Market Sector Update

• Fixed Income and equity markets alike advanced in the second quarter although at a slower pace than earlier in the year, as enthusiasm about the new administration’s growth proposals waned. Yields on the 10-Year Treasury fell 9 basis points to end the quarter at 2.3% even with the 25 basis point rate hike delivered by the Federal Open Market Committee (Fed) on June 14th. As the yield curve continues to flatten we are now at a 145 basis point spread between the 30-year and the 2-year, which is the lowest spread since September 2016.
• The non-investment grade credit markets continued to grind tighter. Although not quite keeping pace with the equity markets, the BofAML US HY Master II Index (BofAMLHY), the index for the Fund, rose 2.13% during the quarter despite falling oil prices that triggered downward price movement for high yield energy bonds.
• As high yield bond prices moved higher, credit spreads continued to narrow (15 basis points qauter-over-quarter). The spread on the BofAMLHY ended the quarter at 377 bps. The yield on the index was 5.71%, slightly lower than the 5.9% reported for the previous quarter-end.
• Flows into the high yield mutual fund category were negative for the quarter totaling -$1.34 billion. Outflows for high yield YTD total -$9.5 billon.

Portfolio Strategy

• The Fund outperformed the benchmark (before the effects of sales charges) for the quarter. Outperformance was attributed to individual security selection within the services sector, outperformance in specific credits and a slight overweight to the leisure and media sub-sectors. Another significant contributor to performance for the quarter was the Fund’s underweight to energy sector. The fund carried a 5% allocation to energy at the end of the quarter while the index exposure was at 14%.
• Higher credit quality non-investment grade bonds outperformed the past three months, which is a reversal from previous quarters. BB-rated bonds returned 2.53% and Bs climbed to 1.69%, while CCCs garnered 1.44%.
• All of the sectors within the high yield categories were positive for the quarter with the exception of the energy sector, which priced down -1.45%. The retail sector remains under some price pressure YTD, but rebounded from the first quarter, capturing returns of almost 2%.
• The Fund retains a 20.56% allocation to senior loans. The BofAMLHY does not have an allocation to loans within the index and the loans were a slight detractor to the Fund for the quarter even though leveraged loans returned 0.76%. Although the strategy is driven by fundamental, bottom-up research selection rather than a quality or sector bias, the Fund’s allocation to CCC paper and loans will allow it be less interest rate sensitive in a rising rate environment.

Outlook

• By any historical measurements, spreads and yields are at the tight end of their respective ranges. This has been driven by extremely accommodative monetary policy and persistently low inflation. The first of these has begun to be dialed back by the Fed, albeit at a very measured pace, while the second has showed few signs of accelerating. Talk of the Fed starting to reduce its balance sheet in the near future could certainly cause some volatility in the bond markets, especially for bonds with longer maturities. The market’s response to this process will be a gauge for the Fed to consider before their next expected rate hike in December.
• In the era of ever present demand for yield accompanied by compressing spreads and lower rates across the entire credit spectrum, there is increasing concern over risk adjusted returns. As yields on the high yield indexes and the exchange traded funds tracking them have pushed down to 5% levels, it begs the question of how much risk investors should be taking for moderate yield. We continue to believe that finding value in the high-yield market is difficult, and considerable caution is warranted in making new investments. Our flexibility to invest across the capital structure, including higher parts of the capital structure (think loans) should continue to provide benefits as we move into a less accommodative monetary environment.
• As always, we continue to focus on our bottoms-up fundamental research and attempting to find those needles in the hay stack that we think offer compelling risk-adjusted returns.

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.

Risk factors: The price of the Fund’s shares will fluctuate with market conditions and other factors. Fund shares are not guaranteed or endorsed by any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation. Closed-end funds frequently trade at a discount from their net asset values (NAVs), which may increase an investor’s risk of loss. At the time of sale, shares may have a market price that is below NAV, and may be worth less than the original investment. There is no assurance that the Fund will meet its investment objective. Investing in high-income securities may carry a greater risk of nonpayment of interest or principal than with 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.

An investment in the Fund is not appropriate for all investors and is not intended to be a complete investment program. The Fund is designed as a long-term investment and not as a trading vehicle.

Ivy Investment Management Company (IICO) serves as the Fund’s investment adviser. IICO is a wholly-owned subsidiary of Waddell & Reed Financial, Inc.

The Fund is a closed-end exchange traded investment company. This material is presented only to provide information and is not intended as investment advice or recommendations for trading purposes. Closed-end funds, unlike open-end funds, are not continuously offered. After the initial public offering, shares of closed-end funds are sold on the open market through a stock exchange. Investment policies, management fees, risks other than those mentioned above, and other matters of interest to prospective investors may be found in the closed-end fund prospectus used in its initial public offering. For additional information, contact our sales desk at 800-532-2780.