Moving to a defensive position for uncertain times

Ivy Apollo Strategic Income Fund
04.08.19

A combination of asset classes may offer lower volatility — a concern for many investors today. The Fund’s sleeve structure allows us to blend three complementary fixed-income strategies while adjusting allocations as needed, based on market conditions and our outlook. In the current environment, that means taking a more defensive position.

We think low interest rates are likely to continue in the foreseeable future, based on the “dovish” policies of major central banks, slower economic growth worldwide and a market dealing with uncertainty about a wide range of issues:

  • Central bank policy: Both the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) have turned to more accommodative interest rate policies in the last three months. Europe’s loss of economic momentum was a key factor for the ECB, which cut its 2019 eurozone economic growth forecast to an annual rate of 1.1% from 1.7%. We do not expect the ECB to raise interest rates until at least March 2020. The ECB committed to providing liquidity to credit markets until 2023 through its targeted longer-term refinancing operations (TLTRO), which is a source of funding for European financial institutions. We believe Fed and ECB policies reflect the global economy, including an expectation that the U.S. is in the later stages of an economic cycle.
  • Slower global growth: Market participants widely are forecasting slower global economic growth in 2019; Ivy estimates the global growth rate this year at 3.4%.
  • Trade dispute: China’s slowing economy and the U.S.-China trade war have raised many concerns about the direction of the world’s no. 2 economy. While there is no resolution yet to the trade dispute, we think a deal ultimately could add economic stimulus, help growth inside and outside both countries, and boost business and consumer confidence. In our view, a deal thus could help prolong the current cycle.
  • Direction of dollar: The strong U.S. dollar was a global market factor in 2018. The Fed’s prediction of no rate hikes in 2019 and one in 2020 will likely cause the dollar to weaken against high yielding emerging market currencies as investors search for yield continues. Lacking a major change in global growth, the dollar should be range bound against developed currencies ( euro, yen and pound) as these countries deal with their own idiosyncratic issues.
  • North Korea: There is concern that the U.S. is losing traction on any agreement to eliminate nuclear weapons.
  • Political uncertainty: Distractions already are developing as we face the 2020 U.S. election campaigns. In addition to the presidential election, there will be voting on all 435 seats in the House of Representatives, 34 of the 100 Senate seats and a wide range of state and local elections.

Against this backdrop, credit spreads have been somewhat volatile but remain compressed. We believe the more dovish Fed — compared with its position at the beginning of 2018 — will keep a lid on credit spreads, and we think the high income sector offers value in certain sectors.

We have chosen to position the Fund defensively in this environment and in general are seeking to move to higher quality securities and longer duration overall.

Philosophy and process

Unlike single-sector funds, the Fund seeks to capture the return opportunities and risk mitigation potential of a diversified mix of fixed-income securities. It invests across a range of factors, including credit, liquidity and complexity, and combines sleeves of three fixed-income strategies.

We believe a portfolio that spans the fixed-income credit spectrum can offer higher return potential from high-yield, high-risk bonds and non-traditional credit vehicles, while using highly rated investment-grade bonds to provide fund liquidity. Flexible sleeve allocations allow for adjustments based on market conditions and our outlook, potentially creating an opportunity to mitigate risk exposure, volatility and overall Fund duration.

The Fund’s stated objective is to seek to provide a high level of current income, with capital appreciation a secondary objective. While income is not guaranteed, the Fund has continued to capture a competitive yield for shareholders. We consider it a defensive fund and have positioned it for an uncertain economic environment.

A closer look at each sleeve

Strategy Sleeve Allocation Allocation at 02/28/2019

Global Bond

Flexible  10–70%

47.5%

High Income

Flexible  10–70%

32.5%

Total Return

Target   20%

20.0%

  • Global bond strategy: Decisions are based on factors including fundamental global themes, such as country analysis, issuer analysis, including domicile, performance and credit history across economic cycles; and issue analysis, including maturity, quality and denomination. We invest primarily in a diversified portfolio of bonds of foreign and U.S. issuers.
  • High income strategy: We focus on bottom-up credit work to find companies we think can outperform throughout a business cycle. We dig into the details of the business models, covenants and competitive advantages as part of our investment decision. While doing the bottom-up analysis, we don’t turn a blind eye to the business cycle or credit spreads, and want to be sure we can be compensated for the risks we take. We ypically hold names throughout the cycle, don’t want to rely on timing the big macro calls and tend to stay away from highly cyclical sectors.
  • Total return strategy: The Fund’s sub-adviser, Apollo Credit Management, manages this sleeve. It provides access to the full breadth of the credit markets, including some nontraditional credit securities. Such securities may not have been accessible to all investors in the past, especially within a mutual fund. Apollo can explore the market for nontraditional opportunities, partner with banks to lend money to smaller companies, or underwrite loans for a select entity — all as part of seeking to generate yield while keeping duration low. As with the other sleeves, it is a long-only strategy. The managers do not pursue derivativeoriented transactions.

Near-term outlook

We see some opportunity now among emerging markets and Brazil in particular, based on reform programs announced by the new presidential administration there. Conversely, Mexico’s new administration has raised some troubling issues that make it less attractive to us now. We also have an ongoing concern about the risk of potential sanctions on Russia and what that could mean for its debt.

In the U.S., we think slower economic growth is likely for the first half of 2019 and we expect the dollar to remain strong. We also do not expect the Fed to raise interest rates this year. However, U.S. economic growth still is above trend, with healthy real income growth and an elevated personal savings rate that we think can insulate against the negative wealth affect from the lower stock market late in 2018.

Labor markets continue to expand, which has kept consumer confidence near cycle highs and supported strong spending growth. But we think trade will continue to be a risk factor going forward. There is a potential for more tariffs followed by retaliatory action that could impact the capital investment plans of many companies. That raises the risk of what we would consider a negative feedback loop that could affect all markets and ultimately consumer confidence.


Late cycle factor risks


An increasingly volatile environment has raised questions about the stock market’s ability to sustain its historic bull run. Our Ivy Live panel shared their views on the subject.

Get the full perspective


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 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 Fund is managed by Ivy Investment Management Company. The total return strategy is sub-advised by Apollo Credit Management, LLC.

Diversification cannot guarantee a profit or protect against loss in a declining market. It is a method to manage risk.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Although asset allocation among different sleeves and asset categories generally tends to limit risk and exposure to any one sleeve, the risk remains that the allocation of assets may skew toward a sleeve that performs poorly relative to the Fund’s other sleeves, or to the market as a whole, which would result in the Fund performing poorly. While Ivy Investment Management Company (IICO) monitors the investments of Apollo Credit Management (Apollo) in addition to the overall management of the Fund, including rebalancing the Fund’s target allocations, IICO and Apollo make investment decisions for their investment sleeves independently from one another. It is possible that the investment styles used by IICO or Apollo will not always complement each other, which could adversely affect the performance of the Fund. As a result, the Fund’s aggregate exposure to a particular industry or group of industries, or to a single issuer, could unintentionally be larger or smaller than intended. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. 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. 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. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. 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.