Ivy Securian Core Bond Fund

Ivy Securian Core Bond Fund
09.30.18

Market Sector Update

  • The economy continues its rebound from the somewhat disappointing first quarter gross domestic product (GDP) growth rate. Estimates for third quarter economic activity are pointing towards a solid print for GDP growth, with most estimates coming in higher than 3%. This follows second quarter growth that was the strongest quarter since the third quarter of 2014.
  • Inflation indicators have picked up along with economic growth. The U.S. Federal Reserve’s (Fed) core inflation target rate is hovering around 2.0%. Year over year increases in average hourly earnings continued to exhibit strength, reaching a high of 2.9% during the quarter. None of this was unexpected though, and the markets remain sanguine about rising inflation.
  • The employment picture remains strong, with the quarter-end unemployment rate at 3.7%, a level not seen since the late 1960s. However, average hourly earnings have yet to reach 3%, the level that would cause the Fed and markets some angst.
  • Stocks continued their strong run, buoyed by strong second quarter earnings and what looks to be a decent third quarter for earnings as well. Results are being driven by corporate tax cuts, but also by strong revenue growth. Corporations in most industries are seeing strong demand from customers. Consumer-facing companies are performing particularly well due to the strong employment picture. Ongoing trade skirmishes have only had a minor impact on a few industries, but this will certainly bear watching.
  • The Fed stuck to its script, raising rates another 25 basis points (bps) in September. It also signaled another hike in December, and up to two 2019.
  • Rates moved up across the curve. The short end of the curve has marched higher all year with the 2-year U.S. Treasury yield reached a 12-year during the quarter. The long end of the bond market appeared to break out of its summer slumber. The 10-year yield finally broke back above 3.0% on September 18 and has continued to march higher into October. Maybe this will put to rest the obsession with an inverted yield curve many have been having since mid 2017.
  • The investment grade (IG) corporate bond market rebounded strongly in the third quarter, following a rough first six months to start the year. Corporate bond spreads fell 17 bps during the period, wiping out all the widening the occurred during the second quarter. Excess returns over Treasuries for the period were 1.69%%. Long corporate bonds had an exceptionally strong quarter, producing positive excess returns of 3.28 %. Corporate bonds in the industrial sector, particularly in energy and communications, outperformed the more defensive sectors, such as utilities and financials.
  • The securitized sectors performed well during the quarter, but could not keep up with the strength of the corporate bond market. Excess returns for commercial mortgage-backed securities (CMBS), asset-backed securities (ABS) and Agency mortgage-backed securities (MBS) were 0.77 %, 0.31 % and 0.17 % for the quarter, respectively.

Portfolio Strategy

  • The Fund outperformed its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, for the quarter. The Fund’s corporate bonds in the industrial sector were the biggest contributor versus the index, led by energy holdings, particularly in pipeline companies. Crude oil reached the highest levels since late 2014, helping this energy outperform most other sectors in the market. An allocation to agency credit-risk transfer securities (CRTs) also added to results for the quarter. CRTs have benefited as credit-rating agencies have upgraded certain CRT tranches. The Fund’s overweight positions in financials and utilities also contributed to results. Finally, we kept the duration of the Fund short of its benchmark, and this positioning contributed to the outperformance during the quarter as interest rates rose.
  • We continue to favor the securitized sector and we added further to the Fund’s overweight positions in ABS and non-Agency MBS during the quarter. We think the underlying fundamentals for residential housing will remain stable, supported by employment growth, rising wages and general economic expansion. Housing affordability has come down recently due to higher mortgage rates and rising home prices. However, overall household debt as a %age of GDP stands at about 65%, which is well below the high levels set during the financial crisis. Also, the % of the total balance of outstanding consumer loans that are more than 90 days delinquent has continued to fall since the 2010. We further reduced the Fund’s underweight positioning in the Agency MBS market to fund purchases in ABS and non- Agency MBS.
  • We reduced the Fund’s corporate bond exposure slightly during the quarter, continuing a rotation out of corporate credit and into structured credit that began over a year ago. We’ve reduced corporate exposure both on a market weight basis as well as in terms of sensitivity to interest rates. In particular we reduced exposure to both consumer cyclicals and non-cyclicals, during the quarter. We are finding better value in energy, banking and in the structured markets.
  • While we’ve reduced corporate exposure over the past year, the Fund remains overweight corporate bonds relative to its benchmark. We are most overweight in the electric utility, transportation, banking and energy sectors. These are sectors where we feel the fundamentals are stronger relative to other sectors that have materially increased leverage over the past several years. We also feel spreads are still attractive in these sectors relative to most other sectors.

Outlook

  • At this point, we believe the chance of a recession before 2020 at less than 10%. We expect growth to slow from the heated pace we’ve seen in the last two quarters, but there’s just too much momentum going for the economy to knock it completely off the rails in the next several quarters.
  • The key leading indicators we follow the most simply don’t indicate an economy that’s in danger of entering a recession any time soon. Durable goods orders and manufacturing jobs are still solid and stock markets are near or at all-time highs. Interest rates have been rising, but are still well below levels that would choke off consumer or business borrowing. Building permits, while they’ve disappointed to date during this expansion, are still well above levels seen before entering previous recessions.
  • We are cognizant that we live in uncertain times and are mindful of a number of potential issues that could upset the proverbial economic apple cart, including further escalation of trade tensions with China, rising inflation rates choking growth and an overly aggressive Fed.
  • We’ve been anticipating the 10-year Treasury yield to trend toward 3 %, but still don’t expect yields to move much higher than that level. We don’t believe the Fed is behind the curve on inflation, so we don’t expect more aggressive tightening than what is already indicated. With that as a backdrop,we expect corporate bond spreads to grind a bit tighter over the remainder of the year.

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, 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.

The Ivy Advantus Bond Fund was renamed Ivy Securian Core Bond Fund on April 30, 2018.

David Land served as a portfolio manager on the Fund until May 11, 2018.

Duration is a measure of a security's price sensitivity to changes in interest rates. A fund with a longer average duration generally can be expected to be more sensitive to interest rate changes than a fund with a shorter average duration.

The Bloomberg Barclays U.S. Aggregate Bond Index is a market capitalization-weighted index, representing most U.S. traded investment grade bonds. 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 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. 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. 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.