Market Sector Update

• Fourth quarter 2020 ended strongly with the S&P 500 Index (the Fund’s benchmark), increasing over 12%. While COVID-19 cases continued to ramp in the U.S. and globally, so too did policy response with the continuation of ultralow interest rates and further fiscal support for households, culminating in the $900 billion relief measure enacted by Congress at the end of 2020. Most importantly, the market was driven by success on the vaccine front with multiple companies (Pfizer and Moderna) announcing 95% success rate in their large COVID-19 vaccine trials. With hopes of a strong cyclical rebound in the economy rising on vaccine success, investors pivoted to cyclical companies most likely to see a material earnings rebound on economic reacceleration. Energy was the market’s strongest performing sector, increasing over 28% in the quarter. Financials followed with gains above 23%, followed by industrials and materials with mid-teens percentage gains. Real estate, consumer staples and utilities underperformed materially as long-term interest rates moved higher along with inflation expectations.

Portfolio Strategy

• The Fund outperformed its benchmark modestly in the quarter with our exposure to financials outweighing our underweight position in energy. The fourth quarter capped off a strong 2020 for our strategy with material outperformance versus the index, and longer-term performance metrics improving as well.
• The Fund remains focused on finding competitively advantaged businesses likely to exceed longer-run earnings and cash flow projections, with a keen interest on investing in areas where we see significant competitive change. We benefit from taking advantage of opportunities presented by the market to buy good businesses at reasonable valuations where our fundamental analysis suggests earnings power is underappreciated. Over the past quarter, the market provided significant opportunity in strong businesses undergoing transitory earnings disruption as the result of the pandemic and related economic effects. To that end, we made several adjustments during the quarter (or before) based on opportunity to add/increase certain holdings in financials (Discover Financial, JP Morgan Chase and Fiserv, Inc.). We believe the earnings of these companies are temporarily depressed based on increased reserves taken in 2020, as well as weakness in payment revenue streams due to restricted travel and entertainment. Temporary earnings disruptions also significantly impacted the consumer discretionary and health care sectors, with consumers unwilling or unable to eat out or schedule certain medical procedures. The portfolio capitalized on attractive valuations in HCA during 2020 and more recently added Sysco Corp. as the leading food distributor to restaurants and institutions.
• Other recent additions to the portfolio were more idiosyncratic in nature. The portfolio significantly added to the position in United Healthcare at a time when election uncertainty made the valuation of this strong organic grower and vital piece of the nation’s healthcare system more attractive. We added D.R. Horton based on our belief in significant pent-up demand for new, affordable single-family homes as millennials move into active home-buying mode. Already well positioned for entry level and first-time move-up buyers, the company is also transitioning to an “asset-light” model (less land ownership) that we believe will yield structural improvement in returns. Significant portfolio exits in the quarter included Fidelity National Info Services (sold in favor of Fiserv at a more attractive valuation), Waste Connections and Lockheed Martin, which were sold after providing strong multi-year returns but lacked significant upside to price targets.

Outlook

• Two critical events occurred in the fourth quarter that are likely to have lasting repercussions on the state of the U.S. economy. Success in the development of a highly effective vaccine was clearly the most important development in terms of understanding a path to economic recovery. Ivy’s economist believes the U.S. economy can expand 6% in 2021, largely the result of substantial anticipated re-opening activity toward the middle of the year. On a bottom-up basis, forecasters suggest this will result in earnings growth for the market of greater than 20%. Our experience over several market cycles suggests companies are far more adaptable during periods of revenue weakness and opt to rationalize cost structures aggressively to protect profits at these times. Over the past nine months, companies have reduced workforces, found more efficient ways to conduct businesses (Zoom, lack of travel), and invested in technology (cloud adoption, etc.) all to protect the downside and prepare for the eventual upturn. This usually results in greater operating leverage (the ability of bottom-line profits to expand faster than revenues) during an upturn than investors expect. We expect this leverage to be most pronounced in companies that were forced to be most cost conscious over the previous nine months and as such we have increased the cyclicality of the portfolio to take advantage of these opportunities. The other obvious development was the transition of power that will soon occur in Washington with Joe Biden’s presidential victory and the democratic capture of the Senate (for all practical purposes). While the margin of the democratic majority is slim in both houses of Congress, they will result in meaningful policy changes that will provide the underpinning of growth in several areas. Most broadly, we would expect that fiscal stimulus efforts will increase, all else equal, under the current power structure. More stimulus is likely to lead to more short-term economic growth and a stronger consumer recovery, while relieving the onus on monetary policy (Federal Reserve bond purchasing and low interest rates) as the dominant policy measures to expand growth. It is widely expected that fiscal stimulus will expand beyond direct payments to include spending on infrastructure, clean energy investment, and state/local funding to offset budget shortfalls that otherwise would detract from growth. Between vaccine success and pro-growth fiscal policies that already supplement highly stimulative monetary policy, short-term growth expectations seem robust. There still exists an element of risk, however, because the ultimate path of COVID- 19 is far from certain. Longer-run ramifications of increased stimulus and the ultimate path of long-term interest rates and inflation also gives us pause in extrapolating robust market gains well into the future. As has been discussed in previous letters, certain pockets of the market have become provocatively expensive, such as high-growth technology, pandemic beneficiaries, clean energy (Tesla), and even alternative asset classes for which there are no valuation paradigms (Bitcoin). Speculative fervor is alive and well.
• The Fund will seek to participate in emerging themes to the extent we are able to uncover competitively advantaged and fairly valued companies that produce solid earnings and free cash flow. We will continue to monitor portfolio risk levels to ensure the Fund is protected from violent swings in expectations around the direction of monetary policy, the future path of inflation, and the resulting impact both could have on the price levels of highly valued companies. As always, we look forward to updating you next quarter. Thank you for your continued investment in Ivy.

The opinions expressed are those of the Fund’s manager 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, 2020, 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.

Top 10 holdings as a % of net assets as of 12/31/2020: Microsoft Corp. 7.0, Apple, Inc. 5.2, Fiserv, Inc. 4.1, Amazon.com, Inc. 3.5, JPMorgan Chase & Co. 3.4, United Healthcare Group, Inc. 3.0, Morgan Stanley 2.9, Union Pacific Corp. 2.7, Alphabet, Inc. 2.6 and NextEra Energy, Inc. 2.6.

The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. It is not possible to invest directly in an index. All information is based on Class I shares.

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Because the Fund is generally invested in a small number of stocks, the performance of any one security held by the Fund will have a greater impact than if the Fund were invested in a larger number of securities. Although larger companies tend to be less volatile than companies with smaller market capitalizations, returns on investments in securities of large capitalization companies could trail the returns on investments in securities of smaller companies. 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. 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.