Market Sector Update

• Despite strong U.S. growth throughout much of 2018, cracks in global economic momentum and tighter financial conditions spooked the markets in the fourth quarter. Elevated periods of volatility for the period across several equity indexes erased the gains experienced in the first three quarters of the year.
• Real estate stocks delivered negative returns as well, but proved to be a bit of a safe haven amid the storm of geopolitical and capital market volatility. The FTSE NAREIT Equity REITs Index, the Portfolio’s benchmark, returned - 6.7% for the quarter, compared to the S&P 500 Index, which declined 14% over the same period.
• Macro-economic conditions remain favorable for real estate operators, despite the mature nature of the current economic cycle. However, the recent market tumult driven by fears of a trade-war induced economic slowdown, coupled with potential for political turmoil in the U.S., have created a cloud of uncertainty over the equity –and real estate– markets.
• In addition, the Federal Reserve (Fed) recent policy remains a wildcard, and it is reasonable to assume real estate investment trusts (REITs) are less positioned for a prolonged rising rate cycle than other sectors.

Portfolio Strategy

• Despite posting a negative return, the Portfolio outperformed the benchmark for the quarter.
• Favorable stock selection across most property sectors was outstripped drove the majority of the outperformance, but an underweight position to the hotel group also was a notable contributor.
• Multifamily owners were among the top performers in the quarter. Revenue growth remained steady for the period, and a consistent cadence of operating strength has renewed investor confidence that 2019 will bring more of the same. The manufactured housing (MH) names were above-average performers as very favorable operating conditions and almost no new supply continue to serve as tailwinds for stock prices. A sizable overweight to MH added to overall returns. We remain overweight to the multifamily group, as we anticipate steady growth through lumpy new supply deliveries, but with some expense pressure.
• DatacenterREITs lagged the broader sector, with share issuance and lighter-than-expected leasing volumes driving the underperformance. The large overweight allocation to the group had a net negative effect and the space was among the Portfolio’s largest detractor in the quarter. However, the continued growth in several demand drivers, most notably cloud computing, artificial intelligence, and data analytics, continues to point to sustained earnings growth for the space and we remain overweight the group.
• Healthcare REITs benefited from the late-quarter 10-Year Treasury rate decline, ultimately delivering sector-leading returns. In addition, a supportive regulatory environment for skilled nursing, combined with benign tenant restructurings, has calmed investors’ nerves regarding additional tenancy failures. Medical office buildings continue to deliver slow, steady growth, which we favor longer term. Though our weight in the group was increased during the quarter to highest level of the year, the overall underweight position was detrimental to index-relative results. We continue to view the group as having excessive levels of new construction, but recognize that healthcare may once again be viewed as a safe haven in a more volatile market.
• Hotel REITs had the largest positive relative impact on the Portfolio from an allocation perspective. We were sizably underweight to this group throughout the quarter, and hotels were the worst performing group within REITs. Hotels are the most economically sensitive REIT sector and also have the highest correlation to broader equity markets. We remain underweight the group on concerns that increasing labor costs and continued new supply will pressure earnings, while increasing economic headwinds will pressure sentiment towards the space.

Outlook

• Entering 2019, the markets are clearly rattled. Higher volatility is intensifying the tightening of financial conditions and risks to growth are to the downside. The deceleration already in place is being amplified by lower market liquidity and the slowing pace of global growth. Concerns of recession, coupled with continued worries about trade and tighter credit, could prompt companies and consumers to pull back, creating the downturn they fear. In spite of the obstacles facing the economy, we believe the expansion will continue through 2019, albeit more measured. The ingredients for a slowdown exist, but we do not think the conditions for a recession are in place. Employment is too robust and consumer spending too strong for the economy to contract in the near term.
• With regard to the current commercial real estate cycle, we continue to see stable operating conditions across the sector with few material concerns on the horizon. Bank lending, commercial construction, equity allocations, and overall pricing metrics remain much healthier than was often the case in previous cycle peaks. Simply moving into the later stages of this recovery does not mean the sector’s fundamentals will turn negative. In fact, the prospect for reacceleration of earnings growth for 2019 appears plausible if we avoid a sharp downturn in economic growth and corporate earnings materialize as expected.
• The “bondification” of real estate has been bemoaned by many market participants as irrational, but has become current reality. Higher U.S. Treasury rates have finally materialized, and while share price gains for REITs have been muted the results are far from the catastrophe many have predicted. 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 while potentially rising borrowing costs, such as a rising 10-Year U.S. Treasury yield, could offer resistance.
• Valuations of private market transactions continue to support REIT valuations, suggesting REITs currently trade at a discount to net asset value, while REIT 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.

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 Dec. 31, 2018, 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 FTSE NAREIT Equity REITs Index is designed to present investors with a comprehensive family of REIT performance indexes that spans the commercial real estate space across the U.S. economy. The FTSE NAREIT Equity REITs index contains all Equity REITs not designated as Timber REITs or Infrastructure REITs. It is not possible to invest directly in an index.

Effective April 30, 2018, the Portfolio's benchmark changed from the Wilshire U.S. Real Estate Securities Index to the FTSE NAREIT Equity REITs Index.

Effective April 30, 2018, the name of Ivy Advantus Real Estate Securities Fund changed to Ivy Securian Real Estate Securities Fund.

The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-cap U.S. equity market. The index includes 500 of the top companies in leading industries of the U.S. economy. 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. 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.