Ivy Energy Fund

Ivy Energy Fund
12.31.18

Market Sector Update

  • World equity markets posted double-digit negative returns in broad market indexes in the fourth quarter with significant volatility again unsettling investors.
  • Volatility hit the oil markets in the quarter, with oil prices rising to a four-year high in October before collapsing more than $30 per barrel in the fourth quarter. Strong supply and demand fundamentals started to deteriorate in the second half of 2018, with concerns about slower global economic growth and its effect on demand; oversupply from OPEC and other producing countries; and stronger-than-expected growth in U.S. shale oil production.
  • The oil market was surprised in the quarter when the U.S. granted waivers for Iranian oil exports to many countries. The waivers and stronger-than-expected U.S. production growth led to the market oversupply.
  • OPEC and non-OPEC partners decided in December to cut production starting in January 2019 by 1.2 million barrels per day for a period of six months. We believe oil demand will continue to grow despite slower global economic growth and the production cuts by OPEC and partner states. We also think the reversal of some of the Iran sanction waivers will help rebalance the world oil market and support oil prices in 2019.
  • 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 in 2019 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 U.S. dollar versus other currencies.

Portfolio Strategy

  • The portfolio posted a negative return for the quarter and underperformed the negative return of the energy benchmark index.
  • Stock selection in the energy sector was the key detractor to performance. The top five detractors relative to the benchmark were Continental Resources, Inc., Whiting Petroleum Corp., Oasis Petroleum, Inc., Parsley Energy and Ensco PLC.
  • About 43% of the portfolio was allocated to holdings in the Oil & Gas Exploration & Production industry segment, followed by about 26% to Oil & Gas Equipment & Services. Those industry segments underperformed the index, and its heavier weighting to integrated oil companies, by 6.8% and 14.0%, respectively. The Fund’s allocation to domestic equity was steady from the prior quarter at about 89% of net assets.
  • The focus of the energy strategy remains on investing in companies that can create value over the full course of the energy cycle. We identify those as companies that are low-cost operators, have strong balance sheets, have the ability to grow profitably and have strong return on capital.

Outlook

  • We believe volatility in the oil market will continue in 2019. The oil markets are concerned about a wide range of market and geopolitical issues, including:
    • Demand growth because of slower worldwide economic growth and the effect of the U.S.-China trade dispute;
    • Greater supply growth because of U.S. shale oil production;
    • Uncertainty about how much OPEC and Russia will cut production, based on the December 2018 agreement, as well as OPEC’s long-term viability as a production cartel;
    • The eventual results in 2019 of the U.S. sanctions on Iran;
    • The impact of reduced production from Venezuela, and the political stability of Libya and the Middle East in general;
    • The fact that very little production is coming off the market when compared to 2018; the U.S., Russia and Saudi Arabia are at all-time highs, and output from Libya and Nigeria has rebounded;
    • Uncertainty about whether U.S. shale companies will demonstrate capital discipline in an environment of lower oil prices;
    • The potential oil market impact of “IMO 2020,” which is the International Maritime Organization’s plan to enforce a lower global sulphur cap on fuel content beginning Jan. 1, 2020, in response to environmental concerns about harmful emissions from ships.
  • Volatility remains a key factor in oil and equity markets, and we think that is likely to continue in 2019.
  • We believe OPEC took a positive and necessary step toward rebalancing the world oil market with its production cut decision and we think the move will help support prices in 2019. We believe that these supply cuts along with continued oil demand growth, despite somewhat slower global economic growth, will eventually lead to a balanced market in 2019.
  • We also think OPEC’s decision gives U.S. exploration & production companies (E&Ps) the “all-clear” to continue maximizing oil production and taking market share, provided they have the cash flow. The U.S. has been the main supplier of new capacity over the last five years, and this is likely to continue for the foreseeable future. Continued supply growth and drilling spending is likely to be a relative positive for E&Ps, oil services and refining companies operating in the U.S.

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.

Top 10 Equity Holdings as a percent of net assets as of 12/31/2018: Concho Resources, Inc., 6.17%; Continental Resources, Inc., 4.77%; EOG Resources, Inc., 4.15%; Pioneer Natural Resources Co., 4.10%; Diamondback Energy, Inc., 3.95%; Phillips 66, 3.74%; Marathon Petroleum Corp., 3.58%; Halliburton Co., 3.56%; WPX Energy, Inc., 3.51%; Valero Energy Corp., 3.25%.

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. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. Investing in the energy sector can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and the cost assumed by energy companies in complying with environmental safety regulations. 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.