Ivy IG International Small Cap Fund

Ivy IG International Small Cap Fund
06.30.18

Market Sector Update

  • International small-cap equities delivered a negative return of approximately 1.6% over the quarter, with an unsettling geopolitical backdrop more than offsetting resilient economic and earnings data.
  • Economic data released during the quarter pointed to steady growth in European gross domestic product (GDP), though at a slower pace than last year. In Japan, a positive surprise on industrial production and inflation data provided comfort following sluggish GDP growth in the first quarter. Despite the broadly stable macroeconomic picture, volatility remained elevated with geopolitical tensions remaining in focus.
  • The strongest performing sectors over the quarter were energy, consumer staples and health care, while financials, industrials and consumer discretionary underperformed. Despite muted performance during the first quarter, traditional safe havens outperformed during the second quarter, with escalating geopolitical tensions trumping concerns over the impact of rising interest rates on the bond proxy characteristics of traditional defensives.
  • Politics continued to add volatility to the markets, with trade tensions between the U.S. and its largest trading partners dominating headlines. The Trump administration began levying tariffs on goods ranging from steel to semiconductors, prompting retaliatory action from a number of its trading partners.
  • In Europe, a governing coalition between the League and the Five Star Movement was formed in Italy, following two months of political impasse. Despite much anti-Euro rhetoric during the election campaign, the new administration reaffirmed the country’s commitment to the single currency once in office.

Portfolio Strategy

  • The Fund posted a negative return for the quarter but outperformed the benchmark. Strong stock selection in the consumer discretionary and energy sectors drove relative gains. Premier Oil plc, an international oil and gas exploration company, which benefited from the continued resurgence of global oil prices and a positive production update over the quarter, was the top individual contributor to performance for the period. Ubisoft Entertainment S.A., a French based video game developer, was also a strong contributor, buoyed by record operating results as well as a partnership announcement with Tencent Holdings Ltd., which we believe should result in an acceleration of revenue growth in China.
  • Within Europe, the Fund remains overweight perceived growth areas in the information technology and consumer space. No major changes to country weightings were made over the quarter. The Fund continues to maintain a bias to the eurozone, with significant country overweights in Germany, France and Ireland. Within Europe, we eliminated a few positions in the portfolio where we felt relative upside was limited, including Arrow Global Group plc (U.K.-based debt purchase and asset management business) and Biotechnology Research and Information Network AG (German biotechnology company).
  • Within Asia, the Fund added to its overweight position in Japan. We believe Japanese small caps, with their large domestic sales exposure, should be resilient if global trade concerns accelerate given the wide moat many have within the domestic market. On the other hand, commercial kitchen equipment maker Hoshizaki Electric Co. Ltd. was sold as we felt the diminishing growth outlook could not support the valuation. Komeda Holdings Co. Ltd. was added to the Fund in June. The company operates a chain of more than 850 franchised coffee stores outside of major urban areas in Japan. We believe the company has an attractive combination of defensiveness (most risk borne by its franchisees) and growth (ambitious store targets seem likely to be met, which we think can be met by existing franchise owners expanding store count). We believe Komeda is deeply undervalued as the firm’s capital light model allows for generous returns to shareholder by way of a 50% payout ratio.

Outlook

  • While the global growth outlook remains broadly positive, geopolitical tensions remain elevated and a number of near-term data points have weakened albeit from elevated levels. Following a strong year in 2017, we remain conscious of the downside risks for markets, and continue to monitor the potential impacts of tighter monetary, financial conditions and the maturity of the business cycle, particularly in the US. Global trade tensions have the potential to further increase volatility across equity markets, with emerging markets and Japan most vulnerable given their export exposure and manufacturing sector size. Within Japan, the Fund remains tilted to the domestic economy as we anticipate a rise in part-time wages, combined with the weaker yen and higher oil prices, to drive a modest but unexpected increase in inflation as the year progresses.
  • While the U.S. and China adopted a more combative trade posture over the quarter, neither country wants nor can afford a large-scale trade war. As a result, we believe the parties involved are likely to move closer to the negotiating table as the year progresses. Tariffs imposed thus far are likely to have limited economic impact, though we are cognizant that markets will remain volatile and present opportunities as they react to headline risks.
  • Key to the coming quarters will be how China responds to slowing domestic consumption and capital investment. While the country’s resolve to tighten policy to allow for financial deleveraging and improve environmental conditions has surprised thus far, if the impact of a trade war deepens to slow growth further, some easing of fiscal and monetary policy seems likely.

The opinions expressed are those of the Fund’s managers for Class I shares and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 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.

The Fund is sub-advised by I.G. International Management Limited, which delegates to its subsidiary, I.G. Investment Management (Hong Kong) Limited, for additional portfolio management responsibilities. References to I.G. International Management Limited include both entities.

Seamus Kelly was added as an additional portfolio manager on the Fund in January 2018.

Top 10 Equity Holdings as a percent of net assets as of 06/30/2018: Matsumotokiyoshi Holdings Co. Ltd. 2.4%, SCSK Corp. 2.1%, Teleperformance SE 2.0%, TechnoPro Holdings, Inc. 2.0%, Tsubaki Nakashima Co. Ltd. 1.9%, NGK Spark Plug Co. Ltd. 1.9%, Sopra Steria Group S.A. 1.9%, Shimadzu Corp. 1.8%, Rubis Group 1.8% and Okamura Corp. 1.8%.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. 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. Investing in small-cap stocks may carry more risk than investing in stocks of larger more well-established companies. The value of a security believed by the Fund’s manager to be undervalued may never reach what the manager believes to be its full value, or such security’s value may decrease. 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.