Investment Update


Investment Update - Ivy Small Cap Growth Fund

Commentary as of June 10, 2020

We last spoke with you in March during the peak of the selloff. Please provide us with a recap of the Fund since then from both a performance and positioning perspective.

Tim Miller: During our last update in late March, there was so much uncertainty about the duration of the crisis, the magnitude of the crisis, and the magnitude of the recovery. Our quality bias served us very well during the correction phase. Changes made re-emphasized that quality bias, selling down some of our less-predictable companies. That proved beneficial as some of our stalwart positions have performed well year-to-date (YTD).

The small cap universe has seen quite a rally since the March lows, which was fueled in part by the monetary and fiscal stimulus in response to the COVID-19 lockdown. The portfolio has lagged during the recovery, which is in-line with what we would expect given our quality bias and skew toward larger names in our universe. In recent weeks, we have seen a bit of a transition to a rally led by cyclical, lower-quality, value-oriented companies, which is clearly a headwind for our style. We don't try to time sentiment swings; we focus on finding sustainable growth companies that can deliver outperformance over intermediate and long-term investment horizons.

At this point, caution seems prudent. Many cyclicals are pricing in a powerful economic recovery. When we speak with companies, obstacles clearly remain for the economy to return to pre-crisis levels. We think it is likely to take longer to return to pre-pandemic levels than many market participants. We continue to be heavily weighted to information technology and health care, which accounts for about half of the portfolio’s total allocation. Consumer names were under more pressure during the drawdown, but participated well during the rebound. We have also removed energy from the portfolio, believing it's too early to have meaningful exposure here and it’s a very small piece of our benchmark.

Small caps lagged during the drawdown, but have outperformed since the market bottom. Our benchmark, the Russell 2000 Growth Index, is down nearly 2% YTD, so we believe the small growth category is healthy and attractive, which could bode well for our portfolio.

Each portfolio manager has primary sector responsibilities. Please share any insights into those areas and where you're finding opportunities.

Tim: My area of focus, consumer discretionary, proved to be the high beta area of our portfolio. We concentrate on the retail, leisure, gaming and restaurants segments in the sector, which did not provide many places to hide given the direct exposure to the COVID-19 crisis. We removed some of our small positions in this sector that were over leveraged from a balance sheet perspective, or where we were uncertain of the outlook given the crisis. We stuck with the companies that we had the most confidence in the fundamentals, such as Churchill Downs, Inc. We also added to certain positions like restaurant chain Texas Roadhouse, Inc. We have a long history with the company, like its high-quality business model and its management team. Texas Roadhouse has had good execution during the crisis. We are maintaining higher quality in consumer names and are slightly overweight to the consumer discretionary sector and expect to maintain those positions.

Ken McQuade: One of the characteristics about the health care sector we've found attractive for a long time is limiting time in the health care environment, or completely eliminating the need to visit health care facilities. Teladoc Health, Inc. is a good example of a company that we owned prior to the crisis, and has experienced accelerated adoptions as a result of the pandemic. We believe this appreciation could remain going forward, which could lead to opportunities for greater market share. We've also been a long-term owner of LHC Group, Inc. As one of the largest home-health companies, LHC provides procedures like physical therapy and rehabilitation at the patient’s home and away from medical facilities. Since many in-office medical procedures have been halted due to the priority of COVID-19 response, we believe demand for the types of in-home procedures LHC performs is likely to grow.

Brad Halverson: Many companies across the information technology sector withdrew guidance or reduced expectations. We believe companies that had strong businesses, such as digital banking, digital marketing and software companies, are likely to better positioned when the economy returns. Investors looked through short-term results and instead looked at those strong business models that performed very well during this environment. Most companies either had exposure to the storage and peripherals space, which has been hit hard, or had exposure to industries like travel, entertainment, or restaurants, which have also been hit hard.

If you were tied to direct work from home teams and movements to the cloud, you generally benefited. An example of such exposures was Five9, Inc., a key player in the contact center market. The company, which continues to be one of the largest holdings in our portfolio, recently announced partnerships with AT&T and Zoom. We believe this illustrates Five9’s durability and could translate to strong performance going forward. With most business adopting shelter-in-place policies to some degree, investors are looking opportunities with demand-side companies. Enphase Energy, Inc. is primarily known for its solar technology, but now offers battery storage, which is in high demand as more employers assess employee output and possible threats to the work-from-home environment. For companies like Enphase, this has been a tailwind.

We still feel confident in the security space as threat vectors continue to rise, particularly in email security. We continue to look at new ideas in areas within the sector. Areas like technology messaging platforms and data centers present long-term opportunities.

Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This informa¬tion 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. The views are current through June 10, 2020, and are subject to change at any time based on market or other conditions.

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. The Fund may invest in Initial Public Offerings (IPOs), which can have a significant positive impact on the Fund’s performance that may not be replicated in the future. 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.

The Russell 2000 Growth Index is an unmanaged index comprised of securities that represent the small cap sector of the stock market. It is not possible to invest directly in an index.

Top 10 equity holdings as a % of net assets as of 05/31/2020: Five9, Inc. 3.4, Teledoc Health, Inc. 2.9, Mercury Computer Systems, Inc. 2.7, Wingstop, Inc. 2.7, Monolithic Power Systems, Inc. 2.3, Proofpoint, Inc. 2.1, Varonis Systems, Inc. 2.1, Globant SA 2.0, Knight Transportation, Inc. 2.0, CareDx, Inc. 2.0.

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. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.