Weighing the risk and reward of asset classes and securities in seeking income around the globe
- A number of measures have been taken within the Fund to alleviate the volatility that we have seen within the markets.
- We believe there is no longer scope to obtain equity-like returns on most parts of the fixed-income markets.
- We continue to look for securities that we consider high quality, which means they offer sustainable growth and are positioned well in their industries throughout the world.
John C. Maxwell, CFA
W. Jeffery Surles, CFA
The Ivy Global Income Allocation Fund underwent a change in name and strategy in June 2012. Formerly the Ivy International Balanced Fund, the mandate was updated to allow for a global investable universe, with the Fund’s investment strategy placing more emphasis on income-generating securities. Since the change, the team has outperformed the Fund’s newly designated benchmark on a one-year basis (before the effects of sales charges) by seeking attractive income opportunities and by tactically allocating among asset classes across the world. Marking the Fund’s one-year anniversary, Portfolio Managers John C. Maxwell, CFA, and W. Jeffery Surles, CFA, share their perspectives on the current market environment and subsequent Fund positioning, and provide their outlook for the months ahead.
A sell-off in stocks and bonds rolled across the globe after Federal Reserve (Fed) Chairman Ben Bernanke remarked the central bank may begin to reduce purchases under its $85 billion bond purchase program before year end. Accordingly, market uncertainty and speculation, and the resulting spike in market volatility, has led us to initiate thoughtful counter measures to mitigate risk within the Fund while maintaining our disciplined investment philosophy: seeking securities across geographic boundaries and market capitalization with income and growth potential.
Counter measures, current strategy
We have taken a number of measures within the Fund to alleviate the volatility that we have seen within the markets. First, in the fixed-income and equity portfolios, we increased our U.S. dollar exposure through the purchase of pure U.S. dollar assets. Additionally, we hedged a broad-based number of foreign assets in various currencies to the dollar. We believe the current environment, punctuated with talk of Fed tapering, a decreasing U.S. fiscal deficit and a gradually improving U.S. economy — which is in better relative position compared to most major economies around the globe — is favorable for the dollar over the long-term. In our view, if the economy improves and the Fed cuts back on its stimulus, the dollar will benefit from expectations of higher interest rates. But if the Fed maintains stimulus because the economy is weak, the dollar will rise on safe-haven demand. That said, we are not expecting sharp gains for the dollar. However, we are expecting the dollar to tick higher. By hedging the currency, we believe we can remove some volatility within the portfolio.
In response to our bullish outlook regarding the U.S. dollar, we started decreasing the emerging-market exposure within the fixed-income portfolio in December, from more than 50% to roughly 35%. Recently, we have lowered it even further. We are concerned that higher U.S. interest rates stemming from the likelihood of Fed tapering will prompt a mass migration out of emerging markets.
In our view, the supportive tailwinds for emerging markets are now slackening, exposing underlying weaknesses that will affect the growth outlook for many emerging-market countries.
Additionally, we have shortened duration within the fixed-income portfolio. Not only does the shorter duration stamp out some rate volatility, but as we run a fairly credit-heavy portfolio in our search for yield, it also reduces spread risk and makes the credit part of the portfolio less volatile.
In a move that may seem counter intuitive given the spike in volatility and our relatively sluggish growth outlook for equities, we increased the equity weighting in the portfolio. In our view, fixed-income markets have maintained low, stagnant rates accompanied by spreads that have gravitated towards the tight end of their historic range. As a result, returns in fixed income are lower than what we have seen in previous years. Given these headwinds, we believe there is no longer scope to obtain equity-like returns on most parts of the fixed-income markets. What’s more, given the uncertainty regarding Fed policy and the resulting spike in volatility, risk-adjusted returns from that aspect of the market have gone down dramatically. While we still expect volatility in equities, when we look at equity valuations and earnings forecasts, we believe there is higher potential total return there. As a result, we have increased the equity weighting within the Fund. The current weighting is approximately 70% equities and 30% fixed income from a previous allocation of 65% equities and 35% fixed income at the beginning of June.
Where’s the yield?
While we think equities are one of the best places to be, not all equities are created equal. From a geographic standpoint, we have established an overweight position in Japan, as we believe Bank of Japan policies will likely continue to inflate asset prices. Within Japan, we seek sectors we believe will benefit from the weak yen and are able to provide some protection from inflation — mainly exporters and real estate companies. Furthermore, we are significantly overweight the UK — due to investment in numerous multinational companies that happen to be domiciled in the country rather than a purposeful overweight stemming from a bullish outlook for the region.
On the U.S. front, we are structurally underweight U.S. equities due to the lower yields available in the market compared to foreign equities. The U.S. dividend plays have been significantly purchased, which in our opinion, has resulted in inflated valuations. However, we continue to sift through the U.S. in an effort to increase our direct exposure as we believe the relatively defensive tilt of the U.S. market will benefit from safe haven flows. As a result, individual security selection within the U.S. has proved difficult. We find ourselves shying away from dividend payers due to the price premium and lower yield. More often than not, when analyzing very similar domestic and international companies with comparable fundamentals, foreign equities have consistently yielded more than their U.S. counterparts. For example, within the telecommunications sector, we have found several foreign equities with high quality balance sheets, strong cash flow and dividend yields in excess of 4%. Two prime examples include Telstra Corporation Limited1, an Australian-based company with a dividend yield of roughly 6%, and Vodafone Group plc2, a multinational UK company with a dividend yield of approximately 5.3%. These are companies that provide similar exposure to a company like Verizon, a stock we don’t own, yet we can pick up some yield by going overseas.
Similarly, this would be the case for utilities. Within the U.S., by and large, these stocks have dividend yields in the 3% to 4% range, while the average yield of our five foreign utility companies is approximately 5.5%. In managing an income fund, yield is key.
The outlook ahead
We view the current global environment as one driven by central bank policy and believe repeated quantitative easing implemented by many central banks demonstrates the current underlying structural weaknesses in developed market economies. With cash yields close to zero, and cash being created in record quantities by developed-market central banks, we feel strongly that investors need to protect themselves by owning assets that central banks cannot create more of. This is why we remain fully invested and overweight equities, despite having a less-than-ideal view on global growth. Furthermore, given the increased volatility in fixed income, the risk-adjusted return that we think is possible from equities looks attractive.
Longer term, we are structurally positive on the majority of emerging-market currencies. However, in the short term we worry U.S. dollar strength and shrinking emerging-market current account surpluses will ease appreciation drivers on emerging-market currencies. This may cause emerging-market central banks to intervene less in their own currency markets and could slow reserve growth and base money creation in emerging-market countries, which act as de-facto monetary tightening. The result: unwinding of portfolio flows to emerging markets and diminishing return potential. Given these concerns, we remain focused on solid dividend yields and continue to look for securities that we consider high quality, which means they offer sustainable growth and are positioned well in their industries throughout the world
1 1.8% of Fund net assets as of 6/30/2013
2 1.2% of Fund net assets as of 6/30/2013
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 June 30, 2013, and are subject to change due to market conditions or other factors.
Risk Factors. Investment return and principal value will fluctuate, and it is possible to lose money by investing. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Dividend-paying investments may not experience the same price appreciation as non-dividend-paying instruments. Dividend-paying companies may choose to not pay a dividend or the dividend may be less than expected. These and other risks are more fully described in the Fund’s prospectus.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available a summary prospectus, containing this and other information for the mutual funds offered by Ivy Funds , call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.