Sweet spot looking sweet once again? Mid caps at midyear

Sweet spot looking sweet once again? Mid caps at midyear

August 24, 2016
Ivy Mid Cap Growth Fund


Story Highlights

  • The news is looking good for domestic mid-cap equities.
  • In 2016, the Fund has seen resurgence in performance. Energy has been one of the Fund’s strongest sectors and greatest contributors to performance year-to-date.
  • Our cautiously constructive outlook is based on the positives we see in the U.S. economy

While sometimes being stuck in the middle can leave much to be desired, other times, the middle ground might be the perfect spot for investors seeking great growth stocks with the potential for less risk than small- or micro-cap stocks. Since the January stock market swoon of 2016, economic indicators continue to confirm that the U.S. economy remains on a growth path, with positive trends for employment and consumer spending and low inflation and interest rates.

How mid caps stack up now

The news is looking good for domestic mid-cap equities. Since January 1, 2016 through July 31, 2016 mid-cap stocks, as measured by the Russell Midcap Index, have been the strongest performing market capitalization group. Year-todate, mid caps returned 10.3% while small caps returned 8.3% and large caps returned 7.7%, as measured by the Russell 2000 Index and the Russell 1000 Index, respectively.

In fact, if you take a look at mid-, small- and large-cap stocks since the market lows on February 12, 2016, small caps have returned 29%, mid caps have returned 26% and large caps have returned 21%. So far in 2016, it has been advantageous to hold stocks in the mid- and small-cap spaces.

Fund outperforms index, peers

In 2016, the Ivy Mid Cap Growth Fund has seen a resurgence in performance. Year-to-date through July 31, 2016, the Fund has outperformed the Russell Midcap Growth Index (the Fund’s benchmark) and a majority of its mid-cap growth peers, before the effects of sales charges. According to Lipper, only 15.6% of all mid-cap growth managers outperformed the Russell Midcap Growth Index with the average fund behind by 249 basis points. This is particularly encouraging given the weakness we saw at the beginning of 2016. The second quarter ended strong and those performance results have continued into August.

Sectors in review, those we are watching


This has been one of the Fund’s strongest sectors and greatest contributors to performance year-to-date. This is in sharp contrast to July 2015 performance from the sector. In the second half of 2015, we were overweight this underperforming group throughout a very tumultuous year for energy investors, a fact which helped swing performance favorably as oil prices rebounded throughout the first half of 2016. We eliminated a number of positions in the portfolio in the last half of 2015, but retained positions in four other energy companies, all of which have had strong recoveries off the low points for energy stocks. We expect the recovery to continue over the next few years as the energy patch begins to get back to work with higher levels of activity.


We are seeing many interesting industrials opportunities in the mid-cap space. It’s a sector that has been damaged pretty significantly due to weakness in the oil and gas industry. This weakness has also hurt the transportation industry. While we are currently in the process of adding a few stocks from this sector, we are also taking our time in the hope that a turnaround is on the horizon for several industrials subsectors.

Despite the fact that the Fund is underweight industrials, we hold a few names that have greatly outperformed the average stock in the sector and the benchmark overall. Part of the reason for the good performance is because some of our holdings are more business-service related and tend to be less economic sensitive. One example is Verisk Analytics, Inc., a company that provides data analytics solutions for customers in insurance, natural resources, health care, financial services, government, and risk management sectors in the U.S. and internationally. This stock has been performing with a lot more stability as of late.

The industrials group also includes some names that are growth cyclical. These stocks’ exposure to energy hurt them during 2015 but there has been a turnaround in 2016 and they now are looking better to those investors who want to participate in the oil and gas industry/industrials sector again.

A.O. Smith is a newly added industrials holding. This company primarily sells large water heaters but also water purification systems in China. Reasons why we like this stock? It benefits from ongoing replacement demand for water heaters on a fairly consistent basis. The current uptick in housing is also contributing to A.O. Smith’s bottom line.


Although an underweight position, this sector provides another area of strength for the Fund. Portfolio holdings in this sector are mostly cyclical and more commodities based, which is something that we typically stay away from. We don’t tend to find many quality growth companies in materials, but there are always a few such as Scott's Miracle-Gro, a long time Fund holding and Valspar, a paint company. Scott’s benefited from more favorable weather patterns over the past 12-24 months. Weather patterns in general have affected many companies over the past few years. Scott’s has been in the cross hairs of bad weather and normal seasonal trends have been a benefit to the company recently. Scott’s also pays a nice dividend. As equity investors search for fixed-income substitutes across markets, Scott’s has benefited from this trend as well. Valspar was bid up significantly on the announced acquisition by Sherwin Williams.

Health care

Health care has helped Fund performance year-to-date and was a stronger performer in July. This sector includes a diversified group of companies across many subsectors of health care from medical technology devices holding Intuitive Surgical, which sells the daVinci surgical robot system, to Zoetis, an animal health holding. In addition to owning a number of biotechs, the Fund own health care services companies such as long-time holding, Henry Schein, the world’s largest provider of health care products and services to office-based dental, animal health and medical practitioners. These companies, on average, have been very strong contributors to Fund performance.


One of the largest sector weights in the Fund has performed in-line with the benchmark recently. There were a number of names that outperformed as well as a number of disappointments. Top performers included GrubHub, a provider of an online and mobile platform for restaurant pick-up and deliveries; Ellie Mae, a recent addition to the portfolio that is a rapidly growing software-as-a-service provider to the mortgage industry; and Trimble Navigation, a recent re-addition to the Fund that provides technology solutions within engineering and construction. Recent underperformers include Service Now, Alliance Data Systems and Teradata. Both Alliance Data Systems and Teradata have been sold from the portfolio.

Consumer staples

This sector has been positive lately and stock selection has been better than the benchmark. Main contributors have been Hain Celestial Group, which manufactures organic and natural products in the U.S., U.K., Canada, and Europe; Blue Buffalo Pet Products, which produces and sells pet food made from natural ingredients; and Mead Johnson, a consumer product company that makes Enfamil infant formula. Mead Johnson has struggled over the past year related to competitive issues in China, significant changes in product distribution patterns in that country, and the foreign currency translation impact of a strong dollar. The stock has been weak over the past six months, but recently it was able to make a nice positive contribution to portfolio performance.

Consumer discretionary

We would like to see improvements to the portfolio within this sector. One recent improvement involved Polaris Industries. Polaris, a reasonably large portfolio holding, has been weak due to company-specific and weather issues that have impacted demand for some of its products, such as snowmobiles. We believe that things are turning around at the company as it reported second quarter numbers that were slightly better than what investors had been anticipating. We are hoping to see other positives across some of the other names in the sector, including stocks being sold at significant discounts due to difficulties across the retail space.

Financials, telecommunications and utilities

Financials has been a drain on performance relative to the benchmark but not substantial. This drain has been largely due to the Fund’s bank exposure and, in most recent months, confusion about the direction of interest rates, which has put pressure on some bank holdings.

We’ve had generally neutral performance with respect to telecommunications and utilities companies. Fund performance for these sectors has generally been in line with the benchmark year-to-date.

Potential opportunities, areas we look to avoid

We are looking for companies where there appears to be a strong balance of growth opportunity and valuation support. We are seeking what we consider to be quality growth companies in terms of their business models and balance sheets. We want to try to buy those companies when they are on sale. We are not value investors, but we are definitely looking for good valuation opportunities to buy good growth companies.

While there are some sectors of the mid-cap universe where we rarely look for names (utilities, telecommunications and materials), we tend to build a portfolio from the bottom up wherever we can find strong growers at good valuations.

We continue to find opportunity in health care, while still recognizing that this continues to be an area that’s a political football. Despite that situation, we have had some success. The Fund holds many strong growth companies in the health care universe that have delivered solid historical returns. We tend avoid owning health care companies that are direct sellers. We also don't own many pharmaceutical companies, as those tend to be the ones that politicians go after first. When we chose to purchase those types of stocks, their performance can impact the entire sector so we tend to be very selective on our purchases.

In consumer discretionary we continue to find compelling companies like a Tractor Supply, a retail chain that offers products for home improvement, agriculture maintenance and animal care, and other names in specialty retail. We have some housing-related companies like DR Horton (a homebuilder at the lower- and intermediate-end of the housing market where there appears to be a lot of demand). Toy manufacturer Mattel, another consumer discretionary holding, is a fairly long standing name in the portfolio that has seen difficulties in its business recently. The company has really started to tackle its issues and we are seeing results in response to the moves that Mattel has begun to make.

We are seeing a lot of opportunity in companies with a technology bend as innovation can happen across a number of sectors. Health care IT, financial IT and industrials IT are just some of the sectors that we are currently exploring.

When it comes to areas we tend to avoid right now, transports (airlines and cruise lines) that require a great deal of fuel to operate is one that comes to mind. Typically when energy prices move higher, airlines and cruise lines struggle until that issue gets played out in the stocks or, with respect to the cruise lines, fuel surcharges are banked appropriately.

The Fund has really never been a big investor in capital intensive areas such as airlines. However, that is an area that until very recently had done pretty well, partially due to demand for air travel but also because airlines just had a huge dividend in terms of lower fuel costs.

Areas that have really benefited from the search for yield within the market are difficult to purchase in terms of valuations right now. These companies are trading at historic premiums whether in consumer staples, utilities, etc. We are currently focused on seeking out areas of the market where we can find some growth and some greater valuation opportunities.

What's next?

Our outlook for the stock market remains cautiously constructive, as it has been for much of 2016. The U.S. economy is in a growth mode, albeit slow growth. Economies elsewhere in the world remain challenged, which restricts the ultimate strength of U.S. companies and the economy. There have been more stresses on the earnings outlook for U.S. companies than we have seen in a considerable period of time. While much of this stress emanated from the energy sector in 2015, the negative feedback loop associated with energy-related employment and spending has had a broader impact on economic growth and corporate health across many sectors.

Earnings have struggled for much of the past 18 months, and the strengthening dollar has been another source of earnings pressure on many companies. This impact should subside as the year progresses, given current exchange rates, but we will continue to see a near-term impact on the earnings of many companies. Labor costs are also drifting higher. The significant decline in stock prices since last May has done much to improve the valuations and investability of many stocks, but much of the market, particularly leading edge growth companies, remain expensive by our calculations. Recent events have provided slightly more clarity about the course of rate hikes by the Federal Reserve, but this topic is likely to remain a continued source of uncertainty and volatility for the stock market.

Our cautiously constructive outlook is based on our confidence that the positives we see in the U.S. economy – greater employment, an improving housing market, low energy prices, more accommodative lending, supportive demographic trends – should be enough to offset the negatives to earnings, allowing earnings and stock prices to move higher. We think these positives will outweigh the negatives as we progress through the remainder of 2016. We believe the ongoing positive but slow rate of growth in the U.S. will drive greater demand from investors for the stocks of clearly differentiated growth companies that can deliver superior earnings performance independent of any sluggishness in the overall economy.

We think the markets will trend more defensively, as well, in terms of both earnings stability and creditworthiness. This will be a response to any increases in interest rates that might come as a result of firmer economic growth, and also because of concerns about simmering debt issues around the world. Valuation will be a concern if earnings growth is less certain and debt issues weight, but could move upward if underlying economic trends in the U.S. continue to improve through better employment growth, a stronger housing market, and any long hoped for improvement in capital spending.

Our preference for high-quality growth companies with stable and sustainable earnings profiles and strong balance sheets should serve our investors well if the U.S. economy struggles to regain a faster growth rate in the latter half of 2016. The Fund is currently overweight health care, an area where we find many vibrant growth stock opportunities. We are happy with the Fund’s energy overweight, as we think oil prices are likely to trend higher based on downtrends in production and supply and growing demand. We are most likely to add to our weightings in the technology and consumer discretionary sectors, and possibly industrials, over the next three to six months.

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Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Please visit www.ivyinvestments.com for the Fund’s most recent month-end performance. Class A Share performance, including sales charges, reflects the maximum applicable front-end sales load of 5.75%. Performance at net asset value (NAV) does not include the effect of sales charges. The Russell Midcap Growth Index measures the performance of the mid-cap growth segment of the U.S. equity universe. It is not possible to invest directly in an index. The Morningstar Mid Cap Growth Category Average measures the performance of mid-cap stocks that are expected to grow at a faster pace than the rest of the market as measured by forward earnings, historical earnings, book value, cash flow and sales. The U.S. mid-cap range for market capitalization typically falls between $1 billion – $8 billion and represents 20% of the total capitalization of the U.S. equity market.

The opinions expressed are those of the Fund’s portfolio manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 2016, are subject to change based on market conditions or other factors, 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 Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. 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. Investing in mid-cap growth stocks may carry more risk than investing in stocks of larger more well-established companies. 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. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.

IVY INVESTMENTSSM refers to the financial services offered by Ivy Distributors, Inc., a FINRA member broker dealer and the distributor of IVY FUNDS® mutual funds, and those financial services offered by its affiliates.

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