Market Sector Update

• The U.S. Federal Reserve (Fed) in December raised the target range for its benchmark interest rate by 25 basis points to a range of 2.25-2.50%, stating it is now in a wait-and-see mode and will rely on future data to justify further tightening. The Fed has met what it previously identified as its dual mandate, with the unemployment rate at 3.9% and core inflation approaching its 2% target.
• The quarter saw a tightening of financial conditions with credit spreads widening, stock prices falling and the yield curve compressing. U.S. economic growth forecasts in general were revised down to a rate of 2.0 to 2.5% in 2019, with no recession expected over the next 12 months.
• The Trump administration’s policies on international trade and investment have emerged as an important source of downside risk for the global economy. Markets expect the new U.S.-Mexico-Canada Agreement on trade will be a framework for similar negotiations with the European Union (EU) and Japan. Negotiations continued in late December with China on that trade dispute and negotiations were expected to continue into 2019.
• Central banks continued to inject volatility into the markets as they try to guide market expectations with their datadependent policies.
• Political concerns emerged from elections as Italy’s new government brought the EU’s sustainability back into the spotlight. The new government’s targeted budget deficit was more aggressive than market expectations, causing the euro to weaken and Italian government debt rates to increase.
• The shape of the yield curve remained flat and is likely to stay that way, based on the Fed’s stated intentions about interest rates and measured inflationary pressures on the long end of the curve. That part of the curve also is being affected by the push of increased U.S. Treasuries supply from budget deficits, Fed balance sheet normalization and increased term premiums versus the pull of global trade concerns, a strong U.S. dollar, political concerns and emerging market volatility.

Portfolio Strategy

• The Fund had a negative return in the quarter that was less than the negative return of its blended benchmark index. Performance against the index and category peers was helped by the Fund’s overweight in Treasuries, floating rate securities and an increase in cash.
• The recent risk-off environment led to a rally in Treasuries, with trade tensions, political concerns about the EU and Italy, and uncertainty about the Fed’s rate plans leading to a rush for U.S. dollar Treasuries. Those factors helped the Fund’s relative performance.
• The high Income sleeve detracted from performance in the risk-off environment that surfaced in early October.
• Across the credit spectrum, lower quality credit outperformed higher quality during the year in both investment grade and high yield until early in the quarter, when the momentum shifted. By the end of the quarter, higher quality ended up outperforming. Each sleeve in the Fund has moved up in credit quality compared with the past, based on our outlook and assessment of valuations.
• We continue to seek opportunities to reduce the volatility in the Fund and to maintain a low-duration strategy. We also continue our longstanding position of holding a higher level of liquidity in the Fund, with the intent of being opportunistic with that capital when dislocations arise in the market.

Outlook

• On the back of expected slower economic growth in the first half of 2019, we think the Fed will raise rates no more than once during the year.
• Labor markets continue to grow and beat expectations, which has kept consumer confidence near cycle highs and supported strong spending growth. But we think trade will continue to be a risk factor going forward. There is a potential for more tariffs followed by retaliatory action that could impact the capital investment plans of many companies. A negative feedback loop thus could affect markets, stocks and ultimately consumer confidence.
• U.S. economic growth still is above trend, with healthy real income growth and an elevated personal savings rate that we think can insulate against the negative wealth affect from the lower stock market late in 2018.
• The Fed’s balance sheet runoff has proceeded smoothly and has not disrupted the markets. The Fed reiterated its intention to use interest policy, rather than the balance sheet, as its active pool. We think the balance sheet runoff will continue until it reaches $3.0-$3.5 trillion.
• The federal budget deficit is expected to rise to $1.0 trillion (4.7% of gross domestic product) in 2019 because of structural forces that have deteriorated by a much greater amount than the offsetting cyclical improvement.

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 Dec. 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 Fund is managed by Ivy Investment Management Company. The total return strategy is sub-advised by Apollo Credit Management, LLC.

Risk factors: The value of the Fund's shares will change, and you could lose money on your investment. Although asset allocation among different sleeves and asset categories generally tends to limit risk and exposure to any one sleeve, the risk remains that the allocation of assets may skew toward a sleeve that performs poorly relative to the Fund's other sleeves, or to the market as a whole, which would result in the Fund performing poorly. While Ivy Investment Management Company (IICO) monitors the investments of Apollo Credit Management (Apollo) in addition to the overall management of the Fund, including rebalancing the Fund's target allocations, IICO and Apollo make investment decisions for their investment sleeves independently from one another. It is possible that the investment styles used by IICO or Apollo will not always complement each other, which could adversely affect the performance of the Fund. As a result, the Fund's aggregate exposure to a particular industry or group of industries, or to a single issuer, could unintentionally be larger or smaller than intended. 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. 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. 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. 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. 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.