Ivy VIP Natural Resources

09.30.19

Market Sector Update

  • Global equity markets were broadly flat in the quarter, while the energy and materials sectors posted slightly negative returns resulting in modest underperformance versus the broader market.
  • Crude oil prices continued to decline after reaching a high point for the year in April at $66 per barrel for West Texas Intermediate (WTI) and $74 for Brent. In mid-September, oil prices briefly spiked to $63 for WTI and $69 for Brent after an attack on Saudi Arabia’s oil infrastructure. However, prices quickly retreated after Saudi Arabia assured markets that any disruption to oil supply would be short-lived. The price for WTI closed the quarter at $54 per barrel and Brent crude oil closed at about $61.
  • In early July, OPEC agreed to continue its production cuts of approximately 1.2 million barrels per day (bpd) through March 2020. The group is scheduled to meet in December to determine if any adjustments need to be made to oil supply. OPEC’s primary goals are to balance the oil market and keep inventories at a targeted level, which will support prices.
  • OPEC production cuts remain necessary because of growing oil supply from the U.S. and other non-OPEC nations. U.S. oil production again grew in the quarter and finished September at 1.3 million bpd more than a year ago. Greater supply levels along with weakening demand trends were bearish for the oil market.
  • Most other commodity prices were down in the quarter as demand trends weakened. Iron ore prices fell by 15% as supply disruptions abated, while copper prices declined about 5%.

Portfolio Strategy

  • The Portfolio posted a negative return for the quarter and underperformed the return of its benchmark.
  • The five greatest equity contributors to the Portfolio's performance relative to the benchmark were Phillips 66, Sherwin Williams, Marathon Petroleum Corp., Magellan Midstream Partners, LP and Exxon Mobil Corp.
  • The five greatest detractors to relative performance were Concho Resources Inc., BHP Group Plc, Rio Tinto Plc, Centennial Resource Development, Inc., and Diamondback Energy, Inc.
  • The Portfolio's exposure to the energy sector declined slightly from the prior quarter, ending at about 64% of equity assets. The remaining sector exposure was composed of materials and industrials.
  • In general, we seek to own companies in the Portfolio with low-cost positions, strong balance sheets and the ability to grow profitably with high returns on capital. We also seek to own companies exposed to favorable trends in their respective commodities and sub-sectors.

Outlook

  • We expect OPEC to extend its current production cuts into 2020 and possibly even increase the amount of cuts. Non-OPEC oil production is expected to grow enough to satisfy global oil demand growth and we think it likely will exceed it. This would require additional cuts from OPEC to balance the market. U.S. production growth is expected to decelerate but still grow in excess of 1 million bpd in 2019.
  • Drilling activity is expected to decline further for the remainder of 2019 as U.S. oil and gas producers reduce capital expenditures in an effort to generate higher returns and free cash flow. As a result, oil production growth in the U.S. is expected to decelerate further in 2020 to less than 1 million bpd.
  • Global demand for commodities is expected to remain challenged as the market seeks clarity on U.S. trade policy. In 2020, we think there may be higher demand growth for oil because of new requirements for low-sulfur fuel in the shipping industry.
  • Energy equities continue to price-in a lower oil price than the current spot price, and it is expected that this gap will eventually converge.

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, 2019, 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 equity holdings as a percent of net assets as of 09/30/2019: Chevron Corp., 5.78%; Phillips 66, 4.86%; Marathon Petroleum Corp., 4.18%; Valero Energy Corp., 3.98%; EOG Resources, Inc., 3.42%; BHP Group plc, 3.35%; Diamondback Energy, Inc., 3.14%; BP plc, 3.10%; Rio Tinto plc, 3.10%; Enterprise Products Partners, L.P., 3.06%.

Risk factors: The value of the Portfolio'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. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in natural resources can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments; and the cost assumed by natural resource companies in complying with environmental and safety regulations. Investing in physical commodities, such as gold, exposes the Portfolio to other risk considerations such as potentially severe price fluctuations over short periods of time. The Portfolio may use a range of derivative instruments in seeking to hedge market risk on equity securities, increase exposure to specific sectors or companies, and manage exposure to various foreign currencies and precious metals. Such hedging involves additional risks, as the fluctuations in the values of the derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. These and other risks are more fully described in the 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.