Waddell & Reed

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    Quarterly Fund Commentary

    WRA Bond Fund (prospectus)
    March 31, 2016

    Rick Perry, CFA

    Market Sector Update

    • The U.S. Treasury market was fairly volatile in 1Q 2016 after the U.S. Federal Reserve (Fed) raised short-term rates in December 2015. As 1Q progressed, it became somewhat clear that the Fed would use a very measured pace for future rate increases. Interest rates ended the quarter lower than the beginning. The yield curve shifted downward and continued to flatten slightly during 1Q. The spread between the 2-year and 10-year Treasuries tightened 17 basis points, or bps (0.17 percent). The 10- year Treasury ended the year yielding 1.77%, down 50 bps (0.50 percent) from the fourth quarter.
    • Credit spreads were volatile in the first half of 1Q, led by weakness in the commodity-based sectors. The second half of the quarter was just the opposite - spreads essentially tightened back to levels at the beginning of 2016. Credit spreads ended 1Q at 155 bps (1.55 percent), after beginning the year at 154 bps (1.54 percent).
    • The macro-economic backdrop was generally supportive for U.S. corporate credit. The main exception to the overall positive back-drop was found in energy. Aside from the energy sector volatility, the steady, slow economic growth the U.S. is experiencing is generally good for the broader credit market. New issuances of debt were again heavy, causing leverage on corporate balance sheets to increase to elevated levels. These proceeds continue to be used for shareholder-friendly activities, such as mergers and acquisitions, share buybacks and dividends.

    Portfolio Strategy

    • As it became clear that the Fed was on a measured pace for interest rate changes and rates outside the U.S. continued to decline, the Fund changed its duration posture from slightly short to slightly long, relative to the benchmark during the quarter. The change in duration posture was beneficial to performance in 1Q. In addition, the Fund worked to position to benefit from a yield curve flattening. Given the uncertainty associated with the timing of the Fed’s interest rate decisions, making large bets on duration and shape of the yield curve didn’t seem prudent during the quarter.
    • Overall asset allocation didn’t change materially during the quarter. The Fund did change allocation within credit slightly, adding exposure to financials and reducing exposures to certain industrials. Financials, particularly the banking and insurance sectors, have become more defensive credit because of regulations enacted after the 2009 financial crisis. The Fund did extend duration in a few selected names during the quarter in order to increase portfolio yield and reduce exposure to rising short-term rates.
    • Credit quality also didn’t materially change during the quarter. Exposure to short-duration Treasuries was reduced and reinvested in securitized assets. Mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS), which have minimal extension risk, were added early in the quarter.


    • The Fed is expected to increase short-term interest rates gradually in 2016, but all increases will be data dependent throughout the year. The Fed’s stance will most likely result in one or two rate hikes during the year. Should the Fed execute on their stated gradual pace for rate hikes, the yield curve is expected to continue to flatten throughout the year and not be particularly disruptive. However, a significant risk does exist that the Fed will act in a way inconsistent with market expectations, which would likely lead to market turbulence.
    • We believe the market is in the late innings of the credit cycle. As a result, we think conservative positioning within the credit market is prudent going forward. Commodity-based sectors and names are likely to remain volatile throughout the year. In addition, secondary market liquidity is expected to remain challenging in the future. We think spread volatility and dispersion will be elevated during the coming year, creating exaggerated market moves as well as some opportunities for excess returns.
    • The timing of interest rate movements in the near term is expected to remain very difficult as the Fed unwinds its zero interest rate policy. Therefore, we do not think it prudent to make significant duration in the coming months. We believe the Fund’s expected asset allocation is not expected to change significantly in the coming quarter unless credit quality trends/metrics or Fed policies change materially in the near term.


    The opinions expressed in this commentary are those of the portfolio 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.

    Investors should consider the investment objectives, risks, charges and expenses of a portfolio and the variable insurance product carefully before investing. The portfolio and variable insurance product prospectuses contain this and other information, available by calling your financial advisor, visiting www.ivyfunds.com or contacting the applicable i insurance company. Please read the prospectuses or summary prospectuses carefully before investing.

    Risk factors. 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 portfolio 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. These and other risks are more fully described in the Fund's prospectus. Not all portfolios or classes may be offered at all broker/ dealers.

    Waddell & Reed Investments refers to the investment management services offered by Waddell & Reed Investment Management Company, the investment manager of the Waddell & Reed Advisors Funds, distributed by Waddell & Reed, Inc..

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