Ivy VIP Advantus Real Estate Securities Fund

Ivy VIP Advantus Real Estate Securities
09.30.17

Market Sector Update

  • For the quarter, U.S. stocks were propelled by a rise in corporate earnings, improved profit margins, lower inflation and steadily rising economic growth. As an investment vehicle, real estate investment trusts (REIT) rose marginally by 0.66% during the period as measured by the Wilshire U.S. Real Estate Securities Index, the Fund’s benchmark.
  • While equities outperformed most asset classes in the quarter, REITs seem to be in a holding pattern while investors digest both incremental macroeconomic news and its resulting impact on long-term interest rates.
  • Interest rates remained steady in the U.S. while long-term yields fell substantially in emerging markets, reflecting improved growth and economic outlooks around the world.
  • The real estate sector saw several disruptions during the period, which impacted sector industries in different ways. The lack of meaningful policy changes out of Washington caused health care and office REITs to underperform. Similarly, hotels and self-storage were lagging the Index until two major hurricanes resulted in thousands of displaced residents in Texas and Florida, producing sharp industry rallies in September.
  • With occupancy levels at or near record highs across most property sectors, REITs will become more reliant on rental rates escalation than occupancy gains to deliver accelerating earnings growth over the longer term.

Portfolio Strategy

  • While producing positive results before the effect of sales charges, the Portfolio trailed its benchmark for the quarter.
  • Properties associated with e-commerce continue to shine, especially industrial warehouse owners, which returned 6.7% during the period. As more retailers seek to enhance their e-commerce presence, the importance of strengthening warehousing and fulfillment capabilities will continue for the foreseeable future. As such, we maintain our overweight position to industrial owners.
  • Data centers were once again a top performer for the quarter, returning 5.6%. While we still see secular tailwinds that could lead to some of the highest earnings growth in the REIT space, valuations have become stretched. As such, we have moved to a market weight position.
  • Despite short-term gains resulting from Hurricanes Harvey and Irma, we remain underweight to self-storage given widespread excess construction and rising tenant concessions packaging to lure new tenants.>
  • Health care REITs were a sizable underperformer as the inability to repeal the Affordable Care Act and a late-quarter rise in the 10-Year Treasury yield put pressure on the industry. We anticipate further pressures on health care and will continue our underweight position.
  • Retail REITs had a mixed quarter with shopping centers up 3.8% and regional malls down 2.3%. We remain underweight to both shopping center and mall REITs, with our holdings skewed towards owners of higher quality properties.
  • The Portfolio is underweight hotel REITs, with holdings concentrated in companies with less exposure to new supply and also those with easier year-over-year comparisons. By contrast, the Portfolio is overweight the office sector, with balanced exposure to coastal urban and suburban markets. We think the sectors fundamentals can outpace most other major REIT sectors in coming years, in part because of ongoing job growth.
  • The industrial warehouse subsector delivered the top returns for the quarter. Operating conditions for industrial properties remain at record levels, driven by e-Commerce related businesses and general economic improvement. We remain overweight as it is one of few where top-line revenue is accelerating and fundamentals appear solid for the near to intermediate future.

Outlook

  • Real estate fundamentals remain broadly solid with near-record level occupancy rates, which drive positive rent spreads. Job growth, particularly in coastal areas, continues to be supportive while the capital markets remain open for both corporate and mortgage lending at attractive rates.
  • We continue to believe that REIT share price performance will be heavily influenced by macro events, with support coming from an improving economy and GDP growth. Investors continue to look toward Washington for policy changes that can have a material impact on the trajectory of GDP and employment growth.
  • Capitalization rates for private market transactions continue to support valuations, suggesting REITs currently trade a discount to net asset value, while pricing compared to broader fixed income and equity markets also looks attractive compared to historic averages.
  • Significant fund raising in real estate private equity funds suggests further support for real estate valuation. Although we see valuations today as justified, a sustain reversal in record-low interest rates —particularly in the long-end of the curve— would likely pressure REIT share prices.

The opinions expressed are those of the Portfolio 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 September 30, 2017, 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 Wilshire U.S. Real Estate Securities Index is an unmanaged index comprised of U.S. publicly-traded real estate equity securities. It is not possible to invest directly in an index.

The Ivy VIP Real Estate Securities was renamed Ivy VIP Advantus Real Estate Securities on April 3, 2017.

Risk factors: The value of the Portfolio's shares will change, and you could lose money on your investment. The value of a security believed by the Portfolio's manager to be undervalued many never reach what the manager believes to be its full value, or such security's value may decrease. An investment in the Portfolio is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. These and other risks are more fully described in the Portfolio's prospectus. Not all funds or fund classes may be offered at all broker/dealers

Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.