Ivy High Income Fund

Ivy High Income Fund
03.31.17

Market Sector Update

  • Several events impacted the credit markets during the first quarter of 2017. The ten-year Treasury rate fell 13 basis points to 2.33% while the two-year note rose almost seven basis points to 1.26%, resulting in a flattening of the yield curve. As we have officially entered a tightening cycle with the Federal Open Market Committee (Fed) delivering another rate hike on March 15th, bond holders contemplated the third hike of the present cycle with projected raises on the horizon. A flight-to-quality occurred at quarter end as the Republicans were unable to repeal the Affordable Care Act and investors contemplated a similar ending for any upcoming tax proposal brought to the table.
  • On March 15 the Federal Open Market Committee (FOMC) delivered another rate hike, the third of the present cycle with projected raises on the horizon. A flight-to-quality occurred at quarter end as the Republicans were unable to repeal the Affordable Care Act (ACA), as investors contemplated a similar ending for any upcoming tax proposal brought to the table.
  • The non-investment grade credit markets continued to grind higher after coming off one of the most impressive oneyear rallies in recent memory. Although not quite keeping pace with the equity markets, the BofAML US HY Master II Index rose 2.71% during the first quarter. Despite overarching macro concerns such as uncertainty with the new Trump administration, tensions in North Korea and volatility in commodity prices; the appetite for yield remains.
  • As non-investment grade prices pushed higher, credit spreads narrowed (38 basis points) and yields indicatively pushed lower. Early March witnessed yields falling below 6% and hitting a multi-year low in the cycle, representing a fairly rich environment for high yield securities. As default activity continued downward, this also pushed valuations higher. The spread on the Bank of America High Yield Index (BOFAHY) ended the quarter at 392 bps, down from 705 bps just one year ago on March 31st, 2016. Tightening of this magnitude has only been seen in two of the last 16 years. Yields on the index were 5.9% at quarter end.
  • New issuance was robust throughout the quarter and totaled $98.7 billion. This was a record quarter of issuance (8th on record) although the majority of the activity was rooted in refinancing.
  • Flows into the high yield mutual fund category were negative for the quarter, equaling -$7.4 billion. This comes after a strong year of inflows in 2016.

Portfolio Strategy

  • The Fund outperformed the benchmark (before the effects of sales charges) for the quarter. Outperformance was attributed to a variety of factors including the Fund’s relative overweight to CCC rated securities, favorable sector allocation, and bottom up individual security selection.
  • Considering YTD performance by credit rating, CCCs have led the pack returning 4.28%, followed by Bs with a gain of 2.33%, then BBs with a 2.02% return. Although the strategy is driven by fundamental, bottom up research selection rather than a quality or sector bias, the Fund’s allocation to CCC paper and loans will allow it to be less interest rate sensitive in a rising rate environment.
  • All of the sectors within the high yield categories were positive for the quarter with the exception of the retail sector, which was down -2.35%. An overweight by sector versus the benchmark and individual credit selection within consumer goods and leisure contributed to performance throughout the quarter.
  • A slightly higher allocation to cash (4.96%) detracted from performance for the quarter in a rising market environment. Credit selection within the healthcare and retail sectors also had a negative impact to performance.

Outlook

  • The stock market is continuing to rally around the belief that President Trump will reduce regulation and taxes on businesses, although neither has been put in place at this time. Manufacturing activity has seen increases in productivity and the White House is requesting as much as a 60% increase in defense spending, which could translate to large infusions of cash and productivity into the sector.
  • We are also starting to see signs of inflation, and the Fed has stepped in with two rate increases in the last six months (Dec. 2016 and Marc. 2017), with as many as two more anticipated in 2017, in an effort to normalize policy and draw down monetary support for the economy.
  • It is our view that finding value in the high-yield market has become increasingly more difficult, and considerable caution is warranted in making new investments. The global reach for yield has kept demand at all-time highs - credit spreads were 392 basis points at fiscal year-end, after narrowing 313 basis points over the timeframe. As such, we believe our continued process of bottom-up, in-depth fundamental research and analysis will guide us to those investments where the risk/reward is in our favor. We also think with the potential of a continuation of rising interest rates accompanied by the possibility of a more active Fed, the ability to continue to invest in loans will be an attractive differentiator for the Fund. We believe our relative underweight to bonds may prove beneficial, as we believe bonds may have more downside risk over the next 12 months.

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 March 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.

Diversification is an investment strategy that attempts to manage risk within your portfolio but it does not guarantee profits or protect against loss in declining markets.

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. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. 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.

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Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which can be obtained from a financial advisor or at www.ivyinvestments.com. Read it carefully before investing.