Market Sector Update

• For the first quarter of 2021, the S&P 500 Index increased 6.2%, the Fund’s benchmark, and the Russell 1000 Index increased 5.9%. Energy led all sectors for the quarter with a return of 30%. Financials followed, increasing 16%. Industrials rounded out the top three with a return of 11%. The quarter’s worst performing sectors included consumer staples, information technology and utilities. As can be seen by the sector leadership, value stocks – those companies with lower inherent growth rates – significantly outperformed growth stocks for the quarter. Cyclicals – those companies with revenues and earnings closely tied to the economic cycle – outperformed defensives.

Portfolio Strategy

• The Fund modestly outperformed its benchmark for the quarter. Sector allocation and individual stock selection both contributed roughly half of the outperformance. The Fund’s allocation to financials (our largest sector overweight) and stock selection within industrials were the main performance drivers for the quarter.
• United Rentals and Deere & Company drove the strength within industrials. Within financials, JPMorgan Chase & Co., KKR & Co. and Morgan Stanley drove strong relative returns. Take-Two Interactive, Costco and Charter Communications were the worst performing equites during the quarter. Underperformance in these companies was not due to fundamental weakness, but a rotation by market participants out of 2020 “winners.” We continue to have strong confidence in each of these names over a multi-year horizon.
• During the quarter, we made very few changes to portfolio composition. Our only addition to the portfolio was American Express, a company that trades significantly cheaper than the market and peers such as Mastercard and Visa. American Express is expected to see rapid growth in revenue and earnings as consumer spending broadens out. The Fund exited positions in Facebook, Intuit and Walmart Inc. at gains to focus on similar securities within each sector at better reward/risk tradeoffs (Alphabet, Microsoft and Costco).

Outlook

• The impetus for the relative market movements in the first quarter was expectations for a sharply accelerating economy as vaccinations take hold and economies open up, first in the U.S. followed by other parts of the world. The recent signing of the latest $1.9 trillion fiscal stimulus bill and expectations for some portion of President Biden’s $2 trillion infrastructure package to be enacted add further support to a significant acceleration in gross domestic product (GDP) growth for both 2021 and 2022. Ivy economists expect U.S. GDP will rise over 7% in 2021 and over 5% in 2022, providing significant support to revenues and profits for the market. As expectations for faster growth and more stimulus increased, so did bond rates with the 10-year Treasury yield rising from 0.9% at the start of the year to over 1.7% as of quarter end. This relatively rapid increase did affect prices on longer duration securities (growth stocks underperforming value) and provided a boost to financials. We do not fear this increase given the rapidly accelerating growth. At the moment, most market participants expect a sharp rise in inflation in the near term as higher energy prices and base effects (comparisons from 2020) create the illusion of rapid price growth. We believe persistent inflation due to a hot economy and resource constraints (labor, commodities, transportation etc.) is not the consensus base case and thus could create future surprises in both the equity and bond markets.
• Counterbalancing expected profit leverage to U.S. and global economic strength, tax rates are broadly expected to move higher as current proposals call for a hike to the U.S. corporate tax rate to 28% from 21% and a global minimum tax on international earnings. While we don’t know the exact destination of tax rates, we expect taxes to be somewhat of a headwind to corporate profit growth in the future. That said, current consensus expectations for >25% earnings growth for S&P 500 companies in 2021 followed by 15% in 2022 seems broadly realistic in light of analysts’ tendency to underestimate operating leverage early in an economic cycle.
• For several quarters, we had been writing about the growing discomfort with the growth and momentum characteristics of the leadership securities within the equity market. We slowly transitioned the Fund to be more valuation sensitive and, as opportunities presented themselves, moved aggressively to purchase securities where saw significant dislocations in their valuations during the early innings of the pandemic. With value having significantly outperformed growth in the latest quarter, some of the valuation opportunity inherent in the market has dissipated. The leadership or momentum stocks within the market have become, in many cases, value stocks or reopening stocks. Expensive growth stocks have underperformed, though only for a few quarters. Left behind, we believe, are the stable compounders: companies expected to grow revenues 5-10% with valuations about in line with the overall market. These companies are not sexy, they are not on any hedge fund’s “re-opening list,” and they are not cheap enough to be called “deep value” during a rotation to value securities. However, as a group, they have become cheaper. We happen to own several of these securities, such as United Healthcare, the most dominant and integral player within U.S. health care. Another is Aon PLC, an insurance brokerage with expected revenue growth in the mid-single digits but a large catalyst ahead in the potential acquisition of Willis Towers Watson. Finally, Fiserv, which is the Fund’s largest active weighting, is valued at a discount to the market on forward earnings with mid- to high-single digit sustainable revenue growth and leverage to growth in accelerated spending on travel, leisure and in-person venues.
• We believe the Fund’s risk characteristics are well controlled. Though the future looks bright, we are cognizant of growing risks in the form of persistent inflation, aggressive use of leverage by market participants, and a Federal Reserve that will ultimately move away from extraordinary accommodation. As always, we thank you for your interest in our strategy and look forward to updating you next quarter.

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 March 31, 2021, 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 03/31/2021: Microsoft Corp. 7.1, Fiserv, Inc. 4.2, Apple, Inc. 4.0, Alphabet, Inc. 3.8, JPMorgan Chase & Co. 3.3, United Healthcare Group, Inc. 3.2, Amazon.com, Inc. 3.2, Mastercard, Inc. 2.9, Union Pacific Corp. 2.7, and Aon Plc. 2.7.

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.