Ivy Funds VIP Energy

12.31.19

Market Sector Update

  • The energy sector posted positive returns during the quarter, but still underperformed the broader equity market.
  • Geopolitical risk remained high during the quarter. Unrest erupted in Iran late in the quarter with protests and an attack on the U.S. embassy in Baghdad, and spilled over into Iraq and the new year. In Iraq, demonstrators began protests against the government and Iranian influence in their country. Iran’s economy continued to struggle from the effects of government policy that has led to higher inflation and unemployment.
  • The “OPEC+” group of producing countries announced a larger than expected cut in production at their meeting in early December. The additional cuts will come from greater compliance and Saudi Arabia’s promise to reduce production voluntarily if other members comply with their quotas.
  • Energy companies are starting to prioritize sustainable free cash flow and increasing returns not production growth. In the U.S., oil production growth is slowing, rig count is lower and capital spending is down as companies change to spending within cash flow. The energy industry also has a growing awareness of ESG investing standards and the demand from many investors to reduce their carbon footprint.

Portfolio Strategy

  • The Portfolio had a positive return for the quarter and outperformed its benchmark.
  • Key contributors to relative performance included holdings in Apergy Corp., Baker Hughes Co., C&J Energy Services Inc., Cactus Inc. and Canadian Natural Resource.
  • Industry allocations were consistent with those of the prior quarter. About 36% of the equity holdings in the Portfolio were allocated to the Oil & Gas Exploration & Production industry segment, followed by about 26% to Oil & Gas Equipment & Services and about 17% to Oil & Gas Refining & Marketing.
  • The Portfolio's allocation to U.S. equity also was steady from the prior quarter at about 91% of equity 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 the additional production cuts by OPEC+ and greater compliance with agreed levels will balance the oil market in the first half 2020 and then move it into a deficit in 2021. We also think natural gas will remain oversupplied in 2020, despite the natural gas rig count holding near record lows.
  • We anticipate that U.S. oil production growth will slow as exploration & production companies change from a growthoriented strategy to focus on more capital discipline and generating free cash flow. Companies are focused on shareholder returns and repairing balance sheets. Spending within cash flow means lower capital expenditures (capex). With the rig count already down more than 20% from its peak, we think a reduction in capex is likely to lead to lower U.S. oil production growth.
  • Demand expectations have improved based on improvements in the U.S.-China trade war, accommodative fiscal policy and forecasts for improving economic growth worldwide. We believe the majority of oil demand growth will continue to come from emerging markets.
  • Geopolitical tensions in the Middle East are likely to continue in 2020 with unrest in Iraq and Iran. We remain concerned about the reliability of oil infrastructure in the region after the attacks in September 2019 on Saudi Arabia oil fields. The security and cost for transportation of crude oil through the Strait of Hormuz also is a concern now, as oil tankers have been attacked.

The opinions expressed are those of the Portfolio’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, 2019, 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 12/31/2019: Concho Resources, Inc., 4.95%; Phillips 66, 4.90%; Valero Energy Corp., 4.64%; Pioneer Natural Resources Co., 4.60%; Marathon Petroleum Corp., 4.13%; WPX Energy, Inc., 3.88%; Cactus, Inc., Class A, 3.66%; Parsley Energy, Inc., 3.59%; Diamondback Energy, Inc., 3.57%; Continental Resources, Inc., 3.55%.

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

Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.