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Will rising rates translate to investor income?

October 23, 2017
Ivy Apollo Multi-Asset Income Fund

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Story Highlights

  • By chasing yield to generate income, investors also chase duration risk and credit risk.
  • The Total Return Strategy Sleeve provides access to the full breadth of the credit markets.
  • The Fund maintains a low duration that allow a focus on higher yielding corporate bonds.

Investors continue to face challenges when seeking income from their portfolios because of stubbornly low interest rates. Many have been left with two choices: Invest in lower-risk, lower-yield securities that may not provide the desired income over time or step up to higher-yielding securities that carry higher risk. But there's another option. Individuals may benefit from a diversified approach that includes allocations to the entire yield spectrum of traditional, nontraditional and alternative strategies.

The yield conundrum

By chasing yield to generate income, investors also chase duration and credit risk. In simple terms, duration is based on yield and maturity, and reflects a bond’s vulnerability to rising interest rates. Credit risk is the risk that a bond issuer will not be able to repay its debts; the greater the credit risk, the higher the yield.

In general, we think investors should consider taking on a degree of illiquidity risk, or the risk based on a lack of marketability of an investment that cannot be bought or sold quickly. Illiquid, nontraditional securities can add options within the world of fixed-income choices.

A potential solution

The Fund is designed to help investors pursue income by combining global reach, well-defined strategies and access to nontraditional credit securities. The Fund offers diversified access to alternative income-producing assets as well as traditional investments via a “sleeve” allocation to four investment strategies.

In creating the portfolio, we target a 50/50 split between fixed income and equities including dividend-paying stocks, global real estate securities, investment-grade bonds, high yield bonds and nontraditional credit securities.

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Role of total return strategy

The Total Return Strategy Sleeve in the Fund provides investors with access to the full breadth of the credit markets, including some nontraditional credit securities. Such securities may not have been accessible to all investors in the past, especially within a mutual fund.

For example, the sleeve’s sub-adviser, Apollo Credit Management, can explore the market for nontraditional opportunities, partner with banks to lend money to smaller companies, or underwrite loans for a select entity — all as part of seeking to generate attractive yield while keeping duration low.

As with the other components of the Fund, this sleeve is a long-only strategy. The managers do not pursue derivativeoriented transactions.

Our market outlook

The persistent strength of the global economy has continued to surprise many in the markets and we expect overall growth to continue to increase slightly in 2018. We expect the U.S., Europe, China and other emerging market countries to be the main engines of this growth.

It's important to note that risk aversion related to emerging markets has declined steadily in 2017. As investor attitudes have improved, valuations of emerging market securities have become less attractive even though macro conditions still are providing some support.

In general, the acceleration in global growth has occurred against a backdrop of low inflation, allowing most developed market central banks to keep interest rates at low levels.

But global monetary policy continues to diverge and we think more central banks are moving away from the policies prompted by the 2008 global financial crisis.

The U.S. Federal Reserve (Fed) has hiked interest rates four times since late 2015 and we think it will raise rates again in December, followed by two more in 2018. The Fed also has announced that it will begin to reduce its balance sheet by allowing maturing Treasury and mortgage-backed securities to roll off. The drawdown will start at $10 billion per month, then increase by another $10 billion each quarter until it reaches $50 billion per month. We think most financial markets already have the Fed's plan built into their projections and we do not expect major volatility as a result.

We think the European Central Bank (ECB) also is likely to begin tapering its quantitative easing program by January 2018. We believe ECB action will provide further evidence that the era of lower rates, including negative rates, and expanding balance sheets is starting to wind down.

The value of the trade-weighted U.S. dollar has weakened this year, although it began to rebound in the third quarter. We think strength in the dollar will depend on several variables, including the Fed's actions while other central banks stand back, the potential for major fiscal stimulus and regulatory rollbacks in the U.S., and some uncertainty about economic growth rates in Europe and Japan. In general, we believe dollar weakness will continue if the latest soft inflation data is not temporary. We also think fiscal policy provides some uncertainty about the future direction of the dollar.

For the Fund in general, we are maintaining a low duration that we believe will allow us to focus on higher yielding corporate bonds in the near term. We also have built what we believe to be sufficient liquidity to allow the Fund to respond to this rapidly changing market environment.

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Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s portfolio managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through October 2017, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

Diversification does not guarantee a profit or protect against loss in a declining market.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Although asset allocation among different sleeves and asset categories generally tends to limit risk and exposure to any one sleeve, the risk remains that the allocation of assets may skew toward a sleeve that performs poorly relative to the Fund’s other sleeves, or to the market as a whole, which would result in the Fund performing poorly. While Ivy Investment Management Company (IICO) monitors the investments of Apollo Credit Management, LLC (Apollo) and LaSalle Investment Management Securities, LLC (LaSalle) in addition to the overall management of the Fund, including rebalancing the Fund’s target allocations, IICO, Apollo and LaSalle make investment decisions for their investment sleeves independently from one another. It is possible that the investment styles used by IICO, Apollo or LaSalle will not always complement each other, which could adversely affect the performance of the Fund. As a result, the Fund’s aggregate exposure to a particular industry or group of industries, or to a single issuer, could unintentionally be larger or smaller than intended. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. 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. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. 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.

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