Ivy High Income Fund
Commentary as of March 24, 2020
Could you touch on performance relative to your expectations? What are you doing in the Fund?
As of Feb. 20, the portfolio was outperforming 95% of its Morningstar peers. As of yesterday, the Fund is only outperforming roughly 15% of its Morningstar peers. The downdraft has been so swift and dramatic that the ability to move in and out of risk isn't realistic - it can't be done. I do think we'll get through this. We have maintained cash at about 3-4%, and outflows have been very manageable. Issues that have sold off the most, we're holding. We continue to have conviction in our investment theses. Analysts are stress testing issues in their universe, and we're looking at what companies' balance sheets will look like given a 1-month, 2-month or 3-month lockdown. We think we’re positioned well to snap back, but the biggest unanswered question is when the recovery will occur.
How about the loan market?
Leveraged loans have been more impacted from a technical perspective than high yield bonds, in our view. Remember, loans are higher in the capital structure. Year-to-date returns have been just as bad as high yield, down 20-22%, depending on the index, which is similar to 2008. The Fund’s allocation to loans is roughly 25% and that exposure has performed in line with the benchmark. Collateralized Loan Obligations are being forced to sell to keep their ratios in line – many can't have too much in distressed debt (by technical definition) by prospectus. As a result, they're forced sellers in this market because they must maintain those ratios. That's why these investors with drawdown capital are putting money to work. Again, technicals can create the opportunity.
For perspective, how does this market compare to the 2016 energy, metals and mining dislocation, especially with the recent volatility in energy?
High yield credit spreads bottomed in July 2014, and then peaked in February 2016 when oil prices bottomed. Coronavirus is definitely impacting the energy space, but OPEC uncertainty has been an issue. There are some similarities:
- Year-to-date through March 23, energy is down 46% in high yield. The Fund is underweight energy.
- In 2014, OPEC said the same thing it is now – keep production up and not worry about the price. The price of oil bottomed about two months later and didn't look back until recently.
- Dislocations like this have been a buying opportunity in the past.
It seems spreads have widened to reflect default expectations – what are your thoughts regarding default expectations?
Spreads have widened across the credit spectrum with CCC spreads exceeding 1,800 bps. The high yield market prices in defaults well ahead of time - that is happening currently. We believe defaults should definitely tick higher, and retail and energy is likely to be the epicenter of the defaults. In our view, this will be priced into the market well in advance. Companies will continue to work with creditors that can help restructure debt on their balance sheets.
That said, we're watching downgrades more so than defaults, especially as BBB rated companies fall to BB ratings. For example, many large and strong companies being downgraded into high yield are creating opportunities for investors like us. Plus, we should keep in mind that oil isn't going away. Demand may fall, but there could be some opportunities in the better-run companies.
How do you think the Federal Reserve’s latest moves will impact the market?
The Fed's decision to provide unlimited resources to buy investment grade credit and municipal bonds has helped take a little risk off the left-hand side of the tail. In terms of dislocation, this is moderately similar to what we witnessed in 2008. The Fed left some details open to interpretation, but it is basically saying it will make sure liquidity continues to exist.
Historically, these types of environments have been a great buying opportunity. When spreads blow out to levels they’re at now, returns 1-year into the future have almost always been positive, and if you go out beyond a year, they've always been positive. Add on that private equity firms are calling down capital to put to work, we think we’re at a point where it makes sense to be buying.
FOR INVESTMENT PROFESSIONAL USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC.
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. 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.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.