Ivy Securian Core Bond Fund

06.30.20

Market Sector Update

  • The falloff in economic activity around the world in the second quarter was unprecedented. As the COVID-19 pandemic raced across the globe, economies came to a halt one by one, triggering a severe global recession. Despite this backdrop, the second quarter saw V-shaped recoveries in most risky-asset classes. Investors, buoyed by the promise of ongoing policy support and facing limited yields in safe assets, came back in force. The recovery was powerful after markets plunged in March. Stocks returned 14%-30% in the quarter, and commodities produced a 5% return. Despite the bounce, returns on vulnerable sectors remain in negative territory for the year with real estate investment trusts (REITs), small cap stocks, commodities and foreign stocks all down double digits. Yields remain anchored near record lows, and the 10-year Treasury rate ended the quarter at a paltry 0.66%. Most points on the yield curve ended the quarter within 10 basis points (bps) of where they started. Aside from the government bond market, volatility remains elevated on continued uncertainty.
  • Credit markets joined the risk-on party, producing some of the strongest quarterly returns on record. Total returns on high-yield and investment-grade corporate bonds were 10.18% and 8.98%, respectively. Substantially all these returns were due to spread tightening as returns on Treasuries were quite muted. High-yield and investment-grade corporate index spreads fell by 254 bps and 152 bps, respectively, producing excess returns of 9.66% and 8.47%, respectively. Utility bonds lead the performance in the investment grade space. Elsewhere in credit markets, assetbacked securities (ABS) and commercial mortgage-back securities (CMBS) bonds had excess returns of 3.26% and 3.23%, respectively. Agency mortgage-backed securities (MBS) lagged, producing just 0.38% of excess returns. Despite the strong recovery in the second quarter, it was not enough to offset the damage done in the first quarter as all investment grade sectors, except for ABS, have still produced negative excess returns relative to Treasuries yearto- date through June 30.
  • The Federal Reserve’s (Fed) policies reflect its determination to make sure that credit reaches Main Street and that market liquidity remains robust. The Fed has expanded far beyond its traditional tools to control monetary conditions and facilitate lending through banks. An unprecedented level of quantitative easing increased the bank’s holdings of treasury and mortgage-backed securities by trillions of dollars in a matter of weeks. With the federal funds rate target already at zero, the central bank turned to expanded security purchases across a broad range of asset classes including corporate bonds, municipal securities, and fixed income exchange-traded funds (ETFs). In addition, the Fed is funding direct corporate lending to small and medium businesses. Investors appear to be following the Fed’s lead and pouring capital into sectors that the central bank is buying. Corporate bond issuance of more than $1 trillion so far this year has been met with strong demand.

Portfolio Strategy

  • The Fund outperformed its benchmark for the quarter.
  • Positive sector allocation results, particularly in the utility, ABS and non-Agency residential mortgage sectors, contributed the balance of the Fund’s performance during the quarter. Of note, we were quite active in the new issue corporate bond market and that activity accounted for about 25% of the Fund’s outperformance. The one notable detractor from performance during the quarter was the Fund’s positions in the secured airline segment, as the industry continues to deal with the unprecedented fall off in air travel and slow prospects for recovery.
  • We were active during the quarter, increasing the Fund’s exposure to corporate bonds by almost 10 percentage points to 48.6%. In particular, we took advantage of several attractively-priced corporate bond new issues. The team focused on adding exposure to industries and credits we feel are likely to navigate what we expect to be a slow and bumpy economic recovery, and come out of this pandemic-driven recession relatively healthy. In energy, we added to exposure in the natural gas pipeline and refining industries. In consumer non-cyclicals, we added names we believe were attractively priced and have business models that will stand the test of time. In utilities, we added several local gas distribution positions. We believe the local distribution company business is stable and has virtually no inherent commodity risk.
  • The Fund’s largest overweight positions in terms or market weight in the corporate bond sector are electric utilities, energy, transportation, banking and consumer cyclicals. The Fund’s energy exposure remains predominantly in midstream pipeline companies and refiners. The largest underweights from a market weight perspective in the corporate space are in capital goods, consumer non-cyclicals, technology, REITs and basic industry. We feel the Fund’s overweight position in corporate credit is prudent given that spreads are still attractive on a historical basis and due to the Fed’s various liquidity programs, which we expect to continue to support the market for some time.
  • Structured exposure fell as a percentage of the Fund’s net asset value during the second quarter. The team further reduced exposure to Agency MBS on rising prepayment concerns. We also reduced exposure to the CMBS space during the quarter. While we have been cautious on retail exposures for a long time, we have become more concerned that the corporate office property market could be dramatically changed due to changing work environments as a result of the pandemic. Some of the proceeds were used to increase exposure to the ABS sector in private-student loan-backed AAA-rated transactions, as well as new positions in the auto loan-backed space. The portfolio remains overweight ABS, CMBS and non-Agency MBS, and underweight Agency MBS. The team remains comfortable with its overweight positions in the consumer-facing sectors of ABS and non-Agency MBS. We believe these structures have sufficient cushion to withstand substantial stress on the underlying borrowers.
  • The team reduced the Fund’s overall duration during the quarter.

Outlook

  • Companies are coming to grips with a starkly different environment than they expected at the beginning of the year. CEOs are reducing capital spending and hiring plans, a factor that will be a persistent drag. Economic research indicates that growth will be guided as much by the public’s view of risk as policy decisions. As states reopen, cases are spiking once again, raising concerns that the nascent recovery might be at risk.
  • This makes forecasting especially difficult as investors try to anticipate the complex interaction between perceived risk, policy actions, and the unfolding recession. It is uncertain how well current economic data is capturing underlying economic fundamentals given significant policy distortions and questions about consumer behavior. This is an epic downturn that’s been met by an epic policy response. It’s not clear where the economy and markets would settle out without the $2 trillion in spending under the Coronavirus Aid, Relief and Economic Security (CAREs) Act and the Fed’s bond buying. Investors, with little historical context to draw on, are falling back on a hopeful view. We’re not as certain and are concerned that the recovery may be stymied as the nation struggles to control outbreaks and Congress tentatively dials down fiscal support. For now, we’re sticking with the mantra of “don’t fight the Fed,” but with a continued eye on owning capital structures that stand the test of time, with or without Fed support.

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 June 30, 2020, 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.

All information is based on Class I shares.

The Bloomberg Barclays U.S. Aggregate Bond Index is market capitalization weighted index, representing most U.S. traded investment grade bonds. It is not possible to invest directly in an index.

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 impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

Risk factors: The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.