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    Quarterly Fund Commentary

    Ivy Micro Cap Growth Fund (prospectus)
    March 31, 2016

    John Bichelmeyer, CFA

    Market Sector Update

    • Equity markets started off 2016 with one of steepest declines the market has ever experienced. Macroeconomic forces were the primary driver as markets tried to digest the ramifications of the first interest rate hike after seven years near zero. After witnessing the dramatic fallout caused by the rate increase, the Federal Reserve (Fed) clearly toned down its rhetoric about the future pace of interest rate increases. This helped catapult stocks higher into quarter end.
    • At the end of 1Q2016, large-cap equites, as measured by the S&P 500 Index, finished in positive territory after plunging from the year intra-quarter. Smaller companies in the Russell 2000 Growth and Russell Microcap Growth indices (the Fund’s benchmarks) also rallied off their 1Q lows but still finished in negative territory and extended their multi-year relative underperformance to large caps.

    Portfolio Strategy*

    • The Fund underperformed its benchmarks for the period ended March 31, 2016. Defensive sectors such as utilities, consumer staples and real estate investment trusts were strong relative performers.
    • In addition to larger, more defensive companies performing better during the quarter, value outperformed growth across all sizes of companies. As a result, micro-cap growth was the area of the market that investors wanted to avoid most.
    • Allocation effect was positive but stock selection was a significant drag. Technology, specifically software and services, stocks hurt the Fund and accounted for a significant portion of the relative underperformance. The markets had very little patience for earnings reports that deviated in the slightest from original expectations and those companies that did were punished severely.
    • Consumer discretionary and materials were responsible for the remaining relative underperformance. Companies such as Tile Shop, Kona Grill and Sportsman’s Warehouse reported solid quarterly numbers but didn’t meet investor expectations for 2016 guidance.
    • Within materials, Flotek Industries was weak once again due to questions surrounding the efficacy of its key product and overall weakness in oil prices. Horsehead Holdings was also down significantly due to collapsing commodity prices and poor management execution.
    • Health care was a drag on absolute returns but the most significant relative contributor given the Fund’s meaningful underweight compared to the micro-cap benchmark. Surgical Care Affiliates and Imprivata were standouts in 1Q with each generating positive double-digit returns.


    • 1Q2016 was yet again another reminder of emotional roller coaster that equites can take investors on. Very few enjoy violent sell-offs like the ones we started the year with.
    • Our primary focus during challenging times is to focus on our research efforts in order to enhance the Fund’s holdings and return potential. More specifically, it means concentrating the portfolio into our highest conviction names, and that is exactly what we did this quarter.
    • The Fund started the quarter with 62 holdings and finished with 53. We were able to add to some of our favorite holdings at what we believe to be attractive prices, as well as add a couple new holdings to the portfolio. Rather than being emotional and reactionary, our primary goal is to follow our research. This commonly will uncover companies with very favorable prospects for long-term capital appreciation.
    • While we don’t wish for anymore sudden, dramatic declines in equity prices, we know there will always be times like this and our objective will be to take advantage of the opportunities when they present themselves.


    *Top 10 holdings (%) as of 03/31/2016: Tile Shop Holdings 3.9, 8x8, Inc. 3.6, Nautilus Group Inc. 3.4, Sportman’s Warehouse Holdings, Inc. 3.1, Motorcar Parts of America, Inc. 3.0, MYR Group, Inc. 2.8, Cornerstone OnDemand 2.7, Zix Corp. 2.7, Intersect ENT, Inc. 2.7 and LogMeln, Inc. 2.8./p>

    The opinions expressed in this commentary are those of the Fund’s manager and are current through March 31, 2016. 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 not a guarantee of future results.

    The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. The Russell Microcap Growth Index measures the performance of the microcap growth segment of the U.S. equity market. The S&P 500 Index is composed of 500 selected common stocks chosen for market size, liquidity, and industry grouping, among other factors. 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 micro-cap 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. 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.

    IVY INVESTMENTS? 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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