Ivy VIP Limited-Term Bond

Ivy VIP Limited-Term Bond
09.30.17

Market Sector Update

  • Rates rose in early July as the June payroll report showed surprising strength, and at the same time reports for previous months were revised higher. The enthusiasm was short-lived, however, as more economic reports came in showing weak inflation and gross domestic product (GDP) growth.
  • August was characterized by the back and forth between President Trump and North Korean leader Kim Jong Un. Comments and tweets by the two leaders weighed globally on stocks, while bonds benefitted from the flight-to-quality trades that ensued.
  • Rates reversed course in September as economic data came in reasonably good, war fears with North Korea lessened and a tax plan started taking shape in Washington, D.C. U.S. Treasury yields ended the quarter higher than they started, with the two-year note up more than 10 basis points to yield 1.49% and the five-year note up five basis points to yield 1.94%.
  • The Federal Open Market Committee (FOMC) announced on September 20 they would begin the task of reducing the size of the Federal Reserve’s (Fed) balance sheet in October. To do so, they plan to phase out the policy of reinvesting all principal repayments from maturing U.S. Treasuries and federal agency securities, as well as monthly principal payments from agency mortgage-backed securities.
  • The new plan is a tapered re-investment plan, whereby over time, fewer and fewer maturities are reinvested. Fed Chair Janet Yellen has said she would like to see this process be about as exciting as “watching paint dry”, causing as little disruption to the markets as possible.
  • The FOMC also released their latest summary of economic projections, including forecasts for the federal (fed) funds rate. It appears they still anticipate a third rate hike in 2017, most likely in December. The implied market probability of a rate hike in December now sits near 70%, a fairly high degree of confidence by historical standards.
  • Another noteworthy development in the newest projections is the terminal (ending) fed funds rate, which has been lowered to 2.75% from their previously forecasted 3% terminal rate, indicating somewhat less optimism about economic growth.
  • The Bloomberg Barclays U.S. 1-5 Year Government/Credit Bond Index ended the quarter at its tightest spread for the year. Corporate bonds have been in great demand and have been the best performing asset in the investment grade universe in 2017.

Portfolio Strategy

  • We have maintained our overweight in investment grade corporate bonds, and feel that the strong performance will continue over both the near- and medium-term. We are also aware that we are in the later innings, so to speak, of the credit cycle and that one day we will want to reduce our overall allocation to credit.
  • We kept the portfolio duration close to, but short of, the benchmark throughout the quarter. We currently maintain our overweight to investment grade credit, as we prefer to generate excess return through asset allocation and credit selection rather than duration bets.

Outlook

  • The Federal Reserve Board of Governors could be changing greatly in the near future. Fed Chair Janet Yellen’s term expires in early February 2018. While she is one of the candidates being considered for the position, it’s not certain she will be the one President Trump chooses. Vice Chair Stan Fischer has resigned effective mid-October. Two other board positions were vacant when President Trump took office. Federal Reserve Board Governor Dan Tarullo resigned earlier this year and Randal Quarles has been nominated to replace him.
  • All members of the Board of Governors vote on monetary policy at every meeting. There are only seven members on the board and President Trump has the ability to appoint four more right now. This could possibly be a game changer. All candidates will, however, have to be approved by the Senate.
  • Lawmakers in Washington, D.C., have moved their focus from health care to taxes and have been working on a tax plan which claims to be simpler and have fewer tax brackets for individuals, while reducing the corporate tax rate to 20%. The stock market met this news with more record highs, and the bond market sold off, fearing a substantial increase in the federal deficit. Time will tell if we get legislation passed.
  • There has been much talk about inflation lately, particularly whether the current lack of inflation is transitory or not. While the Fed believes it is transitory, their position becomes harder to defend the longer inflation remains subdued. Some have attributed the current state of disinflation to the “Amazonification” of the global economy, i.e. disruptions to traditional industries like retail, transportation and lodging.
  • Whatever the cause, inflation is currently seen by most economists as a minor threat to the economy. The Fed will have a chance to see three more inflation and unemployment reports before their next anticipated rate hike, and unexpected results could cause them to take a pause in their plan to raise rates.

The opinions expressed are those of the Portfolio’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, 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 Bloomberg Barclays U.S. 1-5 Year Government/Credit Bond Index is the 1-5 year component of the Bloomberg Barclays U.S. Government/Credit Index, which includes treasuries, agencies, publicly issued U.S. corporate and foreign debentures & secured notes. To be included in the index, securities must have at least one, and up to, but not including five years to maturity. It is not possible to invest directly in an index.

Risk factors: As with any fund, the value of the Portoflio's shares will change, and you could lose money on your investment. 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. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Fund may fall as interest rate rise. These and other risks are more fully described in the Portfolio's prospectus.

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.