Ivy Science and Technology Fund

Ivy Science and Technology Fund
09.30.18

Market Sector Update

  • The global trade war rhetoric turned into action this quarter. Sentiment also shifted in the market from a feeling that tariff threats would lead to a short-lived, negotiated agreement between the U.S. and China to a lengthier and potentially impactful stand-off. Initially, U.S. markets shrugged off most of the headlines and tweets, but volatility and concern grew when additional 10% tariffs on $200 billion worth of goods were implemented in late September. Inflation and rising interest rates are an increasing risk as well, with the 10-year Treasury rate rising above longer term technical limits, causing concern that tighter monetary policy may soon slow down the steady growth we have seen over the last several quarters.
  • The Federal Reserve (Fed) raised interest rates in the quarter, increasing the benchmark rate to 2.25%. Another increase is anticipated in December, which would bring the total number of rate hikes this year to four. Business confidence has held at all-time highs despite tariff and interest rate headwinds. History has shown that the Fed will adapt to data, but with job growth and underlying confidence holding steady, we fully expect rate increases to continue. The one key variable to continued hikes is whether a trade war sparks a drop in economic activity and confidence. We are starting to see signs of weakening in certain pockets, such as Chinese autos and a few industrial areas.
  • Technology stocks continued to show strength through most of the quarter on the back of strong revenue and earnings trends. Late in the quarter, concerns about excess inventory trends and potential weakening in end markets like autos and industrials began impacting semiconductor stocks. Additionally, Facebook surprised the market with a significant guidance reduction, spiking volatility in the short-term.
  • In health care, the period was relatively quiet as we wait for more details on President Trump’s “blueprint to lower drug prices” announcement. We expect more drug pricing discussions to happen during the fourth quarter as the Trump administration rolls out more specifics. This likely grabs a few headlines, but we expect the focus to remain on the broader tariff and macroeconomic issues.

Portfolio Strategy

  • The Fund posted strong absolute returns in the quarter, but underperformed its benchmark. The Fund performed well compared to the broader market.
  • The Fund’s relative underweight to Amazon.com and Apple, along with an overweight position in Micron, accounted for the vast majority of relative underperformance. In fact, Apple and Amazon were responsible for 37% of the index return during the period. Include Microsoft and the three companies accounted for more than 50% of the index return. While we remain confident in these companies (Microsoft and Apple are the top two names in the Fund, respectively), we must be prudent in seeking a balance of innovative names across the portfolio.
  • The health care portion of the portfolio (a sector not represented in the benchmark) saw outperformance return in the third quarter after relative underperformance in the first half of 2018. We believe biotechnology, notably gene therapy, is a key area of innovation that will continue to drive performance.
  • At the subsector level, relative allocations to semiconductors, IT services and consumer discretionary detracted from relative performance.
  • Top relative contributors to performance included Aspen Technology Inc., Universal Display Corp., Euronet Worldwide, Inc., Vertex Pharmaceuticals Inc., and Ionis Pharmaceuticals, Inc.
  • At the end of the quarter, the Fund had approximately 86% of assets in U.S. equities, 12% of assets in international stocks and the residual in cash and cash equivalents.

Outlook

  • We are carefully monitoring the technology supply chain and demand signals coming from key technology end markets. With the risk of tariff-related impacts and derivative confidence tempering, we are being opportunistic in adjusting various positions to align with some of the near-term expected weakness.
  • Semiconductors have contributed strongly to information technology performance over the past couple years and we believe the emergence of new secular growth opportunities, like autos, machine learning and ubiquitous connectivity will continue to support above-market returns in the sector. However, pockets of weakness due to some excess inventory may put pressure on the space in the near term. We remain constructive on semiconductors, but expect some level of volatility that likely creates compelling new opportunities for the Fund over the longer term.
  • Our exposure in biotechnology remains a key area of innovation within health care and an area where we expect our holdings to outperform over the coming quarters.
  • Tax reform and strong underlying demand have bolstered the domestic economy in the face of rising global risks. Globally, markets have been harder hit by trade war concerns, but growth and hiring trends remain strong domestically. We are watching Fed policy changes carefully to ensure a shrinking central bank balance sheet and rising interest rates do not damage credit availability or confidence in the management suite. Through the third quarter, we have not seen any meaningful changes to these key variables. We believe these policy changes, along with threats of trade wars, remain the biggest risk to impact sentiment in the markets. Additionally, we are watching equity valuations carefully in the context of higher levels of growth.
  • Our focus remains primarily on security-specific fundamental research. We strongly believe this attention to bottomup research, coupled with the innovation and transformation under way across the globe, will continue to provide investment opportunities for the Fund.

The opinions expressed are those of the Fund’s managers for Class I shares 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, 2018, 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 equity holdings as a percent of net assets as of 09/30/2018: Microsoft Corp. 8.4%, Apple, Inc. 5.6%, Aspen Technology, Inc. 5.5%, Vertex Pharmaceuticals, Inc. 4.8%, WNS (Holdings) Ltd. ADR 4.4%, Micron Technology, Inc. 4.4%, Euronet Worldwide, Inc. 4.4%, ACI Worldwide, Inc. 4.0%, Facebook Inc., Class A 3.9%, Alibaba Group Holding Ltd. ADR 3.6%.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Because the Fund invests more than 25% of its total assets in the science and technology industry, the Fund’s performance may be more susceptible to a single economic, regulatory or technological occurrence than a fund that does not concentrate its investments in this industry. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market. In addition, the Fund’s performance may be more volatile than an investment in a portfolio of broad market securities and may underperform the market as a whole, due to the relatively limited number of issuers of science and technology related securities. Investment risks associated with investing in science and technology securities, in addition to other risks, include: operating in rapidly changing fields, abrupt or erratic market movements, limited product lines, markets or financial resources, management that is dependent on a limited number of people, short product cycles, aggressive pricing of products and services, new market entrants and obsolescence of existing technology. 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.