Quarterly Fund Commentary
Thomas Houghton, CFA
David Land, CFA
Chris Sebald, CFA
Market Sector Update
- Growth and growth expectations continued to rebound in the U.S. and two of our three favored U.S. leading indicators were up strong. Business sentiment and unemployment claims were at or near their cycle best while housing leading indicators still lag significantly.
- The Federal Reserve reduced its quantitative easing (QE) measures, and expectations narrowed around when its first rate increase might occur, now mid- 2015.
- Two-year yields rose, but long-term interest rates, were little changed in the quarter as investors contemplated the potential that a rise in short-term rates might actually dampen longer-term growth and inflation, supporting low long-term interest rates.
- Credit spreads were weaker over the quarter, driven mainly by weaker demand for high-yield bonds and industrial investment-grade bonds. Investors reversed their reach for yield in lower credits on concern the market went too far and the change in the Fed stance could ultimately raise borrowing costs and reduce credit availability.
- While a strong dollar may be better for consumers in the short run, it certainly won’t help exports or employment in the medium term.
- We made no material change to our interest rate position during the quarter. We continue to believe that if long-term rates do rise, they will do so stubbornly.
- Industrial credit spreads widened the most in investment grade bonds, perhaps a nod to some anticipated cyclical cooling. The quarter definitely ended on a weaker note as investors prepared for a bumpier ride.
- We reduced exposure to financial institution bonds, particularly insurance companies and real estate investment trusts (REITs), and increased holdings in Treasuries, reflecting our concern that valuations in credit bonds are already strong and markets might weaken further.
- It's been a profitable ride for many investors in this U.S. recovery and expansion. As we get closer to normalizing monetary policy, that ride is likely to get bumpier for investors in riskier assets.
- Risky assets have been supported by ultra-cheap debt and highly liquid markets. If it becomes harder or more expensive to access credit when the Fed removes accommodation, some firms will likely struggle with higher costs and be more susceptible to downgrade. Ideally, growth would be strong enough to overcome this; however, that’s not the current backdrop for the current U.S. economy.
- Market liquidity in fixed income is starting to deteriorate, particularly for corporate bonds, and it’s worse for the lower rated riskier securities. Much of this is due to regulatory changes. Banks have significantly downsized their trading desks. Trade volumes are much lower than pre-crisis levels.
- A side effect is that smaller issues, regardless of value, tend to have much higher trading costs. We have reduced the portfolio’s exposure to those positions in recognition of the higher costs and in the anticipation that those costs can go up dramatically in a market downturn.
- We’re not positioning the portfolio for a significant credit downturn, but we will continue to position for a weaker trading environment and a bumpier ride until the Fed’s transition has been better absorbed in the markets.
The opinions expressed in this commentary are those of the Fund’s managers and are current through September 30, 2014. The managers’ 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 f nancial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully i before investing.