Ivy Advantus Bond Fund

Ivy Securian Core Bond Fund
03.31.18

Market Sector Update

  • After an extended absence in 2017, volatility returned to the markets in 2018’s first quarter. The U.S. equity markets fell almost 10% in February over worries inflation would flare up. The Dow Jones Industrial Average lost 400 points on March 1 and more than 700 points on March 22. Both drops followed the Trump administration’s tariff announcements. While nothing seemed to rattle the markets in 2017, it’s likely those days are over. We expect volatility to be a continued presence in 2018.
  • The employment market grew stronger during the first quarter. February’s 313,000 new jobs ranked as the best month in two years. The unemployment rate remained at 4.1%, and could soon fall below 4%, a level last reached in December 1999.
  • Markets are watching for signs that high employment is driving up wages. Wages grew at a 2.9% rate in January, which drove stocks down sharply on worries about inflation. But wage growth came in at 2.6% in February, easing those fears. The markets remain nervous about inflation, and continue to view every economic statistic in light of what it indicates for higher prices.
  • Looking closer, we see strength in employment bringing more people back into the job market and moderating wage gains. Workers who were discouraged or who had dropped out of the job market are showing up again. That takes the pressure off employers to increase wages to fill jobs, and lowers the likelihood that hikes in pay will bring hikes in prices. We believe wage growth would have to reach and then stay at 4% to significantly increase inflation.
  • Investors are also closely watching the Federal Reserve (Fed) under its new chairman, Jerome Powell. Observers had anticipated three interest rate increases in 2018. Powell, during his first press conference, confirmed that the Fed plans to follow that script. Powell also indicated that the Fed plans three increases in 2019. His words were reassuring for markets worried about a spike in inflation, but any signs the Fed and Powell will become more aggressive could spark a swift negative market reaction.
  • International trade became a concern when President Trump announced tariffs on steel and aluminum produced overseas. Soon afterward, he stepped back from those plans but announced new tariffs on China. The markets recovered from their initial declines following the first tariff announcement. The Dow dropped again in late March with the announcement of tariffs on Chinese goods.
  • The corporate bond market was not immune to the volatility. Investment grade corporate bond spreads increased 16 basis points over the quarter. This resulted in negative 0.79% of excess returns, which was the worst first quarter of performance since the financial crisis.

Portfolio Strategy

  • During the quarter we further reduced the Fund’s corporate bond exposure, primarily in the industrial sector. We also substantially lowered the Fund’s exposure to interest rate risk within the corporate sector. The Fund remains overweight corporate bonds relative to its benchmark. Corporate bond spreads widened during the quarter, but with volatility spiking as well, we still don’t think investors are being compensated sufficiently to take an aggressive overweight position in corporate credit in the current environment. We sold positions in communications, consumer cyclicals and pipeline companies. The Fund remains overweight pipelines; we continue to like the stable cash flow profile of the business, but we sold positions that reached their valuation targets. We added further to the Fund’s positions in floating rate debt, particularly in the banking sector. Floating rate debt has performed well in this environment of rising short-term yields.
  • We continue to favor the securitized sector and the Fund remains overweight asset-backed securities (ABS), commercial mortgage-backed securities (CMBS) and non-Agency MBS. We added further to the Fund’s positions in non-Agency MBS during the quarter. The underwriting in this sector has remained disciplined since the housing crisis and we feel the U.S. housing cycle has longer to run relative to the corporate credit cycle. We also added to the Fund’s positions in ABS; in particular we added floating rate securities at attractive levels. We kept the duration of the Fund slightly short of its benchmark.

Outlook

  • Although the U.S. economy is now into its tenth consecutive year of growth, some observers are forecasting a recession for 2020. In this scenario, higher inflation prompts tightening by the Fed and other Central Banks, which in turn slows global growth. Conflicts over trade and tariffs make matters worse, and global economies can fall into recession.
  • For our part, we believe that tax reform could make corporate earnings, solid in 2017, even stronger in 2018. Corporations, on average, have been paying taxes at a 27% rate, which is likely to fall to 21-22%. Tax reform and the potential for increased government spending on defense and other programs could increase economic growth by about 1/2%, a significant boost. Our research team sees companies using stronger earnings to hire more employees and invest in their businesses. Business confidence remains strong, and the tax law’s favorable treatment for repatriation, or cash brought back from overseas, gives companies more money for capital expenditures, hiring, share buybacks and mergers and acquisitions. This should all be positive for economic growth.
  • We don’t expect trade to pose major risks to the economy or to markets. We may experience short-term ups and downs over trade negotiations, but revising previous trade agreements could be positive for the economy over the long term. U.S. trade with Mexico had a smaller economic impact when North Atlantic Free Trade Agreement (NAFTA) was originally negotiated, and it may merit a new look.
  • We expect the 10-year Treasury rate to slowly trend toward 3% unless the market perceives the Fed is behind the curve on inflation. Currently, market expectations of inflation have fallen back from their recent highs, signaling comfort with the Fed’s current policies. We’re with the market on this. While we believe inflation is trending towards the Fed’s goal of 2%, we don’t see it moving fast enough to prompt the Fed to hike more aggressively.
  • As always, there’s the potential for “black swans,” unexpected events that rattle the markets. A few possibilities include the November mid-term elections, North Korea, the Russia investigation, oil prices, and China’s economic growth rate. We’re keeping a watchful eye on three potential disrupters: (1) the possibility that protectionism grows and sets off a trade war; (2) the prospect of the Fed raising interest rates at a faster pace than expected; and (3) earnings either growing much faster (thanks to rising employment and consumer spending) than expected, setting off renewed fears of inflation, or much slower (if tax reform doesn’t have the expected impact) than hoped.
  • Regardless of whether any of these actually happen, we expect more market ups and downs in 2018. Like it or not, volatility is back.

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 Mar. 31, 2018, 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 Ivy Advantus Bond Fund was renamed Ivy Securian Core Bond Fund on April 30, 2018.

The Bloomberg Barclays U.S. Aggregate Bond TR USD Index is a market capitalization-weighted index, representing most U.S. traded investment grade bonds. The Standard & Poor's (S&P) 500 Index is a float-adjusted market capitalization weighted index that measures the large-cap U.S. equity market. The index includes 500 of the top companies in leading industries of the U.S. economy. It is not possible to invest directly in an index.

The Dow Jones Industrial Average is a stock market index that shows how 30 large publicly owned companies based in the United States have traded during a standard trading session in the stock market.

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. 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. 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.