Ivy Advantus Real Estate Securities Fund

Ivy Advantus Real Estate Securities Fund
06.30.17

Market Sector Update

  • Real estate securities in general trailed the performance of U.S. equities in the quarter. Despite solid operating conditions across the property spectrum, investors have been less enamored with real estate investment trusts (REITs) this year.
  • The lingering concern of rising interest rates along with decelerating earnings growth have held back higher share price. Additionally, disappointment in the Trump administration's inability to deliver on its pro-growth agenda has tempered investors' enthusiasm for a re-acceleration of economic growth.
  • The key story for real estate investment trusts (REITs) was the continued woes surrounding certain retailers. The secular headwinds facing the retail business have clearly landed at the doors of brick-and-mortar owners.
  • Investors indiscriminately sold all owners of mall and shopping centers regardless of portfolio quality. This was the second straight quarter of poor performance in retail owners and it appears the headwinds facing retail are not likely to end soon.

Portfolio Strategy

  • The Fund had a modest positive return for the quarter (before the effect of sales charges) and slightly trailed the positive return of its benchmark index.
  • Retail REITs were once again the worst performing group in the quarter. We continue to expect a bifurcation in results between owners of higher quality and lower quality properties. The Fund is underweight both mall and shopping center REITs, with holdings skewed toward owners of higher quality properties with the potential for a combination of rent increases, more defensible tenant bases and redevelopments.
  • The self-storage sector underperformed the benchmark as concerns about new supply and soft rental rates plagued the sector. Favorably, the public REITs still command the upper hand in terms of marketing and internet search capabilities, and we anticipate a normal trough in the latter stage of the real estate cycle, at which point we think multiples can rebound. The Fund remains underweight the sector, given the negative sentiment towards the group.
  • The Fund is overweight the single family rental sector, which lagged in second quarter after missing lofty earnings expectations. Single family rental demand is accelerating with the first wave of Millennials moving out of apartments and into suburban homes. We think the sector has solid growth prospects within the REIT universe and we have a constructive view on its growth and relative valuation.
  • The healthcare sector outperformed for the quarter, aided by a persistently lower 10-Year Treasury yield. We remain underweight this sector given the uncertainty surrounding healthcare reform, and prefer a longer term underweight to the sector given its relatively low growth and sizable interest rate sensitivity.
  • Data center REITs were a top performer in the quarter, benefitting from the continued migration to cloud computing. We think demand will remain robust into the foreseeable future and increased exposure to the group throughout the quarter.
  • The Fund is underweight hotel REITs, with holdings concentrated in companies with less exposure to new supply and also those with easier year-over-year comparisons. By contrast, the Fund is overweight the office sector, with balanced exposure to coastal urban and suburban markets. We think the sectors fundamentals can outpace most other major REIT sectors in coming years, in part because of ongoing job growth.
  • The industrial warehouse subsector delivered the top returns for the quarter. Operating conditions for industrial properties remain at record levels, driven by e-Commerce related businesses and general economic improvement. We remain overweight as it is one of few where top-line revenue is accelerating and fundamentals appear solid for the near to intermediate future.

Outlook

  • Steady economic and employment growth coupled with disciplined lending and construction activity have propelled the current real estate recovery into its eighth year. Fundamentals remain broadly solid with occupancy rates near record levels, which are driving positive rent spreads. Job growth, especially in coastal markets, continues to be supportive to REIT fundamentals, while the capital markets remain open for both corporate and mortgage lending at attractive rates.
  • At a minimum, we think REIT performance could be influenced by macro events with support coming from an improved economy and gross domestic product growth coupled with resistance stemming from rising borrowing costs and secular shift underway with retail REITs.
  • We think REIT fundamentals should continue to benefit from an improving economy, although the pace of growth is being muted by new supply in sectors such as apartments, hotels and self-storage. Despite signs of decelerating cash flow growth, we believe the landscape for commercial real estate and REITs remains constructive. Moving into the later stages of the recovery does not mean the sector’s fundamentals will turn negative. In fact, we think cash flow growth for the sector will decelerate only slightly to 5% in 2017 and lead to another year of dividend growth.
  • Capitalization rates for private market transactions continue to support REIT valuations, suggesting REITs currently trade at a discount to their net asset values, while REIT pricing compared to broader fixed income and equity markets also looks attractive compared to historic averages. Although we think valuations are justifiable, a sustained reversal in record-low interest rates – particularly in the long-end of the curve – would be likely to pressure REIT share prices. We saw evidence of this relationship in the second half of 2016 when 10-Year Treasury yields rose sharply.

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, 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. Past performance is not a guarantee of future results.

Class R6 shares were renamed Class N on March 3, 2017.

The Ivy Real Estate Securities Fund was renamed Ivy Advantus Real Estate Securities Fund on April 3, 2017.

Top 10 holdings (%) as of 06/30/2017: Simon Property Group 6.9, ProLogis, Inc. 5.6, Equinix, Inc. 5.6, Mid-American Apartment Communities, Inc 3.4, Alexandria Real Estate Equities, Inc. 3.2, Equity Residential 3.2, Duke Realty Corp 2.9, AvalonBay Communities, Inc. 2.9, Essex Property Trust, Inc. 2.9, Welltower, Inc. 2.8.

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. 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. Because the Fund invests more than 25% of its total assets in the real estate industry, the Fund may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. These and other risks are more fully described in the Fund's prospectus.

IVY INVESTMENTS® refers to the investment management and investment advisory services offered by Ivy Investment Management Company, the financial services offered by Ivy Distributors, Inc., a FINRA member broker dealer and the distributor of IVY FUNDS® mutual funds and IVY VARIABLE INSURANCE PORTFOLIOS℠ , and the financial services offered by their affiliates.