Market Sector Update

• Volatility persisted in the debt and equity markets on the heels of the same issues that surfaced in the first quarter, including the sensitivities surrounding global trade, rising U.S. Treasury yields and global political turmoil. An examination of the fixed income markets for the quarter would spotlight the 10-Year note reaching a seven-year high of 3.13% in May (the 2-year note jumped 26 basis points in the quarter while the ten-year note moved 12 basis points to 2.86%), only to end the quarter at 2.86%. The Bloomberg Barclays U.S. Corporate Bond Index is now at -3.10% yearto- date, its choppiest start since 2013. High yield bonds fared better than the majority of fixed income asset classes with a gain of +0.89%. Leveraged loans followed closely behind with a gain of 0.74%. Of note, loans outperformed high yield bonds eight out the last nine months. The 10-year Treasuries were down 0.31%, and investment grade bonds fell 0.91%. Amid global trade concerns, emerging market credit fell 3.51%.
• Using the J.P. Morgan Domestic High Yield Index as a reference, yields on high yield bonds pushed to 6.72% at the end of the quarter, attaining its highest level since December 2016. The credit spread, however, narrowed four basis points to 406, following a 368 basis point low hit in April.
• Across the credit spectrum, lower rated bonds continued the trend of outperformance relative to higher rated bonds. Year–to-Date, CCC credits have now returned 2.97%, while B rated investments are up 1.26%, and higher quality bonds of the non-investment grade asset class, BBs, are down 1.52%. The top industry performers in 2018 so far are retail (3.68%) and telecom (2.58%) whereas the largest underperformers are autos (-5.40%) and housing (-1.91%).
• High yield mutual fund outflows continued during the second quarter, amounting to a loss of approximately $5.75 billion. Year-to-date outflows total $23.7 billion ($5.8 billion in exchange-traded funds), double the amount of outflows in the first half of 2017.
• New issue activity decelerated in the quarter, with new volume totaling around $53 billion. This marked the slowest quarter for new activity since December 2016. Leverage loans, on the other hand, saw gross new issue volume of $258.8 billion, the second highest quarterly total on record for this sector.
• Defaults edged lower in the second quarter. June saw no credit defaults, making quarter the lowest quarter of default activity since the end of 2013.

Portfolio Strategy

• The portfolio composition between bonds and loans was little changed from the first quarter. Higher London Interbank Offered Rates (LIBOR) have been favorable to loan yields and with the Federal Reserve indicating they plan to continue down the path of gradual rate increases (for now), our exposure to loans will continue. The Fund outperformed the benchmark (before the effects of sales charges) for the quarter. Our leveraged loan exposure and allocations within the telecommunications, financial, and health care sectors contributed to outperformance.
• With regard to portfolio distribution by credit ratings, our work indicates that there has become less differentiation between credit rating categories. In addition, the compensation (spread) given for taking on more leverage/risk has continued to decline. As a result, we have reduced our exposure to CCC-rated bonds from 28.4% at the beginning of 2018 to 25.2% at the end of the second quarter, as measured by Standard & Poor’s ratings.
• The Fund employs a rigorous fundamental and bottom-up process, so although the previously mentioned sectors helped to achieve returns from an attribution standpoint, being underweight the BB-rated category along with having a shorter-than-average duration portfolio relative to peers also helped.
• Despite the volatility seen in the equity and fixed income markets, there were limited changes to sector weightings in the portfolio.

Outlook

• Despite the instability experienced within a variety of asset classes as of late, high yield credit spreads actually narrowed four basis points throughout the quarter. High yield spreads remained near the lower end of their long-term range, which is consistent with the low risk premium currently observed across other asset classes.
• Although investors welcomed higher yields at quarter-end, they were flirting with decade lows in April. Net supply of new high-yield bonds has been declining recently, creating a positive technical backdrop in the market place. Technicals, however, do not replace fundamentals in our decision making process. Managing the amount of risk we are willing to take for moderate returns in this setting is becoming increasingly important.
• Even though high yield is more correlated to equities than other credit strategies, it historically has offered more downside protection than stocks in volatile times. It continues to be our view that the tailwinds from corporate and individual tax reform, along with deregulation and the resulting boost in consumer and business confidence, will outweigh global trade worries and headwinds for now. The downward trend of default activity for the quarter also remains constructive for the asset class.
• It is our view that finding value in the high-yield market has become increasingly more difficult, and considerable caution is warranted in making new investments. As such, we believe our continued process of bottom-up, in-depth fundamental research and analysis will guide us to those investments where the risk/reward may be in our favor.

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, 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.

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.

The ICE BofAML U.S. HY Master II TR USD Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The J.P. Morgan Domestic High Yield Index is designed to mirror the investable universe of the U.S. dollar domestic high yield corporate debt market. The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes U.S. dollar-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers. It is not possible to invest directly in an index.

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.