Ivy Emerging Markets Equity Fund

Ivy Emerging Markets Equity Fund
12.31.18

Market Sector Update

  • Emerging market equity returns were negative for the quarter, although they outperformed developed market equities. Both emerging and developed equity markets continued to experience significant volatility, especially during December.
  • Mexico was the worst-performing major emerging market in the quarter – down about 19% in U.S. dollar terms – as newly elected President Andres Manuel Lopez Obrador proposed what were widely considered market unfriendly initiatives.
  • China’s market declined about 12% in dollar terms because of concerns about a continued slowdown in the economy and the threat of additional export tariffs.
  • The best-performing emerging markets were Brazil, which was up about 14% in dollar terms with the election of President Jair Bolsonaro; Indonesia, up nearly 10% as economic activity stabilized; and India, up just under 3% as the country benefitted from falling energy prices and an appreciating currency.
  • Energy prices continued to decline until an agreement was reached in early December by OPEC and non-OPEC partners in which Russia, Canada and Saudi Arabia cut output targets beginning in January 2019. They sought to offset a less-than-expected decline in Iranian crude exports after U.S. sanctions and continued growth in U.S. shale oil production.
  • After meeting at the G20 economic summit in Buenos Aires, the U.S. and China agreed to a 90-day pause on increasing the rate of tariffs. It remains uncertain as to whether they will meet a March 1 deadline for a comprehensive agreement or even a framework for new trade terms.
  • Global trade began to slow during the quarter, driven by a variety of factors. It is expected that the U.S. economy will continue to grow but at a materially slower rate, which may in turn lead to a pause in U.S. Federal Reserve (Fed) rate hikes and affect the relative performance of the dollar versus emerging market currencies. Slowing economic growth in China also negatively affected investor confidence across many markets.

Portfolio Strategy

  • The Fund had a negative return for the quarter and slightly underperformed the negative return of its benchmark index.
  • Holdings in the chemical, biotechnology and information technology sectors were detractors from performance. For example, chemical holdings were hurt by the sharp fall in crude oil prices, which temporarily squeezed petrochemical margins. In addition, several holdings related to the internet and technology hardware were hurt during the quarter by negative market sentiment prompted by fears of end-market slowdowns.
  • The Fund benefitted from an overweight position relative to the benchmark to Brazilian financials and energy, which outperformed leading into the Brazilian presidential election. Securities selection in financials in India and South Africa as well as exposure to property stocks in China also were contributors.
  • At quarter end, the largest country overweight positions were in Brazil, India and Russia. The largest country and regional underweights were to Taiwan, South Korea and the member states of the Association of Southeast Asian Nations (ASEAN).
  • The Fund’s largest sector overweight positions were in consumer discretionary, energy and real estate, while the largest underweights were in consumer staples, communication services and industrials.

Outlook

  • We think global growth – while still at a healthy positive level – will slow from 2018 as a result of tighter monetary policy and declining fiscal stimulus in the U.S. as well as the drag from the ongoing trade wars and tariffs between the U.S. and China. While it appears there may be a thaw in the ongoing trade tensions, it is not clear how or if they will reach a complete resolution. We are positioned in cautiously optimistic terms for status quo in the trade war and no further escalations.
  • We believe China has started loosening domestic policy and expect an easing of regulatory, monetary and fiscal policies. We think such a move will support its economy. We already see early measures that are benefitting China’s private sector, personal consumption and infrastructure spending and we think more measures are on the way.
  • Brazil is still in the early stages of a recovery after a record-setting recession. We think valuations remain attractive for equities. Inflation is under control, which we think will allow the central bank to keep rates lower for longer. We are getting early positive details of the form, timing and magnitude of fiscal reforms, but we think implementation will be challenging. Privatization of state-owned companies is likely to provide a budgetary buffer, but we think pension and social security reform will be difficult.
  • In our view, India continues to add an attractive risk profile to the Fund by being relatively immune to the traderelated headwinds elsewhere in Asia. We continue to find what we believe are attractive secular growth stories in financial services, energy and the consumer space. The fall in oil prices also has been a benefit.
  • The Fund is underweight some major emerging markets, such as Mexico, where President Lopez Obrador has already proposed a range of measures that we believe are market unfriendly. The Fund also is underweight South Africa, where national elections scheduled in May could result in a further dilution of the ruling African National Congress Party.
  • Elections may impact fiscal and monetary policies elsewhere in 2019, with India, Indonesia, Turkey and South Africa among the more significant countries to watch.
  • We think valuations remain a supportive theme for emerging markets. While not at extreme discounts in both absolute and relative terms when compared to developed markets, valuations are below historical median levels. Overall, emerging market equities ended the year trading at 10 times the 2019 consensus estimates of projected earnings, a 27% discount to developed markets. We think earnings growth in U.S. equities will moderate significantly, again making emerging market equities look relatively more attractive.
  • We believe positive secular themes continue to propel companies related to technology, the internet, biotechnology, financial services and middle-class consumption, and these remain an integral part of the Fund.

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, 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.

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. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. 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.