Ivy IG International Small Cap Fund

Ivy IG International Small Cap Fund
06.30.17

Market Sector Update

  • International markets delivered positive returns over the second quarter of 2017 in U.S. dollar terms, helped by the weakness in the U.S. dollar which was most evident relative to the euro.
  • Across international equities, small caps outperformed large caps over the quarter continuing the year-to-date trend.
  • Corporate earnings momentum remains more resilient thus far in 2017 than has been the case for a number of years, which we believe should be positive for equities. Focus will now turn to second quarter reported earnings, and company guidance will need to confirm expectations to support equities for the remainder of the year.
  • Stand out macroeconomic moves over the quarter were the strength in the euro, weakness in the price of oil and the move lower in bond yields, although yields did begin to move higher late in the quarter.
  • Politics remained center stage during the quarter – the victory of Emmanuel Macron in the French presidential election was taken positively by markets. In the U.K. the conservative party called a snap election to secure a strong mandate ahead of the Brexit negotiations. This strategy had the opposite effect, as the stronger-than-expected showing of the Labor party left the conservatives short of a majority. We remain cautious on the U.K., and the weakened position of the government ahead of negotiations with the European Union (EU) only adds to the uncertainty around Brexit.
  • Economic data from the eurozone remained strong over the quarter, generally exceeding expectations. This stronger data from eurozone and a more hawkish tone from the European Central Bank (ECB) was the catalyst for the euro’s strength versus the U.S. dollar and Japanese yen. Against the backdrop of a stronger euro, we believe small cap stocks, given their greater domestic exposure, should continue to outperform their more export orientated large cap counterparts. We believe the continued positive economic data from the eurozone further supports the domestic recovery story and the small cap investment case
  • Although the U.S. Federal Reserve (Fed) hiked interest rates for the third time in six months, bond yields moved lower for most of the quarter. Against this backdrop, investors questioned the “reflation trade” favoring financial and cyclical stocks, which began in late 2016 and rotated back toward growth sectors.

Portfolio Strategy

  • The Fund delivered a positive return and performed in line with the benchmark (before the effects of sales charges) for the quarter. Stock selection effects were the main drivers of performance as a number of the Fund’s holdings, particularly within the consumer discretionary and technology sectors, outperformed.
  • Top individual contributors to performance included the plant engineering group Duerr AG, gaming software company Ubisoft Entertainment S.A. and the Japanese material handling company Daifuku Co. Ltd. (holdings represent 1.7% of Fund net assets, respectively).
  • Within Asia, exposure to Japan was reduced in sectors we perceive as having reached levels where valuations have become less justifiable, namely information technology and industrials. However the overweight Japan position was maintained. The Fund reduced its underweight position in the Australia, adding to consumer names that we believe present compelling valuation opportunities, while reducing the materials exposure.

Outlook

  • We believe the improved outlook for global growth is supportive for international equities, as historically both European and Japanese markets have tended to outperform during such periods.
  • We continue to see a number of improving factors in Europe such as a return to positive loan growth, falling unemployment and improving economic lead indicators. With French election risk now removed, an improving eurozone domestic economic backdrop and attractive relative valuations, the investment case for the region remains supportive.
  • As major central banks other than the Bank of Japan discuss policy normalization, we believe there is a clear path to a weaker yen versus the U.S. dollar and euro, which will act as a tailwind for exporter earnings. Japan's reformminded Prime Minister Abe has seen a sharp decline in his approval rating, which we do not view as fatal, but is likely to see a rise in public-sector spending via a supplementary budget later this year. This is likely to further support domestic demand against what is already a very strong macro backdrop, with Japan now in the midst of its longest period of uninterrupted quarterly gross domestic product (GDP) expansion in more than a decade.
  • We will continue to search for opportunities at a company level where we believe the growth opportunity is not fully recognized by the market. Equity markets may see some consolidation over the summer months following a strong first half to the year, but we are optimistic on the outlook for the Fund.

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 June 30, 2017, 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.

Class R6 shares were renamed Class N on March 3, 2017.

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.

IVY INVESTMENTS® refers to the investment management and investment advisory services offered by Ivy Investment Management Company, the financial services offered by Ivy Distributors, Inc., a FINRA member broker dealer and the distributor of IVY FUNDS® mutual funds and IVY VARIABLE INSURANCE PORTFOLIOS℠ , and the financial services offered by their affiliates.