Ivy Crossover Credit Fund

Ivy Crossover Credit Fund

Market Sector Update

  • The U.S. Investment Grade Credit Market posted positive return performance again in the last quarter of 2017. According to Bloomberg Barclay’s fixed income indices, several other sectors also posted positive returns during the fourth quarter, including U.S. corporates, U.S. high yield, U.S. government securities and emerging markets. Domestically, investor sentiment for risk assets continued to be bolstered by expectations that the Trump Administration would be successful at reducing taxes and regulations, thus providing a boost to corporate earnings. Demand for yield in the low global yield environment has remained firmly in place throughout 2017, just as was the case for 2016. The strong global demand for U.S. fixed income is a result of the yield advantage U.S. fixed income provides over both Europe and Asia. Despite record new issuance in the U.S. credit sectors in 2017, the demand for yield and corresponding positive fund flows continued to overwhelm supply, leading to tighter credit spreads.
  • Investment grade spreads tightened 7 basis points (to 89 basis points) in the fourth quarter. High yield spreads widened 14 basis points (to 364 basis points) during the fourth quarter after tightening the same amount in the third quarter. The overall macro-economic environment continued to be generally supportive and stable for U.S. corporate credit. Corporate leverage (as measured by debt to cash flow) declined slightly, but remained at elevated levels in Investment grade, partially as a result of five consecutive years of record new issuance. Thus far, the credit market has largely ignored high leverage, due to the overwhelming demand for yield by both domestic and global investors. Credit spread tightening is being driven by investors’ strong demand for yield, not improving fundamentals. Sector return dispersion remained very low in the fourth quarter. The best performing major sectors in high grade credit during the quarter were basic industry and energy. The worst performing major sectors were technology and banking. Lower credit quality (BBB’s and Crossovers) has continued to out-perform higher credit quality throughout 2017.
  • As was largely expected, the Federal Reserve Board (Fed) raised short-term rates in December, after raising rates by 25 basis points in both the first and second quarters. The move by the Fed led to short term rate increases but had little impact on the longer end of the Treasury curve, as inflation expectations remain muted. Market expectations going forward are for the Fed to raise short term rates two to three more times in 2018. The Treasury curve experienced a significant flattening trend during the fourth quarter. The often-cited two-year to 10-year Treasury spread relationship flattened from 85 basis points to 52 basis points during the quarter. On the long end of the curve, the 30-year Treasury ended the quarter at 2.74 percent, which was 12 basis points higher than at the end of the third quarter. Central Bank policies around the globe are not currently in sync, which could introduce risk and/or volatility into the financial markets in 2018.

Portfolio Strategy

  • The risk-reward relationship in the credit markets did not appear to be particularly attractive during the fourth quarter of 2017. The yield differential between BBB and BB rated credits at the end of 2017 was only 78 basis points, which is quite low from an historical perspective. (The yield/spread differential between higher rated high yield and lower rated investment grade credit can be a good indicator of the risk-reward relationship for credit. A lower yield/spread differential indicates less compensation for risk, in general.) As a result, more conservative positioning within the crossover market continued to be the most prudent strategy. Debt-to-cash flow metrics for investment-grade rated credit is near an all-time high due to the unprecedented amounts of new issuance that has occurred over the last several years. Thus far, the market has overlooked the build-up of leverage as demand for yield has dominated fundamentals. At some point in the future, the increased balance sheet leverage will likely create a significant amount of downgrades from investment grade to high yield. It is reasonable to expect that when the downgrade cycle occurs, better risk-reward opportunities in the crossover market will develop. At the end of the fourth quarter, approximately 87 percent of the bonds in the Fund were rated “BBB” by Standard & Poor’s. Cash was just 3 percent at quarter end, which is in the average expected range of Fund assets.
  • The Ivy Crossover Credit Fund was invested in 50 different names at the end of the fourth quarter, with no investment in any single name above 4 percent. Under normal circumstances, expectations are that the Fund will have 30 to 50 names. The effective duration of the Fund at the end of the fourth quarter was 7.5 years, which was essentially neutral versus the benchmark, the Bloomberg Barclays U.S. Corporate Bond Index. Approximately 91 percent of Fund investments had an effective duration of 10 years or less at quarter-end. Given the uncertainty associated with the Trump Administration, precise timing of the Fed’s short-term interest rate decisions, and unpredictable nature of Central Bank policies outside of the U.S., making significant bets on duration didn’t seem prudent throughout 2017. The Fund’s biggest sector exposures at quarter end were banking, energy, consumer non-cyclicals, consumer cyclicals and capital goods.


  • The financial markets have had remarkable performance in the past several quarters, both in fixed income and equities. Despite that, there are many indications that the market is in the late stages of the credit cycle which has lasted since the Great Recession. From a longer term perspective, the current risk-reward relationship in the credit market is not particularly attractive. In general, Investors are not getting adequately compensated for taking excess risk, as the market appears to be rich/over-bought to some degree. The financial markets have had a “risk-on” sentiment for an extended time period, at least partially fueled by global investors’ quest for yield in a very low yield environment. Therefore, conservative positioning within the credit market seems to be a prudent strategy in the coming quarter. It can be argued that the financial markets are priced close to perfection in multiple asset classes and taking significant risk does not appear to provide adequate risk-adjusted returns.
  • How the financial markets react to potentially higher interest rates is perhaps the biggest risk to market stability in coming months. However, as long as yield differentials between the U.S. and rest of the world remain at elevated levels, U.S. rates are not expected to go materially higher in the near term. As has been the case for several quarters, Central Bank policies inside and outside of the U.S. continue to have a profound impact on the U.S. fixed-income market, both in Treasuries and credit markets. The demand for positive yield from foreign investors is providing an opportunity for U.S. companies to borrow (issue bonds) at very attractive rates. Although the foreign demand has provided a boost to the credit market, it is uncertain how stable this demand will prove to be over the longer-term. Credit metrics for U.S. companies, such as leverage and interest coverage, have been eroding for several quarters as more corporate bonds are issued to meet demand. Should foreign investors reduce their appetite for U.S. credit, the credit market could experience some weakness. Longer term, it seems likely that the yield differential will get smaller as Central Bank policies converge in coming quarters and years. The Fed has repeatedly stated its desire to raise the Fed funds rate at a measured pace. Should the Fed execute on its stated goal of a gradual pace for short-term interest rate hikes, the yield curve is expected to continue to flatten throughout the coming months. However, if the Fed acts inconsistently with market expectations, the financial markets could experience some volatility in 2018.

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 Dec. 31, 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.

The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-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.

Risk factors: The value of the Fund's shares will change, and you could lose money on your investment. 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. 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. 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.