Ivy IG International Small Cap Fund

Ivy IG International Small Cap Fund
09.30.18

Market Sector Update

  • International small-cap equities delivered a negative return for the quarter, with growing trade protectionism risks, limited progress on Brexit negotiations and Italian budget concerns all weighing on market sentiment.
  • Despite an upbeat presentation by European Central Bank (ECB) President Mario Draghi at September’s meeting, expectations for eurozone GDP growth drifted lower in recent months. Economic survey indicators highlight how trade concerns are now weighing on sentiment, with eurozone manufacturing (new orders) declining to mid-2016 levels. In Japan, Shinzo Abe secured a third term as president and should now remain in power until 2021.
  • Emerging-market sentiment was hit by volatility in Turkey, driven by political concerns combined with a deteriorating fiscal balance, a large current account deficit and rampant inflation with the Turkish lira in freefall over the quarter. Elsewhere, U.S. and China trade talks delivered little progress, increasing the risk of further tariffs.
  • Across broad international markets, the strongest performing sectors over the quarter were health care, telecommunication services and energy, while real estate, utilities and consumer discretionary underperformed. There was some divergence in oil prices over the quarter, but overall the commodity was well supported with Brent Crude gaining approximately 4% while West Texas Intermediate was flat. Bond yields, while range bound early in the quarter, rose from late August through quarter end with the U.S. 10-year Treasury ending the quarter above 3%.

Portfolio Strategy

  • The Fund posted a negative return and underperformed the benchmark for the quarter. Poor stock selection in consumer discretionary, materials and real estate drove relative underperformance.
  • Within Asia, three themes drove poor performance, including poor quarterly earnings results, profit taking by retail investors and exposure to the Chinese consumer. Despite the short-term setback, we believe many of our holdings are well positioned going forward and maintain attractive relative valuations. We retain a constructive position on the medium-term outlook for Chinese household consumption, despite trade war headline risk over the shorter term.
  • Underperformance in Europe was largely stock specific, with TP ICAP plc and Sopra Steria Group S.A. top relative detractors to performance (0.7% and 1.6% of Fund net assets, respectively). That said, stock selection in Germany was strong, with an allocation to Fuchs Petrolub SE a top relative contributor (1.1% of Fund net assets).
  • At quarter end, the Fund’s largest country allocations included Japan (37.5%), the U.K. (13.4%) and France (9.0%).

Outlook

  • While equity markets outside of the U.S. have already moved to discount the recent deterioration in the global growth outlook, the near-term investment backdrop remains challenging. We remain conscious of the downside risks for markets and continue to monitor the potential impacts of tighter monetary policy, financial conditions and the maturity of the business cycle, particularly in the U.S.
  • 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. The ongoing trade war between the U.S. and China appears poised to escalate further in the final quarter of 2018.
  • The agreement of a new trade deal amongst the U.S., Canada and Mexico to replace NAFTA poses minimal risks to Japan’s automobile manufacturers and their supply chains. Within Japan, the Fund remains tilted to the domestic economy. We continue to anticipate that a rise in wages, combined with the weaker yen and higher oil prices, will drive a modest but unexpected increase in inflation expectations as the year progresses. Given the paltry yield on Japanese government bonds, a rotation into Japanese equities by domestic investors is expected.

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 Sept. 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.

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.