A micro view in a macro world

Ivy Advantus Bond Fund

Despite reduced optimism regarding the Trump administration’s pro-growth agenda, the economy continues to perform smoothly with gross domestic product showing steady increases. Additionally, recent upticks in employment, housing, and a strong lift in consumer confidence have led to increasingly positive business sentiment.

Even with legislative uncertainty, the big story in the bond market this year has been that long-term rates have fallen as expectations around growth and inflation have been tempered. This, along with the Federal Reserve (Fed) raising the federal funds rate, has contributed to a significant flattening in the yield curve. At the end of the third quarter, the spread between 30-year and 2-year bonds was the flattest since September 1, 2016. Despite our bias for higher rates, we think long term rates should remain low by historical standards.

We believe the current credit cycle will be prolonged with a continued low-rate environment and strong demand for corporate bonds from both domestic and international buyers searching for yield in a low growth, low rate world. Slow and steady economic growth and low inflation are good ingredients for non-government bond sector performance. Overall, the moderate growth backdrop should continue, which is positive for the current credit environment.

Staying selective amidst mixed signals

The current economic backdrop requires heightened risk-awareness and a disciplined investment process. Macro viewpoints help inform and guide sector selection, but security selection through bottom-up analysis is the foremost alpha driver of our investment process. Disciplined analysis has served us well in identifying relative value plus identifying positive catalysts that we believe will drive ratings upgrades and capital return. Our comprehensive approach in researching credits gives us a granular understanding of each opportunity, which is critical in a credit cycle with mixed signals.

Current credit cycle indicators

As shown in the chart below, the investment team reviews multiple market factors when determining the future investment trajectory of the Fund. This chart illustrates the areas they review, along with the current quarter-end results of that review. The current environment doesn’t line up easily to indicators from previous cycles and has not offered many clear indications of what to expect.

Focus on financials and industrials

We are maintaining a significant overweight in corporate credit, as we see the most acceptable levels of risk and reward within this area. In particular, we are finding attractive opportunities in the financials and industrials sectors. We believe the financials sector is poised for continued earnings growth and will maintain a stable credit profile with strong balance sheets and decreasing regulatory burdens. Recently, we added to our exposure in financials, all within the insurance space. We think this sector will outperform as we move farther along through this credit cycle.

We favor the periphery of the industrial sector, in particular within energy and airlines. For instance, the Fund holds Master Limited Partnerships (MLPs) that own pipelines that transport oil. MLPs are particularly attractive right now, as they have relatively stable contracts with already agreed upon prices to move oil through the pipelines. The partnerships have more volume-driven revenue than commodity-driven revenue, so while the price of oil may fluctuate, the revenue from moving it does not.

Additionally, we are finding relatively attractive yields in airline enhanced equipment trust certificates (EETC). EETCs are securities designed to provide airlines a source of financing for aircrafts. The EETC is guaranteed by the airline, plus it is backed by collateral in the form of the airplanes, so if an airline goes through bankruptcy, they must reaffirm all leases on the planes. The attractiveness of yields and overall structure of EETCs are an important part of the portfolio.

Diversifying with structured securities

While we are overweight corporate credit, we are also diversifying our portfolio by tactically adjusting our structured security allocation. For example, the underwriting within the commercial real estate space is the strongest we have seen in years, so we are overweight commercial mortgage backed securities. This is further supported by the strong fundamentals for commercial real estate, office buildings and warehouses, which are expected to maintain solid rent growth.

And while we are broadly underweight agency mortgagebacked securities, we are finding opportunities in the space through Credit Risk Transfer (CRT) securities. In 2013, these securities were created to transfer portions of risk from conventional residential mortgage loans backed by government-sponsored enterprises, such as Fannie Mae and Freddie Mac, to private sector investors. These securities provide an opportunity to increase the yield on the portfolio by assuming credit risk on loans made to high-quality homebuyers. The CRTs offer benefits within our portfolio, including borrowers with excellent credit scores, geographically diverse home ownership base, floating rate security benefits from a rise in interest rates, and gaining exposure to consumer credit diversified from corporate credit.

Moving forward

We believe that the markets will see moderate growth in the near-term but that rates will stay below the long-term averages. We expect policy changes will come from the administration and Congress to boost growth, but those changes are likely to be later than originally anticipated. Coupled with a more robust global growth outlook, this should be a good combination over the next 12 months.

We remain optimistic about the prospect for economic growth above 2% for the rest of 2017. The likelihood of continued business investments remains high, as reflected by the elevated readings in small and large business optimism. We expect the Fed to raise interest rates again this year and to begin scaling back its bond-buying program by re-investing less of the portfolio that matures.

Given the variability of economic signals, we think it is critical to evaluate the numerous factors influencing today’s market. In mixed environments, we believe our active, risk-aware investment process can offer stability in otherwise uncertain times.

Ivy Advantus Bond Fund sector weightings

As evidenced by the charts below, the Fund has certain areas where it stays relatively close to the benchmark when investing - such as CMOs or sovereign debt - but also varies when our research tells us to. The allocations shown are the end result of the reviews discussed earlier and our upcoming outlook for this sector.

Past performance is no guarantee of future results. The opinions expressed are those of the Fund’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 November 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.

The Ivy Bond Fund was renamed Ivy Advantus Bond Fund on April 3, 2017.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund 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 rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/ dealers.