Quarterly Fund Commentary
Thomas Houghton, CFA
David Land, CFA
Chris Sebald, CFA
Market Sector Update
- The U.S. markets in the second quarter were characterized by a serene, unruffled summertime mood that couldn’t be bothered by outside events. Stocks rose to record levels, interest rates fell and credit spreads tightened in a fashion that all but ignored trouble elsewhere.
- The 10-year Treasury fell approximately 19 basis points, somewhat of a surprise in light of positive readings from several economic indicators, including housing, auto sales, business sentiment and consumer confidence, and an uptick in inflation. Obviously, this was a good surprise for the bond market, one that resulted in positive returns for fixed income investments and the Fund.
- It may be that the bond market is pricing in lower growth for the long term. The market appears to be taking the stance that while growth will certainly rebound from its first quarter falloff, it may not rebound as strong as most hoped.
- Credit spreads and other sectors of the non-government bond market narrowed in a beneficial but boring manner over the quarter.
- We made no change in interest rate positioning for the Fund over the quarter, and we continue to think that interest rates will remain in a narrow range.
- As spreads tightened to the point that all sectors approached long-term, but not all-time low levels, we became more careful and cut back on our exposures to corporate bonds and agency mortgage-backed securities. While we don’t see any obvious reason why current valuations would fall, the fact that they are high significantly changes the risk-reward tradeoff.
- We sold names in the following sectors, finding that spreads relative to Treasuries became narrow and the prospect for further gains more limited: consumer non-cyclicals; telecommunications; real estate investment trusts.
- While it may sound like a very old story, we continue to believe that interest rates will remain in a narrow range. The debt overhang and demographic shifts continue to dominate the major long-term themes influencing growth and inflation.
- We expect growth, inflation and market volatility to remain low and believe the Fed will remain accommodative and avoid making any surprise moves that would upset the interest rate apple cart.
- Valuations are our biggest concern right now. Relative yields or spreads between non-government bonds such as corporate, mortgage-backed securities and asset-backed securities continue to push to very, although not extremely, low levels. If the economy improves in the second half and interest rates rise gently, we think these spreads will push even tighter.
- Additionally, it appears investors are becoming even more entrenched in their belief that interest rates will stay low and that they need to reach for yield for performance. Contrary to the belief of some that low Treasury yields reduce the demand for corporate and other bonds, as investors let go of their belief that rates must rise, they buy more non-government bonds and spreads narrow. We think this is the most likely path.
The opinions expressed in this commentary are those of the Fund’s manager and are current through June 30, 2014. 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. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. 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. Fixed-income securities are subject to interest-rate risk and, as such, the net asset value of the fund may fall as interest rate rise. 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.
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.