Pockets of perceived opportunity

Ivy International Core Equity Fund
02.15.19

International equities faced a number of headwinds in 2018. The strength of the U.S. dollar, trade war concerns, the continuation of Brexit negotiations, energy price volatility and political instability all contributed to the decline. The MSCI EAFE Index was down 13.79% for the year and was particularly hard hit during the fourth quarter — down 12.54% and accounting for more than 90% of the year’s poor performance. Despite a volatile 2018, the Ivy International Core Equity Fund team believes pockets of opportunity exists, you just have to know where to look in an evolving international investment landscape.

A look back

The Ivy International Core Equity Fund felt the headwinds of 2018 and was down 17.59%. For the year, the Fund’s positioning remained relatively balanced to the index between defensive and cyclical sectors, but there were three primary drivers of underperformance.

  • Health care — The Fund’s underweight allocation and stock selection in health care accounted for approximately half of the Fund’s underperformance in 2018. Select holdings in health care providers and pharmaceutical companies were large detractors to performance. Uncertainty on health care reform and insurance payer mix proved to be a headwind for these industries.
  • Energy — Over the course of 2018, the Fund maintained a substantial overweight allocation to energy which benefitted performance through the first three quarters of the year. But, as oil prices declined during the fourth quarter that overweight allocation hurt Fund performance and proved to be a detractor for the calendar year. Brent crude finished the year at $53.80, down almost 40% from its early October high.
  • Emerging markets — Emerging markets witnessed increased volatility over the year as trade war concerns, political uncertainty and currency headwinds pressured the asset class. Consequently, emerging markets underperformed their developed market peers and the Fund’s approximately 12% allocation to developing markets was a relative detractor to performance.

The look ahead

There are a number of factors we are carefully monitoring in the current economic environment. Shift in central bank policy, the rise of nationalism and ongoing trade negotiations between the U.S. and China are standout concerns. The question remains: How much longer will the cycle extend uninterrupted by looming risks?

Despite a challenging market environment, we believe pockets of opportunity exist. In our view, relative valuation remains supportive for international equities as developed international markets and emerging markets are trading at a significant discount to the U.S.

International markets are attractively valued
Chart showing High yield bonds performed favorably relative to equities during recessionary and recovery years

Source: Factset. MSCI EAFE Index and MSCI EM Index relative P/E ratio to S&P 500 Index. Data from 12/31/2010 to 12/31/2018. The price-to-earnings ratio (P/E) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The P/E ratios shown above indicate international and emerging markets are trading at a premium to the domestic market if greater than 1 while trading at a discount if less than 1. Past performance is no guarantee of future results.

At a fundamental level, we are increasingly focused on companies with perceived sustainable competitive advantages, safe/high dividend yields and strong balance sheets as well as attempting to reduce our allocations to companies with high exposure to financial leverage. As a result of our relative value investment approach, our highest convictions are in:

  • Energy — As we enter 2019, the Fund maintains an approximately 11% allocation to energy compared to a 6% allocation for the benchmark. In our view, companies have been focused on improving their balances sheets and many have reduced their capital expenditures, which should lead to a supply/demand oil imbalance and thus higher oil prices in 2019. With that backdrop, we think there are many attractively valued stocks and/or growth opportunities in the sector as current stock prices do not fully reflect the prospect of higher oil prices.
  • Information technology — We believe companies within this sector provide relative growth opportunities in industries like semiconductors and hardware storage, or stable growth opportunities in companies focused on information technology services and/or software development.
  • Emerging markets — We remain constructive on emerging markets as we move into 2019 as we believe several of the headwinds that persisted in 2018 are abating. There appears to be a thaw in the ongoing trade tensions between the U.S. and China, which should provide attractive relative growth opportunities within China. In addition, China has started loosening domestic policy and we expect an easing of regulatory, monetary and fiscal policies as we progress into 2019. A stable to weakening U.S. dollar and flat to lower U.S. dollar interest rates should also benefit emerging markets. We started the year with an approximately 12% allocation to emerging markets, with more than 8% of that allocation invested in China.

Though market uncertainties remain, we believe our flexible investment approach, incorporating growth and value securities while staying in the middle two-thirds of the value-growth spectrum, can help us drive shareholder value over time.

Fund Performance

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Past performance is no guarantee of future results. The opinions expressed are those of the Fund’s 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 February 2019, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. The information 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.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI. The MSCI EAFE Index is an unmanaged index comprised of securities that represent the securities markets in Europe, Australasia and the Far East. The MSCI EM Index is an unmanaged index comprised of securities that represent large- and mid-capitalization companies within emerging market countries. The S&P 500 Index is an unmanaged index of U.S. common stocks. It is not possible to invest directly in an index.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. 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. 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.