Ivy IG International Small Cap Fund

Ivy IG International Small Cap Fund
12.31.18

Market Sector Update

  • International small-cap equities delivered a negative return for the quarter, its second worst quarterly performance since the 2008 financial crisis. The 2011 European debt crisis was the last time international equities experienced such negative performance in recent years.
  • In Europe, concerns over Italy’s fiscally aggressive budget plans weighed on financial stocks and pushed peripheral bond spreads wider. The Brexit saga continued, with British Prime Minister Theresa May unable to garner domestic support for her withdrawal agreement with the European Union, forcing a delayed parliamentary vote.
  • Increased trade tensions between the U.S. and China was a significant driver of equity sentiment with increasing concerns around a slowdown in the Chinese economy. When taken in the context of the withdrawal of liquidity by the U.S. Federal Reserve (Fed) through quantitative tightening, equity markets were marked significantly lower over the quarter.
  • Across international markets, the strongest performing sectors were utilities, real estate and consumer staples, while energy, information technology and industrials underperformed. Brent Crude fell by 35% over the quarter, while bond yields also moved lower. The 10-year U.S. Treasury yield closed the year at approximately 2.7%, a significant move from the 3.2% levels of November.

Portfolio Strategy

  • The Fund performed in line with the benchmark though posted a negative return for the period. At the country level, strong stock selection in Australia, the U.K., Switzerland and Spain benefitted performance, while poor selection in Ireland and Germany was a determent to performance.
  • Asia-Pacific allocations contributed positively to performance over the quarter, helped by defensive stock selection within Australia – namely overweight allocations to metals and mining firm, Evolution Mining Ltd., and electric utility, Spark Infrastructure Group. This was partly offset by the Fund’s overweight allocation to the underperforming Japanese market. In general, the Fund’s overweight allocation to the Asia-Pacific region benefitted performance as the region outperformed Western Europe during the quarter.
  • Top relative individual contributors to performance for the period included Evolution Mining Ltd., GLP J-REIT, a Japanese real estate investment trust, and Telepizza Group S.A., a hotels, restaurants and leisure company based in Spain.
  • Three new positions were added in the Asia-Pacific region over the quarter. Of note, the Fund participated in the initial public offering (IPO) of Arteria Networks Corp., the owner and operator of an independent fiber optic network in Japan. We believe this asset has an attractive valuation given the growing demand for data transmission. In Australia, the Fund initiated a position in Nufarm Ltd., an agricultural chemical producer. We view the company as a potential acquisition target, while the company’s omega-3, canola-based fish feed business could provide a strong driver of future growth. In South Korea, non-life insurance Hyundai Marine & Fire Insurance Co. Ltd. was added for its defensiveness and domestic market pricing power, which we believe may drive future earnings growth.
  • During the period, negative relative performance resulted from overweight positions in Premier Oil plc, a U.K. energy company, Total Produce plc, an Ireland based food and staples retailing firm, and TechnoPro Holdings, Inc., a Japanese professional services company. Premier Oil was negatively impacted by the steep decline in the price of oil, while Total Produce experienced the negative effects from an E.coli outbreak that adversely impacted its salad business.
  • In the U.K., the Fund initiated a position in Rightmove plc, the largest U.K. property portal with close to 80% market share. We believe its dominate market share is vital for the company to maintain a successful platform business as recurring subscriptions drive revenue. We believe the company delivers attractive operating margins and generates significant cash, the majority of which is returned to shareholders.

Outlook

  • We believe the principle risk in Europe is the ongoing Brexit saga, with the U.K. parliament expected to vote on the current proposed withdrawal agreement during January. Elsewhere in Europe, the reform agenda of President Macron continues to get sidelined as public protests have forced the French government into significant concessions around pensions, low paid workers and the scrapping of a planned fuel tax increase.
  • The recent decline in equity markets – particularly in the U.S. – is likely to cause the Fed to slow its pace of rate hikes, at least until conditions stabilize. Sharp equity market declines are also likely to impact the calculus of President Trump as his administration seeks to negotiate a trade deal with China, where the macroeconomic data is also showing signs of strain. We think it is reasonable to expect a watered-down trade agreement in the first quarter, with the second quarter to show signs of bottoming out of the Chinese economy as the impact of stimulus is recognized. Given current valuations, such a scenario would likely lead to a strong re-rating of equity valuations, most acutely in North Asia.

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 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.

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 12/31/2018: GLP J-REIT 2.1%, SCSK Corp. 2.1%, &br;Komeda Holdings Co. Ltd. 2.0%, Okamura Corp. 2.0%, Matsumotokiyoshi Holdings Co. Ltd. 1.9%, Aistom 1.8%, Kenedix Office Investment Corp. 1.7%, Rubis Group 1.7%, Manulife U.S. REIT 1.6% and Maxwell Holdings Ltd. 1.6%.

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.