Ivy IG International Small Cap Fund

Ivy IG International Small Cap Fund
03.31.18

Market Sector Update

  • International small cap equities delivered a positive return over the quarter, a resilient outcome given the return of volatility across risk assets and when compared to the negative returns generated for international large cap and global equities over the same period.
  • The strongest performing sectors over the quarter were information technology, utilities and consumer discretionary, while the materials, telecommunications and consumer staples sectors underperformed. Despite the increased market volatility, traditional safe-haven sectors did not outperform as the expectation of higher interest rates weighed against the bond-proxy characteristics of traditional defensives.
  • Numerous political events occurred over the quarter. Vladimir Putin won the Russian presidential election, securing 77% of the votes. The U.S. government entered a partial shutdown as the bill to extend government funding could not be finalized. In Italy, the Five Star Movement emerged as the single largest party in the Italian elections, securing 32% of votes, while the center-right coalition secured 36% of the votes. In Germany, the Social Democratic Party voted in favor of forming a new coalition government with Angela Merkel’s block.

Portfolio Strategy

  • The Fund delivered a positive return and outperformed the benchmark (before the effects of sales charges) for the quarter. Top individual contributors to performance included: Daifuku Co Ltd., a material handling systems provider that has benefited from the secular trend of automating processes in warehouses and distribution centers; Sartorius AG, a German life sciences company providing equipment for the manufacture of biologic drugs for pharmaceutical companies and laboratory equipment for academia; and Nippon Gas Co. Ltd., a Japanese liquefied petroleum gas retailer benefiting from a phase of customer expansion amid energy system reform. It is important to note the Fund exited its position in Daifuku Co Ltd. on growth potential concerns after several years in the portfolio.
  • Within Europe, the Fund remains overweight growth areas in the information technology and consumer space, while maintaining the pre-Brexit underweight to the U.K. We continue to have a bias to the Eurozone, with significant country overweights in Germany, France and Ireland. Within Europe, we eliminated some holdings in the portfolio which had performed well, but we questioned their growth potential moving forward. These holdings included: Royal DSM Heerlen, a Dutch performance materials and nutrition company; Faurecia S.A., the French auto components company; and United Internet AG, a technology holding company which offers telecommunication and web-hosting services.
  • Within Asia, the Fund made no major changes to country weightings and maintained its strategic overweight in Japan. Within the region, two positions were eliminated which included Daifuku Co Ltd.(as previously mentioned) and Man Wah Holdings Ltd. – a Chinese furniture manufacturer reliant on the U.S. for approximately 40% of its sales. The position was sold in February as we believe valuations did not reflect risks from a higher tax rate. While Chinese furniture imports into the U.S. have not yet been targeted, the stock began to reflect rising trade tensions in March.
  • Tadano Ltd., Japan’s largest mobile crane operator, was added to the Fund in January on attractive relative valuation. We believe the company is conservatively managed by the founding family and has attained more than 30% global market share in its niche category of construction equipment, while earning healthy returns on its capital through the cycle.

Outlook

  • While the global growth outlook remains broadly positive, some near-term economic indicators 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, our portfolio remains tilted to the domestic economy.
  • We think neither the U.S. nor China want or can afford a large-scale trade war. As such, the parties involved are moving closer to the negotiating table. And although tariffs imposed thus far will have limited economic impact, we recognize that markets will likely remain volatile as headline risks remain in the near term.
  • The fiscal year for most Japanese companies ended March 31, and we anticipate earnings season will be challenging, particularly for exporters as they provide earnings guidance based upon a yen that is ending the year 4.5% stronger than its 2017 average rate relative to the U.S. dollar. To guard against this risk, we have tilted the portfolio toward domestic-demand companies where a strong currency is neutral, or even a tailwind. However, we will use weakness emanating from overly conservative guidance as a buying opportunity for our exporter names.

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, 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 03/31/2018: Matsumotokiyoshi Holdings Co. Ltd. 2.3%, Rubis Group 2.2, Total Produce plc 2.0%, NGK Spark Plug Co. Ltd. 1.9%, Teleperformance SE 1.8%, Sopra Steria Group S.A. 1.8%, TechnoPro Holdings, Inc. 1.8%, OSG Corp. 1.8%, SCSK Corp. 1.7% and Zeon Corp. 1.7%.

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.