Ivy Municipal Bond Fund

12.31.19

Market Sector Update

  • Municipal market performance was primarily driven by continued record flows into the asset class combined with heavy reinvestment proceeds which overwhelmed supply.
  • Performance was also enhanced by continued investor interest in tax-avoidance strategies linked to the cap on the state and local tax (SALT) deduction and increased foreign demand in the asset class. The Federal Reserve (Fed) signaled that they are on hold with a very high bar for moving rates in either direction. The de-escalation in rhetoric with the announcement of a Phase 1 trade agreement with China and more certainty with Brexit removed some of the equity market/economic risk which resulted in a more risk-on investment environment. Additional strengthening in labor and housing markets, as well as elevated consumer confidence, enhanced the risk-on mood.
  • Interest rates declined modestly on the front-end of the curve while intermediate and longer maturity rates rose slightly, resulting in curve steepening. The U.S. Treasury market yield curve is no longer inverted between the 3-month bill and the 10-year note which has removed much of the imminent recession angst.
  • Defaults in the municipal bond asset class continue to be rare and tend to be highly concentrated in the high yield space. While we anticipate increased headline risk from municipal issuers that have severely underfunded pensions and other post-retirement benefit obligations, we continue to believe these problems are not systemic and they will remain isolated. However, we are beginning to see distressed situations in the high yield space with more frequency. This will need to be monitored closely, as an escalation of defaults or impairments on a larger scale would more than likely impact the investment grade space also, if investor redemptions were to result.

Portfolio Strategy

  • The Fund had a positive return, but underperformed its benchmark. Treasury and municipal rates remain at very low historical levels. The portfolio duration is currently shorter than our benchmark, and the portfolio is defensively structured. We will continue to look for attractive opportunities to re-invest cash flow from bond income and maturity proceeds.
  • We will continue to place emphasis on diversification, higher (overall) credit quality and yield curve positioning.
  • We expect to see continued headlines on municipal pension underfunding and other post-retirement benefits issues. We do not believe investors are being adequately compensated for moving down in credit. We will remain vigilant in monitoring these situations and we will endeavor to avoid investments with these issuers.

Outlook

  • We remain confident that investment-grade municipal bond defaults will continue to be much lower than any other fixed-income alternatives except U.S. Treasuries.
  • While we ultimately expect Treasury yields to be the key driver of the municipal market, we believe municipal bonds provide relative value for fixed income investors, if they are in high combined tax brackets. However, we have experienced unprecedented cash flows into the municipal bond asset class in the last year, with a record 52 straight weeks of inflows, and valuations appear to be stretched by most metrics. Historically, it has been prudent to not invest aggressively at extremes. Therefore, we are exercising patience based on the belief there will be a more attractive entry point to deploy some of our excess cash.
  • We enter first quarter with a heightened level of optimism regarding the prospects for the U.S. economy, while we are also observing some positive signs from other major global economies. We are cautiously optimistic the Phase 1 trade deal with China may get signed and that progress is made toward a Phase 2 deal shortly thereafter. We believe that a solid trade deal with China should unlock restrained U.S. capital expenditures, and boost overall confidence and optimism.
  • Anticipated higher levels of Treasury issuance in the future to finance budget deficits, as well as a potential inflation surprise could force the Fed to alter its policy stance. The big wild card moving forward is the Trump presidency. Because the House of Representatives is solely focused on one issue, impeachment, we have become very pessimistic that any meaningful legislation that would spur economic growth gets addressed. We fully anticipate heated partisan rhetoric to intensify as we approach the 2020 elections. A lack of resolution in the trade conflict with China or an escalation of geopolitical tensions, as well as the possibility of a policy mistake by the Fed could prove to be destabilizing.

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 Dec. 31, 2019, 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.

Diversification and asset allocation are investment strategies that attempt to manage risk within your portfolio but do not guarantee profits or protect against loss in declining markets.

All information is based on Class I shares.

Risk factors: The value of the Fund's shares will change, and you could lose money by investing. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. Investing in below-investment-grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). Exempt-interest dividends the Fund pays may be subject to state and local income taxes. The portion of the dividends the Fund pays that is attributable to interest earned on U.S. government securities generally is not subject to those taxes, although distributions by the Fund to its shareholders of net realized gains on the sale of those securities are fully subject to those taxes. The municipal securities market generally, or certain municipal securities in particular, may be significantly affected by adverse political, legislative or regulatory changes or litigation at the Federal or state level. 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.