShares investment will be reduced if the shareholder sells shares at a greater discount or narrower premium to NAV than he or she acquired the shares.

NextSharesTM is a trademark of NextShares Solutions LLC. All rights reserved. Used with permission.

Ivy NextShares funds are managed by Ivy Investment Management Company and are distributed by ALPS Distributors, Inc.

ALPS Distributors, Inc., NextShares Solutions LLC, and Ivy Investment Management Company or Ivy Distributors, Inc. (or their affiliates) are all unaffiliated companies.

Category: 

Article Related Management: 

Bradley Klapmeyer

Article Type: 

Quarterly Fund Commentary

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