To date in 2017, the Ivy Mid Cap Growth Fund has experienced double-digit returns. The Fund’s performance
as of June 30, 2017 (before the effects of sales charges) was better than both the Russell Midcap Growth Index
(the Fund’s benchmark) and a number of its mid-cap growth peers. Strong stock selection, particularly in
the technology and consumer staples sectors, has been the driving force behind the Fund’s recent relative
outperformance. Below, Portfolio Managers Nathan Brown, CFA and Kimberly Scott, CFA discuss the Fund’s
performance for the first six months of 2017 and investment opportunities they are seeing in today’s market.
Fund outperforms index, peers
For the first six months of 2017 the Fund outperformed the
Russell Midcap Growth Index and a number of its mid-cap
growth peers. Active managers have also seen a recovery
in performance as more than 65% of mid-cap growth
managers have outperformed the benchmark year-to-date,
according to Lipper.
A return to growth, momentum
We believe the first six months of 2017 can be best
described as the return of growth and, to a fair degree, a
return of momentum. This current push doesn’t appear
quite as strong as it did in mid-2015 but we are definitely
seeing an impact to the performance of many the Fund’s
holdings. Over the past several months, we noticed that
a number of the Fund’s truly differentiated, unique and
innovative company holdings are participating in some
of this momentum. This doesn’t seem surprising as these
firms appear to have good earnings and growth prospects
as witnessed by their quarterly reports, balance sheets and
future projections. From a broader standpoint of being
able to discount the market at strong valuations given
the current state of interest rates, the environment still
remains constructive for growth.
In addition, we think the public’s expectations of what
Washington might do are subsiding and believe it is
encouraging that the market has been able to forge ahead
even with diminished expectations. This positive situation
points to a U.S. economy that appears sound and the market
seems to be taking a lot of its cues from economic growth as
opposed to political actions.
Headwind to high-quality diminishing
One of the things that we’ve discussed over the past three to
five years is the persistent headwind to the Fund’s process
of investing in high-quality companies versus those with
high levels of indebtedness. In 2016, we started to see that
headwind abate, and as we turned the page into calendar year
2017, those headwinds continued to diminish. Companies
with the most levered balance sheets in the mid-cap growth
universe are now underperforming the Russell Midcap
Growth Index by about 300 basis points year to date.
This trend has helped the Fund’s performance versus the
benchmark. What we find encouraging about this is if we
think about 2016, we saw interest rates increasing while at
the same time becoming less of a headwind to the Fund. So
far in 2017, interest rates have been flat to down and we are
still seeing those companies with high amounts of leverage
underperforming. We are hopeful this is an indicator from
a performance perspective that the pressure the Fund
was experiencing is truly in the rearview mirror and we
are now able to focus on the organic growth of individual
companies versus companies that are financially
engineering earnings growth.
Contributors first six months
Technology was the Fund’s strongest performing sector
and largest overweight position. Across technology we have
a number of strong software names. The standout in this
group during the first half of the year was Mobileye, a global
leader in the development of vision technology for Advanced
Driver Assistance Systems (ADAS) and autonomous driving.
While Mobileye is no longer a Fund holding — we sold it once
Intel made an offer to buy the company — it contributed a
fair degree to the technology sector’s performance.
Lately, we found several good secular growth companies within
the technology space. Some of them are older companies that
have been in the portfolio for a while like Electronic Arts (EA),
which is benefiting dramatically from a shift from physical
games to digital downloads. There is a nice margin benefit
that EA gets when a consumer downloads a game from a retail
website or Xbox store versus buying it from a local Wal-Mart or
Target. The web aspect of EA’s business has been a great benefit
to the company’s bottom line.
ServiceNow was another Fund holding during this period that
is providing software-as-a-service solutions for some of the
world’s largest companies. It started out as a relatively niche
product for IT help desks but has since continued to grow its
menu of products for all of its customers. We have a group of
companies within the mid-cap space that we continue to take
advantage of within the software-as-a-service model, as the
technology shift has moved from on-premise to off-premise
and licensed business models.
The Fund’s second strongest performing sector was consumer
staples. This sector’s performance was driven by Whole Foods,
which received a buyout offer from Amazon in June. Whole
Foods is a name that has been in the Fund’s unrecognized
growth bucket since late 2015. The grocery store retailer has
been so successful with its business model that it created an
industry within an industry for organic and natural foods.
Whole Foods has performed very well and contributed to
strong sector performance.
Beyond technology and consumer staples, we have seen some
outperformance from the industrials sector. The Fund’s
industrials exposure made a slight positive contribution to relative
returns, primarily due to strong stock selection. Two strong names
were IDEX Corp., a diversified industrial technology company,
and Fortune Brands Home and Security. Our lack of holdings in
the real estate sector, an underperformer for the benchmark,
provided the Fund with a little bit of upside relative performance.
Detractors first six months
From materials to financials and health care to consumer
discretionary, sector performance has ebbed and flowed, but
by far, the Fund’s biggest underperformer was energy. This
is where, from a relative basis, we have had the most pressure
year to date and not enough to offset the strength that we were
seeing elsewhere. During the first half of the year, we reduced
some of the Fund’s energy exposure. We don’t expect to see any
kind of crash in the sector but rather, it appears more likely that
it is going to be very difficult for the price of oil to go too high
and stay there for too long. There is just too much supply. We
think that the amplitude of gains and drops in the price of oil
is probably dampening out secularly for a while and the Fund’s
exposure to energy will probably not increase in the near future.
Health care was a slight overweight in the Fund and was a
source of slight relative underperformance — despite, some of
the best performance on an absolute basis coming out of this
sector. We believe health care includes a fertile group of growth
companies within the mid-cap space, and the group is quite
diversified. We have made a few changes here and there with
a couple of additional names, but for the most part, the bulk of
the Fund’s exposure remains with names that have been in the
portfolio for quite some time, such as: Intuitive Surgical, Zoetis,
Align Technology and Edwards Lifesciences. We still see
positive prospects for these companies going forward.
Consumer discretionary was an area where the Fund was
underweight as there have been a number of secular changes
that are happening for companies within this space, particularly
within retail. Retail has been a very difficult area. We don't think
a day goes by that there isn’t news regarding threats of or actual
store closings or problems with mall traffic. While we still had
exposure to what we consider to be some of the marquee names
and brands in the space like Tiffany & Co., Burberry Group and
lululemon athletica, Inc., we didn't fully anticipate the speed
and ferocity with which the problems in retail would play out.
As a result of these problems, many company profits have been
compromised and these stocks have really struggled to the
downside. We have sold a number of our retail names because
we decided that while these could be good unrecognized growth
prospects with positive cash flow, they just didn’t have enough
proprietary product to be able to effectively compete with online
retailers like Amazon. While retail makes up a fairly sizable
component of the benchmark, we anticipate maintaining an
underweight position in Fund for the foreseeable future.
There are areas within consumer discretionary aside from retail
that appear to be doing well and we plan to add names to the
Fund’s sector exposure in the near future.
Names recently added
MarketAxess and Allegion are two holdings that we have
recently added to the Fund’s portfolio. MarketAxess is a fixedincome
electronic trading platform for institutional investors
and broker dealers. The company’s patented electronic platform
enables fixed-income market participants to source competitive
and executable bids or offers in the broadest range of cash credit
and credit derivatives. MarketAxess has tremendous cash flow
because it’s basically a tollbooth for bond trading. It has very
little capital need, strong cash flow and is growing rapidly by
taking share of a big market. Best of all, the company is doing
all of this with no indebtedness. MarketAxess is also growing its
dividend, and we believe this should be a productive investment.
If the valuation remains supportive and the investment thesis
continues to play out as we suspect, we should be long-term
investors in the company.
Allegion manufactures and sells mechanical and electronic
security products and solutions worldwide. It offers numerous
types of locks; door closers and controls/exit devices; electronic
security products and access control systems; time, attendance,
and workforce productivity systems; doors and door frames;
and other accessories. We bought the stock because there has
been a secular shift going on from just mechanical locks. Simple
key locks are turning into electrical-mechanical locks that can
be opened with a key card or cell phone. There has been this
significant shift going on from a safety perspective, which
should help drive the company’s business. This shift means
the company can sell locks for three times the revenue of the
standard mechanical lock, and they have the exact same gross
margins. If you do the math, this means you are getting three
times the dollars on the new gross profit line that you did from
the old one.
We have expected the market to deliver positive returns in
2017, and thus far, have not been disappointed. We think the
markets can move higher based on accelerating economic
growth around the globe, vastly improved U.S. corporate profits
as compared to the last two years, and the potential benefits of
pro-growth, pro-cyclical policies that can enhance an already
Economic activity in the U.S. is continuing at a low but
stable pace, as housing demand continues to improve, and
consumption in general remains firm tied to ongoing strength
in jobs and wage gains. Global industrial production is stronger
than in recent years as evidenced by the Purchasing Managers
Index in many countries.
Interest rates, while increasing, still seem supportive of
investment and growth, as does the credit environment. The
valuation on the market has expanded with last year’s gains, but
levels are reasonable to support further market appreciation as
we discount additional increases in corporate profits. We think
the factor that should provide underlying support for a corporate
profit and stock market outlook that was encouraging even preelection
is the pro-growth stance of the Trump administration,
should it get organized enough to effect change.
A more supportive regulatory and taxation environment and
a drive to invest in the U.S. could lift an already improving
economic and profit picture to a higher level. The response
from credit markets will be important to monitor, as higher
interest rates could have a dampening impact on a stronger
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 August
2017, 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.
Through July 31, 2018, Ivy Investment Management Company (IICO), the Fund’s investment manager, Ivy Distributors, Inc. (IDI), the Fund’s distributor, and/or Waddell & Reed Services Company, doing business as WI
Services Company (WISC), the Fund’s transfer agent, have contractually agreed to reimburse sufficient management fees, 12b-1 fees and/or shareholder servicing fees to cap the total annual ordinary fund operating
expenses (which would exclude interest, taxes, brokerage commissions, acquired fund fees and expenses and extraordinary expenses, if any) as follows: Class A shares at 1.31%. Prior to that date, the expense
limitation may not be terminated without the consent of the Board of Trustees (Board).
Class R6 shares were renamed Class N on March 3, 2017.
Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Investing in mid-cap growth stocks may carry more risk than investing in stocks of larger more well-established
companies. 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.