Market Sector Update
- Municipal market performance was primarily driven by an extreme supply/demand imbalance, as heavy investor demand (retail, institutional, and even foreign) far outstripped paltry supply. Municipals outperformed Treasuries and all other fixed-income alternatives by a wide margin.
- Defaults in the municipal bond asset class continue to be rare. While we anticipate increased headline risk from municipal issuers that have severe underfunded pensions and other postretirement benefit obligations, we continue to believe that these problems are not systemic, and that they will remain isolated.
- All Puerto Rican credits continue to be pressured, with many trading at expected post-default recovery levels. There is a high level of headline risk, restructuring opinions, legislative noise and rating agency downgrades that will continue to keep these credits depressed.
- At this juncture it appears that the Puerto Rico situation has been walled off from the investment-grade municipal bond market. All news, be it positive or negative, has had very little impact on the investment grade market.
- The municipal yield curve flattened aggressively in the quarter
- Interest rates decreased, with the exception of the front-end of the curve, which was driven by Federal Reserve (Fed) policy expectations. Intermediate and long rates fell dramatically in the quarter as heavy demand far outstripped supply.
- While we expect U.S. gross domestic product to grow at a respectable level, investors appear to be concerned that problems in the rest of the world will be a drag on U.S. growth and result in continued dollar strength and a potential deflationary spiral.
- Europe, China and Japan continue to run very stimulative monetary policy operations, which could continue to prevent U.S. rates from rising too far, even if the U.S. Fed is beginning to tighten policy. Geopolitical risk continues to elevate the potential for additional flight to quality investments.
- Treasury and municipal rates are still extremely low by all historical standards. We remain very cautious as we believe that interest rates will need to normalize at some point in time. The portfolio duration is currently slightly short to our benchmark. We continue to maintain our overweight slant to spread product in the A-BBB range.
- We will continue to place emphasis on diversification, higher (overall) credit quality and yield curve positioning.
- We remain confident that municipal bond defaults will continue to be much lower than any other fixed-income alternatives, besides U.S. Treasuries.
- We will continue to monitor the situation in Puerto Rico, but we do not believe that there will be any spillover into other parts of the investmentgrade market, regardless of the outcome. The Fund currently has no exposure to Puerto Rico credits.
- We do not anticipate any far-reaching tax code overhaul that would alter municipal bond tax exemptions. We expect to see continued headlines on municipal pension underfunding and other retirement benefits issues. We will remain vigilant in monitoring these situations and we will endeavor to avoid investments with these issuers.
- We expect Treasury yields to reclaim their position as the primary driver of the investment-grade municipal market as we move into Q1 2016. Supply/demand technicals will continue to play a very important role in relative performance.
- While it's plausible that the bull market in bonds might be over, we don't believe an outright bear market is beginning. Global central banks appear determined to keep rates artificially low. They continue to express concern that growth may not be sustainable if rates were to move higher. The inflation/deflation argument and geopolitical turmoil will continue to impact the market.
The opinions expressed in this commentary are those of the Fund’s manager and are current through December 31, 2015. The manager’s views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.
Risk factors. The value of the Fund's shares will change, and you could lose money by investing. 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. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). Exempt-interest dividends the Fund pays may be subject to state and local income taxes. The portion of the dividends the Fund pays that is attributable to interest earned on U.S. government securities generally is not subject to those taxes, although distributions by the Fund to its shareholders of net realized gains on the sale of those securities are fully subject to those taxes. The municipal securities market generally, or certain municipal securities in particular, may be significantly affected by adverse political, legislative or regulatory changes or litigation at the Federal or state level. 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.
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 Ivy Funds, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.