Ivy Micro Cap Growth Fund

Ivy Micro Cap Growth Fund
09.30.17

Market Sector Update

  • For the third quarter, the broader equity market once again posted strong returns. Robust earnings, cheap credit, accommodative monetary policy, low inflation and accelerating global economic activity are a few of the key drivers behind the current bull market, which is now the second longest in history. Any risks that could possibly derail the market’s momentum were dismissed by investors and indices that measure volatility.
  • From a style perspective, growth once again meaningfully outperformed value across the market capitalization spectrum, and in a reversal of the previous two quarters, small caps outperformed their larger peers.
  • In terms of absolute returns, the Russell Microcap Growth and Russell 2000 Growth Indices rose, while the Fund was relatively unchanged for the period.
  • Returns in the Russell Microcap Growth Index were led by health care and technology and industrials. Notably, in a testament to the breadth of the market rally, there were no sectors that caused a meaningful drag on performance for the benchmark.

Portfolio Strategy

  • The Fund underperformed the Russell Microcap Growth Index and Russell 2000 Growth Index (its benchmarks) for the quarter ended Sept. 30, 2017.
  • Portfolio performance attribution analysis for the quarter indicates that stock selection was noticeably weak, with allocation effect causing a modest headwind as well. Compared to the benchmark, the Fund was most negatively impacted by holdings within the consumer discretionary, technology and materials sectors. Fundamental underperformance by several larger holdings was the primary cause for this underperformance.
  • The weakness in consumer discretionary was primarily related to a revenue and margin short fall at The Tile Shop. The business had been performing well until recently when the company’s competitive positioning and customer value proposition appeared to have been compromised. As a result a through reassessment of the original investment thesis was conducted and exposure was meaningfully reduced.
  • Technology holdings SPS Commerce and 8x8 were weak during the period as investors questioned each company’s long-term growth profile after they both reported inline quarterly results. In the case of SPS Commerce, it appears the softness in the end markets it serves could persist for some time, whereas 8x8’s fundamental situation seems to be more transitory.
  • The weakness in the materials sector was due to another disappointing report from Flotek Industries. This appears to stem primarily from management’s inability to execute and the position was eliminated.
  • In terms of positive contributors, this was the most disappointing aspect of the quarter since there were very few positive fundamental surprises from the Portfolio’s holdings. Each quarter there is typically a healthy balance between companies that do well and those that don’t, but that just wasn’t the case this quarter. The lone bright spot was health care, which continued to perform well with two recently added companies leading the way – PetIQ and Tabula Rasa Healthcare. Both companies reported results that handily topped investor expectations.

Outlook

  • Thus far this year, the capital markets appear to have almost unstoppable momentum. A recent cover of “The Economist” magazine succinctly labeled the current environment as “The bull market in everything.” For equities in particular, they have shot higher with remarkable little volatility. There are good reasons for this upward move, as the list of positives is long, but it doesn’t mean concerning fundamental issues are not lurking just below the surface, which demand constant consideration.
  • Looking forward, while no one ever knows for sure, it would appear the path of least resistance is still to the upside and our goal remains the same in terms of seeking dynamic early-stage growth companies that have the potential to deliver long-term capital appreciation.

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 Sept. 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.

Top 10 holdings (%) as of 09/30/2017: Aerie Pharmaceuticals 4.1, 8x8, Inc. 4.0, Mimecast Ltd. 3.8, MYR Group, Inc. 3.1, Tactile Systems Technology, Inc. 3.1, Mercury Computer Systems, Inc. 3.1, K2M Group Holdings, Inc. 3.0, Q2 Holdings, Inc. 2.9, Nautilus Group, Inc. (The) 2.8 and Community Healthcare Trust, Inc. 2.8.

The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. The Russell Microcap Growth Index measures the performance of the micro-cap growth segment of the U.S. equity market. It is not possible to invest directly in an index.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Market risk for small-sized companies may be greater than that for medium or large companies. Smaller companies are more likely to have limited financial resources and inexperienced management. Stocks of smaller companies, as well as stocks of companies with high-growth expectations reflected in their stock price, may experience volatile trading and price fluctuations. Furthermore, when the economy enters a recession, there tends to be a “flight to quality,” which may exacerbate the increased risk and greater price volatility normally associated with smaller companies. The Fund’s performance may be more susceptible to a single economic, regulatory, or technological occurrence than if it had a more diversified investment portfolio. The Fund may invest in Initial Public Offerings (IPOs), which can have a significant positive impact on the Fund’s performance that may not be sustainable. . An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 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.