Our view: Current environment, key drives
Markets started 2018 on a good note and stock prices
continued to march higher through the first three quarters
of the year. Large-cap growth stocks also performed
particularly well. The Fund’s benchmark, the Russell
1000 Growth Index, returned over 17% during the same
timeframe. Performance was strongest for profitability,
momentum and earnings quality factors. Value and yieldoriented
factors like dividends and buybacks generally
underperformed. Even after the benchmark’s 15.9%
decline in fourth-quarter 2018, long-term growth investors
could have had a good run with cumulative returns for the
index topping 400% since March 2009.
As 2018 unfolded, the Fund’s portfolio decision-making
was influenced by several issues:
- We were deep in an interest rate hike cycle that appeared
likely to continue through the end of the year.
- Trade outcomes were becoming difficult to predict, but
history shows protectionism doesn’t typically end well
- Markets were likely to experience more price volatility
and correlation swings, characterized by what
we consider irrational selling, which occurred in
December 2018, and irrational buying, which occurred
in January 2019. We thought multiple compression
was more likely than further multiple expansion, given
increased volatility and controversy about the duration
of economic cycle.
Growth has outperformed value for more than 10 years
Source: Morningstar Direct. Cumulative returns of Russell 1000 Growth Index and Russell 1000 Value Index, Mar. 1, 2009 – Jan. 31, 2019, assuming reinvestment of dividends. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. The Russell 1000 Value Index is an unmanaged index comprised of securities that represent the large-cap value sector of the stock market. It is not possible to invest directly in an index. Index returns may not be indicative of the Fund’s returns. See the Fund’s standardized performance information. Past performance is no guarantee of future results.
Against this backdrop, our goal was to improve the overall
quality profile of the Fund. We are mindful of traditional
metrics like return on equity, return on assets, leverage
and margins, but also want to be aware of factor exposures
within the portfolio. Our stock selection boosted relative
performance during the year, and exposure to more
quality-oriented factors proved to be well-timed.
Portfolio adjustments in 2018, the move to higher quality
As the year progressed, notable adjustments were made to
the Fund’s portfolio in an effort to better prepare it for the
increase in volatility that occurred as the economy slowed.
Here are the highlights:
- We reduced the Fund’s relative overweight position in
information technology with the sale of two cyclical
technology names, Applied Materials and Lam Research.
- We reduced exposure to the financials sector as those
stocks appeared to be too highly correlated with changes
in the yield curve versus stock-specific drivers.
- We increased exposure in consumer discretionary, focusing
on strong consumer brands like Nike and Ulta Beauty
that we believe are positioned for more sustainable growth
regardless of the market environment, rather than sectorspecific
beta. (Beta is a measure of a stock’s volatility
relative to the overall market.)
- We increased exposure in health care, targeting multi-year
accelerating growth stories and companies that we believe
have strong open-ended growth opportunities.
- We decreased active beta factor exposure (relative to
the benchmark) and exposure to earnings quality and
- While the Fund’s growth exposure moderated, it
remained higher than the benchmark.
The Fund primarily uses a bottom-up strategy focusing on
companies we believe have dominant market positions and
established competitive advantages. These characteristics
can help to mitigate competition and lead to more sustainable
revenue and earnings growth. Over time, we want and expect
stock selection to be the primary driver of excess returns.
At the same time, we know all factor exposures cannot be
eliminated, and we work hard to ensure the factors expressed
in the portfolio are intentional.
Given our views that volatility was likely to increase and
growth would moderate over the coming quarters, we
improved the overall quality of the portfolio by owning
companies with better returns on equity and assets, higher
margins and lower leverage.
The charts below illustrate the Fund’s improvement in
quality over the past 12 months.
Fund's quality profileas of Dec. 31, 2018 (%)
Fund's quality profile — percentage point changeDec. 31, 2017 versus Dec. 31, 2018 (%)
Relative strength — Growth performance during periods of lower GDP
From a historical perspective, growth investors have tended
to fare well in periods of lower U.S. GDP growth. The chart
below illustrates historical relative performance for growth
versus value (as measured by the Russell 1000 Growth Index
and Russell 1000 Value Index) from Dec. 1978 to Dec. 2018.
When the line is ascending, growth is outperforming on a
relative basis versus value. When the line is descending,
value is outperforming.
As shown, three of the past four periods in which growth
stocks outperformed value stocks (denoted by solid oval),
the U.S. economy experienced GDP growth of less than 2%.
The remaining period of growth outperformance (denoted
by a dotted line oval) coincided with the Dot-com boom
and bust. This was the only period where growth
outperformed and GDP was greater than 2%.
Relative strength — Russell 1000 Growth Index versus Russell 1000 Value Index
Source: Morningstar. *Cumulative returns: Russell 1000 Growth Index ÷ Russell 1000 Value Index (number is positive if growth is outperforming; number is negative if value is outperforming). Past performance is no guarantee of future results.
Snapshot: Average annualized returns (%) — GDP, Russell 1000 Growth Index and Russell 1000 Value Index
||July 1979 — December 1980
||October 1988 — December 1991
||January 2006 — September 2018
Real GDP Growth
Russell 1000 Growth Index
Russell 1000 Value Index
Difference between indices
Chart sources: Morningstar, U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED (Federal Reserve Bank of St. Louis).
Past performance is no guarantee of future results.
Given the relative strength of growth-oriented stocks, some
have asked whether their outperformance over value could
continue in the coming. In our view, the answer is yes. We
believe the market becomes more discerning as cycles age
and sustainable growth is more difficult to find, ultimately
rewarding higher-quality businesses that can continue to
deliver durable revenue and earnings growth. Valuation
is always relevant, but we are willing to pay more for the
right combinations of growth and quality in later stages of
the market cycle. We think our continued focus on higherquality
businesses seems prudent.
We don’t believe a recession is imminent. Despite the aging
cycle, many of the excesses that often precede a recession
are hard to find. These include consumer debt, surplus
inventories, corporate debt, and excess business investment,
which were very muted this cycle. It is possible that later in
the year, and into 2020, the growth deceleration could lead
to a shallow economic recession.
The trade war remains a wild card as it is putting a dent
in business and consumer confidence. There is currently
no sign of a trajectory change on the issue, which bodes
poorly for the durability of economic growth. The Trump
Administration may react to the softening economic growth
with more progress on a trade war resolution, but there is
little indication of that right now.
Barring a legitimate economic recession, we think that the
current modest growth environment remains supportive of
durable, long-term growers, and a quality bias still seems
appropriate considering potential for increased volatility. We
believe a slowdown in growth would likely narrow investors’
focus on stocks with these characteristics, hopefully driving
continued outperformance for growth styles.
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.
Get the full perspective
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 current through February 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.
Class I shares are only available to certain types of investors.
The S&P 500 Index is an unmanaged index of common stocks. 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. Investing in companies involved primarily in a single asset class (large cap) may be more risky and volatile then
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.