Market Sector Update

• In the first quarter of 2017, Morningstar reported national municipal fund performance was up 1.4%, while California municipal funds were up 1.6%. Municipal funds performed better during the second quarter of 2017, with national municipal funds up 2.0% and California municipal funds up 2.3%.
• We believe several factors contributed to positive performance in the first half of the year. First, mediocre economic data (gross domestic product, employment and inflation) released during this timeframe led to low rates. Additionally, we believe that strong technicals were a factor. The 30-day average supply of bonds per the Bond Buyer U.S. 30-day Visible Supply, was $11.4 billion in the first half of 2017, an ordinary number by historic standards.
• Municipal flows were robust in the first half of the year, as measured by year-to-date U.S. Lipper flows of +$12 billion Even with the year-to-date rally in municipal bonds, we remain constructive on the high yield municipal space as new issues come to market with more attractive yields and better collateral for investors. We continue to participate selectively in the new issue market while maintaining ample amounts of liquidity. Going forward we believe the municipal market is attractive vs. other fixed income asset classes based on slower global growth and continued geopolitical risk. While the Federal Reserve is likely to continue to raise rates in 2017 and 2018, we believe that rate increases will be gradual and that the spillover impact to municipal bonds will be muted.

Portfolio Strategy

• The fund outperformed in the first half of 2017 due to the bias toward lower-quality munis and exposure to nonivestment grade tobacco bonds.
• The team continues to see the greatest opportunity in land secured bonds, also known as Mello-Roos/Community Facility District Bonds. We believe these bonds offer a compelling risk/reward profile.
• We are cautious with California charter schools and evaluate these borrowers carefully. The fund is underweight the hospital sector, with 4.6% exposure vs. a 13.6% weighting in the Bloomberg Barclays Municipal Bond Index. We believe that hospitals carry the most ratings downgrade risk of any sector due to proposed healthcare reform that could lead to a rollback of Medicaid expansion, which may strain operating performance and liquidity in the sector.
• We continue to favor revenue bonds over tax backed debt as revenue bonds, in our view, provide higher yields and better diversification from general tax and pension issues currently affecting many municipalities. We feel at this time it makes sense to bring in duration slightly due to municipal valuations being rich, when compared to Treasuries.

Outlook

• In the near term we believe volatility will continue, as choppy economic data continues globally creating large amounts of uncertainty for markets. We believe that we are in the middle- to late-stages of the economic recovery and that, even if meaningful tax stimulus is passed, it will only serve to extend this part of the cycle by one to three years.
• Given this backdrop, we believe rates will remain subdued and that California-based investors will continue to search for tax-exempt yield due to high state tax rates.

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.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. 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. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). Exempt-interest dividends the Fund pays may be subject to state and local income taxes. The portion of the dividends the Fund pays that is attributable to interest earned on U.S. government securities generally is not subject to those taxes, although distributions by the Fund to its shareholders of net realized gains on the sale of those securities are fully subject to those taxes. The municipal securities market generally, or certain municipal securities in particular, may be significantly affected by adverse political, legislative or regulatory changes or litigation at the Federal or state level. 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. Because the Fund invests predominantly in California municipal securities, events in California are likely to affect the Fund’s investments and its performance. As with California municipal securities, events in any of the U.S. territories, such as Puerto Rico, Guam and the U.S. Virgin Islands, where the Fund is invested may affect the Fund’s investments and its performance. These events may include economic or political policy changes, tax base erosion, constitutional limits on tax increases, budget deficits and other financial difficulties, and changes in the credit ratings assigned to municipal issuers of California or U.S. territories.

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.