Applying a risk-aware process in a volatile market

Ivy Asset Strategy Fund

The Ivy Asset Strategy Fund seeks to generate global equity-like returns by blending Ivy’s best ideas in global equities and global credit with other, less correlated assets to mitigate volatility and downside risk. Our goal is to provide a Sharpe ratio superior to that of the MSCI All Country World Index (ACWI) over a full market cycle.

Asset allocation funds come in a variety of shapes and sizes. Many are constructed as fund-of-funds, some rely on exchange traded funds (ETFs) to introduce desired exposures, while others combine the work of disparate fund managers who are focused primarily on their own individual strategies.

Our Fund is built asset by asset, security by security. We draw upon Ivy’s research analysts covering global equities and credit securities to feature what we view as their best ideas. We combine these ideas and seek to exploit relative return opportunities while mitigating overall risk. We then interlace securities with lower expected returns – historically U.S. Treasuries, gold, and high-grade corporate bonds and loans – to seek to further dampen portfolio volatility and help manage downside risk. We do this with the overall goal of providing returns equivalent to the MSCI ACWI with a risk profile that has 70-90% of the expected volatility of the index.

Using a "risk budget"

We utilize a variety of tools to monitor and manage risk, limiting the Fund to 90% of the expected volatility of the ACWI while maintaining a level of at least 70%. We call this our “risk budget” and it guides us in portfolio construction. For example, it allows us to shift from equities to high yield credit when we find what we believe are better opportunities, but also prompts us to search particular industries or geographies that may help offset existing risk exposures.

In addition, we use tools to assess the Fund’s exposure to various downside scenarios, which may help sharpen our desired asset, sector or duration exposure. As of late September, we are near the midpoint of the risk budget, or around 80% of the expected volatility of the ACWI. We have slightly more than 70% of the Fund invested in equity securities and about 18% in various forms of credit, with the balance in Treasuries, gold and short-term securities.

We can make adjustments to adhere to the risk budget in multiple ways. For example, we can adjust the weighting to equities, increase or decrease the risk of the equity sleeve or buy diversifying assets with different diversifying traits. We recently took the risk budget from the upper end of the 70-90% range to about 80% by decreasing the Fund’s equity weighting, reducing the risk of the equity portfolio and buying diversifying assets with negative correlations to the equity portfolio.

Current portfolio positioning

Global equities can comprise between 50% and 80% of the Fund. We invest across developed markets as well as emerging markets that we believe have sufficient opportunity and liquidity. We apply the same criteria of security selection to investments anywhere in the world:

  • Find companies with a defensible, and perhaps expandable, competitive position in attractive categories and end markets
  • Our internal estimates for earnings, cash flow, and return on capital over the next 2-3 years significantly exceed published street estimates and/or
  • The stock’s valuation suggests the market expects fundamental deterioration, where we disagree
  • We persistently compare valuations across geographies, sectors, and styles

The current equity portfolio is technology heavy. We are overweight technology versus the benchmark index not because we are making a sector call but because it happens to be where our research process is finding companies we believe have defensible and expanding competitive advantages that are not reflected in consensus estimates.

The diversifying sleeve is designed to provide a medium for attractive returns outside equities in an effort to help dampen portfolio risk. Securities in the diversifying sleeve can be bought for attractive relative return potential, diversifying traits or a combination of the two.

The asset classes we will use to diversify risk include Treasuries (including Treasury Inflation Protected Securities, which are designed to protect investors from inflation), high yield credit, emerging market sovereigns and credit, investment grade bonds, loans, gold and potentially other commodities via total return swaps. These securities can aid in risk management, and help with potential downside capture and to limit volatility from specific economic environments that traditionally have been unkind to global equities and credit. Uses include:

  • To help mitigate risks inherent in the equity and credit segments of the portfolio (such as interest rate sensitivity);
  • To help manage the risk of an unexpected inflationary period;
  • To help limit the impact of an unexpected global recession and potential deflationary period;
  • To help reduce the overall level of expected volatility.

The diversifying sleeve is currently exposed to both the floating rate loan market and subordinated bank debt market with coupons that have fixed-to-floating-rate optionality. This exposure serves two purposes. It can help manage the impact of higher interest rates, which could affect equity markets. In addition, we know our current equity portfolio construction has a fair amount of exposure to interest rate factors. The floating rate securities – or optionality to floating rate securities, in the case of subordinated bank debt – allow us to naturally diversify a factor exposure that exists in our equity portfolio while using our credit team to pick individual loans and bank debt securities that we believe have attractive relative return profiles.

This is an example of how we diversify and manage the portfolio at the individual security level, rather than just looking at the profile of broader asset classes.

Beyond the bank loans, our current portfolio construction uses Ivy’s credit teams to pick higher yielding securities which provide attractive relative returns as well as some Treasuries and gold to dampen overall portfolio volatility.

Key issues going forward

We are wrestling with the outperformance of U.S. equity markets at the expense of other developed markets and especially the emerging markets. That conundrum has been exacerbated and prolonged by the trade policy stance of the Trump administration. Predicting the administration’s tactics – and even its overall aims – has proven difficult and we have no edge there. However, as valuations outside of the U.S. grow in relative attractiveness, we are likely to begin to shift exposure to those areas as we find opportunities.

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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.

Diversification cannot guarantee a profit or protect against loss in a declining market. Sharpe ratio is a method to examine the performance of an investment by adjusting for its risk.

The MSCI ACWI Index captures large- and mid-capitalization equities in 23 developed market countries and 24 emerging market countries and covers approximately 85% of global equities. 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. The Fund may allocate its assets among different asset classes of varying correlation around the globe. The Fund’s equity wleeve typically holds a limited number of stocks (generally 50 to 70). As a result, the appreciation or depreciation of any one security held by the Fund may have a greater impact on the Fund’s NAV than it would if it invested in a larger number of securities. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. The Fund’s diversifying sleeve includes fixed-income securities, that 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. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. The Fund may seek to hedge market risk via the use of derivative instruments. Such investments involve additional risks. Investing in commodities is generally considered speculative because of the significant potential for investment loss due to cyclical economic conditions, sudden political events, and adverse international monetary policies. Markets for commodities are likely to be volatile and the Fund may pay more to store and accurately value its commodity holdings than it does with the Fund’s other holdings. 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.