Ivy Municipal High Income Fund

Ivy Municipal High Income Fund
09.30.17

Market Sector Update

  • The third quarter of 2017 brought once again a rally in most sectors of the municipal market. With the President’s tax plan currently working its way through Congress, we believe any changes to the tax code will result in lower absolute tax rates and some reductions in exemptions previously afforded to taxpayers. All said, we view this as a negative to the tax exempt market, as it decreases municipal bonds’ tax-adjusted values.
  • The third quarter of 2017 saw lower yields overall. However, we did see some sectors cool off from their very strong returns earlier in the year. Tobacco returns dipped in the third quarter, falling .34%, although the tobacco bonds sector is still up 18.10% for the year. We see little upside going forward as most bonds are priced very close to par.
  • High yield General Obligation bonds tracked in the Bloomberg Barclays High Yield Municipal Total Return USD Index rallied in the quarter and returned a positive 13.43%; however this is somewhat misleading, as one credit skewed the returns. The City of Chicago was the largest and best performing issuer. We continue to view Chicago debt in a negative light as the local pensions continue to be grossly underfunded. With very few credits leading to so much of the total returns, we believe the rally is being driven not by fundamentals but rather by one-off isolated credit anomalies.
  • Puerto Rico continued to hurt total returns versus the benchmark (-5.41% for the quarter) as the Commonwealth’s deteriorating economic health, combined with the devastation of Hurricane Maria, caused prices to decline further. We believe we will continue to see weakening prices for Puerto Rico paper in the future.
  • With the rally in rates during the first eight months of 2017 we have become less constructive on the high yield municipal space, as new issues come to market with historically low absolute yields and weak collateral for investors.
  • Going forward, while we still believe the municipal market is attractive versus other fixed income asset classes based on higher tax adjusted returns, we have turned more bearish as passage of tax legislation in our view will result in more downside than upside on a total return basis.

Portfolio Strategy

  • The fund eliminated exposure to Puerto Rico in the quarter as it became clear that the debt restructuring would take much longer than first anticipated. The primary objective of the Fund is to provide high levels of tax-exempt income and the decision to sell was based on the negative income consequences for the bonds going forward. With no clear picture on the debt restructuring and the massive devastation of Hurricane Maria, we feel any prior projections of recovery are inaccurate and there is more downside to come.
  • We continue to favor revenue bonds over tax-backed debt as revenue bonds, in our view, provide higher yields and better diversification from general tax and pension issues currently affecting many municipalities. Historically, General Obligation bonds have favored well in Chapter 9 bankruptcies; however this was turned onto its head post-Detroit and we expect the same outcome in the Title IV filing in Puerto Rico as well as in Hartford, Conn., if they are forced to file as well.
  • Going forward, we will look for opportunities in bonds with more defensive structures as interest rates continue to hover around historically low levels and credit spreads continue to be tight. We feel at this time it makes sense to remain shorter duration than the benchmark, as we view the sector as fully priced.

Outlook

  • In the near term, we believe volatility will continue, as choppy economic data continues globally creating amounts of uncertainty for markets. It is important that investors realize prudent managers diversify across states and sectors and always limit the amount of exposure to those variables as well as any individual bond.
  • We believe investors will continue to search for tax-exempt yield even if tax legislation is passed. We anticipate any tax cuts will favor lower income brackets, so the demand for municipal bonds should stay consistent with normal levels. Likewise, we believe that supply in the municipal market will remain below norms, which should be a positive for investors.

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.

Diversification is an investment strategy that attempts to manage risk within your portfolio but it does not guarantee profits or protect against loss in declining markets.

The Bloomberg Barclays High Yield Municipal Total Return USD Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody’s Investors Service with a remaining maturity of at least one year. 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 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.