Market Sector Update

• The U.S. Investment Grade Credit Market had a difficult first quarter of 2018 from a total return perspective, as credit spreads widened and interest rates moved higher. According to Bloomberg Barclay’s fixed income indices, several other sectors had a rough start to the year as well, including U.S. corporates and high yield, which both posted negative returns. Investor sentiment for risk assets was volatile beginning in February, triggered by concerns of future trade conflicts and valuation concerns. Financial market volatility continued throughout the remainder of the quarter. Despite the volatility and poor total return, global demand for U.S. credit remained somewhat firm, as a result of the yield advantage U.S. fixed income provides over other options. New issuance in the first quarter of 2018 was a bit lower than in the prior year, but remained at historically elevated levels.
• Investment grade spreads widened 14 basis points (to 103 basis points) in the first quarter of 2018. High yield spreads widened just six basis points (to 370 basis points) during the first quarter, outperforming high grade spreads. The macro-economic environment continued to be generally supportive and stable for U.S. corporate credit, but market sentiment did soften as the quarter progressed. Corporate leverage (as measured by debt to cash flow) declined slightly, but remained at elevated levels in high-grade credit, as a result of five consecutive years of record new issuance. Until very recently, the credit market has largely ignored elevated leverage, due to the overwhelming demand for yield by domestic and global investors. With increased financial market volatility, sector return dispersion increased slightly in the first quarter. The best performing major sectors in high grade credit during the quarter were communications and energy. The worst performing major sectors were utilities and transportation. Lower credit quality (BBB’s and Crossovers) outperformed higher credit quality in the first quarter, as was the case in all of 2017.
• The Federal Reserve Board (Fed) raised short-term rates 25 basis points in March, after doing the same three times in 2017 (first, second, and fourth quarters). The move by the Fed contributed to the flattening of the yield curve in the latter part of the quarter. The common measure of the shape of the yield curve, the yield difference between the 10- year and 2-year Treasuries, declined to 47 basis points at quarter-end. This relationship at the beginning of the year was 52 basis points, but had steepened considerably earlier in the first quarter. Market expectations going forward are for the Fed to raise short-term rates two to three more additional times in 2018. On the long end of the curve, the 30- year Treasury ended the quarter at 2.97%, which was 23 basis points higher than at the beginning of the year. Finally, the Fed got a new Chairman during the first quarter, Jerome Powell. Although Chairman Powell is not expected to act significantly different than his predecessor, a new Chairman does introduce a bit of uncertainty and potential volatility into the financial markets generally.

Portfolio Strategy

• The Ivy Crossover Credit Fund was invested in 55 different names at the end of the first quarter, with no investment in any single name above 4%. Expectations are that the Fund will have 30 to 50 names most of the time. At times when there are less compelling risk-reward opportunities, the Fund may become slightly more diversified. The effective duration of the Fund at the end of the first quarter was 7.6 years, which was essentially neutral vs. the benchmark, the Bloomberg Barclays U.S. Corporate Bond Index. Approximately 88% of Fund investments had an effective duration of 10 years or less at quarter-end. Given thepolitical landscape, timing of the Fed’s short-term interest rate decisions, and unpredictable nature of global Central Bank policies, making significant bets on duration didn’t seem prudent. The Fund’s biggest sector exposures at quarter-end were capital goods, consumer cyclicals, banking, energy and consumer non-cyclicals.
• The risk-reward relationship in the credit markets did not appear to be particularly compelling at the beginning of 2018. The yield differential between BBB and BB rated credits at the end of the first quarter was 99 basis points, compared to 78 basis points at the beginning of the quarter. (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.) Therefore, the risk-reward relationship was slightly more attractive at the end of the quarter than the beginning. Nevertheless, a more conservative positioning within the crossover market continued to be the most prudent strategy. At the end of the first quarter, more than 75% of the bonds in the Fund were rated “BBB” by Standard & Poor’s. Debt-to-cash flow metrics for investmentgrade rated credit is near an all-time high, yet 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.
• The Ivy Crossover Credit Fund underperformed against its benchmark, the Bloomberg Barclays U.S. Corporate Bond Index, during the first quarter of 2018. The primary reason for the underperformance was the underweight to the front end of the credit curve (one to five year maturities) which significantly outperformed the broader market. In addition, sector allocation was slightly beneficial to relative performance, but individual name selection was a detractor. Flows in and out of the Fund remained fairly stable throughout the quarter.

Outlook

• The financial markets experienced a period of extremely low volatility for most of 2016 and virtually all of 2017. This period of low volatility came to an end in the early part of February 2018. Reasons for the increased volatility include short-term interest rate increases, the threat of potential trade conflicts and asset price valuations that seemed stretched in both the debt and equity markets. Credit spreads have widened in both high grade and high yield since the beginning of February, but we have yet to see panic or significant distress. Should the demand for credit soften materially, we are likely to experience some weakness in credit spreads.
• The Fed has repeatedly signaled its desire to raise the fed funds rate at a measured pace. Current market expectations are for the Fed to raise short term rates two to three more times in 2018. Should the Fed execute on its stated goal of a gradual pace for short-term interest rate hikes, the yield curve is expected to remain fairly flat in coming months. However, if the Fed acts inconsistently with market expectations, the financial markets could experience considerable volatility throughout 2018. The new leadership at the Fed (Jerome Powell) may increase the probability of sustained volatility occurring. How effective the Fed is at navigating the transition to a more “normalized” interest rate policy is crucial to how the financial markets behave 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 Mar. 31, 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. 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.