Market Sector Update

• The equity rally that began in mid-February continued during 2Q 2016 despite the volatility stemming from the U.K.’s historic vote to exit the EU.
• Small caps have led U.S. equities higher off the mid-February lows, with the Russell Microcap Growth and Russell 2000 Growth Indices (the Portfolio’s benchmarks) performed well when compared to the Russell 1000 Growth Index. This is a welcome sign for smaller company investors since this segment of the market plummeted almost twice as much as their large-cap counterparts from the 2015 high, a peak they remain meaningfully below.
• Of the 10 sectors in the Russell Microcap Growth Index, all but consumer discretionary had positive returns for the quarter. Two of the largest sectors, health care and technology, contributed most to the total return; however, smaller sectors such as materials, telecommunications and utilities posted the strongest absolute gains.

Portfolio Strategy^*

• The Portfolio outperformed the Russell Microcap Growth Index for the period ended June 30, 2016.
• Stock selection was a significant contributor to the positive relative outperformance while allocation effect was minimal in the quarter.
• Technology provided the biggest boost to the Portfolio on an absolute and relative basis. Several holdings that were weak in 1Q 2016 snapped back sharply after investor fears were calmed by strong quarterly results and robust annual guidance. These names include SPS Commerce, LogMeIn, RingCentral. Additionally, Ruckus Wireless was acquired for a meaningful premium and a new holding, Acacia Communications, appreciated significantly.
• Holdings within health care were also key to the strong performance this quarter. This strength was broad-based as financial outlooks were generally favorable and investor appetite for risk resumed.
• Telecommunications was also a major contributor with the sector’s sole holding, 8x8, Inc., posting continued strong results.
• Consumer discretionary was the lone area of underperformance for the period. Motorcar Parts of America and Sportsman’s Warehouse reported disappointing quarterly results and declined materially. In our opinion, the longer-term outlook remains bright for both these companies.

Outlook

• Performance in the 2Q 2016 snapped back sharply after a weak 1Q 2016. The dramatic sell-off experienced at the start of 2016 was not enjoyable; however, it did provide some excellent buying opportunities that, in our opinion, helped better position the Portfolio for long-term capital appreciation.
• Looking forward, the outlook remains as cloudy as ever due to macroeconomic uncertainties around the globe, but one thing is for sure, the rapid pace of innovation in today’s global marketplace is constantly creating opportunities in the early-stage growth company universe. Downside volatility should no doubt unfold in the future, but our philosophy remains firmly focused on the long-term, and we will allow our investment process to serve as our compass to uncover these opportunities where ever they may be.

 

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Top 10 holdings (%) as of 06/30/2016: 8x8, Inc. 4.4, Tile Shop Holdings, Inc. 4.3, SPS Commerce, Inc. 3.4, Cornerstone OnDemand, Inc. 3.1, LogMeIn, Inc. 3.1, Flotek Industries, Inc. 3.0, Nautilus Group, Inc. (The) 3.0, MYR Group, Inc. 2.6, Q2 Holdings, Inc. 2.6 and Imprivata, Inc. 2.6.

The opinions expressed in this commentary are those of the Portfolio’s manager and are current through June 30, 2016. The manager’s views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is not a guarantee of future results.

The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. The Russell Microcap Growth Index measures the performance of the microcap growth segment of the U.S. equity market. The S&P 500 Index is composed of 500 selected common stocks chosen for market size, liquidity, and industry grouping, among other factors. It is not possible to invest directly in an index.

Risk Factors.The value of the Portfolio’s shares will change, and you could lose money on your investment. Market risk for small-sized companies may be greater than that for medium or large companies. Smaller companies are more likely to have limited financial resources and inexperienced management. Stocks of smaller companies, as well as stocks of companies with high-growth expectations reflected in their stock price, may experience volatile trading and price fluctuations. Furthermore, when the economy enters a recession, there tends to be a “flight to quality,” which may exacerbate the increased risk and greater price volatility normally associated with smaller companies. The Portfolio’s performance may be more susceptible to a single economic, regulatory, or technological occurrence than if it had a more diversified investment portfolio. The Fund may invest in Initial Public Offerings (IPOs), which can have a significant positive impact on the Portfolio’s performance that may not be sustainable. 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.

Variable investment options are subject to market risk, including loss of principal, and are suitable for long-term investing, particularly for retirement. There are charges and expenses associated with annuities and variable life insurance products, including mortality and expense risk charges, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals. Withdrawals before age 59 ½ may be subject to a 10 percent IRS penalty in addition to taxes. Ivy Funds VIP are only available as investment options in variable life insurance policies and variable annuity contracts issued by participating insurance companies. They are not offered or made available directly to the public.