Ivy International Core Equity Fund
Commentary as of March 20, 2020
The coronavirus has not affected all markets in a uniform way. With developed international markets in your purview, we will look to hear and understand what global market implications may be. We have seen a flight from risk assets, which has included the U.S. dollar strengthening.
We’ll start off by framing the issue of the virus: Italy has roughly 41k cases with 3.4k deaths, which calculates to a death rate of more than 8% with 33k cases remaining active. The importance of social distancing and lockdowns are huge. The death rate seems to be much higher than 1-2% in Italy, but we think their numbers are skewed by low testing. We think numbers in South Korean are the most correct with 8.6k cases and their death rate has hovered around 2%.
What's happened in the markets: Japan was closed last night and is down roughly 26% year to date. The S&P 500 Index is down around 25%. European markets are generally down around 36%. Interestingly, Italy remains in-line with other European countries, down around 35%. As you look across the world and Asia particularly, where they are now on the back end of the curve, the China CSI 300 is down 12%, a solid outperformer. South Korea is down 34%. These markets have been trading off lately as the fallout from the coronavirus looks like a global problem as opposed to a localized short-term problem. Japan is the market that makes the least sense as far as what is going on. In order to stimulate, the government has doubled their purchases in the stock market – one of the few countries doing that as a solution.
When we see sizeable market dislocations, we look for mispricing between similar assets. If two companies have similar global exposure, but one is down 50% and the other is down 30% then we'll be buying the company down 50% and selling the stock down 30% if we own it.
Given the flexibility of your mandate regarding regions, countries and companies, what are your thoughts on areas to avoid or where attractive return potential exists?
We are not dramatically changing our positioning. We have slightly increased the cyclical weighting but are still underweight cyclicals, cash remains around 5-6%, and gold at 2%. We aren't dipping into the unknowns like airlines or hotels, but are buying stocks that are down significantly and are in industries we expect to be more stable based on our long-term understanding. For example, we have been buying a European IT consulting company that has been down significantly more than peers, but we believe with similar fundamentals. This is a situation where we have, what we feel is, a risk/reward advantage. Outsized downsides create opportunities and we try act opportunistically while keeping the structure of the Fund the same.
We think while the markets rallied the last couple days, we saw unbelievable currency movements as companies and countries need dollar funding and relative safe-havens, including gold, were possibly being liquidated to pay bills. The big fear is this being a long-term issue instead of a short-term problem. The financial stress could lead to casualties that cascade from one financial institution to another, or one industry to the next. This effect could send the economy into a deeper recession.
Aggressive actions by central banks and governments could shorten the economic impact. Active fiscal response and accommodative central bank policy response will hopefully be strong enough, and we believe global economic numbers will improve sometime in the next three months. If that’s the case then this will prove to be a buying opportunity, but we are not ready to make that call yet.
What’s your perspective on the financial space – what is changing in that investment landscape and what are you doing in the Fund considering the interest rate environment.
Most countries have followed the U.S. in cutting rates, with the U.S. being most aggressive. In two of our biggest markets, Europe and Japan, the central banks have not cut rates because they're both already in negative territory. I've been very impressed with European Central Bank President Christine Lagarde. She has provided attractive funding facilities where banks can borrow at -75bps, offering liquidity lines, new funding lines, and easing capital buffers to give bank’s the ability and flexibility to lend profitably. The Fund remains underweight financials, about 80% of benchmark weight. Within financials, we remain overweight countries, areas and companies that we believe are less affected by the rate environment or are positively impacted by the environment. We still own companies listed on the Hong Kong Exchange which is benefiting from volatility. We own a German real estate holding that we believe may benefit from lower rates and has some stock-specific recovery potential. We own a couple Indian financials. India is in a completely different place in terms of cyclical recovery and asset quality recovery in particular. As the country recovers from the banking crisis, we feel our holdings should benefit. In Europe, we own banks most exposed to increasing inflation expectations, which we believe is likely with the additional central bank stimulus.
I know last year the Fund had an approximate double overweight allocation to energy. Where is the Fund within that sector and thoughts going forward?
The Saudi-Russia price war has hurt. We are exiting a position that has outperformed. We have been reallocating the money to an Indian company which is classified as an energy stock, but they are a conglomerate that happens to refine oil, but we are buying the company for other reasons. The holding is classified as an energy holding so the Fund’s overall weighting won't change. Russia’s actions are what we would expect to happen in a market without a cartel as low cost producers increase production pushing out the higher cost producers. U.S. producers in the Permian basin will lose money on each barrel of oil they produce and will be forced out very quickly a low oil prices. We have been very careful reviewing balance sheets on companies we own. Although we didn’t anticipate the cartel breaking, ultimately it probably is healthy. The companies we own are lower on the cost curve versus what we can buy in the developed world outside of Saudi Arabia and Russia. We are not adding to upstream positions or producers right now.
There has been discussion on two black swan events – coronavirus and oil war – which of the two end first?
We think it's hard to know, but consensus is the coronavirus will bottom first, and we think the market will bottom before the virus itself. In the absence of a contagion occurring, the coronavirus is something we will be combating for at least an additional three months. That is assuming it doesn’t get re-injected to society. Additionally, we believe the coronavirus will suppress oil demand as consumers are sitting at home not using gas which exacerbates the problem for producers. Our guess is oil comes out at a similar time which would be a positive surprise – consensus is it will take longer.
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Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through March 20, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information 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.
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. To the extent the Fund invests a significant portion of its assets in a particular geographical region or country, economic, political, social and environmental conditions in that region or country will have a greater effect on Fund performance than they would in a more geographically diversified equity fund and the Fund’s performance may be more volatile than the performance of a more geographically diversified fund. 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.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.