Ivy Pictet Emerging Markets Local Currency Debt Fund

Ivy Pictet Emerging Markets Local Currency Debt Fund
12.31.17

Market Sector Update

  • The Fund's benchmark, the JP Morgan GBI-EM Global Diversified Index, posted a gain of 0.8% in U.S. dollar terms in the fourth quarter, with currencies almost flat and the yield offsetting a 0.7% decline in local bond prices. The latter were affected by another U.S. interest rate hike and rising global core yields.
  • Mexico fell 9% owing to a hawkish central bank, the recent -0.8% contraction in quarterly growth, uncertain trade negotiations and a deteriorating inflation outlook. Brazil was down 3.4% as the 125 basis point interest rate cut and corruption allegations surrounding President Temer weighed on the currency and the upcoming 2018 elections could further cloud the outlook. Argentina was down 7% as the central bank upped its inflation target for 2018 from 8% to 12% to 15%. Peru gained 3% after efforts to impeach the market-friendly president failed.
  • South Africa gained 11.6% as Cyril Ramaphosa was elected as its new leader, giving him a strong chance of replacing President Zuma. Turkey was down 7% where despite better than expected year-on-year growth of 11.1%, interest rate hikes were less than expected.
  • Russia was up 3%, all from bond prices, as the central bank cut interest rates a total of 75 basis points.
  • In Asia, Malaysia gained 5.2% as exports sustained a strong pace of growth of 21.5% year-on-year. Indonesia gained 2%, mostly from the yield. Thailand was up 2.4%, as the country posted a strong trade surplus with exports up 12.2% over the year.

Portfolio Strategy

  • Overall, we are now overweight emerging market currencies based on fundamentals and neutral to underweight local rates. In Asia, we are overall underweight in local rates as central banks are either on hold or moving towards a more hawkish bias as 2018 could see the start of upward inflation pressures.
  • We expect to be overweight Asian currencies such as the Malaysian ringgit and Indonesian rupiah as growth and exports improve. In Latin America, if Brazil’s ex-president Lula exits the 2018 presidential election, we may turn more positive on the currency. Conversely, we remain cautious on those vulnerable currencies that are more linked to commodities, sluggish growth and political issues. A key example is South Africa which could face another credit rating downgrade.
  • The Mexican peso is another concern with upcoming elections, trade negotiations and soft industrial production, though any positive news could see a surprise turnaround. Russia is an exception where a continued easing bias could present opportunities for us to move overweight local rates. Where permitted, we see opportunities in off-benchmark frontier markets from Nigeria, which is recovering from a very low base, to Egypt offering double-digit yields, a falling current account deficit and improving growth.

Outlook

  • Global markets continue to have a positive tone heading into 2018. Growth continues to accelerate in both developed markets and emerging markets, inflation is within target for most emerging market countries and the normalization in interest rates in developing markets continues to be slow and steady which we believe may prevent any disruption in financial markets.
  • Volatility has been at historic lows, and we question what events could trigger a spike in volatility such as geopolitical risks in Iran, a heavy election calendar in emerging markets to a sudden disappointment in Chinese or U.S. data. Given the strong run in emerging markets, we are also wondering where the top of this cycle might be.
  • Real interest rates in most emerging market countries are close to zero, or even negative, such as in Hungary and Poland, while we believe inflation has probably reached a bottom and may start to rise along with growth. We believe around half of emerging market central banks may turn hawkish in 2018. As a result, we view local rates with caution in 2018. Nevertheless, growth is the key theme for 2018 and should continue to be positive for emerging market currencies, which remain undervalued in our opinion.
  • As a region, Asia is more manufacturing-export-driven and benefits from low oil prices, which could help it outperform on the currency front in 2018. To be sure, demand for fixed income remains robust and an investment-grade government bond asset class yielding 6% remains compelling.

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, 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 JP Morgan GBI-EM Global Diversified is an unmanaged index that tracks the performance of emerging market debt. It is not possible to invest directly in an index.

Risk factors: As with any fund, the value of the Fund's shares will change, and you could lose money on your investment. 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. 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. 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, especially securities with longer maturities. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The Fund may seek to manage exposure to various foreign currencies, which may involve additional risks. The value of securities, as measured in U.S. dollars, may be unfavorably affected by changes in foreign currency exchange rates or exchange control regulations. Investing in foreign securities involves a number of risks that may not be associated with the U.S. markets and that could affect the Fund’s performance unfavorably, such as greater price volatility; comparatively weak supervision and regulation of securities exchanges, fluctuation in foreign currency exchange rates and related conversion costs, adverse foreign tax consequences, or different and/or less stringent financial reporting standards. Sovereign debt instruments are also subject to the risk that a government or agency issuing the debt may be unable to pay interest and/or principal due to cash flow problems, insufficient foreign currency reserves or political concerns. Risks of credit-linked notes include those risks associated with the underlying reference obligation, including but not limited to market risk, interest rate risk, credit risk, default risk and foreign currency risk. The buyer of a credit-linked note assumes the risk of default by the issuer and the underlying reference asset or entity. If the underlying investment defaults, the payments and principal received by the Fund will be reduced or eliminated. Also, in the event the issuer defaults or there is a credit event that relates to the reference asset, the recovery rate generally is less than the Fund’s initial investment, and the Fund may lose money. The use of derivatives presents several risks including the risk that fluctuation in the values of the derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Moreover, some derivatives are more sensitive to interest rate changes and market fluctuations than others, and the risk of loss may be greater than if the derivative technique(s) had not been used. Derivatives also may be subject to counterparty risk, which includes the risk that a loss may be sustained by the Fund as a result of the insolvency or bankruptcy of, or other non-compliance by, another party to the transaction.These and other risks are more fully described in the Fund's prospectus.