Ivy Pictet Targeted Return Bond Fund

Ivy Pictet Targeted Return Bond Fund
09.30.17

Market Sector Update

  • Government bonds ended the third quarter largely unchanged from the start, masking the intra-quarter market activity reflecting heightened political tensions, concerns over costs from the devastating social and economic impact of the multiple hurricanes and stalling progress on U.S. growth stimulus plans. Global growth remains on track for sustained recovery, with unemployment rates stable or lower in most countries. After a strong start to the quarter on solid payroll data, and safe haven buying on the escalating tensions between the U.S. and North Korea, U.S. Treasurys sold off in September with higher yields across the curve, retracing earlier gains in August. The U.S. Federal Reserve (Fed) re-affirmed expectations of another interest rate hike by year end, saying the impact from the hurricanes will be transitory, and suggested that it will announce its plan to reduce its $4.5 trillion asset portfolio in October, effectively shifting from ‘quantitative easing’ (QE) to ‘quantitative tightening’ (QT).
  • Stimulus plans from the Trump administration were hampered by another failure to repeal the Affordable Care Act, and an initial tax reform plan was very similar to the one presented earlier in the year that lacked detail in terms of its financing. U.S. rates ended in a rare ‘bear steepener’, with higher yields and steeper yield curve.
  • In Europe, the September general election in Germany secured another term for Angela Merkel as Chancellor, but in a weakened position as her coalition alliance failed to secure a majority and a new, three-way coalition must be formed. Growth momentum in the Eurozone remained strong though as consumer confidence improved on better labor market data. European Central Bank (ECB) President Draghi implied a gradual slowdown in pace of its asset purchase program will be forthcoming, as inflation remains weak. He said various scenarios to end QE were being considered as the ECB wishes to move cautiously and not undermine the recovery.
  • Bund yields also gave up gains earlier in the quarter, following the disappointing election results to end the quarter flat to the start of the period, as did peripherals. The bund curve ended the quarter steeper but peripheral Europe was flatter. In the U.K., the Bank of England implied a rate hike before year-end on rising inflation and low employment rates, but weak wage growth and low consumer confidence, along with the lack of a clear path for Brexit negotiations, point to a softer economy. U.K. gilt yields also gave up earlier gains to end the quarter higher across the curve.
  • U.S. dollar weakness carried over from last quarter, with only the South African rand and Argentine peso significantly underperforming on political risks. Lack of progress on stimulus programs, heightened tensions with North Korea, uncertainty about future budgetary impacts from the hurricane relief programs weighed on the U.S. dollar. In addition, the upcoming reshaping of the Fed leadership was another risk markets are beginning to evaluate. Focus turned to Europe, with the British pound stronger on higher rate expectations. The euro’s continued strength is an increasing concern for Euro area growth and is dividing the ECB in terms of policy moves. The Norwegian krone was the strongest currency over the quarter, along with other commodity exporters such as the Brazilian real, Canadian dollar, Chilean peso and Russian ruble.

Portfolio Strategy

  • The portfolio outperformed its cash equivalent benchmark. Our spread positions were the largest contributor to performance, with strong performance from emerging market hard currency, sub-financials and U.S. corporates. Rates positioning in the U.S. also contributed positively to performance. In currencies, performance was slightly negative, given our short EM FX exposure vs. U.S. dollar.
  • We have reduced duration over the quarter, primarily in the U.S. as valuation became less appealing at the beginning of September with little priced in terms of Fed hikes. We increased our duration in Germany by increasing as the market priced rate hikes by the ECB soon after the expected end of their QE program, something that the ECB does not seem to be prepared to do given the low inflation numbers in Europe. In credit, we continue to pare back risk in certain sectors, taking profit in sectors such as such as subordinate financials but remain long due to regulatory oversight and continued de-risking by the banks. In currencies, we used the strength of the euro to increase our short in this currency and we diversified part of our U.S. dollar long into Chinese renminbi that is benefitting from portfolio flows and higher cash rates.

Outlook

  • The tax reform plan presented by the Republican leadership in the U.S. lifted hopes of a meaningful policy stimulus, lifting the U.S. economy into 2018. The release still missed a number of details in terms of its financing, a crucial element if the Republicans intend to pass this legislation without having a large majority in the Senate. At the same time, the Fed has moved to start its QT program and has insisted on the strong possibility of another rate hike by the end of the year.
  • Yields have risen and the U.S. dollar has strengthened since the beginning of September, when the tax cut proposal was released. In our view that market is already pricing a high chance of a watered down tax cut of $1.2-1.5 trillion, which is what could be achieved through a small majority in Congress. Similarly, the rates market already assumes about an 80% hike by the end of the year. In this context, our tendency would be to increase our duration in the U.S. and reduce our U.S. dollar longs.

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.

Risk factors: 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. Mortgage-backed and asset-backed securities in which the Fund may invest are subject to prepayment risk and extension risk. The Fund employs investment management techniques that differ from those often used by traditional bond funds, including a targeted return strategy, and may not always perform in line with the performance of the bond markets. The Fund is also non-diversified and may hold fewer securities than other funds and a decline in the value of these holdings would cause the Fund's overall value to decline to a greater degree than a more diversified fund. The Fund expects to use derivatives in pursuing its investment objective. 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. These and other risks are more fully described in the Fund's prospectus. Diversification does not guarantee a profit or protect against&br;loss in a declining market. It is a method to manage risk.