Ivy Small Cap Growth Fund

Ivy Small Cap Growth Fund
12.31.18

Market Sector Update

  • A sharp correction was the story of fourth quarter 2018, a time frame that spared few asset classes or sectors in the equity market. Size mattered, which meant small caps fell the most and large caps the least based on broad market metrics. Volatility surged, with daily and inter-day swings reaching perplexing levels. Fear and uncertainty were driving the decline, as rising short-term interest rates and a tariff fight with China cast a cloud over the near-term direction of the economy and corporate profits. Amid this uncertainty it seemed that the downward momentum of the markets may have been magnified by quantitative, algorithmic trading systems, which were “piling on” the fear factor.
  • In the small-cap markets, some corrections were extreme, with the energy sector dropping over 40% for the quarter. Growth lagged value in small caps for the quarter but outperformed for the year. The fears seemed to be most pronounced in economic-sensitive areas such as materials, industrials and some consumer cyclicals, where lower price to earnings (P/Es) couldn’t provide a safety net. Among the higher P/E technology and health care sectors, there was damage but many of the companies with clear solid growth prospects held in better in spite of higher valuations.

Portfolio Strategy

  • The Fund outperformed the Russell 2000 Growth Index and peers for the quarter (based on Class I shares).
  • The Fund held up well through mid-November but eventually succumbed to the sharp market declines in early December. On a sector basis, our largest weight – technology – was the best performer for the quarter. Investors tended to have more confidence in the forward sales and earnings growth for many of the small software and services companies, hence the better performance from those stocks in spite of higher valuations.
  • As mentioned above, the fear in the market was a cyclical/recession fear, hence sectors like energy, materials and industrials lagged. The worst performer in the quarter was energy, but given the sector’s very small weighting in the portfolio, the impact was contained. In the industrials sector, the Fund is overexposed to industrials services and aerospace/defense stocks, which also outperformed. Finally, in the consumer discretionary sector, the Fund’s outperformance was driven by solid restaurant companies like Wingstop Inc. and Texas Roadhouse, Inc.; Pool Corp. among distributors; and Etsy in the internet space.
  • During this severe level of uncertainly, the Fund’s core focus on high-quality growth companies served us well, and we added to a number of these positions during periods of weakness. Alternatively, the Fund disposed of cyclically exposed companies in the energy, industrials and semiconductor industries; and also harvested a few of our multi-year winners whose market caps had moved into the mid-cap space.

Outlook

  • The Fund’s core stock selection discipline and strategy is able to navigate the current volatile markets without resorting to any market timing or sector rotation vulnerabilities. Extra emphasis on quality and earnings predictability are in place for 2019, something that is already part of the growth criteria that we scrutinize.
  • We believe there will likely be a slowdown in economic growth in 2019, but not a recession in the near-term, so innovative companies serving large-market opportunities should be able to continue to deliver. Most of these opportunities are found in the small-cap technology and health care sectors, the two largest weights in the portfolio.
  • The consumer discretionary and industrials sectors are next largest weights in the portfolio and areas where we find service-oriented businesses and companies with strong product cycles having the best outlooks for 2019. We’ve reduced exposure to the financials and energy sectors.

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, 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 holdings (%) as of 12/31/2018: Mercury Computer Systems, Inc. 2.2, Teladoc Health, Inc. 2.2, Grand Canyon Education, Inc. 2.2, Proofpoint, Inc. 2.1, Texas Roadhouse, Inc. 2.0, Booz Allen Hamilton Holding Corp. 2.0, AMN Healthcare Services, Inc. 1.9, Five9, Inc. 1.9, Paycom Software, Inc. 1.8, and HubSpot, Inc. 1.7.

The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. 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. Investing in small-cap stocks may carry more risk than investing in stocks of larger more well-established companies. 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. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.