All Articles http://www.ivyfunds.com/ Articles en-us <![CDATA[Baptism by fire: Despite volatility, International Growth Fund manager celebrates three-year anniversary with solid results]]> Baptism by fire: Despite volatility, International Growth Fund manager celebrates three-year anniversary with solid results

Chace Brundige, CFA
Senior Vice President,
Portfolio Manager
 

Ivy International Growth Fund – February 2012

 
 
International financial markets have been in the doldrums for much of the past three years, sliding under the weight of an epic global recession, morose economic and business outlooks for most economies and companies, political and social unrest in many corners of the world and several horrific natural disasters. Coincidentally, those were the same three years during which veteran large-cap, domestic-growth fund manager Chace Brundige, CFA, staged his debut in international investing. Brundige, who has more than 17 years of industry experience, took the management reins of the Ivy International Growth Fund on January 1, 2009, and never looked back. In his role as manager, Brundige oversees day-to-day management of the Fund’s more than $200 million in assets (and a total of more than $900 million in the international growth style), selecting investments in companies doing business in diverse markets around the globe. As the Fund marks its three-year anniversary under his tutelage, Brundige discusses his transition to international investing, the challenges and intricacies of global stock picking and his unique approach to finding and owning the world’s most successful companies.
 
1) It’s been three years since you moved from swimming in domestic waters to managing the international-only Ivy International Growth Fund. What was that transition like, and what adjustments did you make in how you look at the world and how you invest?
 
The largest difference has been dealing in a much broader universe, with an infinitely larger number of opportunities. I inherited an international-only growth portfolio when I had been working on the domestic-only growth team for a number of years – so there was a lot to learn just to understand the holdings already in the Fund, let alone the entire investable universe. There are so many more factors associated with international investing; the role of government bodies (executive, legislative and judicial) come into play, monetary and fiscal policies must be considered, different country domiciles and end markets have effects, and we have to know how currency movements affect not only a stock denominated in another currency but also how they can help or hurt a company, depending on how much of its business is import- or export-driven. It’s a whole different ball game.
 
2) Describe your investment philosophy for managing Ivy International Growth Fund.
 
Our investment philosophy is based on the idea that for a company to grow over many years with attractive margins and returns, it must do something its competitors cannot effectively replicate. That’s what we look for. We want to invest in leading, high-quality international companies with sustainable competitive advantages, and we want to buy them when long-term fundamentals are under-appreciated. In other words, we want to get good stocks at attractive prices. Possessing a competitive advantage is key because it leads to the sustainability of growth, and that sustainability leads to the long-term outperformance we seek.
Also key to our philosophy is that we like to maintain a more concentrated portfolio by investing in the companies in which we have the highest convictions, which enables us to know the companies really well. Ideally, we would like to hold these securities for roughly three to five years, but the recent market environment has shifted our investment horizon closer to two to three years, on average.
 
3) How do you identify companies with sustainable competitive advantages?
 
A firm’s competitive advantage can come from a variety of sources, including but not limited to brand equity, cost structure, intellectual property and distribution channels. Screening for good margins and returns, along with strong capital management and quality of earnings, allows us to look at a very large universe and get an initial indication as to whether a company possesses the characteristics we look for. Then we begin to ask several fundamental questions: Does the company have an edge over competitors? What is the source of that edge? Is it sustainable and leverageable? Do potential substitutes exist? If the source is government-enabled, is that enabling policy likely to continue or strengthen?
 
At any point in time, the majority of the Fund’s assets will be invested in long-term holdings chosen for inclusion in the portfolio at a fundamental level. These types of companies have what we believe to be a long-term, sustainable competitive advantage with superior margins and returns. We believe many other investors underestimate the longevity of these companies and their end markets are continuing to grow. A good example is Fresenius SE (2.4 percent of assets at 12/31/2011), a German health care company. It is a leading competitor in dialysis services and equipment, generic injectable drugs, and acquirer of German hospitals. We feel the market underestimates the longevity of three key tailwinds: changes in global diet leading to greater demand for dialysis; tighter regulation of injectable drugs narrowing the competitive landscape; and a push for efficiency in German health care through hospital privatization. We view Fresenius SE as a key long-term holding.
 
A still-large portion of the portfolio, though to a lesser extent, is made up of companies we plan to hold over the medium term. The sustainability of the companies’ competitive advantage is not necessarily clear, but there is some catalyst improving fundamentals in the meantime. The companies that meet these criteria often are growing market share and have above-average margins and/or returns. Valuation becomes more of a factor with these medium-term holdings, so we typically use price targeting to determine weightings. For example, we purchased Taiwanese handset maker HTC when we believed the company garnered an edge in producing and selling Google Android-based handsets. We also believed that edge was temporary and thus sold the stock after it had rallied significantly and consensus sentiment was running very high. Since then, Samsung has become a dominant competitor and market share gainer in the segment and HTC’s stock has suffered largely as a result.
 
The smallest segment of the Fund is typically invested in stocks we intend to hold for a relatively short period of time. Valuation is generally the key driver here, which often arises from top-down, sector or country-specific situations or trends. These companies generally possess at least some edge over the competition, though the key driver is typically valuation due to what we believe is a market misperception or lack of appreciation.
 
While the Fund’s country and sector weightings are largely a result of our bottom-up security selection, in most environments we take macro factors into consideration so that we can mitigate some type of risk, i.e., currency, government, environment, geographic and economic. We also may opportunistically exploit top-down situations and trends when we see them.
 
We typically invest in stocks at a beginning weight between 0.5 percent and 1.5 percent of net assets. As we become more comfortable with a given company and its growth prospects and our conviction deepens, we continue to build the position. The resulting portfolio is typically comprised of 50-75 securities, spread across many countries and regions (with a focus in developed markets) and encompasses nearly all sectors.
 
4) Who helps you identify and keep up-to-date on your holdings? What kind of research can you access?
 
The international trading day is very long. A couple hours after the
U.S. closes, Australia and then Asia begin the next day’s trading. Each night and early morning is spent monitoring new events as they develop in those markets, with a focus on key changes, in preparation for our daily morning meeting. The investment management team meets daily for our Morning Meeting at 8:45. Almost all of the firm’s 30 portfolio managers, nine assistant portfolio managers, 24 research analysts, three economists and research directors, along with our president, chief investment officer and chief executive officer gather to share various economic, monetary, political, industry and company trends and issues. The information derived from this meeting is key for me in developing views on and monitoring the changing macroeconomic environment, evolving sector-specific conditions, and individual firm concerns or opportunities. Given the depth and breadth of the information shared at this daily meeting, it is an essential part of my investment process.
 
Most of our equity analysts are assigned along specific industry lines globally, and in addition to contributing in the daily Morning Meeting, they make timely investment recommendations (both buy and sell) which are reviewed at a separate weekly meeting, which, again, includes almost all of the investment management team.
 
I also work closely with the firm’s other international portfolio managers to generate and share best ideas gathered individually or through formal meetings with the analysts.
 
Other than the intelligence gathered from our investment division as a whole, we use everything from research reports and conference calls to on-site meetings and travel to help with analysis. I travel globally to visit the management of companies in which I am interested or am considering for investment. I also often go to conferences held in the U.S., where there can be 25 to 50 companies from a particular region. Those conferences allow me to meet with management teams and stay abreast of recent developments. I attended two such conferences in early January, one for German companies held in New York and the other for Latin American companies held in Florida, which allowed me to meet individually with more than 30 management teams in a highly efficient manner.
 
5) What has the Morning Meeting been like during the last couple of years, as the global economy has struggled through obstacles ranging from recession and sovereign debt to political upheaval and natural disasters?
 
Let me start by saying our ramped-up global resources have increased my effectiveness. Years ago, I might have had to do currency or government policy research on my own but now there are analysts and economists that focus almost entirely on those things. And not only have we improved our resources, but we include more people in the discussions now as well. Economic reports and forecasts, currency movements and fixed-income spread updates used to take up to two or three minutes of the Morning Meeting. But now, that is all so interconnected and so important that discussing it might take up a good half hour before we begin to dive into sectors and individual companies. Because these are the factors and issues driving market movements, we all must pay close attention. Having those resources so much more involved in the conversation has been invaluable.
 
6) What’s it been like managing an international growth fund during such a volatile and uncertain period?
 
Probably the most notable effect from the volatility during my three-year tenure on the Fund is that we have to pay so much more attention now to the macro environment. We have used the same fundamental, bottom-up process when looking for high-quality international firms but we’ve had to add an emphasis in our approach on the macro overlay. Putting a company’s balance sheet, growth potential and valuation into the appropriate government, currency and geographical context has been necessary – particularly over the last year when headline risk has been so prevalent. For example, the appreciation of the yen has been dramatic recently and that really hurts what are deemed to be the higher-quality Japanese companies – the exporters. It has created a major headwind for them while also providing Korean stocks with a pretty substantial tailwind. All of these things need to be taken into consideration when looking at each company’s business model and the risks to which it is exposed.
 
Another effect from these tumultuous years has been our use of some light currency hedging. During my time managing the Fund we’ve lowered the portfolio’s net exposure to the euro, yen and British pound at one point or another in order to protect on the downside. We don’t make these decisions lightly, as we prefer to carry the currency exposures of the underlying securities in the portfolio, but when we have high conviction in the asymmetry of potential currency moves, and believe that move is not in our favor, we try to shield our U.S. dollar-based investors from those risks. I’ve also learned to appreciate the massive changes in global monetary and fiscal policy and their impact on business, consumer and investor sentiment.
 
7) Have you made any material changes to the Fund since you took over as manager?
 
In 2009, my first year as manager, the Fund’s upside was limited versus the benchmark. It was conservatively positioned, a posture that I agreed with at the time. Unfortunately, as I was learning the international universe that first quarter of 2009, it was difficult to react as quickly as I would have liked when the market turned around. The high-quality companies that helped mitigate downside risk in 2008 and early 2009 didn’t do as well once the compression reverted, relative to mid- and lower-quality peers. However, since then, with my knowledge of the space and the additional global resources available to me, I’ve been able to be more nimble to protect on the downside and opportunistic (using those shorter- or medium-term holdings buckets) to capture the upside after any rollover.
 
8) Where are you finding opportunities now, and how is the Fund currently allocated?
 
As always, I am focused on picking good stocks first, and the country and sector weights are largely driven by that fundamental stock-selection process. At a sector level, we continue to underweight the materials and financial sectors along with consumer staples, and remain overweight in energy (primarily through services) and consumer discretionary. Technology remains the Fund’s largest overweight because so many of those companies really fit the fundamental characteristics we’re looking for in core holdings. Telecommunications is also overweight but that is partially due to the very low (less than 2 percent) weighting in the benchmark.
 
The Fund’s largest country weights remain in developed Europe (the U.K., Germany and France) and Japan. And while we did reduce emerging market exposure this year relative to 2010, specifically in China, we envision adding some exposure there this year as opportunities develop.
 
We are vigilant in assessing the right time to shift to a more aggressive and cyclical positioning, largely a confluence of valuation, expectations, and the ability of Western governments to drive economic growth, however short-lived.
 
Apple (3.9 percent of assets at 12/31/2011) is the Fund’s largest position; it might seem odd that an international fund’s largest holding is an American company, but this enterprise continues to build a robust business and gain market share around the globe. We feel the company’s leadership in product design and development combined with attractive valuation and potential dividend yield gave us no choice in embracing this rather consensus position. We continue to focus on a handful of European leaders who are well positioned to capture global growth outside of Europe. These include adidas, Diageo and Volkswagen (2.2, 2.4 and 1.7 percent of assets at 12/31/2011, respectively). We continue to focus on increasing Asian wealth and consumption, especially of luxury goods, with holdings in LVMH, which owns the prestigious Louis Vuitton brand), luxury Swiss watch maker Swatch and Pinault-Printemps-Redoute, which owns the Gucci and Bottega Veneta brands (1.4, 0.8 and 1.9 percent of assets at 12/31/2011, respectively).
 
9) What is your outlook for the months ahead?
 
To succeed in this environment, we must not only correctly anticipate the policy changes of western governments, but also the markets’ reaction to them. So far this year, it seems that investors are electing to sell last year’s favorites, staples, health care, telecoms, utilities and buy its laggards, especially materials and certain industrials. Financials are mixed thus far, with the most troubled banks continuing to struggle.
 
While this early trading will probably not be kind to the Fund’s relative performance, we currently lack conviction that it will continue through the year (though we are keeping an open mind).
 
The most obvious roadblock to deep cyclical leadership in the western world is the current self-reinforcing cycle of high government debt loads leading to a lack of confidence and therefore less investment and hiring, which then leads to lower gross domestic product (GDP) and tax revenues, and thus ever-higher debt/GDP ratios – not an attractive picture. We struggle to come up with a scenario in which global nominal GDP reaches a sufficient, sustainable level to achieve “escape velocity,” where this cycle is broken. Currently the entire investment world is pondering the effectiveness of recent European policies, especially with respect to bank funding and capital requirements, and the knock-on effects on medium-term economic growth.
 
China, of course, is an important factor in the performance of cyclical stocks generally and materials specifically. To the extent that China has embarked on an easing cycle, these sectors will undoubtedly receive a boost. However, we do not expect Chinese easing to resemble 2009, when massive government-induced loan growth flowed directly into large infrastructure projects of various types. Instead we expect continued focus on internal consumption, affordable real estate and on reviving the health of small and medium businesses that have been left behind by the banking system.
 
In addition, the cyclicals do not have the same depths (margin and earnings estimates, working capital draw downs) from which to rebound as they did in 2009. While many will point to the stretched valuation spreads (for instance, consumer staples appear expensive versus the market) of less-cyclical companies, we cannot think of a time or situation (highly questionable growth and very low interest rates) where this should be more true, or accepted. Therefore, we are careful not to overstay our welcome as certain stocks become overvalued in our eyes, yet we look to reinvest those proceeds not necessarily in “cheap” cyclicals, but in current or new investments that we think have attractive business models, management teams, pricing power and end markets combined with reasonable valuation.
 
10) Given that outlook, why do you think Ivy International Growth Fund should be in an investor’s portfolio?
 
As I would always argue, I think having international diversification in a portfolio is beneficial for almost all investors. Not having all of your “eggs in the U.S. basket” seems like a smart move from both a return potential, because so much growth is outside the U.S., and a currency diversification standpoint – many believe there is a significant threat that the U.S. government printing more money will inflate its currency. In addition, the universe of international companies is roughly double the number in the U.S., providing a plethora of opportunities to choose from across geographies and sectors.
 
Regarding the Ivy International Growth Fund specifically, our focus on risk mitigation and conviction level in Fund holdings helps us in our effort to participate in positive market environments, while striving to protect our gains in weaker markets. We seek to avoid large risks by not chasing returns or forcing ourselves into large bets while also being disciplined in our bottom-up investment process, making consistent decisions based on our fundamental research.
 
We think in a world in which economic growth is under pressure, firms with competitive advantages will prevail. And because finding firms with competitive advantages is the focus of our investment process, we believe the Fund will continue to do well going forward.
 

MSCI EAFE Growth Index is an unmanaged index comprised of securities that generally reflects the performance of securities representing international growth securities markets. It is not possible to invest directly in an index. Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. (www.msci.com)
 
Consider all factors. 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. 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. 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.
 
The Ivy Funds are managed by Ivy Investment Management Company and distributed by its subsidiary, Ivy Funds Distributor, Inc.
 
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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.

 

]]> <![CDATA[DALBAR Again Awards Ivy Funds for Outstanding Client Communication]]> <![CDATA[For Fourth Year in a Row, Ivy Funds Among Top Barron's "Best Mutual Fund Families" Over 5 Years]]> <![CDATA[A strategic asset mix designed to provide a smoother ride in periods of market volatility]]> A strategic asset mix designed to provide a smoother ride in periods of market volatility

 

Cynthia Prince-Fox, CFA 
Portfolio Manager

 

Ivy Balanced Fund – January 2012

 
 
 
Recent stock market volatility, driven largely by Europe’s sovereign debt crisis and fear that the global economy could slip back into recession, has created a difficult market environment for investors and fund managers alike. Here, Ivy Balanced Fund Manager Cynthia Prince-Fox shares her perspective on the current economic and market environment, outlines her strategies for protecting capital while positioning the portfolio to capitalize on volatility-driven opportunities and provides her outlook for the months ahead.
 
The volatility that has roiled the investment markets in the past five years is unprecedented in my 28 years of investment experience. We have made slight adjustments to the portfolio that we believe are in the best interest of the Fund’s investors, both in response to and in anticipation of global and market events. However, despite this prolonged volatility, we have not changed the fundamental strategies we apply in managing Ivy Balanced Fund, which has consistently delivered on its objective to provide total return through a combination of capital appreciation and current income. Over time, the Fund has produced competitive returns.
Striking a prudent balance
Ivy Balanced Fund seeks to provide income and long-term appreciation of capital by investing generally in medium to large-cap, well-established, U.S.-based companies that exhibit strong growth potential, undervalued companies whose asset values or earnings power has not been recognized, and high-quality fixed-income securities with minimal credit risk. Historically, the Fund’s allocation ranges have been between 50 and 75 percent in stocks and between 25 and 50 percent in fixed income.1 Right now, equities generally look attractive to us and prospects for fixed-income returns are less compelling. We think the interest-rate risk on the bond portion of the portfolio is low. We believe this low interest-rate environment could persist for some time, as political and headline risk is likely to last well into 2012. The Fund’s current allocation reflects this longer-term view; it maintains a higher weight in equities, with approximately 61.7 percent of investments in equities, 22.9 percent in fixed-income securities and the remainder in cash, as of Dec. 31, 2011.
 
Ivy Balanced Fund differentiates itself from other balanced funds due to its higher-quality bias — a characteristic that has proved advantageous against the market’s sustained volatile backdrop. We limit the number of holdings in both equities and fixed-income securities. The Fund currently maintains about 50 equity positions. With respect to the fixed-income portion of the portfolio, we have been predisposed to corporate debt vs. Treasuries, given the low interest-rate environment. This proved to be a good strategy through the first half of 2011, but somewhat less effective in the third quarter as Treasuries rallied on the flight-to-quality trade. Nonetheless, the fixed-income portion of the portfolio has performed relatively well and generally in line with the equity portion in 2011. Importantly, due to our quality bias, the fixed-income portion provided ballast during the big market sell offs we’ve seen recently.
Europe-driven adjustments
Europe has been a major force in driving market direction for some time. We responded to the region’s debt crisis and subsequent fallout by decreasing the Fund’s exposure to more economically sensitive sectors. A strong profit cycle, huge profit recovery and the lack of excesses in the economy led us to a more pro cyclical stance; now we’re moving toward more structural growth. We have taken some risk off the table, which is why the Fund’s cash level is around 15.5 percent. We have attempted to gear the portfolio to outperform in the current volatile environment by protecting on the downside and participating on the upside when those swings occur. We are looking to increase the Fund’s yield slightly, not only through fixed-income holdings but also through higher-yielding stocks, where we are not seeking capital appreciation so much as a strong dividend yield. Note: Dividend-paying investments may not experience the same price appreciation as non-dividend­paying investments.
 
We think the debt crisis in Europe will continue to steer the markets and will continue to impact sentiment and economic growth, the two levers that drive equity markets, well into 2012. until some type of resolution is achieved in Europe, a lack of confidence will weigh on the global economy. Moving forward, we will keep our focus trained on Europe’s economy. Many U.S. companies are highly dependent on their businesses in Europe, which is why we’ve positioned the equity portion of the Fund slightly more defensively.
 
Technology companies are among our greatest areas of concern. Many technology companies have significant exposure to Europe and rely on that exposure for a large portion of their revenues. Our strategy in this area has been to focus on companies whose profits are not heavily dependent on their European exposure, i.e., they have healthy revenues from other sources. We have scaled back exposure in technology as well as in the industrials sector, where again, many companies are heavily dependent on their European exposure. health care is yet another sector that is vulnerable to Europe’s troubles. For example, for a period of time the Fund had exposure to a dental supply company that had 48 percent exposure to the European market. In Europe, dental expenditures are discretionary, as they are here in the U.S., so we reduced exposure there.
 
Sometimes, a company’s European exposure isn’t readily obvious, but most multinational companies rely heavily on their European business. Occasionally, that’s not a problem. One such example is McDonald’s, which has significant exposure to Europe and is among the Fund’s 10-largest holdings (representing 1.7 percent of net assets as of Dec. 31, 2011). Despite the economic turmoil, this fast food giant’s European sales have been robust, much as they were here in the U.S. throughout the 2008/2009 recession. People trade down; they still want to go out to eat, but instead of opting for the white-tablecloth types of restaurants, they’ll opt for McDonalds, which has always offered good value and currently has a strong pipeline of new product offerings.
Brighter spots in the U.S.
The positives are that the Fund has been able to exploit the U.S. economy and corporate profits. Corporate America is doing well, and the profit recovery has been tremendous. The savings rate has gone up, despite persistent high unemployment, although it has probably capped given where interest rates are currently. The ratio of household debt payments to disposable personal income in the first quarter of 2008 was 13.8 percent. The ratio had fallen to 11.5 percent by the first quarter of 2011 and total outstanding consumer debt also had declined.2 We don’t think there’s a lot of economic downside for the u.s. at this point in time, unless we were to see some unsavory event in Europe.
 
A third round of quantitative easing by the U.S. Federal Reserve has been a source of speculation. In our view, such an event would be dwarfed by any number of things that may happen in Europe. The issues in the U.S., such as unemployment, are more structural than cyclical, so we don’t think the Fed will have much impact. It basically has run out of bullets, so any additional easing would, in our view, be a positive but short-term event.
 
Several months ago, we were more pro-cyclical, largely because what typically drives us into a recession is an over-build or overheating in different areas of the economy. spending on housing has not yet recovered enough to push gross domestic product lower, with new home sales rising just 1.3 percent in October, but spending on autos, conversely, has been one of the few bright spots in spending. From an employment standpoint, productivity coming out of this cycle has been extremely strong. Corporations have cut to the bone, and further cutting from this point seems difficult. During the last recession the U.S. lost more than 8.5 million jobs; since the bottom, only a fraction of that figure has been added. However, corporate profitability remains high and balance sheets are the strongest they have been in decades, with low levels of debt and high cash balances. In this environment, it is difficult to find excesses such as high inventories, aggressive hiring or capacity expansions. Capital expenditures (cap ex) have been one of the few areas of strength in the economy, but the amount of capacity that has been built since the recession has been negligible. Estimates for capacity in the system have just started to grow after declining since the recession, so much of the cap ex early on seems to have been primarily maintenance cap ex, and the need for capacity just doesn’t seem to be there.
Looking ahead
As much as we’d like to think differently, we think Europe’s problems are likely to persist for some time and will continue to cast a shadow over global markets. There have been some deficit discussions, but now action is necessary. The European union (Eu) finance ministers have met to discuss how to implement the European Financial stability Facility guarantees, and discussions continue around deficit reduction. If irrational politicians scuttle the talks, stocks are likely to reverse. But we could also see the opposite. Clearly, there is no way Europe is going to avoid a recession; it’s just a matter of how deep it will be.
 
We believe the dynamics that are in place have created a number of uncertainties that are unlikely to be resolved anytime soon. That may not sound like particularly good news; however, we recognize that periods of volatility and a changing global economy create new investment opportunities. We believe the current uncertainty has created an opportunistic time for investors to consider the role that Ivy Balanced Fund could play in their portfolio. In times of market volatility and uncertainty, Ivy Balanced Fund’s focus on quality, consistent, disciplined approach and a defined mix of equity and fixed income securities and is designed to help keep investors from dramatic swings while seeking to provide a stream of current income and long-term appreciation of capital.
 
 
Data quoted is past performance and current performance may be higher or lower. Investment return and principal value of an investment will fluctuate and shares, when redeemed, may be worth more or less than their original cost. Please visit www.ivyfunds.com for the Fund’s most recent month-end performance.
 
Performance at net asset value (NAV) does not include the effect of sales changes. Class A share performance, including sales charges, reflects the maximum applicable front-end sales load of 5.75 percent. S&P 500 is an unmanaged index of common stocks. Citigroup Treasury/Govt sponsored/Credit Index is an unmanaged index comprised of securities that represent the government and corporate bond markets. It is not possible to invest directly in an index.
 
1 The Fund may invest up to 20 percent of its total assets in non-investment-grade debt securities which may include several bank loans or floating rate notes.
 
2 source: Reports on “household Debt service and Financial Obligation Ratios” and “Consumer Credit,” u.s. Federal Reserve Board, June 2011.
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2011, and are subject to change due to market conditions or other factors. Data quoted is past performance and current performance may be higher or lower. Investment return and principal value of an investment will fluctuate and shares, when redeemed, may be worth more or less than their original cost. Please visit www.ivy.com for the Fund’s most recent month-end performance.
 
Consider all factors. The value of a security believed by the Fund’s manager to be undervalued may never reach what the manager believes to be its full value, or such security’s value may decrease. 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. 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. 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 the Fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the Fund, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 

The Ivy Funds are managed by Ivy Investment Management Company and distributed by its subsidiary, Ivy Funds Distributor, Inc.

]]> <![CDATA[U.S. economic growth likely to outperform Europe in 2012]]> U.S. economic growth likely to outperform Europe in 2012

Derek Hamilton
Vice President,
Global Economist

Ivy Funds Market Perspective - January 2012

 
 
Markets leave behind a year of volatility and uncertainty in 2011 but face some of the same issues in looking ahead to 2012. Tighter monetary and fiscal policies across emerging markets coupled with the European sovereign debt crisis have resulted in slower global economic growth the last few quarters, and we think that slowdown is likely to continue in the first half of 2012. As growth slows, we expect governments globally then will begin turning to easier policies. We think the combined impact of these policy changes and recent declines in commodity prices should help stabilize the slowdown by midyear, allowing economic growth to improve in the second half of 2012. 
U.S. shows momentum entering 2012
Developed markets continue to focus on debt loads and the ensuing economic headwinds they create. But unlike most world economies, U.S. gross domestic product (GDP) growth has some momentum going into 2012. While there are some signs of improvement in the U.S. economy, growth still is likely to slow somewhat as we go through the year. In general, U.S. GDP remains dominated by consumer spending, which still is under pressure. Income growth has been muted, although we recently have seen encouraging signs of better employment growth. Overall, the U.S. needs to see employment continue to increase and at a faster rate.
 
However, lower commodity prices are a positive sign for U.S. consumers. In the first half of 2011, commodity prices were pushing higher and squeezing the ability of consumers to maintain their spending levels. Now that prices have come down from the highs of 2011, consumers have a bit more to spend on other goods. For example, Brent crude oil prices have fallen steadily from around $125 per barrel in April 2011 to about $110 at year end. If the global economy bottoms as we expect, oil prices may move higher in the second half of 2012, which would be a headwind for
U.S. growth.
 
There are factors in addition to consumer spending that we think will affect the prospects of the U.S. economy in 2012. Uncertainty about U.S. fiscal policy is likely to increase during the year, especially as the U.S. elections draw near. Capital spending by businesses is likely to continue to increase, although we think it will be more slowly than the last few years. Export growth, which recently has been a driver of GDP growth, is likely to slow as global economic growth slows. Finally, we think slower government spending at the federal, state and local levels will continue to be a drag on U.S. growth. Overall, we expect U.S. GDP will grow around 2.5 percent in 2012. 
Eurozone debt still a concern
The story in Europe still is one of austerity in the face of weak economies. We continue to believe that the eurozone countries will be in recession, and expect the southern countries to face a deeper contraction than the northern countries. It will be difficult for the northern, export-oriented countries to continue to grow, given their exposure to southern Europe’s economies and the slowing emerging markets.
 
We also expect the euro currency to continue to depreciate against the U.S. dollar. This would cushion some of the headwinds for the northern eurozone countries, since it would reduce the relative cost of their exports. However, given that southern eurozone countries have much less exposure to exports outside of the region, they will not benefit as much from a weaker currency. For the eurozone overall, the fiscal drag from tax increases and spending cuts will continue to be quite large, and the impact may increase as the year progresses.
 
The banking system in Europe also is under tremendous pressure to shrink, and we believe this undoubtedly will lead to less lending in the region. Given the dependency on bank lending for corporations in the eurozone, this deleveraging is another headwind for growth. We thus expect GDP for the eurozone countries to decline by about 1.5 to 2 percent. Given the focus on lower fiscal deficits, the European Central Bank (ECB) will be the only institution able to help buffer the downturn. While there is some question as to whether the ECB will enter into a quantitative easing-style program by purchasing government bonds, similar to past actions by the U.S. Federal Reserve, we have little doubt that the ECB’s balance sheet will continue to increase rapidly. So the end result is essentially the same. The ECB also has some room to cut interest rates a bit more, but that room is limited with its base rate at 1 percent as 2012 gets under way.
 
Outside of the eurozone, growth in the U.K. has been helped by exports, the majority of which go back into those countries. This situation coupled with its own fiscal austerity means we think the U.K. also will have a recession, although more mild than in the eurozone. We estimate U.K. GDP will decline about 0.5 percent in 2012. The Bank of England is currently engaged in its own quantitative easing program by purchasing government bonds, and this is scheduled to conclude at the end of February. We believe the central bank is likely to push forward with another round at that time, given the expected weakness in economic growth. 
Growth in Asia and emerging markets
The economy in Japan continues to recover from the widespread effects of the earthquake, tsunami and resulting nuclear disaster that damaged the country in early 2011. Rebuilding continues in the areas affected by these disasters, which will support domestic demand to a point. However, given that the economy is extremely sensitive to global trade, we expect exports to slow going forward. This ultimately will feed into the domestic economy, hurting capital spending and employment. We estimate GDP in Japan will grow by about 0.5 percent in 2012, driven by these rebuilding efforts.
 
We expect economic growth in the emerging markets to continue to outperform the developed world. Growth had slowed in the second half of 2011 because of tighter monetary and fiscal policies and slower global growth. But we think this slowdown is likely to bottom out in the first half of 2012 because policymakers have started to ease.
 
We think GDP growth in China is likely to be 8 percent in 2012, with exports continuing to slow. The housing market there has started to correct, and we anticipate weak activity in that sector this year. This weakness will be partially offset by the government’s social housing program, which is designed to provide more affordable housing. Consumer spending held up well in 2011 and shows little sign of slowing at this point. As the economy slows further, in part because of weaker exports, we think China will continue to pursue an easier policy, both on the monetary side (via more liquidity in the banking system) and via increased government spending.
 
The growth picture looks more complex in India. Economic activity has been slowing following stubbornly high inflation and aggressive central bank tightening. Credit growth has slowed and shows little sign of turning, and capital spending has been extremely weak because of high interest rates and a government that has slowed project approvals. It is becoming increasingly clear to us that India’s government is not conducting policy for the benefit of economic growth. We are becoming concerned that further delays in economic reforms could damage long-term economic growth potential. For 2012, we expect India’s GDP to grow 6.5 percent, which would be the lowest annual growth rate in 10 years.
 
Finally, we expect a slight slowing in Brazil’s economic growth. The country’s economy grew at a rapid clip in 2010. But we estimate Brazil’s 2012 GDP growth will be slightly less than the 2011 pace of 3 percent. 
Elections add to uncertain outlook
As we look ahead to the global economy in 2012, we know there are risks to the story, both to the upside and downside. It is possible that eurozone leaders finally will take action to restore confidence in the region’s currency and economies. In addition, the momentum in the U.S. economy in the second half of 2011 could continue throughout 2012, resulting in stronger growth than anticipated. The expected easing in emerging markets could be more substantial or have a larger effect than expected, resulting in stronger growth. But that could be considered both a blessing and a curse: While hard landing fears could erode, commodity prices could reaccelerate and cause inflationary pressures to return in these economies. And higher commodity prices would hurt demand in the developed world. Finally, recent saber-rattling in Iran again highlights the risk of supply disruptions in oil-producing regions.
 
We expect two issues that we have discussed in the past – economic volatility and a lack of political leadership – also are likely to be present in 2012. Economic volatility in part is a derivative of the lack of political leadership, which leads to a lack of confidence from consumers and businesses alike.
 
Elections will be at the forefront in 2012, including the critical U.S. presidential election. There are a number of issues the U.S. needs to deal with in the near future. First and foremost, there is a significant issue for the U.S. economy coming on Jan. 1, 2013, the date on which multiple tax cuts and programs are scheduled to expire. At some point, politicians also will have to deal with the U.S. budget deficit, whether by choice or through the force of the markets. This will require major decisions on overall tax policy and entitlement spending.
 
There also are presidential elections scheduled in countries including France, Finland, Mexico, South Korea and Taiwan. Given the crisis in Europe and issues related to aging populations and slowing economic growth, these elections will be watched closely by markets around the world.
 

Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are not meant to predict or project the future performance of any investment product. The opinions are current through Jan. 6, 2012. Mr. Hamilton’s views expressed in this article are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
Investment return and principal value will fluctuate, and it’s possible to lose money by investing. 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.
 
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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 
]]> <![CDATA[Federal Reserve outlook: Will 2012 be the year of the dove? ]]> Federal Reserve outlook: Will 2012 be the year of the dove?

Ivy Funds Market Perspective – January 2012

 
 
The Federal Reserve — always a popular target for critics — will find itself not only squarely in the crosshairs of its usual detractors in 2012 but also likely in the crossfire of politicians from both political parties with increased attention on what are always key election issues: jobs and the economy.
 
Combine election-year politics with lingering high unemployment and a change among the Fed’s policy-voting ranks and 2012 may be a year where Fed Chairman Ben Bernanke has plenty of leeway
— and perhaps encouragement — to offer additional stimulus if he feels it is necessary.
New voters
Under the unique structure of the Fed’s policy-setting Federal Open Market Committee (FOMC), voting rights annually rotate among the 12 regional Federal Reserve Bank presidents. Although Fed officials are quick to downplay the significance of being a so-called “voting member,” noting that all the regional Fed presidents participate in the meetings, to those outside the policy table it is significant. And, this year, because of the annual transition, it may appear to be a dramatically different Fed. One media analysis predicted 2012 will be the “Year of the Dove.”1 historically, Fed policy “doves” are those who see monetary policy’s primary mission as growth — or in the current environment, job creation — while “hawks” see containing inflation as the top priority of monetary policy.
 
In 2011, the Fed chairman saw FOMC voters from both camps dissent against policy actions. Regional Fed presidents from Dallas, Minneapolis and Philadelphia — all hawks — voted against the FOMC’s August promise to hold interest rates at exceptionally low levels through at least mid-2013. The same trio also dissented the following month, opposing the FOMC’s decision to launch a new round of stimulus, known as “operation twist.” From the dove side, Chicago Fed President Charles Evans wanted the Fed to take additional steps to stimulate the economy and dissented against FOMC decisions in both November and December.
 
This year, the most likely source of dissent will be Richmond Fed President Jeff Lacker. Lacker has dissented a total of five times during two previous stints as a voting member and in December was already establishing the groundwork for further dissents in 2012.
 
“Despite large-scale efforts to provide more monetary stimulus, growth has disappointed and inflation has ratcheted upward,” Lacker told attendees of an economic outlook conference on Dec. 19. he went on to say that “monetary stimulus can at times move inflation more than employment.”
 
The rest of the FOMC’s 2012 voting members, including regional Fed presidents and the Fed governors based in Washington, D.C., are all extremely unlikely to dissent against Bernanke. That includes two new Fed governors nominated in December by President Barack Obama to fill vacancies on the Federal Reserve Board. Although Obama picked Republican Jerome Powell and Democrat Jeremy Stein, Fed policy votes historically do not fall along political lines and Fed governors virtually never dissent against the chairman.
 
As a result, Bernanke should have far more policy leeway than he had in 2011 if he decides the central bank needs to offer the economy further stimulus.
New forecasts
The January meeting will not only include a new slate of policy voters, but it will entail the Fed taking another step in providing additional policy transparency to the markets, with Fed officials offering quarterly projections of future monetary policy. FOMC members decided on the change at the panel’s Dec. 11, 2011 meeting and announced it on Jan. 3.
 
The FOMC’s public communications process has been in an almost constant state of evolution, going back to former Chairman Alan Greenspan’s tenure. Until 1994, the FOMC did not even publicly announce its interest rate target changes, instead leaving it to traders to guess the Fed’s action based on the central bank’s trading activities in the market. Greenspan started the move to transparency with post-meeting statements, but the FOMC has become significantly more public under Bernanke. One example: At the conclusion of Greenspan’s last meeting as Fed chairman in January 2006, the FOMC’s publicly-released policy statement was barely 100 words compared with nearly 400 words from the Bernanke Fed’s December 2011 meeting, which also included far more perspective than what was offered by any previous Fed chairs.
 
In addition to instituting regular press conferences — a substantial step for the historically tight-lipped central bank — Bernanke has also instituted a quarterly Summary of Economic Projections (SEP) that reveals the range of FOMC member forecasts on economic growth, unemployment and inflation. Starting in January, the SEP will also include the interest rate forecasts, which will show a range of Fed officials’ views on future rates, the likely timing of the first interest rate increase based on their individual economic projections, and their expectations for the Fed’s investment portfolio. That portfolio has grown substantially as the Fed worked first to stabilize and then boost the economy — steps that came in addition to dropping its key interest rate target to the current historic low of 0 to 0.25 percent in December 2008.
 
Although some Fed officials have spoken in favor of providing the public with additional information, the minutes of the Fed’s December meeting show some were concerned that the additional forecasts may prove misleading.
 
Some FOMC members “saw an appreciable risk that the public could mistakenly interpret participants’ projections of the target federal funds rate as signaling the committee’s intention to follow a specific policy path rather than indicating members’ conditional projections for the federal funds rate given their (individual) expectations regarding future economic developments,” the minutes said.
 
The minutes also indicated Fed officials are still at work on another proposal that spells out the FOMC’s longer-run goals and policy strategy. FOMC members reviewed a draft statement at the December meeting and sent it back to a subcommittee for additional work.
 
“Participants generally agreed that issuing such a statement could be helpful in enhancing the transparency and accountability of monetary policy and in facilitating well-informed decision making by households and businesses, and thus in enhancing the committee’s ability to promote the goals specified in its statutory mandate in the face of significant economic disturbances,” the minutes said.
 
Although it is not known what was in the draft that Fed officials reviewed, it appears the Fed is likely headed toward something similar to an inflation target — the benefits of which economists have debated for years — that could either act as a guide on its own or perhaps in tandem with some kind of unemployment forecast. Such a statement would be one way of aligning policy directly with the FOMC’s dual statutory mandate of price stability and maximum employment.
 
There is also at least some market expectation that the Fed will announce both inflation and jobs targets. A December New York Fed survey of the 21 so-called “primary dealers” that serve as the Fed’s counterparties for open market trading operations found expectations for not only an inflation target, but “most of these dealers also commented that the inflation target would also be accompanied by an explicit unemployment forecast or further guidance on the FOMC’s (unemployment) goals,” a survey analysis said.
 
Not all Fed policymakers like the idea. During a Jan. 5 Bloomberg radio interview St. Louis Fed President James Bullard said that he believes the Fed is “very close to having inflation targeting.” however, he stressed that the Fed “should not tie monetary policy decisions explicitly to the unemployment rate because the unemployment rate is a somewhat mysterious economic variable.” Specifically, the St. Louis Fed chief noted the situation in Europe where unemployment has not fallen below 7 percent for two decades.
 
Bullard’s view, however, is not unanimously held by other Fed officials. During a November interview on CNBC, the Chicago Fed’s Evans suggested the Fed commit to holding interest rates down until unemployment falls to 7 percent as long as inflation remained below 3 percent. 
 
2012 FOMC voting members
Ben S. Bernanke, Federal Reserve chairman
Janet L. Yellen, Federal Reserve vice chair
Elizabeth A. Duke, Federal Reserve governor
Sarah Bloom Raskin, Federal Reserve governor
Daniel K. Tarullo, Federal Reserve governor
William C. Dudley, New York Fed president
Jeffrey M. Lacker, Richmond Fed president
Dennis P. Lockhart, Atlanta Fed president
Sandra Pianalto, Cleveland Fed president
John C. Williams, San Francisco Fed president
 
Regardless of what change, if any, the Fed might finally settle on, one important benefit would be allowing the Fed to perhaps modify its August commitment to hold rates exceptionally low through mid-2013. In addition to the three Fed officials who cast dissenting votes against that announcement, others have been critical of the Fed’s August promise because it tied policy moves to calendar dates instead of to the economy and the economic outlook. As a result, such promises can carry little weight with markets that know policy decisions will be based on current and expected economic activity. So far, the markets have indicated a rate hike is unlikely until some point in early 2014 at the soonest. Respondents to the New York Fed survey said there is a 45 percent chance the first rate increase will come in the second quarter of 2014 or later.
Same old problem
In addition to potential confusion, a perhaps bigger problem with forecasts, of course, is that they can be off target and, as a result, introduce additional uncertainty.
 
The Fed may already be seeing some of that as a result of the November SEP where policymakers projected December unemployment at 9 to 9.1 percent. When the November 2011 jobs report was released a few weeks later, however, unemployment had improved to 8.6 percent — or where Fed officials did not expect to find it until December 2012. Unemployment improved again in December 2011 to 8.5 percent — its lowest level since February 2009.
 
Some insight to the Fed’s views about the improving jobs data can be found in the Fed’s December meeting transcript. At that meeting, some Fed officials said a reduction in workforce participation that contributed to the lower unemployment number likely meant that sentiment about an improving jobs picture was “overstated.” Fed officials noted that unemployment still remained high — particularly longer-term joblessness.
 
The meeting transcript also indicated that Fed officials noted unemployment still remained high — particularly longer-term unemployment; and that real jobs improvement will come only gradually. The Fed views the nation’s long-term jobless rate at somewhere between 5.2 and 6 percent, which was the general range of unemployment from the mid 1990s until the financial crisis and recession drove it to nearly 10 percent. 

Long-time Fed watchers know the central bank has some history with a slow economic recovery on the eve of a presidential election. Heading into the 1992 election, President George h. W. Bush felt that the Fed was not doing enough to stimulate the economy. he later blamed Fed Chairman Greenspan for costing him a second term in the White house.

2012 FOMC meeting schedule
Jan. 24-25 
March 13
April 24-25
June 19-20
July 31
Sept. 12
Oct. 23-24
Dec. 11
 
Viewed against the backdrop of 20 years ago, the promise to keep rates low into 2013 could be viewed, at least in part, as a way to try to keep Fed policy from being seen as attempting to influence the election. Similarly, while the Fed hopes that the raft of new public information about interest rate views will influence interest rates paid by businesses and consumers — it could also potentially provide the Fed with a means to signal the market about additional stimulus in advance of such moves in a way that could be viewed as more organic and derived from other policymakers rather than being directed by Bernanke himself.
 
A close read of the December meeting minutes, in fact, might leave some with the impression that another round of stimulus may, in fact, be on the horizon.
 
“A number of (FOMC) members indicated that current and prospective economic conditions could well warrant additional policy accommodation, but they believed that any additional actions would be more effective if accompanied by enhanced communication about the Committee’s longer-run economic goals and policy framework,” the minutes said.
 
1MarketWatch, Dec. 18, 2011
 
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Ivy Funds and its fund managers and analysts, and are not meant to predict or project the future performance of any investment product. The opinions are current through January 12, 2012, are subject to change at any time based on market and other cur­rent conditions, and no forecasts can be guaranteed.
 
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 any of the Ivy Funds, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.  

Investment return and principal value will fluctuate, and it is possible to lose money by investing. Past performance is not a guarantee of future results.

]]> <![CDATA[Separating volatility from risk is key as we look to 2012]]> Separating volatility from risk is key as we look to 2012

Mike Avery
Ryan Caldwell
Co-Portfolio Managers
 

Ivy Asset Strategy Fund – January 2012

 
Challenging 2011 prompts cautious growth outlook
The Ivy Asset Strategy Fund closed a challenging 2011 with an ongoing focus on opportunities in equities, particularly in U.S. companies. Co-portfolio managers Mike Avery and Ryan Caldwell review the events that supported the emphasis on equities markets and offer an outlook for 2012.
The background for equities
Despite a “double-dip” scare early in the year, recession did not return to the U.S. in 2011 and we do not expect one in 2012. The Federal Reserve has indicated it will keep interest rates at current levels next year, so money will remain very cheap. And it’s hard to have a recession when the cyclical sectors of the economy, such as housing and auto production, have yet to fully recover.
 
In addition, U.S. corporate balance sheets appear to be in very good shape because of actions companies took after the 2008 credit crisis to reduce costs and raise cash. As a result, we think companies are likely to maintain high margins next year. We also think the U.S. is likely to continue to be considered a “safe haven” investment option, as was shown in late 2011 despite a credit rating downgrade by Standard & Poor’s in August.
 
In our view, equities are inexpensive whether analyzed by forward price/earnings ratio or the equity risk premium (ERP). The ERP is the concept that investors should be compensated for taking additional risk, and it can be used to compare how equities are priced relative to bonds. Our current calculation of the ERP suggests that equities have not been this inexpensive relative to bonds since the late 1970s, and that conclusion is one important factor for the Fund favoring equities over long-duration, fixed-income securities.
Separating volatility and risk
While equities markets have been volatile this year, we think it’s important to separate volatility and risk — the concepts are not interchangeable. It can be very difficult to accurately assess and price risk, but we believe equities markets are focused appropriately on pricing risk now. The correlation among various global equities markets has increased to historically high levels, indicating that markets believe all risk is systemic or common across the asset class, and generally is not specific to location or market capitalization.
 
But we do not think risk is as clearly priced in the fixed income markets, with the exception of municipal and high yield securities. Volatility in fixed income markets overall has been lower and the returns have been solid, leading many investors to move to those securities. We continue to think that extreme risk aversion has driven up the price of assets that are perceived to be safe and has driven down the price of assets that may participate in future growth.
 
In the intermediate to longer term, we do not see fixed income as a safe haven and anticipate much higher volatility and much more risk than what the market is assigning now with
U.S. interest rates at historic lows. In our view, many investors are taking on risk simply to avoid that volatility. When fixed income investors perceive that U.S. inflationary pressures are building, leading to a future rise in interest rates, we think they will be forced to move out of fixed income or risk leaving their money tied up in investments paying comparatively low yields. If this reallocation occurs, we think equities are likely to benefit, particularly in relation to fixed income investments.
Next steps in Europe
The European equities in the Fund are focused on companies with a combination of products or services that are geared to the emerging middle class globally, and on those with a cost advantage. We expect to continue this approach in the near term.
 
In looking back at 2011, we had expected Europe’s leaders to find a solution to the region’s sovereign debt crisis. The problem is well understood, given the near impossibility of having monetary union without fiscal union. Recent actions by the European Central Bank amount to aggressive monetary easing, and we expect such efforts will continue in order to bring down the cost of capital for the European Union (EU) countries that are struggling with their debt loads.
 
We think a credible fiscal union of some type is required to allow the transfer of capital from the stronger EU members to the weaker, less competitive ones. Nevertheless, from an investor’s perspective, we think that recent actions by EU leaders are likely to be interpreted positively and have been reflected in equities prices.
 
The future of the euro currency also has been in question as a result of the sovereign debt crisis, but we do not expect any major changes in the single-currency union in the near term. It’s important to remember that Germany is a major beneficiary of the eurozone because 40 percent of its economy is export based. Germany is in an export boom, which has added jobs. Companies there have benefitted from spreading their supply chains around the eurozone, reducing labor costs and becoming very productive and competitive. But that situation would change without the euro currency.
 
If the eurozone were to break apart and Germany were to return to the deutsche mark, economists and currency strategists estimate the mark would show significant appreciation against the U.S. dollar and most major currencies. Germany’s exports would be likely to decline because its costs no longer would be competitive, and its unemployment rate probably would increase over time.
 
So we conclude that it’s in nobody’s best interest for the euro to fall apart or for countries to exit the currency union. We do see an intermediate to longer term risk if the debtor countries — especially Spain and Italy — cannot achieve the austerity required to manage their debt. We expect total debt around the world to increase in 2012 — sovereign, corporate and private. Central banks and governments have been easing steadily since mid-2011 in response to slow economic growth. The world is desperate for growth and governments are acting desperately to generate that growth, thereby proliferating what we see as a very big credit cycle. 
 
As economies reaccelerate, which we expect around the second half of 2012, we think the year could provide a positive growth surprise, especially relative to some economists’ forecasts for U.S. gross domestic product (GDP) growth at only 1 to 2 percent. That range looks a little low to us. We may see central banks start to tighten liquidity in the future as growth accelerates, especially in the U.S. and China — the world’s largest economies.
China’s economic future
China’s economy has been the target of a “hard landing” scare, but we see no evidence of a hard landing on the horizon. After the onset of the 2008 credit crisis, China began a very aggressive fiscal stimulus program and it worked — in fact, it worked too well. China’s 2009 GDP growth exceeded 10 percent, which is a level that the government knew was not sustainable. In 2010, China began increasing interest rates and tightening lending requirements as part of a concerted effort to slow its growth. Over the course of 2010 and 2011, that effort succeeded in slowing the Chinese economy. China now is gradually easing monetary and fiscal policy, but the full benefit of those actions won’t be seen until the second or third quarter of 2012.
 
Perhaps more significantly, it appears that inflation in China peaked several months ago. November inflation was below 5 percent, December is forecast around 4 percent, and inflation is expected to stay around 4 percent at least through early 2012. Declining inflation should give China the leeway to continue its monetary easing, which we think will lead to an environment that is friendly to equities.  
 
To reiterate, the information we have learned through our research and travels to China does not support fears of a hard economic landing. In fact, across Asia, we think there are markets that could grow faster with more infrastructure and more fixed asset investment in place, and this includes parts of western China.
Cautious outlook for growth
The aggressive policy intervention across the globe may have positive effects on economic growth. We estimate U.S. fourth-quarter 2011 GDP growth at 3 to 4 percent, and think 2 to 3 percent growth is likely in 2012. As a result of the 2008 credit crisis, policy makers moved aggressively to avoid a deflationary spiral that could have led to an economic depression. But we do not see an indication of widespread deflation in any of the economic statistics. We do see inflation in the global economy, however, and believe there is a risk that the aggressive monetary easing could cause mispricing in the long term. With an aggressive monetary policy and currency risk, we expect to maintain a gold position as a means to manage that risk.
 
These factors overall eventually will present a new challenge in identifying the next “safe haven” investment. In pursuing this challenge, we will stay true to our mandate by researching all markets and asset classes, identifying what we feel are the best investment opportunities, managing risk, and ultimately doing what is in the best interest of our shareholders.
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s 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 Jan. 3, 2012, and are subject to change due to market conditions or other factors.
 
Risk Factors: As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. These and other risks are more fully described in the Fund’s prospectus. The Fund may allocate from 0-100 percent of its assets between stocks, bonds and short-term instruments, across domestic and foreign securities, therefore, the Fund may invest up to 100 percent of its assets in foreign securities. 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. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The Fund may focus its investments in certain regions or industries, thereby increasing its potential vulnerability to market volatility. The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk, as short selling involves the risk of potentially unlimited increase in the market value of the security sold short, which could result in potentially unlimited loss for the Fund, and the value of investments in derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time and storage costs that exceed the custodial and/or brokerage costs associated with the Fund’s other holdings. 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.
 

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 mutual funds offered by Ivy Funds, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.

]]> <![CDATA[Muni bond market looks to 2012 after predictions of 2011 collapse prove greatly exaggerated]]> Muni bond market looks to 2012 after predictions of 2011 collapse prove greatly exaggerated

Ivy Funds Market Perspectives - January 2012

 
 
MEREDITH WHITNEY’S LATE 2010 FORECAST FOR TURMOIL in the municipal credit markets and “hundreds of billions of dollars” in defaults certainly had an impact. Two months after the high-profile prediction, and with other pundits joining the chorus, so many jittery investors had bailed out of the muni market that borrowing costs rose to two-year highs in January 2011.
 
But rather than retreat, the muni market rallied. Measured year-to-date from Jan. 1 through Nov. 30, municipal bonds were up 8.63 percent as measured by the BarCap Municipal TR USD Index. The growth outpaced the broader bond market, which was up 6.67 percent over the same period as measured by the Citi USBIG Index, and equities, as measured by the Standard & Poor’s 500 Index, which were up 1.08 year-to-date.
 
The performance is at the far end of the spectrum from what Whitney and others predicted.
 
“I sort of laugh because it is funny if you look back starting with Meredith Whitney in November 2010 as well as many other pundits coming out and predicting the doom in hundreds of billions of dollars in muni defaults,” said Michael Walls, portfolio manager of the Ivy Municipal High Income Fund. “Most municipal bond professionals realized that the vast majority of governments would minimize other expenses, but continue paying their debts.”
Beating expectations
Certainly, as there are every year, there were municipal defaults in 2011, including a couple that were high profile:
  • On Oct. 12, the city council of Harrisburg, Penn., voted to seek bankruptcy protection after wrestling with $310 million in debt related to a trash incinerator project. Prior to the vote, the city had spent a decade battling with funding issues connected to an upgrade of the city’s incinerator.
  • On Nov. 9, Jefferson County, Ala., filed for the largest government bankruptcy in U.S. history, with $4.2 billion in debts including more than $3 billion related to a sewer project. Reports noted that the county’s borrowing interest rates jumped in 2008 because of swap agreements in place during the financial crisis.
While both generated headlines, they were not a surprise to Walls and his Fund’s analyst team.
 
“These credits were distressed and that they got into these positions was no surprise,” Walls said. “These were not overnight scenarios. There were long periods of missteps, mismanagement and many other things that caused these credits to fail.”
 
Overall, municipal defaults for 2011 are projected around $2 billion. The Distressed Debt Securities Newsletter made some headlines in December predicting $20 billion in defaults using a broad measure that includes issues where no payments have been missed, but where the publisher said there may be defaults in the future. Even using the newsletter’s arguably inflated numbers, the totals would still be a fraction of what some predicted heading into 2011.
 
The pundits, Walls said, failed to realize that it is extremely difficult for a municipality to file bankruptcy, which is blocked by law in some states. Another major hurdle is that when declaring bankruptcy, a municipality must prove its insolvency in court – an extremely difficult step when they can raise taxes to generate additional revenue. Even if it is able to pass the legal requirements, the end result of a bankruptcy filing is a loss of access to credit markets that are critical to municipal finance because of the seasonality of tax revenues.
 
“There is only one group that does well in a chapter nine and it is the attorneys,” Walls said.
 
The process aside, Walls notes that muni doomsayers also did not take into account that many 2010 elections were won by candidates that ran on platforms of austerity and fiscal tightening. Although moves such as layoffs and service reductions may have a negative impact on local communities, from an investor perspective it frees up additional funds that can be used to meet debt payments.
Looking ahead
Another factor that some critics may have overlooked is that, in many areas, conditions are showing some improvement.
 
“If you look at state and local tax receipts, they have consistently gone up throughout 2011, albeit you are not seeing a lot of growth, but it is consistent and we believe that you have seen the bottom,” Walls said.
 
Revenue from all sources, including taxes and fees, exceeded annual budget projections in 32 states during fiscal 2011, according to the most recent edition of the Fiscal Survey of States, which is published twice annually by The National Governors Association and the National Association of State Budget Officers. Compared against fiscal 2010 levels, personal income tax collections were up 9.7 percent in fiscal 2011, while corporate income tax collections were up 9.4 percent and sales tax collections were up 4.8 percent.¹
 
The report also notes that states have begun to replenish depleted “rainy day” funds. After peaking at $69 billion, or 11.5 percent of general fund expenditures, in fiscal 2006, reserve fund levels dropped more than half to $30 billion, or 4.6 percent of expenditures, at the end of fiscal 2009. Fiscal 2012 budget projections predict that number to rise to $41 billion in fiscal 2012, equaling 6.2 percent of planned expenditures.
 
Although, the report cautions that state budgets still remain below pre-recession levels and that there are some unknown issues on the horizon — most notably the economic recovery and potential cost increases related to health care — conditions are improving.
 
“In 2012, states appear on track for continued, at least moderate, financial improvement highlighted by increasing general fund expenditures, rising tax collections and the slow restoration of state rainy day funds,” reads the report, noting that if current trends continue, state budgets will stay on a “positive, albeit slow moving track.”
 
¹ Forty-six states begin their fiscal years in July and end them in June. Two operate on an October to September schedule, one is September to August and one is April to March.
 
The BarCap Municipal TR USD Index is an unmanaged index of securities representing the municipal bond market. The Citigroup USBIG Index is an unmanaged index of securities representing the broad U.S. bond market. The Standard & Poor’s 500 Index is an unmanaged index 500 widely held stocks that is generally considered to represent the U.S. stock market. It is not possible to invest directly in an index.
 
The opinions expressed in this article are those of the Ivy Funds and its fund managers and analysts, and are not meant to predict or project the future performance of any investment product. The opinions are current through January 6, 2012, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
Past performance is no guarantee of future results. Consider all risks: As with any mutual fund, the value of the Fund’s shares will change, and it is possible to lose money on your investment. 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. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). 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.
 
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 mutual funds offered by Ivy Funds, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
]]> <![CDATA[Finding domestic potential in an uncertain environment]]> Finding domestic potential in an uncertain environment

Hank Herrmann
CEO,
Chairman of the
Investment Policy Committee                             


Ivy Funds Market Perspective – January 2012


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Looking back at 2011, the keywords of the year for the financial markets seemed to be volatility and uncertainty. The S&P 500 Index, as an example, saw 11 days when it increased 2 percent or more, and 19 days when it decreased 2 percent or more over the course of the year through November, according to Bloomberg.
 
While some issues have changed or evolved as we enter 2012, there are issues that continue to hang over the financial markets, namely the European debt crisis and whether the region can sustain a fiscal union, and the political environment in the U.S. as we proceed through a presidential election year.
 
But amid the changing news and uncertainty, while many investors have sold on the lows or held cash at historically low rates, we’ve seen something behind the headlines. Economic fundamentals in the U.S. are steadily improving. Amid the uncertainty, we see a positive outlook for domestic equities. 
Fundamental facts
While the macro issues around the world have simmered, we continue to see positive fundamental statistics in the U.S. that reinforce a more constructive outlook. There are a number of reasons to feel positive; and when you put the pieces together, we believe that the U.S. may be one of the more attractive places to invest in a challenging global environment. Let’s look at several key points:
 
  • The dollar is in a period of improvement against foreign currencies, which means money is likely to flow from offshore into U.S. financial assets. With the challenges in the eurozone, global investors with significant exposure to European assets are likely to move their assets elsewhere. We believe the logical place to move, on a valuation and a quality basis, is the U.S. 
  • Thanks in large part to aggressive stimulus measures that have been in place since 2008, the U.S. economy is steadily improving. Unemployment is still too high, but the job market is looking better, as unemployment claims in mid-December came in at the lowest level since 2008. The unemployment rate has fallen nearly a point. Factory orders have been increasing for months and retail sales are rising more than expected, especially auto sales. It is apparent that the U.S. has avoided the double-dip recession that many feared just a few months ago. U.S. gross domestic product (GDP) growth is projected to come in around 3.5 to 4.0 percent for the fourth quarter of 2011, and while it may slow some in early 2012, it is still projected to rise approximately 2 percent for 2012, which is strong relative to the rest of the developed world.
  • The U.S. federal deficit is now contracting, in part because war costs are going down, but also because tax receipts are rising, driven by better corporate earnings and more people working.
  • Our trade deficit also is getting better. U.S. dependence on imported oil is diminishing, due to new technology that allows development of very substantial deposits of shale gas and oil here at home. These new resources may over time help to strengthen our trade balance and our geopolitical position. 
Combine all of this with the fact that the valuations on U.S. equities look very reasonable right now, particularly if you factor in some improvement in corporate earnings in 2012, and you begin to see potentially better returns. According to Birinyi Associates, in 2011 U.S. companies authorized spending more than $453 billion to buy their own stock, putting 2011 on track for the third highest annual total behind 2006 and 2007. Given where the stock market is presently priced, it appears to us that we are at the lower end of a wide band for price-to-earnings (P/E) ratios. Companies in the U.S. have some of the strongest balance sheets in the world, and domestic equities look more attractive to us than elsewhere at this point. 
There’s always a caveat, or two
In fact, there are seemingly more than two at this point. The two that follow, however, are especially important at this juncture.
 
Election years are unpredictable by nature and the U.S. is in the midst of a particularly partisan and acrimonious one. Political uncertainty is likely to dampen the potential of the domestic equity market somewhat as we move toward November. We can’t overstate the importance of politics; it will get much attention in the coming months. Regardless of the outcome of the election, however, the U.S. will move toward more fiscal responsibility. Our hope is that the politicians can move toward consensus on this key issue without prodding from the financial markets.
 
In Europe, we are likely to see some material restructuring, although the form of that remains unclear, hence more uncertainty. As we’ve noted many times, financial markets don’t like uncertainty. Will the eurozone see fiscal union, with financial oversight under a common authority? Or could we see a membership restructuring? The political and financial issues in Europe are thorny but not intractable. They will take time to resolve, and will be an overhang for investors in the coming year.
 
As we look forward, we think the U.S. equity market provides strong potential in what continues to be an uncertain global financial and political environment.
 
 
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered to represent the U.S. stock market. Investments cannot be made directly in an index.
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Herrmann and are current through January 2012. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. Waddell & Reed Financial, Inc. is the ultimate parent company of Waddell & Reed, Inc. and of Ivy Funds Distributor, Inc.
 
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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.

 

 

]]> <![CDATA[Turbulence, Perspective and Opportunity]]> Turbulence, Perspective and Opportunity

 

IVY FUNDS INVESTORS SERIES – December 2011

 
 
Long-term investors should look beyond market volatility
One definition of volatile says the word means “tending to rapid and extreme fluctuations.” Some would say that also defines the stock market, given the price movements in recent years. While stocks can be volatile, especially in response to major domestic or world events, historical market data show that prices typically have returned to less volatile patterns over time. That can be good news for long-term investors. 
 
The 2008 credit crisis led to considerable fear and uncertainty about the global economy, which in turn contributed to significant volatility in stock prices. Global stock markets plummeted when the crisis first took hold, recovered in 2009 and then stumbled again. The lack of a clear solution for sustainable worldwide economic growth and expanding problems in Europe’s sovereign debt markets combined to hurt investor confidence and prompt many to look for ways to reduce risk.
 
When it comes to the stock market, volatility typically refers to the size and frequency of price movements. Volatility can be shown using standard deviation, a measure of the variance in the returns of a given security or market index. In general, higher volatility means a wider range of potential values for a security or index, and the possibility of sharp movements over short time periods – whether up or down.
 
The volatility in global markets in recent years has caused some to suggest the current period is more volatile than at any point
in recent decades – and perhaps the onset of a “new normal.” While history cannot predict where the market is headed, a review of market volatility over time can be helpful in assessing the current situation. 
Volatility shows historical patterns
An analysis of data back to the 1929 stock market crash shows that periods of volatile price movements have not been unusual. Volatility historically has increased sharply during times of major global events or economic disruption, and then gradually has declined to what might be considered more normal levels, often after the triggering issues are resolved.
 
The green line in the chart below shows the historical mean, or average, level of standard deviation – or volatility – in the stock market since 1926, as represented by the S&P 500 Index. The periods of increased volatility are the spikes above that line. The level of volatility and the length of time it stays above or below the average have varied widely in the market’s history.
 

History of Market Volatility

(annual standard deviation of S&P 500 Index, 12/31/1926 - 12/31/2010)
 
Events since 2008 – and especially in recent months – have again induced higher volatility into the stock market as a whole. Mike Avery, President of Ivy Investment Management Co., says, “I think we’re in a period in which increased volatility is going to be more normal for a while. It may be that investors became comfortable in a period where volatility was relatively low, but the last three years changed all that.”
 
One indicator of the increase in volatility can be seen in the table at right, which shows the number of days when the stock market finished more than 2 percent higher or lower, based on the S&P 500 Index.
 
A review of the period from 2000 to the end of October 2011 shows that more than one-half of the stock market’s “up” and “down” days have been recorded since 2008. There was a similar increase in volatility early in that time period, which coincided with the end of the Dot-Com Bubble, the terrorist attacks of 9/11 and the onset of the Iraq War.
 
But in the intervening years – roughly 2003 to 2007 – the market recorded much lower levels of volatility. In fact, for three of those years, there were a total of only two days when the market was up 2 percent or more and there were no declines of that magnitude. All in all, it was a period of unusually low volatility in stocks.
 
Looking further into history, the decade of the 1990s generally had lower than average volatility in the stock market overall. But that period followed a highly volatile era that began in the mid-1980s and included the “Black Monday” stock market crash of October 19, 1987, when the S&P 500 Index fell more than 20 percent in a single day. A global stock market decline followed, and most major exchanges had declined by a similar amount by the end of that month.
 
More recently, the S&P 500 Index dove 6.7 percent on Aug. 8 and has moved since then within a broad – but volatile – trading range of 1,074 to 1,284. That includes a gain of more than 4.3 percent on Nov. 30.
 
Philip Sanders, Chief Investment Officer of Ivy Investment Management Co., says he thinks the markets could remain relatively volatile in the near term as investors watch for a resolution to the debt issues facing the U.S. and the European Union. “We think the volatility is likely to continue until there are stronger signs of policy direction and economic recovery,” Sanders says.
 
Perception affects strategy…and results
In his 1992 book Market Volatility, Yale University economics professor Robert J. Shiller took on the subject of price volatility. Shiller used statistical evidence to analyze whether price movements were the result of fundamental economic factors, or whether they were due to “changes in opinion or psychology” among investors. He wrote that economic value accounts for some aspect of price, but “…investor attitudes are of great importance in determining the course of prices of speculative assets. Prices change in substantial measure because the
investing public en masse capriciously changes its mind.”
 
The sharp moves up and down in today’s markets can challenge even the most seasoned investors. When economic news or the market’s volatility becomes sufficiently unsettling, many investors decide to step to the sidelines and hope to “time” their re-entry to an improvement in market conditions.
 
But there’s a problem with that strategy: It is not possible to accurately predict the exact timing of market moves. History shows that long-term investment success is more likely to be the result of a consistent approach, based on time in the market – not market timing. Attempts to time the market also can lead to buying high and selling low, which is the opposite of a successful investing strategy.
 
Selling when markets decline or become turbulent can leave an investor on the sidelines when stocks change direction – which can happen quickly. For example, the S&P 500 made a one-day gain of 11.6 percent on Oct. 13, 2008, after eight straight sessions of falling prices.
 
 
The charts above make it clear that, even in volatile markets, missing just a few of the stock market’s best single-day performances could have a significant effect on your portfolio. While the effect on returns of the S&P 500 Index in the last 20 years is noteworthy, for example, it is even more compelling in just the past 10 years. Only a fully invested portfolio would have produced a positive return during that period, as shown in the chart above at right.
 
In fact, some financial planners have noted that investors who move out of stocks during volatile markets may be trading one perceived risk for another form of risk. For example, holding cash in an attempt to avoid stock market volatility could raise the potential for missing longer term investment goals, as the real rate of return on cash currently is negative once the impact of inflation is calculated. 
Looking beyond current markets
Increases in stock market volatility have been the norm in periods of uncertainty or as a result of major events for more than 80 years. When the outcome of such ”shocks to the system” become more clear or the events are fully resolved, investor confidence tends to rise and volatility tends to decrease to the historical mean. In the long-term, stock investors generally have been rewarded for patience and consistency, as shown in the chart below.
 
Although periods of volatility may be unnerving for individual investors, an experienced management team can distinguish between daily market noise and real long-term investment risks to position a portfolio accordingly. At the Ivy Funds, we look across the globe at all asset classes as we review investment opportunities. We think investors will be compensated over time for accepting volatility in the current market environment, in which we think extreme risk aversion has driven up the price of assets that are perceived to be safe and driven down the price of assets that may participate in future growth.
 

Performance Over the Long Term

(12/31/1925 - 10/31/2011)
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Ivy Funds and are not meant to predict or project the future performance of any investment product. The opinions are current through Dec 5, 2011, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 
Ivy Funds are managed by Ivy Investment Management Company and distributed by its subsidiary, Ivy Funds Distributor, Inc.

 

]]> <![CDATA[European crisis: Pressure mounts as new leaders emerge ]]> European crisis: Pressure mounts as new leaders emerge

Ivy Funds Market Perspectives – December 2011

 
 
In some of his first remarks as Spain’s Incoming Prime Minister, Mariano Rajoy sounded not like a man swept into office in a landslide, but someone preparing to face the daunting challenges facing his country.
 
“Hard times lie ahead,” Rajoy told supporters gathered outside his party’s headquarters on Nov. 20. “We are going to govern in the most delicate situation Spain has faced in 30 years.”
 
The pressure was immediately evident. Although Rajoy won by the biggest majority in a Spanish election in nearly three decades, there was no honeymoon period. Calls for him to unveil both his cabinet and a plan to reduce his country’s deficit — among the eurozone’s largest — began immediately.
 
Recognizing the likely pressure, Rajoy asked the markets to give him “more than half an hour” to address the crisis. he didn’t get it.
 
Traders instead turned up the pressure on Spain with Spanish borrowing costs increasing as 10-year bonds rose 20 basis points to above 6.5 percent in the aftermath of the election. The risk premium, which measures the spread between the Spanish 10-year and the benchmark German bund, rose 28 basis points to 466. The market action may be a reflection of a top criticism of Rajoy and his Popular Party — their apparent unwillingness to share details of their plans with the public.
 
Still, the victory by Rajoy is seen by many as good news for both his country and the evolving European crisis.
 
“This is a long-term positive,” Jeff Surles, fixed income analyst for Ivy Funds, says. “The conservative party in Spain has a pretty good grasp of what’s going on and they are likely to implement needed austerity measures within Spain.”
The changing of the guard
Rajoy’s victory, and his party’s capture of 186 of the Spanish Parliament’s 360 seats, marks the third European government to change in as many weeks as the crisis has continued to escalate. Only days earlier, Mario Monti assumed office as Prime Minister of Italy and Lucas Papademos took over as Prime Minister of Greece on Nov. 11. Similar events unfolded in Portugal in June and in Ireland in February.
 
While Rajoy is not expected to take office until Dec. 21, both Monti and Papademos are leading what are known as technocratic governments. Instead of career politicians, Monti, who was Italy’s representative to the European Commission, has built a cabinet of people from banking, finance and academics. Papademos, meanwhile, is a former vice chairman of the European Central Bank.
 
“These governments are going to have broad mandates to implement additional austerity packages through their Parliaments,” Surles says. “And once they’ve passed through their Parliaments, they will also have to implement them into their fiscal plans and make sure that the adjustments happen throughout their economy.”
 
That will likely take time. Surles says it looks like Greece, where the crisis formed two years ago, has a three- or four-month mandate. That might feel like a lot of time for some other European leaders.
 
In Italy, Monti said in mid-November that the future of the euro depends partly “on what Italy does in the next few weeks” as that country battles to address a $2.6 trillion debt that is believed too large for other Euopean countries to rescue. Meanwhile, the Italian 10-year-bond dances around 7 percent — a level that Surles says “will bury them” if Italy tries to fund itself. And in Spain, Rajoy has said he hopes Spain won’t need a bailout before he takes office next month. To accomplish that, Spain, which also has the highest jobless rate in the eurozone at more than 20 percent, will need to get the yield on its 10-year bond to move lower.
Beat the clock
Time is of the essence throughout the entire region. A rise in French bond yields led Moody’s Investor Services to warn that rising borrowing costs and an uncertain economic outlook could result in a loss of the coveted AAA rating.
 
 “Elevated borrowing costs persisting for an extended period would amplify the fiscal challenge the French government faces amid a deteriorating growth outlook, with negative credit implications,” Moody’s said in a Nov. 21 note. Investors saw the report as a sign of contagion into countries previously viewed as safe. In the days prior to the Moody’s report, yield spreads between 10-year French bonds and comparable German bonds rose to more than 200 basis points. Although the spreads tightened about 50 points after the Moody’s report, they are still well above their historical average of 40 to 60 basis points. The spread is being influenced on both sides as an investor flight to quality means money is moving away from the perceived higher-risk bonds of some nations, thereby pushing yields on those bonds higher, and into the relative safety of Germany, where the increased demand drives yields lower.
 
France, as the second-largest eurozone economy, is critical to the entire continent. Surles says if France loses the AAA rating, the European Financial Stability Facility’s (EFSF) euro zone bailout mechanism may not function. however, there is technically some question about what a cut by Moody’s would mean if the other rating agencies don’t follow suit with a downgrade.
 
“In many cases they require two of the three rating agencies to downgrade the country before they’ll actually recognize that it’s not AAA anymore,” says Mark Beischel, co-portfolio manager of the Ivy Global Bond Fund and global director of fixed income. “So, if S&P downgrades them and Moody’s and Fitch still have them AAA, they might still be considered AAA. But, at that point, the writing will probably be on the wall.”
 
A week after its warnings to France, Moody’s issued an even stronger warning for the region, publishing a report that said the crisis could lead multiple countries to default on their debts or exit the euro — a threat to the credit standing of all 17 countries that use the currency. Moody’s also said that because politicians have been slow to act — taking steps only “after a series of shocks” — some countries may be shut out of credit markets “for a sustained period.”
 
“The probability of multiple defaults by euro-area countries is no longer negligible” Moody’s said in its Nov. 28 report.
 
Meanwhile, on the same day the Organization for Economic Cooperation and Development (OECD) issued its own report on the crisis, saying the events in Europe are a key risk to the global economy. The OECD, which also slashed its 2012 growth outlook for the region by nearly one-third, said it fears that some European leaders do not grasp the urgency of the situation.
 
The interconnectedness of the region was illustrated yet again on Nov. 25 when Standard & Poor’s lowered its long-term rating for Belgian debt from AA+ to AA . The country, which has its own internal political turmoil, has one of the EU’s highest debt levels compared with the size of its economy, reaching nearly 100 percent of gross domestic product, and is heavily reliant on its trade partners.
 
“With exports of over 80 percent of GDP, Belgium is one of the most open economies in the eurozone and is therefore … highly susceptible to any weakening of external demand,” S&P said.
 
There were signs, however, that some progress had been made. On Nov. 27, France, Germany and Italy indicated that they were willing to agree on new rules that would encourage increased policy coordination and spending discipline on all 17 nations. German officials have said they hope to see the necessary treaty changes by the end of 2012. However, France and Germany are reportedly also engaged in preparing contingency plans if the treaty negotiations fail that could tighten spending oversight in the region. French officials say that a commitment to reduce fiscal debt could allow the European Central Bank (ECB) to take on a greater role in stabilizing markets.
 
Meanwhile, calls for additional support for the EFSF have continued to mount. Finland, Germany and the Netherlands have all called on the International Monetary Fund to play a bigger role in the EFSF to act as a firewall against market panic.
European union?
When European leaders created the European Central Bank a decade ago it was thought that different interest rates could not emerge within the zone of a united currency. That viewpoint, however, did not recognize what now appears to be a potentially critical weakness of a monetary pact without a related fiscal union. While there is one central bank, there is no centralized budget control. The disconnect can create profound problems when individual countries take on too much debt against too little growth and not enough capital.
 
After a failed attempt at an early-November G-20 meeting to find outside help, pressure has continue to mount on the ECB to take action. So far, the central bank has resisted the type of intervention that the Federal Reserve has done in the U.S.
 
Mario Draghi, who took over as the president of the European Central Bank on Nov. 1, has instead pushed back on the governments to implement reforms to rescue their economies.
 
In his first public speech Draghi said the ECB would not start printing money and that the bank would stick to its core mission of controlling inflation. Moving away from that goal, he said, would risk the ECB’s credibility.
 
“Gaining credibility is a long and laborious process,” Draghi said. “But losing credibility can happen quickly — and history shows that regaining it has huge economic and social costs.”
 
The ECB did cut its key interest rate by 25 basis points on Nov. 3 and Surles says it is highly likely that the ECB will cut another 25 basis points when it meets again on Dec. 8.
 
These cuts, however, simply reverse what Surles says were previous policy mistakes by the ECB: 25 basis-point rate hikes in the spring and summer that “really hurt and stalled out European economies.” Both of the previous cuts were made under the leadership of Draghi’s predecessor at the ECB, Jean-Claude Trichet.
 
Amid the current calls for ECB action are those who want the ECB to reconsider its mission. Unlike the Federal Reserve, which is charged with price stability and maximum employment, the ECB is responsible solely for maintaining price stability.
 
Some ECB officials, especially the Germans who dominate the central bank, have been particularly vocal about any changes to the mandate. however, Ewalt Nowotny, a member of the ECB’s governing council and the head of the Austrian National Bank has said that officials need to discuss the role of the ECB “in these difficult times.”
 
Surles says that at some point, the crisis becomes one of price stability.
 
“If they continue to let yields do this in Italy, they are not going to have price stability in the eurozone,” he says. “And at the end of the day that is the sole mandate that they need to adhere to.”
 
The European Union has already lowered its growth forecast for next year. In a Nov. 10 report the European Commission said that the European economy is struggling with weak confidence, financial turmoil, government austerity and a slowdown by European trading partners. As a result, the Commission now projects that EU gross domestic product will grow a mere 0.6 percent adjusted for inflation — one third of the 1.8 percent growth it previously projected.
 
Some analysts have suggested that comments from German Chancellor Angela Merkel, who has opposed the idea of euro bonds out of a belief they discourage fiscal responsibility by individual countries, signal that the breakup of the eurozone may be the eventual outcome.
 
“It’s entirely possible that you might see one or more countries leave,” says Dan Vrabac, co-portfolio manager of the Ivy Global Bond Fund. “They key is whether it is in a structured fashion or a panic mode and nobody knows which it is going to be. This type of uncertainty has a real negative psychological impact on the markets.”
 
At the end of November, however, EU officials and the world’s key central bankers were working together in a bid to prevent that from happening, although critics said the steps were not substantial enough. On Nov. 30 eurozone ministers agreed to provide Greece with an 8 billion euro ($10.7 billion U.S.) rescue loan to help that nation address its immediate cash crisis.
 
While EU officials said the move showed “important progress” the markets seemed to respond otherwise, driving the cost for European banks to fund in dollars to its highest level in three years. In response, the Federal Reserve, in an effort coordinated with the EU and other key world central banks, cut the cost of emergency dollar funding for European banks. The swap arrangements were initially launched during the 2007 crisis and closed in early 2010. They were revived three months later as conditions worsened in Europe.
 
“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and … help foster economic activity,” the central banks said in the Nov. 30 joint statement.
Looking ahead
In the coming weeks there are several scheduled key events in Europe. The Ivy Funds investment team continues monitoring the course of events and meets daily to discuss the issues.  
 
  • Dec. 08 ECB interest rate decision and press conference 
  • Dec. 09 EU leaders summit 
  • Dec. 13 First meeting of new Spanish Parliament 
  • Dec. 21 Date by which new Spanish Prime Minister expected to take office 
  • Dec. 31 Date by which Greek Parliament votes on 2012 budget   
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Ivy Funds and its fund managers and analysts, and are not meant to predict or project the future performance of any investment product. The opinions are current through December 1, 2011, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
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 any of the Ivy Funds, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 
Investment return and principal value will fluctuate, and it is possible to lose money by investing. Past performance is not a guarantee of future results.
 
International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. 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. The lower rated securities in which the Ivy Global Bond Fund may invest 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 funds or fund classes may be offered at all broker/dealers.
]]> <![CDATA[The Hitchhiker's Guide to the Bond Market]]> The Hitchhiker's Guide to the Bond Market

Dan Vrabac
Portfolio Manager
Ivy Global Bond Fund


Ivy Funds Market Perspective - November 2011

 
 
Back in 1979, Douglas Adams published The Hitchhiker’s Guide to the Galaxy. The Guide of the book’s title was an electronic device (not unlike an iPad) which had access to all the information available in the universe. One of the story’s running themes was that the main characters would turn to the Guide when they got into trouble on their intergalactic journeys — which happened frequently in Adams’ humor and mayhem-filled science fiction parody of hitchhikers in Europe. Because the Guide was typically accessed in times of trouble, “Don’t Panic!” were the first words to flash on its screen when it was turned on.
 
This is an appropriate analogy for thinking about today’s bond market. Every time you turn on your computer and pull up your market screen or search for market news, the headlines and price moves are enough to jar the most steadfast of souls. Our advice: Don’t Panic! Here’s why.
 
Cognitive dissonance results when your brain is considering contradictory concepts simultaneously. Today, this is very true for investors who desire higher income on their investments, but at the same time are bombarded by media pronouncements that bond bubbles exist and that buying bonds at today’s low interest rates is a sure loser. Yet investors are scared of equities, as evidenced by over $400 billion withdrawn from equity mutual funds by retail investors since 2007 (according to the Investment Company Institute). Result: panic, or at least a modicum of anxiety. So, is there a way to overcome cognitive dissonance, reduce panic, and be comfortable investing in bonds?
 
Bond fund managers attempt to avoid most of the bubble risk by prudent asset and maturity selection.1 For example, consider the three primary ways that bond investors can get hurt — rapidly rising interest rates, rapid increases in inflation, and defaults. The first two can be mitigated by having a long investment horizon, by the maturity of the bonds owned, and by adding adjustable rate bonds into your portfolio. Default risk may be mitigated by the quality of the bonds you own, the seniority of those bonds, and also by careful use of derivatives.
 
Earning additional income in the current low interest rate environment means either investing in longer maturities, or taking a little more risk in the type of bonds you own (it is possible to do both, but let’s concentrate on investors who don’t want to take both risks at the same time). If you’re buying longer maturity bonds to get extra income, you are probably going to buy U.S. Treasuries or very high quality corporate or municipal bonds. However, in today’s market, those yields may not adequately compensate you for the first two risks mentioned above — rapidly rising interest rates and inflation. If one or both of those occur, long maturity bonds will suffer significant price declines. If you need your money, you’ll take a big capital hit when you sell. These are the type of bonds and bond funds the financial media talks about when it spreads fear about bond bubbles and claims that bonds today are expensive.
 
However, by only focusing on one area of the bond market, we think those pundits are missing very good opportunities in other sectors of the bond market. Specifically, we believe bond funds that invest primarily in medium and lower-grade corporate bonds with short to medium-term maturities may be just the thing for panicky investors suffering from cognitive dissonance. Corporate bonds yield more than government bonds, so you don’t need to take on excessive maturity risk to earn a decent income. A good mixture of high, medium and lower quality corporate bonds in your portfolio can help reduce both volatility and any potential adverse impact from defaulting bonds, though diversification cannot ensure a profit or protect against loss.
 
Furthermore, adding global bonds provides additional diversification and yield opportunities. The Ivy group of bond funds have decades of management experience in analyzing and selecting all of these types of corporate bonds for your portfolios.
 
Selecting bonds from companies that have survived numerous economic cycles, that have strong balance sheets and cash flows, or that have substantial tangible assets available to the bondholder in the case of default — this is how the Ivy bond fund managers mitigate the risk of owning corporate bonds versus government bonds. Traditionally, government bonds were seen as a safe haven. However, ultralow yields on short to intermediate bonds and inflation risk embedded in longer bonds means that investors may need to look beyond government bonds to achieve their desired income level. As an aside, one should recall that not even some government bonds are safe today — one need look no further than Europe to understand that.
 
 
 
Let’s take a look at how much extra yield is available in the corporate bond market versus the government bond market. As you can see in the chart above, you can earn a lot more income and keep a shorter maturity by investing in corporate bonds. Focus on the yellow vertical bar which highlights yields at the 5-year maturity range. Currently, the 5-year U.S. Treasury yield to investors is less than 1.0%. As an aside, according to Bankrate.com, 5-year jumbo certificates of deposit are paying around 1.25 percent (and your money is tied up for five years, and subject to penalties for early withdrawal). Now look at the corporate bonds. Investment grade BBB bonds at 5 years yield nearly 3.0% (red line); adding some U.S. dollar emerging market bonds of BB quality gets you over 5.0 percent (green line), and adding in some U.S. High Yield “B” bonds gets you up to over 6.50 percent (purple line). As you can see, blending corporate bond funds across different quality ranges and geographic sectors can improve your income potential, enhance your portfolio’s diversification, and help to mitigate downside risk from inflation and rising interest rates.
 
Risk Factors
Now, let’s discuss the risk involved when buying bond funds that consist primarily of corporate bonds. In the first place, there will always be volatility in a bond fund’s net asset value (NAV). Typically, the lower the credit quality or the longer the maturity the more volatile a fund’s NAV will be.
 
In times of stress, medium and lower grade bond prices may fall precipitously. Here are the primary reasons why this occurs:
 
  • Wall Street traders don’t buy to hold, they buy to trade. In a sudden market downturn, they may be left holding bonds that suddenly no one wants, while they watch prices melt away. They will sell at lower prices just to remove the bonds from their inventory to avoid further losses.
 
  • Some investment managers may experience cash outflows from their funds during periods of market stress. They may be forced to sell at any price in order to meet redemptions. Being forced to sell, they often — to use the old expression — “throw the baby out with the bathwater.” They end up selling their best bonds, because those are the only ones for which liquidity or demand exists in the market.
 
  • During periods of market stress, markets can temporarily dry up — no one is willing to buy or sell bonds — so although there may be little trading volume, dealers duly mark down prices until sellers and buyers are brought together.
 
  • Speculators (short-term traders), like Wall Street traders, sell to avoid further losses because they are only concerned with price moves, and not generating a long-term stream of income.
 
  • Leveraged players (like hedge funds) receive margin calls on borrowed funds and are forced to sell their bonds to raise cash.
 
These stressful situations are a tremendous buying opportunity for those bond funds that keep liquidity on hand to take advantage of adverse market moves. Adroit managers will add to existing positions or start new positions when prices are depressed. Sure, in the interim, what’s already in the portfolio will be hit by market moves. This is the NAV volatility referred to above. But here’s the important thing to remember: bonds are not stocks. If a stock price falls, there is no guarantee it will ever come back up, or perhaps not come back enough to get your money back or earn a decent return. Bonds, however, are a contract — at the stated maturity, you get back your original principal. In the meantime, you collect interest. It doesn’t matter if you buy bonds at a premium to their par value — with bonds, your return is locked in at purchase — assuming you hold to maturity and no default takes place. Furthermore, once the period of stress passes, bonds can potentially move back to at or near their prior levels. Therefore, unless you are speculating on interest rate moves by buying long-duration bonds or bond funds, we think the best strategy for bond investors is to hold tight (or better, add to their holdings) at times of market stress.
 
Here are two examples of how bond prices performed in the recent market stress during August-September 2011. One is a U.S. high-yield bond, and the other a U.S. dollar denominated emerging market bond. It’s important to remember that these situations were not a result of a change in a company’s fundamentals — they primarily reflected a sudden loss of market liquidity and a panic by the motivated sellers described above.
 
Melco Crown Entertainment (MPEL) develops, owns and operates casino gaming and entertainment resort facilities. The bond in question is the 10.25 percent due May 15, 2018. The bond is rated B1/B+, and is callable in 2015. The U.S. high yield market suffered one downdraft in early August, and a second downdraft in late September. On Sept. 28, MPEL bonds were priced at 107.25; by Oct. 4, they were down to 87.50. This means the yield on the bond (yield to worst for all of you bond aficionados) rose from 8.33 percent to 13.13 percent — nearly five percentage points of additional yield. However, market liquidity began to recover during October, and those that needed to sell were mostly out of the market. The price has returned to 107.00 — a round-trip of nearly 20 points on each side. During such times of stress, very little trading actually takes place, as noted earlier. However, those managers who are prepared are able to move quickly to take advantage of such situations.
 
Our second example is a U.S. dollar-denominated emerging market bond — OAO Sovcomflot (SCFRU), a Russian energy transportation company that owns and operates tankers that carry oil and gas. The company is majority-owned by the Russian government. The bond in question is the 5.375 percent due Oct. 27, 2017. The bond is rated Ba1/BBB. Although the bond price deteriorated slightly during August and early September, the bulk of the decline hit about mid-September. On Sept. 16, SCFRU was priced at 97.875 for a yield of 5.79 percent. By Oct. 4, the bonds had dropped to 80.50, to yield 9.71 percent. Today, the bonds are priced around 91.50, to yield 7.15 percent.
 
Keep in mind that these were individual occurrences; many bonds held their value reasonably well during this time period, while some may have had even bigger price moves than the examples above. Furthermore, these are price moves of individual bonds. The NAV of the bond funds won’t move nearly as much as individual bonds in the funds.
 
There are two lessons to learn from the examples above, one for investors in bond mutual funds, and one for the portfolio managers of these funds. For the investor, the lesson is to not panic and sell your bond fund when the NAV is adversely impacted by temporary market forces. For portfolio managers, the lesson is to be fully aware of the risky nature of the current market environment and to keep a supply of cash and liquidity on hand to take advantage of big price moves in order to benefit the funds’ investors for the medium and long-term.
 
So, what should an investor do?
As mentioned previously, it’s important to remember the contractual nature of bonds. They will from time to time experience volatility in the pricing as our examples demonstrated, but at some point you get your money back, if held to maturity. In the current low interest rate environment — one that may last for a considerable period of time — investors need new sources of income. We believe corporate bond-oriented funds can provide just the ticket for taxable investors.2
 
Studies have demonstrated that individual investors receive returns far below the returns of both market indices and the reported performance of mutual funds.3,4 The primary reason for this is that investors overreact to market moves and financial news reports. Therefore, don’t succumb to panic; lower the cognitive dissonance created by the tsunami of excited but often misguided financial news reporting. Take a longer-term view. Secure a reasonable income stream while mitigating the risk of significant capital loss through prudent investments in corporate bond-oriented mutual funds.
 
So, to all of you investment hitchhikers out there, remember — Don’t Panic! Let us be your “guide” to a better investing future.
 
As of 9/30/2011, OAO Sovcomflot bonds accounted for 0.08 percent of the Ivy Global Bond Fund portfolio. The Fund did not hold a position in Melco Crown Entertainment.
 
1 The Ivy Global Bond Fund’s March 2011 Market Perspectives went into detail on why all bonds and bond funds are not alike. It discussed the possibility that bubbles might occur in some parts of the bond market but not others, and how the Ivy Global Bond fund uses shorter duration and corporate bonds to provide a reasonable income stream and reduce NAV volatility.
 
2 Although this note primarily addresses taxable corporate bonds, municipal high income funds work the same for the tax-exempt investor. For example, the Ivy Municipal High Income fund portfolio invests primarily in revenue bonds; the issuers of these bonds are typically stand-alone entities such as not-for-profit hospitals, continuing care retirement centers, or utilities. These entities generate revenues on their own and the bonds are not supported by the tax base of any government entity. Therefore, they generate Ivy Global Bond Fund a higher income stream than tax-exempt municipal government obligations and are analyzed similar to taxable corporate bond issuers.
 
3 See the Journal of Pension Benefits, Volume 16, Number 1, Autumn 2008, “The Tyranny of Choice”. This study utilizes the Dalbar “Quantitative Analysis of Investor Behavior” that has been done for 17 years. According to the Dalbar website, “Since 1994, DALBAR’s QAIB has been measuring the effects of investor decisions to buy, sell and switch into and out of mutual funds over both short- and long-term time frames. The results consistently show that the average investor earns less — in many cases much less — than mutual fund performance reports would suggest.”
 
4 A second example that details how excess trading hurts returns is the landmark study by the behavioral economist Terence Odean: “Do Investors Trade Too Much?”, The American Economic Review, December 1999.
 
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Ivy Funds and its fund managers, and are not meant to predict or project the future performance of any investment product. The opinions are current through November 15, 2011, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
Consider all factors. Ivy Global Bond Fund: As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. 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. 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. The lower rated securities in which the Fund may invest may carry a greater risk of nonpayment of interest or principal than higher-rated bonds.
 
Ivy Municipal High Income Fund: 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 high-income securities may carry a greater risk of nonpayment or interest or principal than higher-rated bonds. 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. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). 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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
]]> <![CDATA[Strong 2011 company fundamentals coupled with a bruised 2008-09 investor psyche...]]> Strong 2011 company fundamentals coupled with a bruised 2008-09 investor psyche...

An odd pairing still offers potential for U.S. growth

 

Kimberly A. Scott 
Portfolio Manager

Ivy Mid Cap Growth Fund - November 2011

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While a company’s market capitalization and valuation are important, the true differentiator of return potential in the market today is growth, says Kimberly Scott, portfolio manager of Ivy Mid Cap Growth Fund. The following is her view of the current market environment.
 
Today’s investors have more access than ever to stock and bond markets around the world, but our research suggests that growth stocks here in the “good old U.S.A.” are where true opportunities have the potential to shine.
 
One advantage to investing in U.S. stocks is the potential for relative stability in a volatile market and an economy characterized by protracted slow growth. An additional advantage is transparency. The proliferation of analysts, as well as the wealth and availability of information on domestic companies, means investors can typically get a better sense of what they are buying and gauge the likelihood of a given company’s future growth.
Reality vs. expectations
With so much focus on challenging macro events around the world, investors may be bailing out of the stock market at a time when we see companies that have historically strong fundamental operating positions. In addition, many stocks appear to be undervalued, both on their own merits, and certainly relative to other assets, such as fixed-income securities. We are seeing a potential mismatch of reality and expectations, in which we have stronger 2011 company and economic fundamentals, but 2008-09 investor psyche.
While the current economic outlook is certainly not robust, we see it as being much more stable than the dire circumstances of three years ago; yet investors continue to be concerned that the economy will rapidly come unhinged much as it did in 2008. They are reacting in a knee-jerk fashion to every headline, selling stocks on fears that European dysfunction, a slowdown in the Chinese economy or a U.S. double dip may mean disaster for stocks, only to swerve sharply back into stocks on more optimistic headlines. While we understand the concerns, given the severity of the economic downturn and the stock market reaction of three years ago, we find the indecisiveness of so many investors to be counterproductive and in itself dysfunctional.
 
Recognize slow growth, focus on quality companies
 
We choose to focus on two broad factors. One, an economy that will have difficulty receding from a position of such slow growth, and two, companies that are operating from a position of relative strength given:  
  • The swift and acute restructuring of their businesses since late 2008 and early 2009;
  • The general strength of their capital structures;
  • Their broad access to low-cost funds, should they choose to invest more aggressively. 
In addition, we believe the management teams of these companies are investing prudently for the future, while keeping an eye on the tumultuous past, and more often than not, their organizations are delivering measured and profitable growth.
 
While we have been concerned that all of the dire news around the globe could create a negative feedback loop that has the ability to create economic stress, we remind ourselves that the economy is already running at a very low level, probably close to base demand. We think the environment would have to change significantly for the worse for the U.S. to see a serious recession. In fact, we believe many key sectors, such as housing and industrials, particularly automobile manufacturing, are operating at levels below that which is necessary to meet intermediate to long-term demand, including, with autos, even replacement demand.
 
Many U.S. banks, which were the central point of such stress just three years ago, are now overcapitalized and excessively cautious in their lending practices, such that a new credit cycle catastrophe, which would lead to further strict lending practices and recessionary conditions, is difficult to see. Hiring remains slow, as seen in all of the employment data, even as companies grow profits, in many cases, to record levels. The will to do more with less on the labor front also makes it less likely that we would see a spike in joblessness leading to a cascade of economic weakness.
Still constructive on the market
Our evaluation tells us that U.S. companies are as healthy today as at any point in recent economic history. They are generating high levels of profits and returns, and they have generally clear access to capital at historically low cost. Company management teams are working hard to balance investing for the future with a serious respect for the trials of the 2008-09 economic downturn, which had so many of them questioning survival. This prudent approach is part of the reason why the economy is not moving forward more strongly, but is also the reason it will be difficult for the economy to face an extreme challenge to the downside.
 
So even with so much volatility over the past few months, we continue to remain constructive on the market. We are finding attractive opportunities to invest in companies that don’t need a strong economy to deliver solid organic revenue and earnings growth. There are many mid-sized U.S. companies with exciting growth prospects and investment potential, and we are focused more acutely on the stocks of these “Greenfield Growth” companies – terminology we use to describe companies with innovative products and services as a platform for high visibility and long runway growth trajectories. We find opportunities to invest in Greenfield Growth companies across many different sectors of the market.
 
Our goal is to continue to seek to provide growth of capital. In helping to manage risk, we search for high-quality growth assets at what we believe are attractive prices, and invest with a long-term perspective that lets our investment thesis mature over an investment period of three to five years. We like what we see as opportunities to own great companies across the growth spectrum, and across all sectors. However, we remain mindful of the many risks inherent in all the issues around the globe. We carefully watch the macroeconomic environment, and are willing to make changes to the portfolio as our conviction level changes.
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through November 15, 2011, and are subject to change due to market conditions or other factors.
 
Investment return and principal value will fluctuate, and it is possible to lose money by investing. Investing in mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. These and other risks can be found 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.

 

]]> <![CDATA[Rising dividends attract investors seeking income]]> Rising dividends attract investors seeking income

 

Market Perspectives November 2011 

 
Companies around the world learned hard lessons in the financial crisis of 2008, including the importance of carefully managing debt. Corporate profitability overall now is high and balance sheets are the strongest they have been in decades. Many companies are using their cash for dividend payments, providing income for investors during this time of low interest rates.
 
For example, the trailing 12-month dividend per share for S&P 500 companies has risen modestly since 2009.1 In addition, the companies that are components of the Dow Jones Industrial average now are forecast to distribute $102.7 billion in dividends during the 12-month period that began Oct. 1, 2011 — a year-over-year increase of nearly 12 percent.2
 
The slow pace of global economic growth is likely to mean slower corporate earnings growth in the years ahead, which may add to the potential appeal of dividends. For example, earnings for S&P 500 companies in the second quarter of 2011 showed a 19 percent increase from the same period a year ago, while earnings for the third-quarter are showing a 15 percent increase.3
 
Building an income stream
Investors often use their portfolios as sources of income, especially during retirement. The extremely low interest rates in recent years have made it difficult for many to meet their income objectives solely through purchases of corporate or government bonds, or by investing in fixed-income mutual funds. Dividend-paying stocks, and the mutual funds that invest in them, may be an additional source of income.
 
In September 2011, dividend payout ratios — the dividend payment per share divided by earnings per share — for the S&P 500 companies were at or near all-time lows, implying ample flexibility for future dividend hikes or share repurchases. In addition, 22 percent of dividend-paying S&P 500 stocks had a dividend yield — the payout as a percentage of the stock price — that was higher than the 10-year corporate bond yield.4
 
That yield gap has narrowed as the U.S. stock market has come off its recent lows. For example, in late October the 10-year Treasury bond yield was around 2.3 percent, the 10-year corporate bond yield was about 3.8 percent and the S&P 500’s dividend yield was near 2.2 percent.5
 
But outside the U.S., companies with low or no debt and free cash flows also are paying dividends, and often at much higher yield rates than U.S. companies. The differences in many cases reflect the changing economics around the globe, with growth in developing and emerging markets driving demand for the products and services of multinational firms.
 
 
Dividends and mutual funds
Put simply, companies can share their profits with stockholders — including stock mutual funds — by making cash payments in the form of dividends. The stock mutual funds that receive these dividends then are required to pass them along to fund shareholders in regularly scheduled payments — typically quarterly, semiannually or annually. Shareholders also usually can choose to reinvest their dividends in the fund or take them as cash payments. Mutual funds specializing in dividend stocks have seen inflows of $23.6 billion through Sept. 30, 2011, or twice as much as in all of 2010.6
 
John Maxwell, portfolio manager for the Ivy International Balanced Fund, says he has continued to pursue dividend-yielding stocks in the equity portion of the Fund as a source of income. He says equities remain inexpensive when compared to bonds now. “By increasing the focus on yield through equities, we are looking to increase the income level of the Fund,” Maxwell says. “I’m also optimistic about yield prospects in the near term, as dividends have been a big part of our stock selection criteria over the last 12 months,” he says.
 
Maxwell notes that “the dividend play” — seeking yield through dividends — potentially can provide an alternative for income now. Dividends from strong companies can offer higher income potential than the low yields on Treasuries, he says, without the extra risk and leverage associated with high yield instruments, which now yield about 8.7 percent.7
 
 
 
Past performance does not guarantee future results. The hypothetical investments are for illustrative purposes only and are not indicative of any investment. The illustration does not take into account the effect of taxes or transaction costs and also does not consider the possibilities for investment growth associated with investing the dividends paid in cash in other performance vehicles. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered to represent the U.S. stock market. MSCI EAFE is an unmanaged index comprised of securities that represent the securities markets in Europe, Australasia and the Far East. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI. Investments cannot be made directly in an index.
 
Chace Brundige, portfolio manager of the Ivy International Growth Fund, says, “In my opinion, the biggest risk to income investors today is eventual inflation. With dividend-paying stocks you at least have a fighting chance to benefit through the potential for rising dividends and stock prices.”
 
While not calling for the immediate return of inflation, Brundige says that it is a risk in the future as government leaders work to re-ignite economic growth. And dividend-paying stocks can offer some inflation protection, he says. For example, as prices rise with inflation, corporate earnings often rise and allow dividend payments to increase. Interest payments on bonds, however, remain static unless they are inflation-indexed or carry a variable rate, which most do not. In addition, if a company has pricing power for its products and can maintain or even grow profit margins during inflationary times, its share price may rise — but bond prices typically fall.
 
While fixed-income investors who are concerned about inflation often invest in very short-term or inflation-indexed securities as a way to counter that risk, those types of securities offer very low yields now. Dividend payments also can be a positive indicator of a company’s financial health. In part, this is because the company’s management is forced to focus on making money now to support the dividends. It’s important to research a dividend-paying company thoroughly to ensure the company has the growth potential to maintain those payments. The research can uncover stocks at multiple points in the dividend process, including:
 
  • Dividend payers — companies with a long history of growing dividends at rates significantly higher than inflation 
  • Dividend growers — companies whose long-term business prospects offer the potential to increase their dividend at rates higher than inflation or to begin paying a dividend in the near future
 
The stock selection process followed by portfolio managers and analysts at the Ivy Funds includes a thorough review of fundamental factors.
 
Maxwell says he selects the stocks for the Ivy International Balanced Fund and the Ivy International Core equity Fund, which he also manages, after researching companies that demonstrate strong cash flows, less leverage on their balance sheets and solid opportunities for growth. Those features are among the indicators that demonstrate a company can support ongoing dividend payments.
 
The case for dividends now
In the current environment of volatile markets and an uncertain global economic outlook, Ivy Funds continues to think that companies with strong business models and brands, clear market opportunities, strong cash flows and the operational ability to fuel revenue growth will prosper.
 
Dividends paid on the stocks of such companies can contribute to an investment income stream, add diversification to the stocks component of a portfolio and reduce volatility. Remember, diversification does not ensure a profit or protect against loss, although it can help reduce the overall risk and volatility of your investment portfolio.
 
1 Source: International Strategy and Investment Group
2 Source: “Dream of no Credit risk,” Barrons.com, Oct. 22, 2011
3 Sources: “Weekly economic report,” International Strategy & Investment, Aug. 15, 2011; “Third Quarter of ’11 S&P 500 Earnings Snapshot,” Bloomberg, Oct. 26, 2011
4 Source: Morningstar Inc.
5,7Source: Barclays Bank plc
6 Source: Strategic Insight
 
 
Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be more or less than their original cost. Please visit www.ivyfunds.com for the Funds’ most recent month-end performance.
 
Performance at net asset value (NAV) does not include the effect of sales charges. Class A share performance, including sales charges, reflects the maximum applicable front-end sales load of 5.75 percent.
 
JP Morgan GBI Global Ex US TR USD is an unmanaged index comprised of securities that represent the global market excluding the U.S. MSCI AC World Ex USA is an unmanaged index comprised of securities that represent the securities markets around the world excluding the U.S. MSCI EAFE is an unmanaged index comprised of securities that represent the securities markets in Europe, Australasia and the Far East. MSCI EAFE Growth is an unmanaged index comprised of growth securities that represent the securities markets in Europe, Australasia and the Far East. It is not possible to invest directly in an index.
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Ivy Funds and its fund managers, and are not meant to predict or project the future performance of any investment product. The opinions are current through Nov. 2, 2011, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
Consider all factors. Dividend-paying investments may not experience the same price appreciation as non-dividend-paying instruments. 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.
 
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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 
Ivy Funds are managed by Ivy Investment Management Company and distributed by its subsidiary, Ivy Funds Distributor, Inc.
]]> <![CDATA[Europe faces recession as sovereign debt crisis turns focus to Italy]]> Europe faces recession as sovereign debt crisis turns focus to Italy

Ivy Funds Market Perspective – November 2011

 
 
The ongoing sovereign debt crisis across Europe hit another difficult patch in early November as attention again turned to Italy. Investors showed they are losing faith in Italy’s ability to fund itself, driving yields on the 10-year Italian bond above 7 percent. This volatile market action took place against the backdrop of a new forecast showing a sharp economic downturn in the region and a recession in 2012.  
Rapid changes, uncertain direction
Investors have worked hard for months to keep up with the rapidly changing developments and headlines that swirl across the globe. Europe’s leaders are struggling to implement a long-term solution for the debt problems that continue to plague countries across the euro zone and roil global financial markets.
 
For example, Italian Prime Minister Silvio Berlusconi initially had pledged to resign as his country’s debt came under pressure, then hesitated after rejecting an interim government. That drove yields to levels considered unsustainable – Greece, Portugal and Ireland required bailouts when their bond yields rose above the 7 percent mark. Unlike those countries, Italy’s $2.6 trillion in debt is thought to be too large for other European countries to rescue. Berlusconi later confirmed he would resign after the Italian parliament approves debt-reduction measures and there is an election to replace him. Italy’s Senate on Nov. 11 approved an austerity package and sent it to the parliament’s lower house for approval, which would clear the way for a new Italian government. Recent news reports named Mario Monti, an economist and former European Union (EU) commissioner, as the front-runner to succeed Berlusconi. There is speculation that Monti may lead a “technocratic” government to implement austerity measures and economic reforms, and ultimately reduce Italy’s debt load.
 
Earlier this year, the European Central Bank (ECB) began repeated interventions in the credit markets, buying the debt of the so-called “peripheral” European countries. The ECB purchases reportedly have continued in support of the latest problems with Italian debt.
 
Demands for Greece to meet its commitments for greater austerity measures eventually led to the resignation of Prime Minister George Papandreou, again leaving uncertainty in the
market about a solution to that country’s debt issues. Lucas Papademos, the former vice president of the ECB, has been named to lead a coalition government in Greece.
 
As the fears about debt problems worsened, the EU sharply reduced its 2012 growth forecast for the 27-member bloc of countries, saying it can’t exclude the possibility of a prolonged recession. The European Commission, the EU’s executive arm, said in its semiannual forecast released Nov. 10 that the economy is struggling with weak confidence, financial turmoil, government austerity packages and a slowdown in Europe’s main trading partners. It said the EU’s gross domestic product in 2012, adjusted for inflation, would grow just 0.6 percent, well below its forecast of six months ago of 1.8 percent.
 
John Maxwell, portfolio manager of the Ivy International Core Equity Fund and Ivy International Balanced Fund, says the recent “alarming” move in Italian yields shows that markets are demonstrating they want action, not further discussion about the debt crisis. “Europe is on the cusp of having to act or running out of time. I think that anything short of unlimited funds and explicit sovereign spread interest rate targeting will fail to calm markets. However, I do believe Europe’s leaders want to preserve the union and thus will act.”
 
Chace Brundige, portfolio manager of the Ivy International Growth Fund, adds that he expects the ECB to intervene in credit markets to support Italian debt. “The ECB is likely to be forced into a Quantitative Easing strategy, in which it promises its support in unlimited amounts,” Brundige says. “I think there is a high likelihood of a sharp relief rally, accompanied by renewed weakness in the euro. While sentiment toward the EU would clearly improve, the value of its currency would be pressured by the new supply – just as with the U.S. dollar in March 2009.”  
Our current viewpoint
The worsening situation in Italy adds pressure on EU leaders to take decisive action and resolve the debt crisis. We do not think the dissolution of the EU is likely because the stakes are so high and because all parties understand the consequences of a serious misstep. Ultimately, we think a Quantitative Easing program of some type – a balance sheet expansion by the ECB
– is the only viable solution.
 
Recent economic data from Western Europe has not been particularly constructive: disappointing production results, budget deficits and inflation rates. We do see significance in the ECB’s decision to cut interest rates two days after Mario Draghi became the central bank’s president earlier this month. Markets have long been of the opinion that the ECB needed to cut rates, not raise them as happened in the spring and early summer. That welcome news was matched by the ECB’s expansion of its balance sheet through support of the credit markets in Europe.
 
Our general view is for the markets to continue to work slowly higher, as long as there is no major policy misstep in Europe. Again, we do not think that is likely because the stakes are so high. We think it is quite possible that equity valuations will stay low across Europe because of the uncertainty. But as long as the U.S. economy continues to recover and profits stay on a positive trend, which we think is likely, then we think the U.S. equity market should be able to make progress.
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Ivy Funds and its Fund managers, and are not meant to predict or project the future performance of any investment product. The opinions are current through November 11, 2011, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
Consider all factors. 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 return and principal value will fluctuate, and it’s possible to lose money by investing.
 
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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
]]> <![CDATA[Economic challenges ahead - emerging market growth demands resources]]> Economic challenges ahead - emerging market growth demands resources

Fred Sturm, CFA
Portfolio Manager
Ivy Global Natural Resources

Ivy Global Natural Resources Fund – October 2011 

 
Almost all global investment assets went through major price adjustments in the third quarter – one of the most challenging periods for natural resources in many years. Fred Sturm, portfolio manager for the Ivy Global Natural Resources Fund, says increased uncertainty about the economic outlook has added volatility to resource markets worldwide, but he thinks there are indicators that could point to a turnaround. 
 
While the current market crisis is centered in Europe’s government debt problems, economic concerns also have begun to spill into emerging economies, including new discussions about growth risks in China. We think the slowdown in China is a successful response to specific policy initiatives to slow growth and reduce inflation pressures. The economic indicators that we track, including electricity consumption and year-over-year retail sales, simply do not support the idea of a hard landing there. The emerging markets more generally have both fiscal and monetary policy options available to stimulate activity as inflation pressures ease. In fact, we think inflation pressures are cresting now and expect more accommodative language about interest rates from central banks in those countries before year-end.
 
In aggregate, developing economies now represent close to half of the global economy, and we expect economic growth in this group at an annual rate of 6.0 to 6.5 percent, anchored by China. This underpins our estimate of global growth at about 3.5 percent. We remain undeterred in our belief that, over a multi-year period, resource sectors will benefit from a growing and industrializing world primarily driven by developing countries facing supply growth challenges. Where additional supply is constrained, we think resource businesses still should be able to generate reasonable profits, so we do not expect a sharp deterioration in global corporate profits.
Taking the long view on markets
Investment markets have had to digest a number of disappointing headlines in recent months, leading to the steep sell-off in the third quarter and rapid reductions in analysts’ expectations. Fast and sustained “waterfall” sell-offs are not the norm for these markets, but the shock of 2008 makes it extremely difficult for investors to be patient. Markets typically go through a bottoming phase that shakes out nervous investors, moving shares to stronger holders and setting up the next advance phase.
 
We think some market indicators are once again hinting this is under way, as we saw in 2002-03 and 2008-09. These tests and retests can be challenging and rapid price changes can cause investors to get whipsawed. But taking time to focus on long-term trends and fundamental valuations can provide useful guideposts. Based on our analysis, stock price valuations for the broad stock markets are reaching attractive levels, although not as cheap as 2008. While valuations speak to multi-year return potential, not to exact timing, we think market sentiment indicators also show we are closer to a low than a high.
Energy prices hurt by economic outlook
In the energy sector, concerns about the global economy caused the share prices of energy services companies and energy producers to decline by roughly 30 percent. We think markets have priced-in a Brent Crude oil price of about $80 per barrel, compared with the quarter-end spot price of $103. We believe prices below $80 are only sustainable if global growth drops to 2.5 percent or less – as noted, we do not expect that to happen.
 
In other words, much already has been discounted in financial markets. If energy prices do not decline for a sustained period, then we think the stocks are too cheap at current levels. In our view, oil prices still can drift as we work through a soft patch in the global economy and we have some resumption of crude oil production from Libya. However, what the world absolutely cannot afford is for Saudi Arabia to become destabilized, as has happened in Egypt and Libya. We believe Saudi Arabia will need higher budget revenues to maintain a positive economic environment and political stability, which could require $20 per barrel more than its previous $60 budget break-even level. Most other OPEC nations are in a tougher spot and want to defend a price closer to $90, which is a level we believe the world can afford over a normal business cycle. This leaves investors to decide whether oil prices are likely to stay below $80. If so, then energy shares are likely to decline further; if not, then values are attractive now. Our forecasts for global growth, tracking non-OPEC supply shortfalls, and recent inventory data suggest that energy prices are more at risk of drift than sharp decline.
 
In addition, there are indications that prospects for offshore energy development are actually turning higher as permit approvals in the Gulf of Mexico improve and global offshore development is set to increase. We think companies more geared to offshore drilling would be the direct beneficiaries, but the major oil producers also will benefit. We also think profit margins and unit growth onshore are likely to stall, but we expect solid cash generation unless there is a bigger decline in energy prices. We still believe natural gas prices in the U.S. are among the cheapest commodities relative to economic value. Over a three- to five-year window, we expect the gas-oil spread will narrow.
 
We have made the case in the past that coal production challenges in China and India will keep inventories tight for global seaborne coal. The outlook for metallurgical coal is harder to discern. This coal used in making steel is more difficult to find and mine, which is why prices have been elevated relative to costs of production. The concerns about global growth caused investors to sell down these companies during the quarter, and investors also have punished companies that pre-announced disappointing production rates. We think there is share price recovery potential for thermal coal companies, but they will need to deliver better production and synergy targets before significant rebounds can be sustained.
 
We met with solar power companies in China during the quarter and reviewed their operations. This is a sector that we feel has long-term opportunity from the perspective of diversifying energy sources and providing local energy production security. However, it still requires subsidy to be competitive and barriers to entry have not been high enough to discipline capacity. We expect China will step up its internal installation of solar, which could help offset some expected demand weakness in Europe. 
Metals reflect economic weakness
Mining stocks were hard hit during the third quarter, reflecting investors’ views that economic weakness would translate into much lower metals prices. Copper declined 26 percent and leading producers sold off more. We believe that growth in copper supplies still will be muted and that increasing cost pressures now require long-term incentive pricing to be sustained near $2.75 per pound. The spot price closed September at $3.15, and bearish investors could point out that there is further downside risk if a global recession were to develop. However, we believe share prices now reflect long-term pricing at $2.25-$2.50, which is below our assessment of incentive pricing.
 
Our models that correlate gold with currency reserves suggest global gold prices could be 10 to 15 percent too high, notwithstanding global macroeconomic concerns. However, we still expect gold to remain in a primary uptrend and elevated until central bankers raise real interest rates – and we do not expect that to happen until at least 2013. Based on our expectations for working through the European sovereign debt and bank credit risks, we are more inclined to trim back exposure to gold than materially increase it during the fourth quarter.
The way forward
In summary, we think natural resource sectors have been oversold, which may provide potential opportunities for resource investors. We can’t forecast the timing, but we expect market conditions to improve in the near term – barring what we would consider to be further government policy blunders – and over the next three to five years. We do not expect a global recession and now think the world will “muddle through” its economic challenges if there are no sustained systemic shocks. As a result, our tag line remains, “It ain’t great, but it ain’t 2008.”
 
Among other things, we think this forecast requires central bankers and government leaders to provide sufficient liquidity for economic activity and to ensure the banking system is supported. If global investors believe the European banking system will be protected, then we think the result of Europe’s debt crisis primarily will be a period of moderate recession in the euro zone. We think China and the emerging markets will continue to lead global growth, although at a slightly slower rate; Canada will have moderate growth again in 2012; and the U.S. will avoid recession but post slow economic and job growth.
 
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager 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 12, 2011, and are subject to change due to market conditions or other factors.
 
Consider all factors. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. 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. Investing in natural resources can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments; and the cost assumed by natural resource companies in complying with environmental and safety regulations. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the prospectus. Not all funds or fund classes may be offered at all broker/dealers.

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.

]]> <![CDATA[Secular evolutions in response to a changing market environment]]> Secular evolutions in response to a changing market environment

Ivy Asset Strategy Fund - October 2011

 

 
Below, co-portfolio manager Mike Avery reviews how the Fund has evolved — while being guided by a consistent philosophy — over the last 15 years.
 
Since the beginning of our time managing the Ivy Asset Strategy Fund in 1997, we have been focused on seeking investments with the potential to capture high total returns, while also seeking to preserve capital by managing downside risk. With no set allocation mandates to limit our flexibility, the Fund’s broad purview enables us to look across a variety of asset classes: stocks, bonds, cash, precious metals, derivatives and currencies, without geographical, capitalization or asset class constraints. The flexibility of the Fund is a key element of our approach and allows us to apply global research toward pursuing the best opportunities. Unlike many “world allocation” funds that include allocation mandates, our go-anywhere capability allows us to pursue a greater variety of potential opportunities. Over the years, this has enabled us to move into different investments and geographic areas as changes in demographics and markets and political and economic events reshaped the global market. Since January 1997, we have made five strategic, significant shifts in the structure of the portfolio.
 
In the beginning
In the late 1990s, we were focused on the developed world — primarily U.S.-centric securities, with a tilt toward technology, media and telecommunications. These were the sectors we thought offered the most compelling growth opportunities that we could identify at that time. The portfolio maintained this U.S.-centric exposure until late 1999. Here’s a look at how the Fund was allocated during this period. As you can see, through most of this period the Fund held a high allocation to U.S. equity securities.
 
Allocation ranges reflect positioning at the end of each quarter over the period indicated on each table. Risk management tools such as futures and options are generally included in the cash line. USD equals U.S. dollar-denominated.
 
Moving through the tech wreck
In early 2000, at the peak of enthusiasm for U.S. equities, we began to reduce the portfolio’s equity exposure and moved into fixed-income securities as a hedge against equities. By 2001, the Fund had substantially reduced exposure to equities, with approximately 70 to 80 percent
of investments in fixed-income securities. This served clients very well at that time, as U.S. equities progressed through a severe bear market. At the time, you could have said that Asset Strategy was more akin to a fixed-income fund, rather than an equity fund, and certainly not a
world allocation fund. Consistent with our broader philosophy, given the choices available to us and the macro-economic environment, we determined this was the best place to be for our investors.
 
 
Growth skepticism coming out of recession
In early 2003, the U.S. economy was coming out of a recession, but skepticism about growth was still very high. Everyone was trying to determine where the world would find growth. Our investment team began to think less about which specific markets or countries to invest in and began thinking more about the world in terms of where people were enjoying rising prosperity. From 2003 to 2007, we focused on the infrastructure build-out taking place in Asia, capitalizing on the rising demand for materials, energy and industrials. To some, the Fund may have looked similar to a natural resources fund at that point. The reason we were focused on those areas at that time was because we had the flexibility to do so, and that’s where we felt the best opportunities were.
 
 
Amidst the financial crisis
As 2006 rolled into 2007, we began to use derivatives as an asset class to hedge the portfolio in a more meaningful way. Even though we continued to like materials, energy and industrials, based on the infrastructure boom that was occurring in Asia, the prices of those securities began to reach a point that we determined was too high, despite the underlying growth drivers and still-high enthusiasm for equity exposure in the market. While our focus was still very much on China and energy, it made sense to us then to use derivates as a way to mitigate the systemic risk exposure of the Fund. We think this was a wise move, as derivatives were very cheap at that time and given the strength of the urbanization and infrastructure build-out
that was underway in Asia. This strategy worked well for shareholders until July 2008. As we moved through the crisis it became clear that cash would be the preferred way to protect investors. The Fund’s cash allocation rose to levels above 45 percent and stayed very high.
 
 
A Focus on emerging consumption
In the uncertain market environment that characterized much of 2008, we expanded our focus beyond urbanization and infrastructure build-out occurring in emerging markets to the domestic consumption sectors — those areas where, as people enjoy rising prosperity, they
are likely to spend more money on things such as consumer goods, entertainment, financial services, technology and transportation. That’s how we’ve structured the portfolio to this point. Once again, we see an environment in which disbelief of growth and a very high level of risk aversion dominates markets and creates what we believe to be the mispricing of securities. This combination of factors has led us to increase the Fund’s equity weighting and focus on the companies that we believe are attractively priced and well positioned to participate in thematic growth.
 
 
These secular and, in our view, strategic and responsive changes to the portfolio over time, are a key element of why the Fund has earned the track record it has. Our mandate – to capitalize on opportunities across a variety of asset classes: stocks, bonds, cash, precious metals, derivatives and currencies, and without restriction — has not changed. We believe that flexibility is at the core of our process and while the portfolio is always evolving, the process that builds the portfolio is fundamentally unchanged. To be sure, recent months have brought more volatility to the market as a whole, and the portfolio has not been immune to that. We believe that in the future Fund shareholders will be compensated for taking on volatility in an environment in which we think extreme risk aversion has driven up the price of assets that are perceived to be safe and has driven down the price of assets that would participate in future growth. As it should, the portfolio has evolved and adapted to the market environment. What has stayed constant is our mandate and our strict focus: on researching all markets and asset classes, identifying what we feel are the best investment opportunities, managing risk, and, ultimately, doing what is in the best interest of our shareholders.
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund 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 14, 2011, and are subject to change due to market conditions or other factors.
 
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. These and other risks are more fully described in the fund’s prospectus. The Fund may allocate from 0-100 percent of its assets between stocks, bonds and short-term instruments, across domestic and foreign securities, therefore, the Fund may invest up to 100 percent of its assets in foreign securities. 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. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The fund may focus its investments in certain regions or industries, thereby increasing its potential vulnerability to market volatility. The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk, as short selling involves the risk of potentially unlimited increase in the market value of the security sold short, which could result in potentially unlimited loss for the fund, and the value of investments in derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time and storage costs that exceed the custodial and/or brokerage costs associated with the Fund’s other holdings. Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.
 
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.
 
 

 

]]> <![CDATA[Uncovering the causes of economic uncertainty can lead to solutions]]> Uncovering the causes of economic uncertainty can lead to solutions

Derek Hamilton
Vice President,
Global Economist

Ivy Funds Market Perspective OCTOBER 2011

 
Uncertainty in economic indicators and financial markets has increased significantly in recent months, based on factors ranging from an increase in debt levels in the developed world to rapid growth in emerging market countries. But what is causing this uncertainty and how can investors respond? 
Debt and the lack of political leadership
The first and arguably most important factor is the increase in debt levels in the developed world. Starting in the mid-1980s, U.S. private sector debt — namely consumer debt — relative to gross domestic product (GDP) and income increased for two decades. This primarily was an increase in mortgage debt based on continuously lower interest rates and easier lending standards. Once the 2008–09 recession hit, that debt load became unsustainable and has been declining relative to GDP and income.
 
This is a headwind now because many households are in a so-called balance-sheet recession. In a nutshell, a high and unsustainable level of debt absorbed an extreme shock to the system, caused by the bursting of the real estate bubble. This shock has prompted consumers to pay down debt as the value of their assets has declined relative to the amount of debt.
 
It is very difficult for an economy to grow without credit growth, which is why actions by the Federal Reserve have resulted in little economic growth. It does not matter how low the interest rate is on a loan if there is no demand for the loan. This is important because a lack of credit growth coupled with weak employment growth results in consumer spending that is much more susceptible to shocks.
 
U.S. government debt also has increased rapidly in recent years. Granted, annual federal budget deficits in excess of 10 percent of GDP were worsened by the recent recession. However, if you normalize fiscal revenues and spending for the weak economy, the structural budget deficit was more than 6 percent of GDP in 2010, according to the Congressional Budget Office. And this does not take into account the future promises to support Social Security and Medicare.
 
So the trend of rising spending will only accelerate from here, and policymakers face a challenge. While large fiscal deficits are unsustainable, low economic growth is much more susceptible to budget cuts via higher taxes and/or lower spending. Thus, U.S. officials must come up with a credible long-term deficit reduction plan while providing a boost to growth in the short term. Among other things, we think a simpler and more efficient tax code — including lower rates while broadening the base — would help achieve that goal. This is a very important part of achieving more sustainable growth, but it looks like these issues will not be dealt with in the near future. Politicians in both parties seem more concerned about elections in 2012 than on doing what’s best for the economy. A clear example of this attitude was seen in the protracted debt ceiling debate in August, which resulted in a further hit to consumer and business confidence. Another battle over an increase in the debt ceiling is likely to occur during the next two months, along with continued negotiations over deficit reduction.
 
This brings us to Europe. Many countries within the euro zone have problems with high private and government debt, but some face their most serious problems on the government side. This is the crux of recent market volatility. Governments in Europe have decided to reduce budget deficits now. In “peripheral” Europe, countries such as Greece and Portugal are struggling with this mandate because large tax increases and spending cuts are being enacted while these countries continue to experience recessions. The government debt load in Greece already is at an unsustainable level. As GDP continues to fall, tax revenues also fall and fiscal spending rises, increasing the debt load even further.
 
We have known about the problems in Europe for more than a year, but policymakers there apparently lack the political will to come to a resolution. We think the key problem is that it is impossible to have a monetary union without a fiscal union. There are 17 different governments in the euro zone with many different objectives. Each country approaches the problem from a different perspective and with different directives from its population. There was some indication in early October that Europe’s government leaders are finally realizing the urgency of the issue. Markets need to see that European officials are actively involved in shoring up the banking system and building the firepower to stave off future problems. After these are in place, Europe can deal with Greece in an effective way and push for an actual debt restructuring. 
Impact of emerging market growth
The growth in emerging market economies may seem like an odd area to cite for economic volatility, especially given our longstanding view that these markets are the long-term growth story. But consider the situation from the perspective of developed markets.
 
One thing that comes with rapid growth in emerging markets is the increasing need for commodities. Whether it is energy and metals to fuel industrialization or agricultural goods for consumers who want to eat more protein, the demand for commodities is unlikely to wane soon. In the past, when the U.S. and Europe had periods of weak economic growth, there usually also would be low inflation as the demand for goods would not exceed the supply. However, as emerging markets largely are the incremental buyers of commodities, prices increasingly are determined by growth outside the U.S. and Europe. Consumers in the U.S. and peripheral Europe are experiencing weak income growth, especially when government transfers are excluded. If prices rise, income gets squeezed and the economy slows. And with high unemployment, wage gains will not offset the rise in prices.
 
At the same time, the rise in commodity prices coupled with strong domestic demand brings about monetary and fiscal tightening in emerging markets, which inevitably slows economic growth in those countries and acts as a further headwind for developed countries. This is especially true in China. In response to the 2008 economic crisis, policymakers around the world eased aggressively in order to combat the rapid slowdown in growth. In particular, China allowed local governments to borrow aggressively through the banking system in order to increase investment. This policy was successful in keeping the growth slowdown brief. However, inflationary pressures started to rise as growth recovered. Over about the past year, China has been steadily tightening policy in order to bring about slower growth and lower inflation, which ultimately will be another headwind for growth in developed markets. 
Building confidence in economy and markets
In summary, we think all of these issues mean the cyclicality — or volatility — of the economy has increased. Uncertainty brings lower confidence, and lower confidence brings more volatility. It is unlikely that these issues will be resolved soon, as the debt burden will continue to be worked off in the developed world and the increasing need for commodities will continue in emerging markets. However, we think stronger political leadership would help to decrease this uncertainty. We believe U.S. officials must address the weakness in the economy while dealing with the long-term budget issues, and policymakers in Europe must quickly deal with the problems at hand, both in the banking system and at the sovereign debt level. We also believe effective actions by policymakers across the globe would give confidence to both consumers and businesses, and to the markets as well.
 
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are not meant to predict or project the future performance of any investment product. The opinions are current through October 11, 2011. Mr. Hamilton’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
 
Investment return and principal value will fluctuate, and it’s possible to lose money by investing. 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.
 

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 www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.

 

]]> <![CDATA[One investor's fear is another investor's opportunity]]> One investor's fear is another investor's opportunity

Bryan C. Krug, CFA
Portfolio Manager
Ivy High Income Fund

Ivy High Income Fund – October 2011

 
 
Investor uncertainty seemed to rise with this year’s summer heat. After a protracted debt ceiling debate in Washington and an evolving debt crisis in Europe, the idea of a slow but continuing U.S. economic recovery wilted away and was replaced by predictions of a recession. The outlook has curbed investor risk appetites, resulting in a flight to safety as investors seek lower volatility and greater liquidity in their portfolios.
 
What is the outlook for the U.S. economy and are there places where investors can get both a degree of safety and potentially higher returns? Bryan Krug, portfolio manager of the Ivy High Income Fund, shares his views.
 
In recent weeks, we have certainly seen across-the-board risk aversion in the markets in response to events in Europe, which is the biggest issue facing the markets, and fears of a U.S. recession. Even with Standard & Poor’s downgrade of the U.S. credit rating, investors from around the world moved into the safety of U.S. Treasuries, driving yields down to historic lows and boosting returns on U.S. government debt.
 
The question as to whether we are actually in a recession — which will be determined after economists have had an opportunity to review the economic data — may garner a lot of headlines, especially as we head toward next year’s presidential election. Is the U.S. heading into a recession? We think the chances of either the U.S. entering or narrowly avoiding a mild recession are about equal. However, we would emphasize the word “mild.”
 
Stuck in the “muddle?”
We base this view on several factors. Notably, the current levels of activity in many areas of the economy simply do not have the room for the kind of steep declines we experienced during the financial crisis in 2008. For example, prior to the financial crisis and recession, we saw new housing starts in the U.S. at more than 1 million in 2007. In recent months, the number has been closer to 300,000, which is near the lowest level seen since data tracking started in 1959. Similarly, auto and truck sales, which were well above 17 million vehicles in 2006, were below 12 million last year — or about the level we saw in the early 1980s.
 
It is also important to recognize that U.S. banks are extremely well capitalized compared with three years ago and the degree of financial leverage is nowhere near what we saw at that time. Not only are banks better prepared to handle — and mitigate — a potential downturn, corporations are also in better shape and are, in fact, profitable. Firms have done little hiring — as evidenced by the current U.S. jobless rate — and are basically staffed at levels to meet 2008-09 demand. At that level, a soft economy should not foster a substantial further rise in unemployment. In addition, we have seen a number of firms take advantage of opportunities to reduce their financing costs. Businesses, overall, are in a fairly strong position.
 
For investors, rather than worrying about a recession, we believe it is more important to recognize that we will spend some time in what we call a “muddle through” economy. We will be somewhere between mild recession and slow growth, and we believe investors who cling to the same safe havens they sought in 2008 will be shortsighted. In fact, we strongly believe that investors can benefit by taking advantage of opportunities in the corporate bond and bank loan markets as they present themselves.
 
Credit opportunities
We see demand for high-yield credit funds increasing over the next year as investors recognize these opportunities. A major reason is retail investors have few other options for generating any kind of income stream — this is especially important to the baby boomers nearing retirement. Treasury yields are near historic lows. Currently, two-year Treasury yield is below 0.2 percent, the five-year is below 1 percent, and the 10-year is hovering around 2 percent. Meanwhile, investment grade bonds are yielding around 3.5 percent. In this environment, and with an average yield on high-yield credit above 8 percent, we are seeing a willingness by investors to take on increased credit risk instead of duration risk. Investors are starting to realize that it does not make sense to lock up their money for 10 years at 2 percent yield when they can opt for a shorter investment period with a greater income potential.
 
Further, we see increased high-yield demand from institutional investors. Pension funds are seeing a larger percentage of the U.S. population moving toward retirement, increasing the need for income. As a result, investors are moving away from duration-based assets and into more yield-based instruments. Along the same lines, insurance companies are increasing their exposure to the high-yield markets as the need for income in annuity products increases.
 
We currently see a lot of value in the high-yield market. Skittish investors, fearing a series of defaults, caused a wave of redemptions in high-yield funds over the summer, creating liquidity issues for fund managers. We believe this fear has been overdone and has, in fact, created opportunities. The market is pricing in a default rate of about
7 percent for the high-yield market. However, based on current fundamentals, we expect defaults will actually continue to run below 2 percent for the next 12 to 18 months.
 
Our view is based on many of the same factors that will limit the depth of any recession — especially that corporations, overall, remain profitable. These companies are also telling us that they are simply not seeing the same things that they saw in 2008. To be clear, these firms are not experiencing phenomenal growth — it is not that type of environment — but they are not seeing things fall apart either. Like many individuals, they tell us they are looking at what has happened in the markets in recent weeks, such as some of violent swings in stock prices, and say that the markets are not reflecting of what they are observing in their businesses. We are hearing this same view from a broad spectrum of businesses, including areas that would seem to be hit the hardest by a recession. For example building companies, which suffered greatly in the 2008 recession, have told us that while business is not great, it is not worse than it was six months ago.
 
The same volatility that has captured a lot of headlines in the equity market is also having an impact on credit markets. Uncertainty has driven borrowings costs higher — substantially in some cases — for some borrowers. For example, we have seen recent issues come to market with yields of around 10 to 12 percent that, had they come on the market a month earlier, would have had a coupon of around 8 percent based on what we saw at that time. It is important to stress that this rise in financing costs is not driven by fundamentals of the borrowing businesses, but we believe is instead a creation of the increased risk aversion in the markets.
 
Investors should have ample opportunity to take advantage of this opportunity as we head into the fall. Bond issuance, which has been slow in the current environment, is expected to pick up in coming weeks with several issues on tap.
 
 
The opinions expressed in this commentary are those of Mr. Krug and are current through October 7, 2011. 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.
 
Investment return and principal value will fluctuate, and it is possible to lose money by investing. 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 high-income 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.
 
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.
]]> <![CDATA[Catching small fish in the big pond]]> Catching small fish in the big pond

Timothy Miller, CFA 
Portfolio Manager

 

Ivy Small Cap Growth Fund - October 2011

 
 
2011 got off to a good start in the small-cap equity market. Generally small-cap stocks were outperforming large-cap stocks and growth continued to outperform value. Since the end of first quarter, however, small-cap stocks have come under pressure as a confluence of investor concerns has weighed heavily on the markets. Timothy Miller, portfolio manager for the Ivy Small Cap Growth Fund, reviews his fund’s objectives and investment philosophy during these volatile times.
 
Managing growth portfolios for many years, through many cycles, is always challenging and interesting. For the Ivy Funds Small Cap Growth Fund team, it’s all about following a consistent and fairly simple philosophy – no matter the business cycle, we look for innovative companies that are pursuing exciting opportunities for expansion. We focus on companies we think have the potential to develop from small caps into mid caps in the future.
 
We believe the common characteristics of successful small-cap growth companies are their ability to:
 
  • Pursue markets that are growing at a substantial rate when compared to the industry and/or general economy;
  • Be leaders in their industries by increasing market share and creating barriers to entry;
  • Produce superior financial returns;
  • Use strong management to execute business opportunities.
Differentiating high-quality companies from simply promising ones 
First, we ask a lot of questions. What market is this company pursuing? How large is the market or how large do we think it can get? How fast is it growing? Next, we examine the competitive dynamics of the market. We tend to prefer to own the leading companies in this market; this could mean their leadership position is based on proprietary products, strong distribution or robust marketing. Generally, the more concentrated the leadership, the safer we view the companies are for investors.
 
A company’s financial model is a critical factor as well. These companies are small. They need financing and must have the ability to generate sufficient profitability and free cash flow to fund growth. Their return on capital has to either be currently adequate, or have the potential to achieve a superior level to attract investors and sustain valuations.
 
In examining companies, the small cap growth management team analyzes sales and unit growth, and the driving force behind it. We also review trends in gross and operating margins. How’s the operating cash flow? How much operating cash flow is the company generating relative to its capital expenditure (cap ex) spending? This leads to further analysis regarding how much free cash flow is actually being generated. We also need to know the return on capital the company is achieving from its business.
 
Finally, we conduct a critical assessment of company’s management. We look for depth of management and review its vision, focus and ability to generate good returns for shareholders over a multi-year period.
 
Reviewing these key philosophical metrics as well as several individual factors allows us to identify what we consider to be the best growth companies in the emerging small-cap marketplace. 
Structuring the Fund’s portfolio and managing risk 
We believe in owning companies across the growth spectrum. This includes:
 
  • Aggressive growth companies: Less seasoned firms that offer the potential for faster growth for longer periods of time.
  • Accelerating growth companies: More seasoned firms that offer the potential for strong growth and deliver margin expansion.
  • Consistent growth companies: Most seasoned, larger firms that offer the potential for predictable revenue and earnings growth.
  • Out-of-favor growth companies: Firms not priced for growth that may have experienced a management misstep or set back. Sometimes, these companies fall into this category because of the current business cycle, environment or investor sentiment. 
Using the growth spectrum classification system assists our management team in dealing with market volatility, which is heightened in the small-cap growth space. This method, along with others, helps us strive to generate consistent returns over time, whether we’re in an expansionary environment or a sluggish one, or a period where sentiment is very bullish or somewhat cautious. We believe that having a structure like this over time provides better
consistency of performance. 
Ivy Small Cap Growth Fund vs. others
The primary difference is the concentration of the Fund’s portfolio. The Ivy Small Cap Growth Fund tends to focus on a group of about 55 to 60 companies. We blend larger firms in which all of the business elements are alignedand in place with dynamic, faster growing smaller firms. Each of these companies should typically demonstratestrong competitive and differentiated positions. We believe these are the companies that will reflect healthy financialreturns and cash flow over time.
 
As a result, the Ivy Small Cap Growth Fund is managed toward having a higher quality bias than many of our small cap growth peers. In addition, the Fund is trending toward lower volatility than its peers as indicated by a lower standard deviation on both a three-year and five-year basis, according to Morningstar.1 
Fund’s outlook 
As anticipated in the first quarter, we believe the rate of growth is likely to continue to fade in 2011. Companies are still struggling with rising commodity and labor costs and a slowing economy, but nevertheless, we expect small-cap earnings to continue to outperform larger companies for the year. This should be the foundation for another healthy year for the group, and relative earnings performance may be the key differentiator. The focus this year remains on adding exposure to industries such as health care, employment services and others that we believe have favorable operating leverage opportunities.
 
Regardless of the economic environment, we believe that there will always be opportunity for small-cap innovators to generate excitement in the market. In today’s volatile times, the necessity of economic hardship just may be the mother of invention. 
 
1 Morningstar, August 31, 2011. Comparison of Ivy Small Cap Growth Fund vs. average small cap growth class A funds. Standard deviation: Three-year basis (25.50 for Ivy Small Cap Growth Fund vs. 26.80 for peers) and five-year basis (21.61 Ivy Small Cap Growth Fund vs. 22.64 peers). Standard deviation of an asset return series measures the deviations of a return series from its average. This metric is often used as a determination of risk for an asset. A relatively large standard deviation implies there have been large swings in the return series and thus riskier, whereas a relatively small standard deviation implies there have been small swings in the return series and thus less risky. To gauge the relative risk of an asset, it helps to compare similar assets together and compare standard deviations and returns.
  
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager 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 1, 2011, and are subject to change due to market conditions or other factors.
 
Consider all factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. Investing in small or mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. 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.

 

]]> <![CDATA[InvestEd 529 Plan takes on Ivy Funds Name]]> <![CDATA[Heightened volatility, correlated markets create potential opportunities]]> Heightened volatility, correlated markets create potential opportunities

Ivy Asset Strategy Fund – October 2011

 
 
EXTREME VOLATILITY WAS THE MARKET NORM in August and September, with the major indexes frequently falling or rising three to four percent on a given day. Much of the volatility was driven by anxiety surrounding Europe’s debt crisis, which has also caused record correlations among stocks. Asset Strategy Fund co-managers Mike Avery and Ryan Caldwell and assistant manager Jonas Krumplys share why they think such an environment favors good stock selection.
 
Despite the nearly unprecedented volatility that has pummeled the markets in recent weeks, economic data does not yet show the weakness reflected in equity prices. We’ve seen some slowing in regional manufacturing and the employment picture remains troubled, but executives and business owners continue to report that while they are concerned about the future, generally they have not seen a significant decrease in activity.
A mixed global economic picture
As we look around the globe, we see a mixed economic picture. China’s economy appears healthy and we anticipate it will produce attractive growth, although it has slowed a bit from its peak. The big concern there has been inflation, but it appears to us that particular fear has receded a bit as energy and commodity prices have moved lower.
 
Brazil’s central bank recently cut interest rates after a series of rate hikes, possibly ending its tightening cycle, and the Turkish Central Bank cut rates as well. We may be seeing a move toward easier monetary policy in emerging markets, which at some point will be very positive for those economies. Economic growth in those regions has continued to be very strong, and even though it has slowed a bit recently, we believe the absolute levels remain very good.
Euro zone plight continues
The big story continues to be Europe, where the debt crisis has intensified and driven much of the recent volatility in global markets. The crisis stems from a downward economic spiral that has hammered Europe’s weaker economies, starting with Greece, which has a debt load that exceeds 140 percent of gross domestic product (GDP). The Greek government has cut spending and raised taxes to try to entice stronger economies, such as France and Germany, to continue bailing them out. Unfortunately, it looks like those budget cuts have sent Greece’s economy into even deeper distress. We anticipate this crisis will worsen before it is resolved, and we think it is likely that Greece will eventually default. At times the confidence crisis has been poised to spread to Italy, Europe’s third-largest economy, requiring intervention on the part of the European Central Bank (ECB). The country’s latest move has been to raise taxes, a tactic we think will create an even bigger drag on its economy.
 
European leaders have been trying to create a financial plan to contain the recurring crisis. The ECB has purchased some Greek and Italian bonds, but we feel its efforts have done little to calm investor anxiety or create the confidence needed to effectively turn this situation around. The problem remains with Europe’s banking system. It is under-reserved and inadequately capitalized to manage the fallout that would result from a sovereign default. We believe the endgame in Europe will be a big recapitalization, and we expect to continue to see extreme volatility in the euro zone until recapitalization becomes a reality. The vulnerability of the European banking system is the key to this crisis and providing investors with clarity and certainty that the banking system is strong and well capitalized will be one of the keys to resolving it.
Correlations near all-time high
As these events play out on the global front, we have taken a different approach to our thinking about Fund allocation. Sovereign debt has been a good performer in the last four to five weeks, but we think our advantage is to be lower in the capital structure, given our three-year outlook. So, high-yield securities and equities are more attractive to us now than sovereign debt.
 
We’re now seeing a very high level of correlation among stocks. Correlation is a statistical measure of how two securities move in relation to each other. A high correlation indicates securities are moving in the same direction. A low correlation indicates securities that are not performing similarly. In the S&P 500 on a one month basis, correlation has risen to over 80 percent compared with an average over the past 20 years of 28 percent. There are three fundamental mathematical drivers of correlation: market volatility, stock-specific data in the markets and stock-specific volatility, which is idiosyncratic risk. This has been a big focus for us during the past 12 months. Correlations at these levels mean the market is not discriminating among companies or sectors. We do not think this is justified and correlations will eventually recede.
 
In a typical market decline, stock-specific volatility will decrease because the correlation of the fundamentals driving earnings typically increases, and broad market volatility increases. There’s little differentiation among stocks in a typical bear-market, because companies may be cutting revenue forecasts or earnings, correcting inventories, reducing head count or undertaking any number of other actions.
 
However, during this correction, we have not seen the correlation among company specific events increase. The correlation of the earnings-per-share revisions to stock prices usually is around 30 percent; right now, the correlation is at 1 percent. We do not expect this to last. While security prices have been moving together — company specific events like earnings revisions have actually shown more dispersion than typical. This leads us to believe that in the future, if correlation between stock prices decreases, good stock selection will be rewarded as the market begins to price based on company fundamentals.
Emphasis on selection
We believe this environment means it’s time to be more active. We want to position the Fund in ways that will enable it to exploit what we think are better trends, better companies and better sectors. When the market isn’t differentiating in return on a stock-to-stock basis, and there’s no correlation among the fundamentals, there are opportunities in discerning which companies have good growth profiles, strong balance sheets and high cash flow yields. That means tremendous opportunities for good stock pickers. Valuations are indiscriminate, but the fundamentals are quite diverse, and we think certain stocks are very attractive right now.
 
We do not believe these dislocations can persist. When the short-term correlations eventually dissipate, stock returns are going to become linked to their fundamentals, which will cause correlations to decline. When that happens, we believe fundamentally good companies will be winning the day. That’s why we are concentrating heavily in our high-conviction positions. We’re doing our homework, performing fundamental research on each potential holding. That work has resulted in the Fund’s current net-equity position, with fewer stocks in the portfolio and bigger weights. As a result, the risk in the Fund currently has more to do with individual stocks and their trajectories than the risk in the market.
A look ahead
We believe market volatility will remain high. Additionally, the time period in which we operate has compressed markedly in the last three years. Bad gets bad really fast and good gets good really fast. We don’t anticipate that changing until systemic risk declines. In the meantime, one item on our watch list is the potential for sentiment data to create an economic reality. Markets don’t predict anything, but they do influence the outcome. Sentiment is terrible, but the actual economic data recently is not terrible, in our opinion. When we look at behavior around sentiment, which is important, we are nervous on two fronts. We’re concerned about how corporate chief financial officers (CFOs) behave because we are starting the underpinnings of a capital expenditure cycle. CFOs say their businesses are chugging along, but they want to protect margins because they’re not confident. This is of particular concern in Europe, where we think the economic outcome will be more of a contraction because policy makers made a massive policy mistake, rates are too high, the yield curves are too flat, economic activity is slowing domestically and there is genuine, widespread fear of recession.
 
The other area of concern for us relates to high-end consumers. This is critical; high-end consumption has driven the rebound in retail sales. Look at companies lthat produce high-end, luxury consumer goods which have done very well through the downturn. Sales of luxury cars are off the charts, and not just in China, but in Europe and the U.S. as well. The high-end consumer has been the savior of the global equity markets. If these consumers decide to rein in their spending, things could get worse quickly.
 
With these concerns in mind, we will continue to carefully monitor risk and think about protecting shareholder capital. In analyzing the next 12 to 36 months, we think the key factors will be more about owning the right stocks and the right sectors at the right price within a very volatile market environment.
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund 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 7, 2011, and are subject to change due to market conditions or other factors. The S&P 500 is an unmanaged index that tracks the stocks of 500 primarily large-cap U.S. companies.
 
Risk Factors: The Fund allocates from 0–100 percent of its assets primarily among stocks, bonds, and short-term instruments, across domestic and foreign securities. • 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. • With regards to fixed-income securities in which the fund may invest, these are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. • Because the Fund may concentrate its investments, the Fund may experience greater volatility than an investment with greater diversification. • The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk. • Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the Fund’s prospectus. • Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.
 

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.

]]> <![CDATA[Moving to the cloud: Opportunities multiply as consumers embrace the technology]]> Moving to the cloud: Opportunities multiply as consumers embrace the technology

 

Ivy Funds Market Perspective SEPTEMBER 2011

 
 
The Ivy Funds investment team is increasingly looking at cloud computing, which is attracting an increasing amount of attention and investment dollars. With its arrival on the scene, we are clearly seeing another major shift in how companies and individuals utilize technology. Simply put, the world is looking for cost-effective ways to achieve mobility and ubiquitous computing – the ability to seamlessly access the information they want and need, any time, and in any place.
 
Cloud computing is about “real time on the fly” through data centers to provide the kind of metered bandwidth that users need and that is clearly becoming important as the world moves beyond mobile devices and electronic mail. At the end of the day, it’s about on-demand, self- service capabilities for any number of applications — e-mail, voice, music, video, photographs, and others — in a timely and reliable but very measurable and cost-effective manner. And the cloud? It’s anything and everything that’s stored on the Internet instead of on a computer’s hard drive.
 
One of the greatest things about cloud computing is the level of security it provides. The cloud backs up data so that if a user’s home computer breaks down, he or she can still access digital files no matter where they are. Because cloud computing stores an individual’s digital files on remote computer servers instead of on his or her own hardware, the user has less need for individual storage and the expenses associated with it.
 
A software perspective
The “cloud” is basically a new delivery model that expands the market for software consumption by making software more affordable and enhances the capabilities of the solutions themselves. In the past, an enterprise information technology department would buy all the pieces to deliver a piece of software. This would involve purchasing hardware and infrastructure software, finally the software itself, and then hiring people to manage the solution on site, which would demand a certain level of expertise and would incur a lot of upfront costs. With cloud computing, “software as a service” (SaaS) allows a user to simply subscribe to a service that is delivered over the Internet. In this scenario, a customer pays a recurring fee on a per-user basis, so upfront costs are lower and costs scale as usage increases/decreases in terms of number of users.
 
Three things are enabling cloud computing solutions to become widely available: The exponential decline of hardware prices, better connectivity and increased hardware utilization via virtualization software. VMware is one example of how investors can capitalize on the cloud computing trend. This is a software company that makes virtualization software, which saves enterprise customers money in the form of lower hardware costs (better hardware utilization). VMware also enables SaaS companies to deliver their solutions economically over the Internet. The savings again comes in the form of lower hardware costs associated with hosting the software. SaaS also provides traditional software vendors a better way of delivering their solutions. Consider Intuit, which we would normally think of as a seller of QuickBooks or Turbo Tax in the form of “on-premise” software. A customer would typically purchase QuickBooks from a retail outlet, install it and hopefully get it to work. But now, Intuit is moving these customers online, where they will simply create a user name and password, in order to access the software and consumer it online. This allows Intuit to expand its margins by not having to pay retailers a fee to sell the software and enables it to drive sales through its existing customer base. Intuit now owns its customers’ data and can observe how customers are using the software in real time, which enables Intuit to iterate and improve the solutions with more rapidity and to better understand what additional solutions their customers might be interested in buying.
 
The ability of cloud computing to expand the market for software usage is why Ivy is excited about the software industry and software as a service, in particular. But it’s also affecting industries outside of software. Consider retailer Williams Sonoma, which purchased software from a company that was recently acquired by Salesforce.com. Salesforce.com provides applications for sales and customer service, a platform for building and running business applications and also offers an enterprise collaboration application. Its products are significant because it’s becoming important for retailers to understand what people are saying about their products over the Internet, on Facebook and other social media. Via the cloud, Salesforce.com enables Williams Sonoma to monitor the Internet and retrieve all mentions of Williams Sonoma, so it can spot problems and fix them early or identify customer trends the company can pursue in profitable ways.
 
Networking, telecommunications
Networking is an important area in cloud computing, but it doesn’t get as much attention as software. With networking, we’re seeing many more devices, bigger data centers and a greater number of data points between the devices and the places where information and applications are stored. What’s become clear is that we need bigger, better networks, with bigger, faster pipes to aggregate data from homes and businesses. Optical transport and higher-level technology transport methodologies are making those pipes faster. What’s been significant in the past five years is that from an investment perspective, we’re making the networks smarter. We now have load downs that prevent over stressing one data center while another is idle. Privatization of traffic is basically identifying what is most important and sending it first.
 
Within all of this, beyond just specialization in niches, there are real-time issues to address, such as noise and video. Incorporating all of these can be an unpleasant experience. There are companies, such as Acme Packet, that specialize in session delivery network solutions. Acme Packet has a session border control, which is a service delivery architecture encompassing man different product categories. In effect, it opens up the pipe, keeps it open and everything goes through prioritized and already pre-cleared from the security standpoint once the session has been established.
 
Another topic is scale. Most of what is happening today on the cutting edge of networking has to do with server virtualization and efforts to get more utilization in storage and the computer part of the network. The idea is to take all of the individuals who want to have their traffic switched, aggregate in mass and still provide everyone with the control they need to get more optimization out of the switching layer. A few companies are already pursuing this. Juniper, which provides high-speed, reliable switching routers, is working on something it calls QFabric, which has an open standard called Open Forum. A number of other companies are working on this, the most prominent being Hewlett-Packard.
 
The final topic with respect to scale is, importantly, storage. With the price of memory dropping, it’s pretty inexpensive for a user to keep a lock on his device, but there are some situations in which a user wants to keep information in the cloud for quick accessibility. The frequency of use may not be so high and the type of device may not be consistent. There’s a lot going on in this area as well. The best example we can point to is the human Genome Project. Studying massive amounts of information from each individual human gene, trying to find commonalities, creates the need to go across the data base and storage elements to figure it out. Within storage, a company like NetApp has storage tuned to work best in a virtualized environment.
 
Data mining for retailers is another compelling need, and Starbucks serves as a good example. It has a royalty program that allows them to see what people are buying, what trends are developing, and it has helped the company improve the customer experience.
 
Hardware storage, semiconductors and related components
The nuts and bolts of the underlying semi-conductors and pieces of hardware enable a lot of cloud computing. All of these pieces work together, and that’s how the cloud touches every part of technology and flows pervasively across technology and into other industries. From the hardware and semiconductor standpoint within the need for real-time computing, we’re seeing more investments in the next-generation data centers. Google, Facebook and Apple are already doing it, and it’s driving a lot of spending.
 
The importance of being able to push massive amounts of data through the network relies on semiconductors produced by companies such as Broadcom. Underlying the microprocessors, there’s Intel. On the small-cap side, there’s NetLogic — the point being that there are lots of different semi-conductor firms that have benefited at different touch points, whether it’s the network or inside the data center or certain particular configurations that enable certain pieces of software.
 
NetApp and several other semi-conductor companies are logical investments that you can see that are most directly impacted by the cloud. And there are other key beneficiaries: Apple’s bandwidth capability due to the proliferation of the devices and the interconnection of its Internet Operating System (IOS). We’ve watched it invest heavily in a data center in North Carolina for a long time. We all know the frustration with having several Apple devices that are not synched. To get music here, there or anywhere, now you’re going to be able to synch all those devices wirelessly, which is a big deal here as well as in the emerging markets.
 
When we think about emerging markets, we think about how and where technology is evolving, what the next generation of devices might be and where the growth will take place. For example’ hearing aid devices could constitute just one application. If you consider the adaption of PCs, WiFi and connectivity are key. That’s where the cloud comes in — the ability to access that bandwidth, and then to access photos, music and other applications from just about any device.
 
Health care and other arenas
The cloud is changing delivery models in many other industries, such as health care. In that arena, we can look to Cerner, a health care software company that touches hospitals, doctors and others in the health care realm. hospitals typically invest locally in their information technology infrastructure. So, rather than making that enormous spend locally, they’re able to tap into resources because of the bandwidth capabilities and higher power in the data center. By doing that, they have much better access, a more cost-effective solution and an ability to ultimately provide better care for their patients as well.
 
Cerner is taking in all that data and not only using the interaction with the doctors and administrators at various hospitals, but is also capitalizing on that to run a more efficient data center, which ultimate results in better costs for the hospital. Consider medical records, the probability of doctors sitting at home on their PC with the ability to do video conferencing with patients, or a doctor who goes on vacation and learns they have a patient in the emergency room; he or she can immediately access a patient’s records and immediately admit the patient to the hospital or call in a prescription.
 
A bright and cloudy future
Clearly, a tremendous amount of information already lives online, in places ranging from Facebook and other social networks, to emails services and gaming applications. But the tremendous potential of a full online existence remains unfulfilled. The market for cloud computer services and software is expected to grow more than 27 percent annually over the next five years, reaching $73 billion by 2015, according to International Data Corp. It estimates that by 2015, software-oriented cloud services will account for roughly three-quarters of all spending on public cloud services. With projections like that, we’re looking for — and increasingly finding — an abundance of compelling investment opportunities that cross technology and sectors.
 
 
Past performance is not a guarantee of future results. The opinions expressed in this article are those of the Fund’s investment team and are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. The opinions are current through August 31, 2011.
 
Investment return and principal value will fluctuate, and it’s possible to lose money by investing. 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.
 
S&P 500 is an unmanaged index of common stocks. It is not possible to invest directly in an index.
 
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, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 
]]> <![CDATA[Muni markets '11: Nothing to fear but fear itself]]> Muni markets '11: Nothing to fear but fear itself

 

Bryan J. Bailey, CFA
Portfolio Manager
Ivy Municipal Bond Fund
 

Ivy Municipal Bond Fund – September 2011

 

 
For municipal bond investors, it has been a tumultuous year. after taking a beating early in the year amid a high-profile (and incorrect) forecast of a virtual muni market meltdown, municipal investors were able to find stability only to be shaken again — this time amid uncertainty on how a downgrade of the nation’s sovereign credit rating would ripple through the market. This fall, federal spending will again be in the spotlight as a select bi-partisan Congressional committee works on a plan to cut more than $1 trillion over the next decade and perhaps again raise concerns about the availability of federal funds for local governments.
 
Should municipal bond investors be concerned?
A tale … full of sound and fury
Although economic uncertainty has left investors in all asset classes a bit jittery, for municipal bond markets, it appears investors may have spent the past year facing a lot of sound and fury, the significance of which is difficult to determine.
 
The turmoil was initially stoked in late 2010 when financial analyst Meredith Whitney predicted as many as 100 major muni-bond defaults totaling $100 billion or more would happen in 2011 as local governments wrestled with financial headwinds. While the comments roiled the municipal bond market it turned out Whitney, whose reputation was built on prescient comments about the banking sector prior to the 2008 financial crisis, was far off the mark with her forecast. however, through Aug. 12, defaults this year have totaled a modest $757.8 million1 — or 0.7 percent of what Whitney projected for the year. To put the disparity in the forecast in an even sharper perspective, keep in mind that Whitney’s prediction called for the market to average more than twice that figure (a total of nearly $2 billion) in new defaults each week for the entire year. Looking back from a vantage point in the early autumn of 2011, it is almost surprising that a prediction so clearly wide of the mark would have an impact on the markets.
 
In fact, according to a July Bloomberg report, through the first half of this year defaults were down 60 percent from the same period in 2010 when there were 60 defaults totaling $2.29 billion and even further below the first half of 2009 when there were 144 defaults totaling $4.98 billion. Most of this year’s issuers that have encountered difficulty have been small ones that draw their revenue from special-assessment districts, housing developments and hospital complexes, not general tax revenues. Going forward, we do not expect defaults will break historical norms for the rest of the year and expect virtually all of the defaults to occur in the high-yield space. In fact, according to a Moody’s Investor Service study of the period from 1970 through 2009, there were only 54 rated defaults among 18,400 municipal issuers rated by Moody’s over the 39-year period, equating to a 0.09 percent 10-year average cumulative default rate.2
 
In the wake of the overblown default fears, municipal markets were once again faced with another potential headwind — this time by political wrangling over the debt ceiling that continued deep into the eleventh hour. While the sometimes over-the-top rhetoric of the debate appears to have had a far-reaching impact — there are indications it ruffled everything from consumer confidence to stock prices — experienced municipal bond investors recognized that the fear that federal funding cuts might lead to increased levels of municipal debt defaults was once again overblown in the markets. And while Standard & Poor’s did end up downgrading the federal credit rating and, in turn, later lowered the ratings on some other government issues because of their close tie to the federal government, we believe the $3 trillion municipal bond market remains stable and highly credit worthy.
 
Focusing on the facts
One benefit of this year’s turmoil is that it has clearly illustrated why it is important for investors to fully understand what risks they are taking with their money. For the individual investor, that understanding can provide important stability during times when the broader markets are reacting sharply to the news of the day. We believe It is important for investors to not get caught up in hype and let the media influence their investment decisions.
 
In the municipal bond market, it is important to recognize that defaults are exceptionally rare. There are reasons for that. State and local governments are not corporations and cannot “go out of business.” In fact, by law states cannot file for bankruptcy and many states have laws that prevent municipalities from filing. Even without the legal constraints, a municipal default is an exceptionally expensive proposition to the point that it is virtually never a viable solution because it is almost assured to prevent the municipality from future borrowing and access to the capital markets. Municipalities are created to provide services and are not profit-driven. In situations where funding falls below local budget projections, the municipalities will generally impose austerity measures by reducing services or other costs — such as employee wages or benefits — or raise income through increased taxes, fees or other service charges.
 
It is also important to recognize that, although federal lawmakers may be headed back into a spending battle, the states are far better equipped — and more experienced — at balancing their books after going through the recent recession. Unlike their federal counterparts, state lawmakers cannot deficit spend, as a result, states have already made sometimes painful decisions to control their costs. Additionally, it appears that states may be in better shape financially than they were a year ago. In July, the Nelson A. Rockefeller Institute of Government at the State University of New York at Albany issued a report saying state tax revenue was up an average of 9.3 percent during the first quarter and continued to run ahead of year-ago levels into the second quarter.
 
Looking ahead
We don’t expect any significant change to the current low levels of default activity going forward. Budget gaps at the state and local levels have been addressed and, we believe, when combined with reports of tax revenues above last year’s levels, the result is that states are generally in better shape financially than they were a year ago. Although the federal spending situation remains murky, we do not believe state and local governments are heavily reliant on federal funds to make debt payments. We would expect state and local governments to view any increased funding from the federal level as an unexpected surprise and not critical to their financial picture in most cases.
 
While budget tightening at the state and local level should not have an impact on debt payments, it is, however, having an impact on new debt issuance. We expect investor demand for municipal bonds will continue to outpace supply through the end of the year as we continue to expect a light calendar for new issues.
 
Municipal bond fund investing
For investors looking to participate in the public finance market, municipal bond funds can offer numerous benefits when compared against investing in individual bonds, most notably professional managers who carefully monitor the fund and are able to potentially capitalize on opportunities and mitigate risks before they might even become apparent to many holders of individual bonds. The Ivy Funds team continually monitors the portfolio which is designed to allow the team to be aware of any possible credit deterioration far in advance of an individual investor.
 
Because funds are considered institutional buyers, pricing can be much more favorable for a fund than for an individual bond investor and the fund provides the investor far more liquidity than if they hold an individual issue. The fund is marked to market on a daily basis and provides daily liquidity to its investors. Individual debt instruments are not always easily liquidated and trading individual bonds can be expensive.
 
Perhaps most important is the diversification of a bond fund. Unlike an individual bond purchase, which ties an investor to one credit exposure, one spot on the yield curve and the potential for greater loss if that one issue would happen to default, bond funds can include a mix of issues with a wide range of maturities.
 
Diversification is one of the strongest features of the Ivy Municipal Bond Fund, though diversification alone cannot ensure a profit or protect against loss. The Fund holds a mix of investment-grade bonds, primarily revenue bonds. Unlike general obligation bonds, revenue bonds are backed by a specific revenue source. Ivy’s revenue bond holdings are widely diversified across all sectors of the municipal bond market as well as geographically.
 
The Fund has a range of maturities from one to 35 years. Because of the way the Fund is structured, its average maturity is 14 years, but its option adjusted duration (which is the Fund’s sensitivity to interest rate changes) is approximately 8.66 years, or similar to what an investor would see on a 10-year bond.
 
However, while the duration is similar to a 10-year bond, its taxable-equivalent yield can be higher — and in some cases significantly higher — depending on the investor’s tax bracket. For example, as of 8/31/11, the Fund’s annualized 30-day SEC yield was 2.85 percent. Tax adjusted to a taxable rate for an investor in the 35 percent tax bracket, the figure equates to a taxable-equivalent yield of 4.38 percent compared with a yield of approximately 3.72 percent on a corporate A-rated bond.
 
The Fund is managed for low levels of total return volatility. On a risk-return basis, it can provide a degree of protection on the downside while participating on the upside. The Fund has historically had a lower standard deviation and the Fund has historically had a low turnover ratio.
 
Although the media has offered a bleaker outlook on the state of the municipal markets, this seems to us to be nothing more than overblown headlines. As of the beginning of the third quarter the public finance markets continue to chug along despite some of the economic headwinds currently facing the country.
 
1Bank of America/Merrill Lynch report in Barron’s article Aug. 29, 2011
2U.S. Municipal Bond Defaults and Recoveries, 1970-2009, Moody’s Investor Services, Feb. 11, 2010
 

Fund Performance
As of 06/30/2011 Quotron Inception Date 1-Year 3-Year 5-Year 10-Year Life Expense Ratio Expense Waiver
Class A (NAV) WMBAX 9/15/00 3.42% 5.56% 4.42% 4.43% 4.72% 1.15% 1.15%
Class A (Load) WMBAX 9/15/00 -0.98% 4.05% 3.52% 3.97% 4.30% 1.15% 1.15%
Class C (NAV) WMBCX 09/21/92 2.64% 4.77% 3.61% 3.58% 4.35% 1.90% 1.90%
Class C (Load) WMBCX 09/21/92 2.64% 4.77% 3.61% 3.58% 4.35% 1.90% 1.90%
S&P Investortools Main Muni Bond -- -- 3.70% 5.35% 4.64% 4.99% -- -- --
Lipper General Municipal Debt -- -- 2.73% 4.08% 3.37% 3.89% -- -- --
 
Ivy Muni Bond Fund A Shares Annualized 30-Day SEC Yield as of 8/31/2011:  Subsidized 2.85%  Unsubsidized 2.85%
Ivy Muni Bond Fund C Shares Annualized 30-Day SEC Yield as of 8/31/2011:  Subsidized 2.21%  Unsubsidized 2.21%
 
Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Please visit www.ivyfunds.com for the most recent month-end performance.
 
Performance at net asset value (NAV) does not include the effect of sales charges. Class A share performance, including sales charges, reflects the maximum applicable front-end sales load.
 
Index Description: Standard & Poor's/Investortools Municipal Bond is an unmanaged index comprised of bonds held by managed municipal bond fund customers of Standard & Poor's Securities Pricing, Inc. that are priced daily. It is not possible to invest directly in an index.
 
Consider all factors. 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. 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. These and other risks are more fully described in the Fund’s prospectus. The Fund may include a significant portion of its investments that will pay interest that is taxable under the Alternative Minimum Tax (AMT). Not all funds or fund classes may be offered at all broker/dealers.
 
30-Day SEC Yield represents hypothetical net investment income earned by a fund over a 30-day period, expressed as an annual percentage rate based on the fund's share price at the end of the 30-day period. This hypothetical income will differ (at times, significantly) from the Fund's actual experience; as a result, income distributions from the fund may be higher or lower than implied by the SEC yield.
 
The opinions expressed in this commentary are those of the Fund's manager and are current through June 30, 2011. 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. As with any mutual fund, the value of the Fund’s shares will change, and it is possible to lose money on your investment.
 
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 mutual funds offered by Ivy Funds, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.

 

]]> <![CDATA[Brazil fears appear overblown; opportunities beckon]]> Brazil fears appear overblown; opportunities beckon

Jonas Krumplys, CFA
Portfolio Manager
Ivy Asset Strategy New Opportunities Fund
 

Ivy Asset Strategy New Opportunities Fund – September 2011

 
 
Commodities stocks have been among the most negatively affected by the recent declining market sentiment, with many driven their lowest valuations of the year. Commodity-rich Brazil, the world’s eighth-largest economy and a major exporter of hard and soft commodities ranging from iron ore to soy, is shaping up to be one of 2011’s worst-performing equity markets. But Jonas Krumplys, portfolio manager of the Ivy Asset Strategy New Opportunities Fund, still sees pockets of potential opportunity in Brazil.
 
The concerns surrounding Brazil’s economy and markets are not without merit. After surging 85 percent in 2009 - 2010, the Bovespa stock index entered a bear market on July 27 after declining 20 percent from its November 2010 bull-market peak. The pullback caused some companies to postpone initial public offerings or discount them significantly.
 
The industrial sector represents a significant component of Brazil’s gross domestic product (GDP) at approximately 25 percent (proportionally the second-largest in the Americas), and agriculture is roughly 4 percent. Brazil’s No.1 export partner is China. We believe the greatest concern now is that China’s economy, which has grown too rapidly for too long, is overdue for a hard landing. While that appears to bode poorly for Brazil, it’s important to recognize how and what Brazil exports to accurately assess the potential impact of China’s slowdown. 
 
Currently, Brazil’s total exports are only 12 percent of GDP; half of those exports are commodity based, and half of those commodity exports are agricultural. To break that down more specifically, Brazil is the world’s first or second largest exporter of coffee, sugar, soy products, orange juice, poultry and beef — commodities the world is not about to do without. This is a significant distinction, as we think prices for these commodities are not likely to collapse. We believe that the wealth of its natural resources and the stability of its export commodities mean Brazil is inherently more stable than the recent equity market decline would suggest. 
Inflation fears overdone
There are economic issues in Brazil, including concerns that the loan growth rate is too high, consumers are carrying too much debt and the country has credit difficulties. But these issues are true of all underdeveloped emerging markets when it comes to mortgages, credit cards or small- and medium- enterprise (SME) loans. The fact that Brazil’s annual loan growth rate has been roughly more than 20 percent since 2004, and is not slowing, is not unusual or alarming, in our view.
 
Inflation, which has run above the Brazilian central bank’s annualized target range of 4.5 to 6.5 percent since April, also has investors’ attention. In an effort to slow the pace of inflation, policy makers have raised the benchmark interest rate five times this year. There was a fear among some investors that Brazil would have to raise rates above 14 percent. But in fact, on August 31, policymakers cut Brazil’s benchmark Selic rate by 50 basis points to 12 percent, bringing its tightening cycle to an end. The government also has cut spending this year by 50 billion reals ($31.46 billion) to help dampen demand and reduce inflation.
 
We think inflation will become less of a concern once the interest rate cycle turns around, which is likely to happen late this year, and if the government continues to watch spending. Brazil’s fiscal debts are coming down (with a current debt-to-GDP of 60.8 percent) and we believe its economic growth rates are sustainable: The economy is forecast to grow by approximately 4 percent this year after expanding 7.5 percent in 2010.
 
Such a backdrop has created what we see as a favorable buying environment in equities, despite recent ominous headlines. With respect to price-to-earnings (P/E) and price-to-book ratios, the Bovespa is in line with similarly developing economies. Its price-to-book ratio of 1.37 times, is 6 percent below the low of 1.47 seen in 2008-2009. Brazilian companies are trading now at 1.5 times book value with a P/E of around 10. Average debt-to-equity of Bovespa companies is near 90 percent, compared with 145 percent for the S&P 500. 
Opportunities in real estate
While Brazil’s lending rate is high by U.S. standards, it’s important to recognize that real estate lending rates in Brazil are tied to a government program rather than to the central bank rates. Financed by the government-owned Caixa Bank, the Minha Casa Minha vida (My House My Life) program, launched in 2009 with a goal to build and sell 3 million homes by the end of 2014, is one of the world’s most ambitious social housing programs. The total market value of outstanding mortgages represents less than 5 percent of Brazil’s GDP vs. a range of 50 to 100 percent of GDP in the U.S. or Western European economies.
 
The Fund’s current exposure to Brazilian real estate is about 9 percent of total assets, with 4.5 percent in residential developers and 3.5 percent in commercial projects, including offices and shopping malls. Despite a population base of nearly 200 million people, Brazil has only about 400 shopping malls (compared with approximately 105,000 in the U.S.). But there is demand for a great many more. This is one of the most under-penetrated markets in the world — despite Brazil being the world’s eighth-largest economy. Inflation rates of over 1,000 percent less than two decades ago means that commercial mortgages are a relatively new phenomenon The existing malls primarily were built by wealthy individuals who had made their money in industry, agriculture or mining and were looking for an inflation hedge. The occupancy rate in Brazil’s malls is near 100 percent and sales per square meter are growing very rapidly. 
Despite challenges, future appears promising
Recent events have not significantly changed our outlook for Brazil. Its economy has slowed on the industrial side because the Brazilian currency has appreciated so dramatically. That appreciation has hurt the profitability of companies making machinery, buses and cars, for example, which is an issue because Brazil is also a major auto exporter. Brazil is trying various tactics to temper its currency’s exchange rate, including charging taxes on foreign investors buying Brazilian stocks and bonds. It recently began taxing currency speculators at a rate of 1 to 25 percent in order to manage capital inflows into the country.
 
There is no doubt that the industrial side of Brazil’s economy has slowed, but we think it was growing too fast last year. The Brazilian economy should not grow faster than 4.5 percent per year because its infrastructure is so poor. This is a country the size of the continental U.S. but it has fewer paved highways than the U.K. — a far smaller country. Less than 10 percent of the roads in Brazil are paved, it has almost no passenger rail system and there are not enough freight railways. There are only three freight railway companies and two of them are controlled by iron ore companies. Brazil needs more airports and larger, more efficient ocean ports to accommodate the growth it is envisioning.
 
We see this need to build infrastructure as an investment opportunity. Petrobras, a Brazil-based leader in development of advanced technology for deep-water and ultra-deep-water oil production, plans to increase oil production from its current pace of 2 million barrels per day to 4 million by 2020. Petrobras will need 28 drill ships to accomplish its plans, and it must build three major refineries and an enormous amount of pipeline. The Fund is investing in this expansion by owning a couple of engineering and construction firms. One is a French firm, Technip-Coflexip1, which is one of three companies in the world that can operate a flexible riser that can reach the bottom of the ocean. It’s currently building a factory and research center in Brazil to supply floating production, storage and offloading systems to Petrobras. Another is Petrofac Limited2, a U.K.based company that provides facilities solutions to the oil and gas production and processing industry.
 
The Fund also owns Cosan3, with businesses in energy, food, logistics, infrastructure and agriculture property management. It’s also the largest private producer of ethanol, a commodity Brazil will need to fuel its infrastructure expansion. Cosan just completed a multibillion-dollar joint venture with Shell to produce low-carbon biofuel — ethanol made from sugarcane, an abundant crop in Brazil. Shell is combining its extensive retail experience, global network and research in advanced biofuels with Cosan’s technical knowledge of large-scale biofuel production. The joint venture aims to produce more than 520 million gallons of ethanol annually to support Brazil’s burgeoning demand.
 
An additional holding is Brasil Foods4, the world’s 10th-largest food company and Brazil’s second-largest in revenue. The company is 60 percent domestic and sells a wide range of products, including poultry, pork, processed meats, frozen foods, and dairy products.
Tactical shifts, outlook
To manage short-term volatility, we have trimmed equity holdings in the Fund, including Brasil Foods (which nonetheless remains among the Fund’s top 10 holdings). Stocks tied to economies thought to be export-related have taken it on the chin in recent weeks, as have commodities. And we think that the markets will continue to be volatile in the near term on the negative sentiment surrounding the European banks and European sovereign debt.
 
Historically, Brazil is wary of inflation and tends to keep rates
high; however, as conditions change, it has room to again notch rates down to spur growth. It also has a sovereign wealth fund, hundreds of millions of dollars in foreign reserves, healthy banks with high tier-one capital and a government surplus. So we’re going to ride out the volatility and headline risk about Brazil, which we think is overdone.
 
1. Technip-Coflexip represented 1.27% of investments as of June 30, 2011.
 
2. Petrofac Limited represented 1.375 of investments as of June 30, 2011.
 
3. Cosan represented 1.13% of investments as of June 30, 2011.
 
4. Brasil Foods represented 2.40% of investments as of June 30, 2011. The Bovespa is a Sao Paulo-based stock and futures exchange. It tracks around 50 stocks traded on the São Paulo Stock, Mercantile & Futures Exchange. The Standard & Poor’s 500 Index is an unmanaged index of common stocks. Neither index is an investment product available for purchase.
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund 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 July 28, 2011, and are subject to change due to market conditions or other factors. Unless specifically noted within the text, holdings mentioned within this perspective are as of August 30, 2011.
 
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. The Fund may allocate from 0-100% of its assets between stocks, bonds and short-term instruments, across domestic and foreign securities. 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. Investing in small or mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The fund may focus its investments in certain regions or industries, thereby increasing its potential vulnerability to market volatility. The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk, as short selling involves the risk of potentially unlimited increase in the market value of the security sold short, which could result in potentially unlimited loss for the fund, and the value of investments in derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time and storage costs that exceed the custodial and/or brokerage costs associated with the Fund’s other holdings. 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.
 
  • Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.
 
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.

 

]]> <![CDATA[An Easy Way to Diversify]]> <![CDATA[Don’t throw the baby out with the bathwater when it comes to stocks ... stay focused on long-term value]]> Don't throw the baby out with the bathwater when it comes to stocks ... stay focused on long-term value

Matthew Norris
Portfolio Manager
Ivy Value Fund
 
 

Ivy Value Fund – August 2011

 
 
There has been little doubt recently that investors are nervous. Up, down, up, down, up, down, it is hard to know where to turn. The reasons for the uncertainty have been obvious: S&P’s downgrade of U.S. long-term debt, fear of losing money, recession anxiety reminiscent of 2008, sovereign debt issues in Europe, gross domestic product growth is stagnant and the list goes on.
 
But the other issue obvious to astute investors is that now may be just the right time to take advantage of the volatility in an uncertain market and look for good deals. The old adage “buy low, sell high” is never more important than investing with a value strategy in mind. Buying a company’s stock at a price that one feels is below its true market value can be smart.
Everybody wants a good deal
Say you go to a local retailer to purchase a pair of blue jeans. The brand you normally purchase is marked down from $75 to $50. This seems like a good deal, so you buy a pair. A few months later, the same store is having a sale. If you purchase one pair of your favorite jeans for $50, you can get another pair for just a penny. This purchase translates into two pairs of jeans for about $25 each. Both scenarios represent good deals and are perceived as value purchases. 
Value funds seek to take advantage of opportunities in a volatile market
Value investors believe that, over time, the market’s tendency to focus on short-term events and performance can drive stock prices to low levels, creating buying opportunities among temporarily undervalued investments. When the Russell 1000 Value Cumulative Return and the Russell 1000 Growth Cumulative Return are compared over time, value investments have provided attractive results when reviewed against their growth counterparts.1
 
Mutual funds that use a value strategy work in much the same way as the “good deal jeans example.” These funds search specifically for what managers feel are undervalued companies — financially sound, quality firms with stock prices that have been beaten down due to transitory factors that are unrelated to their fundamental health. Value funds can be used to capitalize on market opportunities and add diversification to a growth-oriented portfolio, though diversification cannot ensure a profit or protect against loss. 
Our investment approach
We start with detailed research, looking at one company at a time to find those whose stocks we feel are trading substantially below our estimate of their intrinsic value. It is critical in value investing to clearly understand what companies are worth and their plans for the near- and longer-term future. We seek to purchase quality companies at what we believe to be discounts because of their potential opportunities to regain full value and make money for Fund shareholders. We do not deviate from this approach in response to short-term market events. Instead, we stay the course and look for value over the long term.
 
Our investment approach is simple. We use both top-down (assess the market environment) and bottom-up (research individual companies) analysis in our selection process. In general, in selecting securities for the Fund, we evaluate market risk, interest rate trends and economic climate. Equities selected must represent value in a combination of relative and absolute measures. We attempt to concentrate the Fund’s equity holdings in companies with leading positions in their respective industries, and that have solid management teams, strong balance sheets and high barriers to competition. Our overall objective is to provide long-term accumulation of capital. 
Companies considered for the Fund must:
  • Trade at a notable discount – significantly below their intrinsic value by about 30-50 percent as determined by normalized earnings
  • Have a catalyst for improving fundamentals (cash flow, earnings and balance sheet)
  • Appear poised to deliver sound investment returns
Recent holdings of Ivy Value Fund
Given current market conditions, we have found several undervalued yet high-quality, growing companies with great balance sheets and business models. Some of our most recent value purchases have been in the energy, information technology and financial sectors. Most notable among the purchases were: 
  • RenaissanceRe Holdings Ltd., a provider of reinsurance and insurance coverage and related services. This stock is currently trading around book value with earnings growth of more than 18 percent per year for the past decade. We believe this stock offers an opportunity for us to purchase an “investment seed” at a discount that has the potential to bear fruit over time.2 
  • Regency Energy Partners, L.P., a provider of midstream natural gas and natural gas line services. This security is currently offering a dividend of more than 7.5 percent and has a history of raising its dividend every quarter, which we believe translates into an opportunity to gain from the appreciation of the stock, (i.e. hopefully, “buying low and selling high”) but also adding additional dividend income to shareholders.3 
  • Marathon Oil Corporation, a company engaged in exploration and production, oil sands mining and integrated gas. It has a current price/earnings ratio of 6 while compared to the current price/earnings ratio of the market at 13. We feel this translates into an excellent value opportunity for this company.”4 
The Ivy Value Fund has historically delivered a strong, long-term performance record. The Fund occasionally experiences short-term volatility, but as long-term investors, we view those volatile periods as opportunities rather than threats. The Fund purchases high-quality companies when their stock price appears below the value we believe is correct for that company. In turn, we sell those same names when they reach what we feel are appropriate valuations. We believe bottom-up, company-by-company analysis will produce solid returns over the long term.
 
Remember, value investing means “good value,” not cheap companies.  We focus on knowing the difference between firms that are temporarily underappreciated or misunderstood and those that will be unable to weather the storm for a comeback.
 
1 Source: Zephyr StyleADVISOR. Russell 1000 Value is an unmanaged index comprised of securities that represent the large cap sector of the stock market. Russell 1000 Growth is an unmanaged index comprised of securities that represent the large cap sector of the stock market. It is not possible to invest directly in an index. Index performance results do not take into account the fees and expenses of the individual investments that are tracked. Results include reinvested dividends. Past performance is no indication of future results.
 
2 As of 8/18/2011: RenaissanceRe Holdings Ltd. represented 2.5 percent of net assets in the Fund.
 
3 As of 8/18/2011: Regency Energy Partners, L.P. represented 3.7 percent of net assets in the Fund.
 
4 As of 8/18/2011: Marathon Oil Corporation represented 2.2 percent of net assets in the Fund.
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 18, 2011, and are subject to change due to market conditions or other factors.
 
Consider all factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. The value of a security believed by the Fund’s managers to be undervalued may never reach what is believed to be its full value, or such security’s value may decrease. 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.
]]> <![CDATA[Uncertain government policy shakes markets, prompts defensive moves]]> Uncertain government policy shakes markets, prompts defensive moves

 

John Maxwell
Portfolio Manager
Ivy International Core Equity Fund

Ivy International Core Equity Fund – August 2011
 

 
Investors are closely watching government policy debates around the world, and they are increasingly uncertain about the decisions that will result and the impact on the global economy. John Maxwell, portfolio manager for the Ivy International Core Equity Fund, says this uncertainty has contributed to the recent volatility in equity markets and is likely to continue until we see signs of a self-sustaining economic recovery.
Ongoing concerns in Europe, emerging markets
Governments do not move at the speed of the markets and government policy can’t shift the direction of a country based on market prices or bond yields. But policy decisions are critical to investors because the impact of those decisions can be significant and long-lasting. Global investors continue to be unsettled by slow economic growth overall, and we think the policy debates about austerity in Europe and the U.S. are not supportive of growth.
 
Recent economic reports from two of the leading European economies have only added to the uncertainty. France, the second-largest economy in the euro zone, reported on August 12 that it had recorded no growth in the second quarter, raising market concerns about France’s ability to meet its deficit-reduction plan. Germany, the economic leader in Europe, followed on August 16 with its own weak gross domestic product (GDP) report, showing growth of just 0.1 percent in the second quarter, compared with expectations for 0.5 percent.
 
The ongoing sovereign debt problems in what often are called the peripheral countries in Europe also continue to raise concerns. The European Central Bank has intervened repeatedly into the markets, buying Spanish and Italian government bonds to help stabilize the yield curve for those issuances. But global investors still want stable sovereign debt markets across the euro zone, and a plan to bring that stability has not been agreed upon by those governments. The recent meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy did result in a wide-ranging plan to strengthen the euro, harmonize annual budgets and generally converge fiscal and economic policies across Europe. “Germany and France feel absolutely determined to strengthen the euro as our common currency and further develop it,” Merkel said after the meetings. But the two leaders refused to add to the European Financial Stability Fund or to consider proposals for eurobonds now.
 
Despite the discouraging daily headlines that often follow these events, we think there are some positive signs in the European economy. For example, the Europeans are showing much more determination in defending the Italian and Spanish yield curves. This is a strong sign of support for the continuation of the euro zone and increases the likelihood that the euro zone will be more fiscally united in the future. There are other things that could help third-quarter GDP in Europe, including lower gas prices and more holiday or vacation time in Southern Europe, as North Africa bookings have virtually collapsed because of the turmoil there.
 
The current environment of uncertainty and fear also hindered growth in emerging-market countries. We remain consistent in our long-term view that the growing middle-class populations in developing countries will continue to work toward a higher standard of living. That will require vast amounts of infrastructure and increasingly productive economies, and will drive up demand in those countries for the products and services of consumer-facing companies. So far this year, encouraging economic news and positive corporate earnings have helped boost the performance of stocks driven by domestic demand in developed countries. But the sovereign debt issues, natural disasters, inflation concerns and revolutions in the Middle East and North Africa all detracted from emerging market sentiment. 
Taking a more defensive position
In managing the Fund, we primarily invest in what we consider to be reasonably valued large companies with strong cash flow. We are guided by four current global investment themes that we believe should generate above-average growth:
 
  • the growing income of emerging market consumers, particularly in Asia;
  • investments related to infrastructure;
  • solid and believable dividend yield;
  • the accelerating activity in mergers andacquisitions (M&A)
In the current market environment, we continue to pursue the emerging-market consumer theme, although in a low-cost way, and we are focusing more on the dividend theme than the M&A or infrastructure themes. We have moved the Fund in a more defensive direction and decreased exposure to cyclical stocks. We have turned instead to what we think are more stable businesses, with a focus on companies that have good balance sheets and are market leaders in their industries. We continue to emphasize cash-flow generation. The Fund now is overweight defensive stocks relative to the benchmark.
 
We also have adjusted the Fund’s sector positioning since the end of the second quarter. In information technology, we have focused on companies that offer good dividend yields, low or no debt and market leadership. We have continued to increase exposure and overweighting in telecommunications, compared with the benchmark, because of the defensive nature of the low valuations and high yields in the sector. The Fund remains underweight in utilities and financials.
A cautious outlook
We remain consistent — and cautious — in our outlook, so the Fund will maintain a defensive tilt in the near term. Government involvement in markets generally leads to lower multiples and we think it will continue to do so. We still see opportunities in emerging markets and have maintained the Fund’s exposure to these countries. Inflation risks appear to be peaking in markets like China and Brazil. We also believe there could be a significant increase in the “risk-off” scenario from investors, given the debt problems in Europe and the slowing global economy. The world still has not achieved the economic growth level we have been looking for since 2009, so we still are waiting for a self-sustaining recovery. If we see such a development, we will buy into that growth. For now, we expect very modest economic growth for the rest of 2011 in developed markets.
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 18, 2011, and are subject to change due to market conditions or other factors.
 
Consider all factors. International investing involves additional risks including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. 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. Not all funds or fund classes may be offered at all broker/dealers.
 
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 at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
]]> <![CDATA[Ivy Funds Adds to Domestic Value Team]]> <![CDATA[Government policy, debt concerns join slowing global growth to jolt markets]]> Government policy, debt concerns join slowing global growth to jolt markets

   

Michael L.Avery
Co-Portfolio Manager
Ryan Caldwell
Co-Portfolio Manager		    
 

Ivy Asset Strategy Fund – August 2011

 
 
We have seen tremendous volatility in recent weeks. In our view, the world is debating the status and viability of economies and markets in two primary ways. There clearly is uncertainty surrounding macro risk and policy mistakes in a deflationary environment. We think the consensus argument surrounds whether there will be continued negative reaction to policy mistakes in the U.S. and in Europe, compounded by the fact that we are in a deflationary environment in which regulators have few tools to combat the problems of overleveraged developed economies. The counter argument focuses on the sustainability of corporate earnings growth, which has far exceeded nominal growth rates of gross domestic product (GDP) in the U.S., Europe and Japan. We are on the side of believing more sustainability to earnings growth exists — sustainability that will help fuel at least limited global growth — rather than siding with the policy mistake/deflationary argument.
Policy mistakes magnified in a deflationary environment
The risk of a deflation policy mistake seems to be front and center in the market’s mind, along with concern that we are heading into another global recession. We are surprised by the change in perception with respect to the U.S. economy. All along, we thought that nominal GDP in the U.S was going to be subpar for some time. So far, that has been the case, as nominal GDP in the first half of 2011 was roughly just 4 percent. The composition of GDP actually shouldn’t have been surprising, given the oil price shock and supply chain disruption from Japan. Inventory and exports both detracted from GDP in the first half of the year. Importantly, S&P 500 revenue growth in the first half of 2011 was 11 percent. Profitability was 18 percent. We expected and are getting a sluggish developed market recovery.
 
Working through the two big events in the first half of the year that restrained growth — the oil price shock due to unrest in the Middle East and the supply chain disruption out of Japan — we think we’ll recover some of that growth in the second half, although we think it will still be subdued at around 2 percent. That means in a good quarter, when inventory and exports can swing, we could see 3 to 4 percent growth; in a bad quarter, we could see zero growth. Perception of that growth, however, has changed markedly in the last few weeks as policy makers have stepped forth. 
Staying the allocation course amid uncertainty
The Fund is allocated largely the way it was a month ago, with approximately 85 percent of investments in equities, 14 percent in gold bullion and 1 percent in cash. The Fund has not been hedged during the last month, despite the market’s volatility, and is not hedged now. Clearly, we are concerned about risk and managing downside risk remains our priority. However, we also take seriously our mandate to produce a positive, currency-adjusted return over a three-year period. To that end, we have used the market’s recent volatility to reposition the Fund in a way we think is more efficacious given our one- and three-year outlooks. We remain focused on global growth. 
Policy questions and a lack of confidence
The crux of the broader problem is that we don’t see coherent fiscal policy. There is no fiscal policy “magic bullet” that will spur growth, which will remain subdued. Neither U.S. political party has done anything to create growth. The two tactics on the table — raising taxes and cutting spending — are both repressive to growth.
 
We have long believed that the U.S. economy is suffering a consumer balance sheet recession. Interestingly, the top 10 percent of income earners have continued to show accelerating growth sequentially. From the first quarter to the second quarter, the high end got better. From June to July, the high end got better. But we think the real risk to the economic recovery doesn’t have to do with the balance sheet recession — it has far more to do with confidence among the high-end spenders, corporate CEOs and CFOs that are retrenching due to the uncertainty that the politicians and policy makers have created. We think the reflexivity risk is far greater than the sluggish growth risk. The data through July show that the high end has held in well; we will be watching closely to see if that continues in the face of stock market volatility.
 
With respect to monetary policy, the Federal Reserve has made it clear it is going to fight deflation vehemently. By locking funding in through mid-2013, the Fed is trying to encourage investors to take duration and asset risk. By locking in low rates, they are forcing investors out on the risk curve. While this commitment may not be a massive change to the consensus expectation for Fed tightening, it did give leveraged players certainty to carry. The market’s response was immediate: mortgages, leveraged players and leveraged mortgage REITS all saw price explosions. The Fed wants to reinvigorate a credit cycle that will drive asset prices higher. This has been and, we believe, will continue to be the strategy going forward. The best price indicator we have seen is the price of gold going higher, which tells us inflation expectations are rising. We think we’ll see a bigger credit cycle than the one we just exited. The locking in of funding will drive stock buy backs, credit expansions from companies and will encourage the private sector — mainly corporations and investment players — to leverage capital.
 
The mid- to longer-term outlook is shadowed by fiscal and monetary issues. Nonetheless, there are places where we feel growth is prevalent and accelerating, and we have tried to steer the portfolio toward those places. 
Recent developments in Europe
In July, due to market action in Italy, Europe was forced to come up with broad-scale changes to the European Financial Stability Fund (EFSF). Those changes expanded that bailout fund’s tool box, so now it can directly buy back bonds of the periphery nations, take preemptive measures where it deems fit, and provide capital to European banking systems. These were all very important changes that gave Europe the power to contain problems in the periphery. Unfortunately, the size of the EFSF was not increased, and currently stands at $440 billion (U.S.).
 
To put that into perspective, the Italian market currently has €1.6 trillion (euro) in debt outstanding, while Spain has €680 billion in debt outstanding. The bailout fund isn’t large enough to contain the issues. That’s forced the European Central Bank (ECB), which has the unlimited ability to expand its balance sheet, to step in and bridge the gap. The market put tremendous pressure on the curve in the periphery, and the ECB subsequently bought a large amount of debt in both Spain and Italy to try to bring back the interest rates in those curves. Spreads in Spain and Italy got as high as 400 basis points; right now, they’re hovering around 270 to 280 basis points. The ECB essentially brought Europe back from the brink.
 
The changes to the EFSF are now going to have to go through parliaments in Europe. That will begin in September and we hope by the beginning of October the EFSF will be fully operational with all of its new powers. In the interim, it is highly likely the ECB will have to continue to expand its balance sheets to provide stability to the marketplace.
 
We think the problem with Europe all along is that it has announced measures to deal with its crisis and then it hedged those measures. We’re seeing a game of chicken between the policy makers in Europe, the ECB and the marketplace. The market puts pressure on Europe and the ECB to act, Europe and the ECB act and spreads come down, and then they start hedging their actions and the market spreads right back out. To keep this situation stable, we feel the ECB is really going to have to be on the Spanish and Italian curves. The good news is it has the tools to do it. Ireland, Portugal and Greece are different situations; Greece is going to be restructured in a soft manner, while Portugal and Ireland are both on bailout facilities and are going to have to continue to implement austerity plans, which will likely be very painful.
 
Ultimately, we think there should be tighter fiscal integration in the euro zone, which points to the euro bond. That has many implications in Europe. The euro bond is problematic both for Germany and for poor countries, which will have to use their credit ratings to support it. It’s not popular among constituents, and it has dramatic ramifications in the periphery, where sovereignty is probably going to be extracted from those countries in exchange for using the common credit rating of the euro zone. Both of those are going to be very difficult to put through politically and will create a lot of noise in the marketplace going forward. It has to happen, however, to provide stability to the euro and get a common credit rating that will allow rates to come down. We think Italy stands to benefit tremendously. The debt load there is now 119 percent of GDP at the public level. Because of its labor market, Italy has a structurally low-growth economy with a potential GDP of 1 to 1.5 percent.
 
The changes at the EFSF will also likely allow it to provide capital into the Spanish banking system. Spain had a large real estate bubble that put a lot of pressure on its banking system. Many of the smaller banks in Spain need capital, but the market simply isn’t willing to provide that capital. The EFSF can now provide that capital to Spain’s banking system, which should help it go forward.
 
We are expecting Europe to get a handle on Italy and Spain, but it will be a drawn-out process with significant pressure on both countries by the market as well as political pressure and there will be a lot of volatility. We may see a bank or two go bankrupt, particularly in Spain, but wide-scale bankruptcies out of the core are highly unlikely. The type of write downs that may need to be taken in Greece are simply not severe enough to warrant that. They may have to engage in some restructuring, but Europe now has the policy tools to deal with the Italian and Spanish issues. 
Pressure on emerging markets
Emerging markets have been under considerable pressure to raise rates to fight off inflation from currency carry as well as a vigorous rebound in economic growth. One of the benefits of the sell-off in commodities, specifically in energy prices, is that it will allow emerging market policy makers to slow their tightening measures. Inflation in China, for example, is 6.5 percent. We believe we’ve seen the peak in inflation there, so the question then becomes, “Will growth crash?”
 
We think China’s growth will moderate in the 8 to 9 percent range on a real basis, with 13 to 14 percent nominally, which is far more important for revenue growth. While China won’t be aggressively loosening monetary policy, the majority of the tightening is behind us, which should allow for better growth in the second half of the year than we saw in the last quarter. For India, another large economy with strong nominal growth, falling energy prices will be a huge benefit. It will take a lot of pressure off the government and India’s central bank. 
Bullish on corporate earnings
We have been bullish on corporate earnings, partly because we believe management teams are skeptical of the recovery. They have not believed the recovery they’ve seen in revenue and are loathe to spend, which is partly why unemployment in the U.S. is more than 9 percent; companies are not hiring. Capital expenditures are still running under depreciation despite the fact they were up 30 percent in the second quarter of 2011. Margins are staying far higher than the bears are willing to admit. S&P 500 companies generated 11 percent revenue growth in the second quarter vs. nominal U.S. GDP of 4 percent. More than two times nominal GDP was produced in the top line with bottom line profitability at 18 percent.
 
The antithesis of sluggish growth is going to be better-than-expected profit growth, because companies are sourcing their revenue growth and costs from outside the U.S. and profitability is dropping within the
U.S. We see companies with cash flow yields, dividend yields and return on invested capital that are as strong as they have ever been. The market appears to us to be in one of the cheapest quintiles of free cash flow and earnings yield as far back as we can see. The market today, on a “cheapness” basis — based on cash flow generations, margins, incremental margins and return on capital — appears to us to be about as cheap as it was in the fourth quarter of 2008 and the first quarter of 2009. 
When to hedge
We are often asked why we aren’t hedging the portfolio. For us to provide a real rate of return in a nominal interest rate environment that is as low as it is, we are going to have to embrace volatility at some point in the investment cycle. We look at and manage downside risk on a rolling three-year basis. We understand that our client base at times does not want to embrace volatility, but therein lies the opportunity set that we see in real returns. We think the real return in equities is far higher than in any other asset class. The cost/benefit question we have to ask ourselves is, “Should we embrace the volatility and will it reward the Fund with return over that three-year period in time?” Right now, we think the answer is yes.
 
Another factor to consider is the cost of hedging. There are several primary valuation measures we track when we’re looking for opportunities to hedge the portfolio. We look at the level of implied volatility on various indices versus realized volatility on those indices; we look at skew, being the cost of puts relative to the cost of calls; and we look at the term structure of the volatility surfaces of those indexes as well as the implied vs. realized correlation. What we see right now is that because investors seem to be leery of equities and will pay anything to strip volatility out of their portfolios, hedging has become extremely expensive — it’s currently three standard deviations above the average cost of buying puts on any global index. The cost of those puts is in the 99th percentile on every index that we’re looking at. It’s the most expensive we’ve seen. Right now, it wouldn’t be unusual to pay 5 to 6 percent for a put option that will go until the end of the year and that is 5 percent out of the money. To break even on that, the market would have to go down 11 percent from here. And because you’re paying 5 to 6 percent up front for that option, if the market goes up 5 to 6 percent, you’re not going to participate in any of the rebound from these low levels. That’s what you’re paying in terms of opportunity cost and how much downside you’re going to need from this point. We realize there is going to be some volatility, but when you systemically overpay for protection, you cut your legs off in terms of your potential return opportunity. Those are the things we continue to watch and when those valuation metrics come down, we will look for opportunities to layer in some hedges at a reasonable price.
 
We are often asked why we aren’t using index futures, given that they’re less expensive. Granted, the cost of futures is lower on a commission basis and debt spreads, and volumes are extremely high right now. In terms of liquidity, we have plenty to choose from. But what we have to look at is the opportunity cost of using futures. On a volatile day when everyone is getting whipsawed and the market is up 5 percent and you’re using futures, that isn’t going to be a true return to the Fund in terms of what you’re paying on those futures when the market goes up. Correlations are high right now, so we have the ability to use a lot of different tools in the derivatives universe to effectively hedge the portfolio. We aren’t doing that now because we think the risk is to the upside. 
A flexible strategy
We do wish to underscore that we take risk management exceptionally seriously. That is our first mandate. We have the flexibility to orient the Fund in a way where we see, over a three-year period, what we think are the best opportunities for risk and reward. We are taking that opportunity to generate what we feel is optimal risk/return. And from that perspective, as well as an historical performance perspective, we believe we are succeeding in our mission.
 
Of the 35 Class A funds in the Morningstar World Allocation category that had at least a 3-year track record through July, only six had downside capture ratios1 vs. the S&P 500 Index that were lower than the Ivy Asset Strategy Fund.The Fund had a downside capture ratio of
53.7 — meaning that, over the 3-year period ended July 31, 2011, the Fund only incurred a little more than half the losses of the S&P 500 Index in periods when the index fell.
 
We also should note that the upside capture ratio of the Fund exceeded all six of the peer funds that had lower downside capture ratios1 during the 3-year period ended July 31, 2011 — a volatile period that included the market decline of late 2008/early 2009, the ensuing run-up in the second half of 2009 and early 2010, the mid-2010 correction and the post-crisis highs of April 2011.
 
In general, the Morningstar World Allocation funds that had better downside capture ratios were more devoted to holding cash and other assets that generally haven’t performed well when equity markets rose. In short, the Fund has offered a good balance of downside protection and upside potential.
 
1 Downside Capture Ratio measures a manager’s performance in down markets. A down market is defined as those periods (months or quarters) in which market return is less than zero. In essence, it tells you what percentage of the down-market was captured by the manager. For example, if the ratio is 110, the manager has captured 110% of the down-market and therefore underperformed the market on the downside. Upside Capture Ratio is a similar indicator, measuring a manager’s performance in up markets. In those markets, a higher ratio means the manager outperformed the market on the upside. (Source: Morningstar)
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 9, 2011, and are subject to change due to market conditions or other factors.
 
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. These and other risks are more fully described in the fund’s prospectus. The Fund may allocate from 0-100% of its assets between stocks, bonds and short-term instruments, across domestic and foreign securities, therefore, the Fund may invest up to 100% of its assets in foreign securities. 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. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The fund may focus its investments in certain regions or industries, thereby increasing its potential vulnerability to market volatility. The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk, as short selling involves the risk of potentially unlimited increase in the market value of the security sold short, which could result in potentially unlimited loss for the fund, and the value of investments in derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time and storage costs that exceed the custodial and/or brokerage costs associated with the Fund’s other holdings. 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.
 
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 at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
 
]]> <![CDATA[Letter to investors]]> Letter to investors

 
 
AUGUST 2011
 
 
We have recently seen the most dramatic and rapid market movements since the financial crisis of 2008. The volatility is driven by several factors, and can be very unsettling. However, I want to assure you that the entire investment team at Ivy Funds continues to review all market sectors, economic data and global events with an eye toward doing what is best for our investors. We meet every weekday morning to discuss events and ideas, we will continue to do so, and we are working constantly to be astute stewards of the assets you have entrusted to us.
 
This is among the most frustrating environments I have seen in a very long time. Economic fundamentals remain fairly sound, corporate earnings are strong, financial institutions have liquidity, yet various political issues in the U.S. and Europe have created tremendous uncertainty. Financial markets never like uncertainty.
 
The key events we’ve all been reading or hearing about – specifically the package Washington has put forth as part of its step to raise the debt ceiling, and the sovereign debt crisis in Europe – have created more uncertainty rather than helping to mitigate uncertainty. On top of that, Standard & Poor’s, a rating agency, cut its rating on long-term U.S. government debt for the first time in history. All of this has resulted in a perfect storm to rattle the markets.
 
It will take time to settle all of this and for rationality to return. I’d like to say this will go away quickly, but the truth is the markets are the victims of political governance failures. We need more leadership in Washington and in Europe. In time, however, certainty surrounding these issues will develop. Given that, I think it is important for investors to understand that now is not the best time to drastically change long-term investment plans, or sell securities at a loss. We believe it is better to retain a longer-term perspective, wait for sensibility to return and continue to monitor your asset allocation with the guidance of your financial advisor.
 
While we’ve all heard some predictions of an outright recession in the U.S. and a big decline in earnings, we do not believe that is likely to happen. The following quick review of the primary issues impacting the markets right now, and our impression of each, may help as you evaluate your situation.
 
  • First, if the market was truly worried about the U.S. defaulting on its long-term debt, you would not see the rush of money into U.S. Treasuries that we’ve recently witnessed. Over the last week or so, U.S. Treasury securities have seen their yields decline and their prices rise. This is not a sign of concern to us about default. U.S. debt securities remain among the safest in the world, and investors continue to recognize that. 
  • The recent debt ceiling package, after much argument, blame and difficulty in Congress, solves thedebt-ceiling crisis for the short run. But it comes with a timeline to get deficit reduction measures established; a timeline that runs nearly through the end of this year and has a high likelihood of failing. The financial markets simply don’t like this package because it is politically divisive and has yet to show that it can solve any of the uncertainty while clearly decreasing the U.S. deficit. 
  • In Europe, the so-called resolution of the sovereign debt crisis that took place several weeks ago involves a number of commitments but doesn’t address several problems. In short, the European Central Bank (ECB) chose to buy the sovereign debt of Ireland and Greece, but specifically not the debt of Italy and Spain, which became the big issue after the package was announced. European leaders are taking too long to reach a decision on several different sovereign debt issues. There remains a great deal of disagreement among the key players as to who should bear what burdens.
     
  • Is this environment similar to 2008, and could we see similar prolonged market declines? Today we have a fundamentally different and stronger environment, as U.S. financial institutions have tremendous liquidity (unlike 2008), credit markets are functioning normally, consumers andcompanies have scaled back their debt, and corporate profits are strong. The complex investment instruments and systems in place in 2008 are largely non-existent, and the environment is much more tightly regulated. The issues we face today are entirely separate, and in some ways more easily solvable, though consensus and leadership will be required.
Over time, we believe that the message from the financial markets is certainly going to get the attention of the various government authorities. But how quickly they can get focused and gain consensus on credible plans for the deficit issues in the U.S. and Europe is unpredictable. However, we do believe that will happen and will happen reasonably soon. 
 
The financial markets overall, and individual investors and corporate leaders in particular, need more confidence in government and in the future. I think once some action is taken, confidence will improve and the underlying economic tone, which mostly is constructive, should calm the markets down.
 
During this difficult environment, we encourage you not to overreact. In the language of the successful investor, “it is never wise to sell low and buy high.” Remember, a strong financial plan is developed with a sense of clarity and perspective, with your long term goals in mind.
 
Our investment team will never forget that it is your money we are managing. Rest assured, we will continue to monitor the markets, and manage your assets with a profound understanding and appreciation for the trust you have placed in us.
Sincerely,
 
Hank Herrmann
 
 
Past performance is no guarantee of future results. The opinions expressed in this article are those of Mr. Herrmann and are current through August 2011. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. Waddell & Reed Financial, Inc. is the ultimate parent company of Ivy Funds Distributor, Inc.
 
]]> <![CDATA[Maintain long-term view despite recent dramatic market moves]]> Maintain long-term view despite recent dramatic market moves

Fred Sturm
Portfolio Manager
Ivy Global Natural Resources
 

Ivy Global Natural Resources Fund - August 2011

 
 
Despite the dramatic market moves of the past two weeks, we still expect global economic growth to return — tepid, for sure, but growth nonetheless. We expect margins and corporate earnings to prove more robust than the stock market apparently now believes, based on the recent market action. If we are correct, then markets have the potential to recover smartly after the shake-out.
Macroeconomic concerns remain
We believe the euro structure is poorly equipped to deal with the contrast of a solid core in Northern Europe – principally Germany, Europe’s largest economy – and a challenged group of periphery countries including Greece, Ireland, Portugal, Italy and Spain. We expect the European Central Bank (ECB) will step up its direct market intervention efforts of buying the sovereign debt of these countries, as it has recently. This intervention was a positive move, but the market is likely to test the ECB’s resolve. Its resolve must hold or some banks in Europe could be at risk, and we already have begun to see some pressure on selected European bank stocks.
 
The U.S. appears to be stuck in political wrangling rather than engaged in implementing solutions to its debt and budget issues. The lack of a long-term policy decision on these matters prompted Standard & Poor’s to downgrade U.S. Treasury debt on August 5 to AA+ from AAA with a further negative watch. The other major ratings agencies, Moody’s Investors Service and Fitch, have maintained their ratings at this time. Under normal circumstances, downgrades of a country’s debt lead to a higher cost of capital – for example, higher bond yields and a weaker currency. But we think a flight to safety, given current market and economic headlines, may well provide an offsetting prop to the U.S. dollar and help keep yields low. The U.S. Federal Reserve made it clear in its policy statement on August 9, that interest rates will stay low for an extended period of time.
 
Emerging-market countries have been tightening policy to combat inflation. Emerging markets stocks have been stuck between superior growth, relative to developed markets, and more hostile monetary policy. We expect these emerging markets to re-establish leadership once inflation has clearly peaked and investors begin to anticipate easier monetary policy. We expect inflation will peak in the third quarter and we may have easing measures by the fourth quarter. An announcement that we think really would generate excitement would be easier monetary policy intentions in China. However, we think China may hold off a little longer because it wants to wrestle commodity prices lower first.
A long-term view
We have made few changes to the portfolio of the Ivy Global Natural Resources Fund, but given the rapid price decrease of equities, we are looking to increase exposure at some point in the next several weeks. In the years prior to natural resources gaining widespread interest, higher quality companies with more visible prospects tended to fare better during stock market declines. However, now “swing traders” that also hold the stocks of these companies can apply additional pressure. This means we anticipate an opportunity to further concentrate in preferred sectors and companies, but we may need to wait for this selling to move through the system.
 
We maintain our bullish view on gold. While the stocks of companies in this sector have performed better than other sectors, they have not kept pace with the price rise of the metal itself. Coal stocks have been poor performers because they have had some delivery and cost pressure misses. However, we think electricity growth in emerging markets will be an enduring theme during the next three to three to five years. We still like this group despite the recent market pummelling. We also continue to favor energy service companies. Oil prices may be pushed lower by liquidation, but we do not expect low prices to last long enough to materially impact energy exploration and development expenditures.
Broader investment implications
Going forward, earnings estimates probably will need to be trimmed. Investor uncertainty can overshoot on the downside, compressing valuations further, but many stocks have fallen significantly to levels that we think offer stronger valuation support. Global forward price/ earnings ratios range from 9 to 14 times, with the average roughly 11 times. Even after allowing for a reduction in earnings expectations, we think this still leaves equities moderately undervalued relative to historic comparisons and very attractive relative to fixed income alternatives when using a multi-year view.
 
When we look at stocks, we favor financially strong market leaders – weaker companies are more exposed during challenging periods. We also prefer companies with what we consider attractive dividend yields. More than 150 U.S. companies have yields beyond government bonds, with at least a chance for dividend growth.
 
We think the macro issues around the globe should lead to sustained easing in monetary policy, and that easing should be supportive for limited-supply assets such as gold. Given additional social and budget stresses for oil-producing nations, we believe a higher oil price will be needed going forward, relative to past years. We would put that price at roughly $80 (U.S.) per barrel, and consider a price less than that to be unsustainable. Investors in oil may put pressure on prices as they liquidate, but Saudi Arabia is the only effective source of spare oil. The Saudi government may allow prices to drift temporarily, but it has the means to defend prices if it wishes.
 
 
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 10, 2011, and are subject to change due to market conditions or other factors.
 
Risk Factors: Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. 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. Investing in natural resources can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments; and the cost assumed by natural resource companies in complying with environmental and safety regulations. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the prospectus. Not all funds or fund classes may be offered at all broker/dealers.
 
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.
]]> <![CDATA[Summertime...and the livin' is queasy...(1)]]> Summertime...and the livin' is queasy...(1)

Dan Vrabac
Mark Beischel, CFA
Co-Portfolio Managers

 

 Ivy Global Bond Fund – August 2011

 

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The Global Financial Crisis bequeathed to us a complex, volatile investment environment that could continue for quite some time (if you don’t believe us, check your Reinhart and Rogoff 2). It is incumbent upon portfolio managers to properly assess this environment and structure their portfolios in such a way as to minimize the risk of permanent capital loss while still providing a decent return to the investors who trust the managers with their hard-earned funds.
                                  
So, as portfolio managers of the Ivy Global Bond Fund — and also as investors in the Ivy Global Bond Fund — what is it that we are paying closest attention to this summer?
Things That Go Bump in the Night
Here is our list of some of the more important issues facing investors today — not in any particular order. Not only are all of these issues important, they also tend to be intertwined. Although you could write a book (or perhaps a short story) about each of these, in the interest of time and space we will do our best to get these points across as briefly as possible. We also promise to end on a somewhat more upbeat note.  
  • Europe and the Euro
  • Low economic growth in the U.S.
  • The U.S. debt situation and AAA rating
  • The U.S. dollar and its reserve currency status
  • The U.S. inflation outlook
  • China’s growth outlook and problem loans
Europe and the Euro
The European crisis started in Greece, and then spread to Ireland, Portugal, and Spain. Now even Italy is under threat. The crux of the crisis is debt sustainability. The headlines all seem to focus on what European leaders will do to bail Greece (et al) out of the crisis. To us, this focus on bailouts is wrong-headed. A bailout implies that there is a liquidity crisis. In a liquidity crisis, the solution is to provide enough temporary funding to a country so that it can make its debt payments until it gets back on its feet. This is what European leaders have been trying to do for Greece for well over a year now — not only to no avail, but also causing the crisis to spread to other countries. What we believe Greece and some of the other so-called peripheral European countries are suffering from is a solvency crisis — they owe so much debt that there is no way out short of a default or bankruptcy. In other words, their economies cannot grow enough or generate enough revenue to sustain the current levels of debt. Furthermore, the onset of fiscal austerity programs in all of these peripheral countries will have an additional negative impact on growth. Therefore, the level of debt keeps growing at an alarming pace.
 
We think there are two feasible solutions.3 The first is a default. This would likely involve a dramatic writedown of Greece’s (and perhaps other peripheral countries’) debt load. To us, this is the most logical and likely end result to the situation. That means the lenders — primarily the European Central Bank, European governments and European commercial banks — will likely take an immense hit to their capital. The more peripheral countries this spreads to, the bigger the impact. Unfortunately, the longer Europe’s leaders take to realize this the worse the situation gets.
 
As an aside, it is also possible that one or more peripheral countries may be forced out of the Euro currency due to their debt problems. Significantly reducing debt loads is typically one part of the road to recovery; another part is a significant depreciation or devaluation of the currency. As long as the peripheral European nations cling to the Euro, the depreciation/devaluation route is not open to them, and their growth prospects will be significantly reduced. It should also be said that regaining stability in a defaulting country with a big currency write-down doesn’t guarantee immediate success — we think it will take years and involve a lot of pain. However, that is the ultimate conclusion to the end of a debt binge.
 
The second solution is what some are calling a “Eurobond”; essentially— instead of having Greek government bonds, German government bonds, Italian government bonds — there would be one Eurobond guaranteed jointly and severally by all of the European nations. This is the ultimate bailout of the peripheral nations by the strongest nations in Europe. It also puts the German and French taxpayers on the hook for all of the peripheral country debt. Without true debt restructuring in the periphery, we believe the creditworthiness of the core (Germany and France) will eventually be called into question. We believe the political roadblocks to this type of fiscal union are too large to allow this solution to occur before the extreme economic circumstances in one or more of the peripheral countries create a default situation.4
 
IVY GLOBAL BOND FUND POSITION: We have no government bond investments in peripheral Europe. Our total Western European bond exposure is about 1% of the portfolio, and this is in corporate bonds denominated in U.S. dollars. Finally, we have a “short” position on the euro given our belief that it should decline versus the U.S. dollar as the crisis unfolds.
Poor Growth Prospects in the U.S. — Lowered Potential Growth
Potential Gross Domestic Product (GDP) growth is the rate at which the economy can theoretically grow based on its expected labor and capital inputs.5 If the actual GDP growth rate is faster than potential, then the economy risks overheating and a rise in inflation. If the actual GDP growth rate is slower than potential, it’s typically recessionary and disinflationary as productive resources aren’t efficiently utilized. The U.S. economy is currently very much in the latter area.
 
Real potential GDP growth has declined sharply in recent years. Before the Global Financial Crisis, potential GDP growth was fueled by excessive borrowing and was estimated to be between 3% and 3.5% on an annual basis. However, the Congressional Budget Office (CBO), the official arbiter of the country’s potential growth rate, now sees potential growth over the next decade at 2%.6 Our own calculations show potential GDP growth to be 2% or below.
 
Why is this important? The GDP of the economy today is approximately $15 trillion. Growing at 2% instead of 3.5% results in approximately $225 billion less in real GDP annually; after a decade, with compounding that would grow to a nearly $3 trillion difference!
Poor Growth Prospects in the U.S. — Lousy Employment Situation
Prior to the Global Financial Crisis, there were approximately 138 million employed Americans. The level of employment today is closer to 131 million. But that’s not the full story. Employment drops during every recession; however, in the typical post-World War II recovery, employment is back to its pre-recession level within two years. Three years after the recession began we would typically have employment three percentage points higher than it was at the start of the recession. The situation today? Three years after the onset of the recession (and global financial crisis), the number of Americans employed is five percentage points lower than at the onset of the recession!
 
Now consider the numbers. As we mentioned, there were 138 million employed at the onset of the recession. In a typical recovery, where three years down the road we would have 3 percent more workers than at the beginning of the recession, we would have approximately 142 million employed today. Because 131 million are actually employed today, a case could be made that we are actually short 11 million jobs and not 7 million. Let’s take this one more step. The Social Security Administration calculated the national average wage income at $40,711 for 2009 (the latest available data). If you multiply that by 11 million, the annual amount of lost income is nearly $450 BILLION dollars. Assuming the majority of that amount would be spent, it represents a huge drag on GDP growth.
 
IVY GLOBAL BOND FUND POSITION: With such a low potential growth rate and lack of job creation (not to mention the ongoing housing crisis — a huge negative wealth effect for the consumer), interest rates should remain low on average. However, as we have seen over the past few years, the volatility of the economy has increased markedly. Some have described this as a “low Sharpe ratio” environment — low returns with a lot of risk. The Ivy Global Bond Fund addresses this by having a low duration in an attempt to mitigate the volatility, and investing in corporate bonds in an attempt to gain additional yield in a low rate environment.
The U.S. Debt Situation and the AAA Rating
We covered the U.S. debt situation in-depth a year ago in our July 2010 Portfolio Perspectives, and our comments are still relevant today. The debt topics du jour are the debt ceiling and the credit rating of the U.S. The U.S., of course, is in no danger of not having enough resources to meet its debt obligations. As of the time of this writing, Congress and the President have arrived at a temporary solution to the debt ceiling problem. They have kicked the can far enough down the road to avoid a technical default for now; unfortunately, the real problems have not been dealt with.
 
Today the public debate is centered on how the government is going to deal with a large budget deficit and an already high federal debt-to-GDP ratio. The focus of this debate has led the U.S. government (and many governments around the world) to prematurely embrace fiscal austerity— primarily by cutting government spending. However, this is putting the cart before the horse. The real underlying danger today is poor economic growth, high unemployment, and reduced competitiveness of the U.S. economy. The proximate cause of our problems today was the private sector borrowing binge over the last nearly three decades prior to the onset of the global financial crisis in 2007. The high government deficits and debt are merely symptoms of this problem. We absolutely must deal with spending over the medium-term and long-term, but fiscal austerity in the face of a flagging economy has been demonstrated to be not only an inappropriate response, but a dangerous one — a response that can exacerbate the poor economic situation.7
 
Some investors and politicians are concerned that if we don’t deal with the deficits and debt right now, then the U.S. is going to suffer a downgrade in its credit rating. While further downgrades could have an immediate adverse market reaction, we would argue that the market has had ample time to digest this possibility, and therefore such a negative reaction would be short-lived.8 We believe the U.S. was not downgraded by Standard & Poor’s because of the debt ceiling or the size of the deficit. We think the real reason for a downgrade was the fact that the government has not yet adequately dealt with the medium-to long-term problems of health care, social security, and defense spending. As an aside, we think the rating downgrade of the U.S. could have more negative implications in Europe than in this country. Now that the U.S. AAA rating is being called into question, the market is (rightfully) wondering why France would remain AAA. Should France lose its AAA status, then the entire bailout structure put into place in Europe for the peripheral countries gets called into question.
 
The lack of action on these big spending issues weighs heavily on the minds of all investors — particularly the foreigners who own over 40 percent of our federal debt. But we don’t think that spending control is the most pressing issue today. We believe the first item on the government’s agenda should be to get the economy growing again— and this may require more deficit spending in the near-term, and not less. We think the U.S. government should focus on offsetting lackluster economic growth now while forming a credible fiscal plan to deal with the longer-term problems — especially in health care expenditures.
 
The U.S. is recognized throughout the world as always providing liquid and open markets; we have been the “go-to” country in times of global distress. We risk sacrificing this credibility not because of the debt ceiling or a rating downgrade, but because we have not forcefully dealt with the more problematic longer-term issues facing us. The longer-term implications of a loss of trust in the U.S. could be severe. We should follow the wisdom of Alexander Hamilton, first secretary of the United States Treasury, who remarked:
 
“But who would lend to a government that prefaced its overtures for borrowing by an act which demonstrated that no reliance could be placed on the steadiness of its measures for paying? The loans it might be able to procure would be as limited in their extent as burdensome in their conditions. They would be made upon the same principles that usurers commonly lend to bankrupt and fraudulent debtors, with a sparing hand and at enormous premiums.”9
 
IVY GLOBAL BOND FUND POSITION: Our primary concern is with insufficient growth, and fiscal and monetary tightening now will only make the near-term situation that much worse. Issues such as the debt ceiling and the U.S.’s debt rating only increase market uncertainty and volatility. The Ivy Global Bond Fund has ample liquidity on hand to help steady the ship and to take potential advantage of any mispricing opportunities which may occur.
The U.S. Dollar and its Reserve Currency Status
Investors have shown a lot of concern over the U.S. dollar’s status as the world’s primary reserve currency. The following factors are usually cited for the concern:  
  • The impact of the debt ceiling debate;
  • The rapid increase in government debt;
  • The huge expansion of the Federal Reserve’s balance sheet;
  • The rise of China;
  • The downgrade of the U.S.’s “AAA” rating.  
There is a lot of misinformation and misunderstanding regarding exactly what it means to have reserve currency status. Briefly, a reserve currency must be very liquid; it must be supported by a large and liquid domestic bond market; it cannot be subject to capital controls; the country underlying the currency must be trustworthy (i.e. not having a history of default, runaway inflation, or other forms of confiscation); it will be widely held by central banks around the world; the reserve currency country must be willing to supply all the currency the rest of the world needs; and, it will be used for business and financial transactions globally. The U.S. dollar became the world’s de facto reserve currency following World War II under the Bretton Woods agreement; even though this agreement fell apart in the early 1970s, the U.S. dollar remains the primary reserve currency today, constituting over 60% on average of global central bank foreign exchange reserves.
 
Quick question: Can you name another currency that meets the qualifications stated above? We can’t. Sure, there are a few currencies out there that can supplement the U.S. dollar in central bank holdings,
e.g. the Euro, the Japanese yen, and to a lesser extent the British pound. But none of those currencies could replace the U.S. dollar as the primary reserve currency because no country meets all of the necessary qualifications. What about China? Although in the next several years we fully expect the Chinese currency to become more important and gradually be added to the list of currencies used for reserve status, we think we are several years away from that happening — again, consider all of the qualifications and ask if China meets those today.
 
We fully expect the U.S. dollar to decline in importance over the next decade as central banks continue to move toward a multi-currency approach with respect to their reserves. Other currencies will start to be                 utilized in business and financial transactions as well. But — in spite of the current debt ceiling shenanigans going on in Washington, the loss of AAA status, and the rising debt — we believe the U.S. dollar will remain the primary reserve currency for years to come.
 
IVY GLOBAL BOND FUND POSITION: Unlike a lot of global bond funds which depend on currency movements for their return, the Ivy Global Bond Fund considers itself U.S. dollar-based and seeks return first through income on its investments. If we don’t believe there are sound fundamental reasons to invest away from the dollar, we will maintain a large U.S. dollar orientation in the Fund. We expect to gradually increase our exposure to emerging market currencies, but the high risk environment in the aftermath of the Global Financial Crisis warrants caution and slow progress toward that objective. We won’t trade every wiggle in either currencies or interest rates, because we believe that is detrimental to the long-term capital preservation of our investors.
The U.S. Inflation Outlook
At the current time, we are not concerned with the potential of a sustained rise in inflation in the U.S. Lower potential growth and the poor employment situation discussed above are the primary reasons. Without wage growth, we think it is highly unlikely that inflation expectations (a key variable watched closely by the Federal Reserve) get out of control. True, commodity prices and imported inflation have been on the rise. However, these have tended to have only a temporary influence on the price level. Furthermore, the higher commodity prices go, the greater the negative impact on growth. Lower growth tempers demand, which keeps inflation under control.
 
In the medium-term, what could cause us to change our inflation outlook would be a sustained rise in commodity prices (over several years). This would have to be accompanied by a sustained increase in import prices other than commodities. How could this happen? The high rates of growth in China and India are causing continued strong demand for commodities; that demand will not only increase commodity prices, but lead to higher generalized inflation in their economies. Higher inflation leads to higher wages. Higher wages will require their companies to charge higher prices for their products — resulting in higher import prices in the U.S. For nearly a decade the U.S. has benefitted from China exporting deflation; in the years ahead, the emerging world — as their domestic economies grow — could begin exporting inflation to the U.S. and the rest of the developed world.
 
The scariest development occurs if the U.S. hasn’t gone far enough down the road in terms of improving its competitiveness at the same time the inflation in emerging markets gets passed along to developed countries. The ugly possibility of stagflation in the U.S. then becomes the grim reality. We do not see this in the near future, but it is a concern in the medium-term.
 
IVY GLOBAL BOND FUND POSITION: The short duration of the Fund and the extra liquidity are designed to make the Fund much more maneuverable. Should inflation become a problem, the Fund can quickly attempt to take advantage of higher yields as interest rates rise and spreads widen.
Chinese Growth (in particular), Global Growth (in general)
The real questions in China are whether or not its underlying growth rate is peaking, and whether its inflation is cyclical or structural. The answers are crucial for the performance of the global economy and the markets, as everyone knows that on the margin China is perhaps the most important player globally. Let’s deal with growth first. China continues to print good numbers, but the quality of that growth is increasingly being called into question. The concern is that China’s debt levels are growing faster than the economy, and the economy is requiring more and more debt to continue those high levels of growth. If you’ve lived in the U.S. for the last 10 or 20 years, you know how that ends up working out. Furthermore, the main concern of China’s leaders (and Western investors) is the unbalanced nature of that growth. Investment spending as a percent of GDP in China is higher than it has ever been for any other country; conversely, its consumer spending as a percent of GDP is very low. The authorities have taken several steps to curtail the growth of debt, but they have been unable to control unofficial sources of credit. As China continues to raise interest rates and reserve requirements on banks to slow loan growth, the impact on the economy will likely be further softening. At a time when the developed countries of the world are slowing once again (and those same countries are entering a period of fiscal and monetary austerity), it does not bode well for global growth overall. Finally, developed countries that have done well, e.g. Germany, are highly dependent on continued growth in China.
 
Now let’s consider Chinese inflation. The higher interest rate and reserve requirements mentioned above are not only an attempt to fight credit growth but also inflation. Where is the inflation coming from? Some economists believe it is temporary, a result of higher pork prices (pork being a significant portion of consumer spending). The pork-based inflation has occurred numerous times in the past and has always proved temporary. However, there is strong evidence that the current higher level of inflation is structural, and China will need continued tight policies and lower growth to battle it. The evidence here is rising wages. By allowing recent wage hikes to stick, the authorities appear to be acknowledging that inflation expectations among the population have risen. Without wage hikes, there would be social unrest, which is an anathema to the authorities. Finally, there is an economic concept known as the Lewis Turning Point. Expect to hear more about this with regard to China. Essentially, a Lewis Turning Point is reached when, in a developing economy, the rural-to-urban migration has peaked. The economy moves from a situation where wages are low and stable to one where wages begin rising as the new supply of labor is not enough to meet the demand. This would mean China has a structural, and not a temporary inflation problem.
 
IVY GLOBAL BOND FUND POSITION: We believe that these intense internal pressures in China warrant continued appreciation of the currency, so we have positions that benefit from a rise in the Chinese renminbi versus the U.S. dollar. A higher value of the currency will give consumers greater purchasing power, and reduce the need for the government to offset the money supply increase resulting from high trade surpluses. Finally, a higher currency is a key tool in fighting inflation.
Ok, Enough “Things That Go bump in the Night”; Where are the opportunities?
Like others, we believe there are good opportunities ahead in several emerging market countries. There are also opportunities in companies in developed countries that do business in emerging markets. However, one cannot emphasize strongly enough that in spite of all the improvements, these are still emerging markets — they operate under different rules of law, they have mostly immature and/or small local markets, and their per capita incomes are very low by developed country standards. Therefore, investors must make sure they are being sufficiently rewarded for investing in emerging markets.
 
Although emerging markets have the potential to continue to grow as a percentage of the Ivy Global Bond Fund, it isn’t the only place where opportunity may be found. We will continue our search for the best companies in the world, whether in emerging or developed countries — and we will do our best to preserve capital while providing a reasonable flow of income to the investor. In this Perspectives, we just wanted to let you know that not only are we aware of the risks facing investors, we are doing our best to mitigate those risks.
 
The opinions expressed are those of the Fund 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 August 10, 2011, and are subject to change due to market conditions or other factors.
 
Consider all factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. 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. 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.
 
 
1. Our apologies to George Gershwin.
 
2. “ This Time Is Different: Eight Centuries of Financial Folly,” Carmen Reinhart and Kenneth Rogoff.
 
3. Emphasis on “feasible.” There are plenty of so-called solutions being offered that really do nothing to address the debt sustainability problems.
 
4. On July 21, 2011, European leaders came up with a plan that contains elements of both of the solutions described above. However, we think the plan doesn’t go far enough in either direction. We expect further pressure on Europe and European bond prices until the debt sustain ability issue is properly addressed.
 
5. Potential GDP growth is basically determined by growth in the labor force and growth in productivity. Both of these have trended lower over the past decade.
 
6. CBO’s 2011 Long-Term Budget Outlook, June 2011.
 
7. Expansionary Austerity: New International Evidence; IMF Working Paper July 2011 (WP/11/158).
 
8. On Friday, August 5th, Standard & Poor’s downgraded the U.S. debt rating from AAA to AA+. The other two rating agencies, Moody’s and Fitch, have not indicated any downgrade in the very near-term.
 
9. The Federalist Papers, number 30.
]]> <![CDATA[At mid-year, we’re staying cautious yet focused, as a number of issues impacted capital markets around the world]]> At mid-year, we're staying cautious yet focused, as a number of issues impacted capital markets around the world


Michael L. Avery
Chief Investment Officer
Co-Portfolio Manager
Ryan Caldwell
Co-Portfolio Manager
 
Jonas M. Krumplys, CFA
Assistant Portfolio Manager
 
Aaron D. Young
Investment Analyst
 

 

Ivy Asset Stategy Fund - July 2011

 

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TOPPING THE LIST OF CONCERNS facing investors are ongoing sovereign debt issues in peripheral Europe, uncertainty surrounding the U.S. debt ceiling, a sliding dollar and rising social tension in the Middle East and North Africa. Against these headwinds, however, we are seeing positive signs, including growing corporate earnings, which are a key driver of longer-term equity performance, and equity prices that remain reasonably valued.
Staying the allocation course
The Fund has approximately 87 percent of assets invested in equity securities on a net basis. We have just over 11 percent of the Fund in gold and 2 percent in cash. We continue to have no exposure to fixed income and our use of derivatives has remained at a fairly low level.
 
Within the equity portion of the portfolio, we continue to allocate approximately half of the Fund’s equity assets to the U.S., and a quarter to emerging markets (primarily China). The remainder of assets are allocated to other developed markets, including Europe. This positioning has helped support the Fund’s stability during recent market volatility, as well as across the past year.
 
Although broadly optimistic, we currently remain concerned about the debt problems in the European periphery. In the past month, we have seen the headlines swinging wildly, from those supporting the likelihood the issues will be resolved to others bemoaning the potential for a disruptive debt crisis across several countries.
 
In June, we would have been talking about Greece, and in July, we have walked through a solution involving rolling some of the extensions of Greek debt and lowering interest rates there. Most recently, attention has shifted to Italy, which today looks like more of a liquidity issue than a true debt concern. We continue to watch comments from officials at the European Union (EU) and the European Central Bank (ECB), who seem willing to continue to kick the can down the road with these issues, effectively extending the situation in the hopes for a better solution in the future. We don’t know what the resolution will be, but it will probably be something in the form of the ECB buying sovereign credits that are at risk, on a daily basis, and continuing to do that until they just basically wear the market down. The objective would be postponing any substantive issue until after September/October, when Jean-Claude Trichet steps down and Mario Draghi steps up as President of the ECB.
 
The market also fixated on whether the U.S. debt ceiling would be raised on August 2. As we thought, politicians came up with a last minute deal to raise the debt ceiling while pushing most hard choices on spending off into the future, at least high enough to take it off the table as a political issue, meaning into early 2013.
Inflation and emerging markets
We continue to be concerned about growth and inflation in emerging markets and are watching those issues carefully. Over the past month, the Chinese have reported new inflation numbers at 6.4 percent year-over-year, led by pork prices, which are a key part of the Chinese consumption basket. It’s is generally believed that this is the peak of Chinese inflation, and many commentators expect to see the Consumer Price Index (CPI) fall through the balance of the year.
 
We have also seen China raise interest rates on both deposits and on loans. Across the emerging world, policy makers are engaging in the tricky balance of trying to bring inflation under control while continuing to support absolute high and attractive levels of growth. We continue to be interested in investing in the emerging world, specifically in the areas where we can see people growing per capita GDP and becoming more prosperous.
Recent accounting scandals
There have been many headlines recently about accounting scandals at a number of Chinese firms, and Moody’s has raised a red flag on more than 60 companies. While that is concerning, we think it’s important to acknowledge that the vast majority of the Chinese companies that have had any type of accounting issues are companies that are listed on the Western Exchanges, not Hong Kong or China. Most of the companies that have had problems are reverse-merger companies that chose to list in the U.S. through their merger with another company because they want to avoid some of the scrutiny that comes from listing in the Chinese or Hong Kong markets. Those markets require more extensive verification with local auditors who know the company and who spend time with investors who know the company.
 
When we look at large companies listed in China, it’s been our experience that the accounting has been as good there as in a lot of other countries in the world. We are careful to look through the financial statements with a critical eye, regardless of where in the world the company is listed. In general, the companies owned by the Fund that are listed in China and Hong Kong have not been ones associated with these accounting scandals.
 
We are frequently asked why the Fund is 80 percent long equities with very little hedge. Part of the answer is that we think the market sentiment has been very negative and that investors have been very risk averse. The cost of protection has risen to the point where it just does not make sense for us to try to hedge, because the premium that it would incur would more than eat up any potential performance we might gain. The cost of reducing volatility seems especially high in light of our positive view of the equities we own.
Stabilizing the recovery
We continue to focus on policy makers’ efforts to stabilize the recovery in developing markets; the Japanese auto manufacturing and supply issue continues to be important and continues to distort data, both in Japan and across most of the developed world. In the U.S., we are seeing a variety of uneven data indicators. We continue to look forward to higher capital expenditures going forward, and we continue to expect to see data improve going through the balance of the year as some of the issues and distortions following the Japanese earthquake and subsequent supply chain disruptions work themselves out.
Challenges remain
Overall, our outlook remains guarded, as significant challenges remain. As we discussed, sovereign debt issues in European periphery countries are yet to be resolved, and debt levels in the U.S. are still very high. For that reason, we anticipate only modest improvement and low to modest GDP growth in the U.S. for some time to come. We believe the outlook for U.S. equities is improving given that excess liquidity is finding its way into financial assets. Our outlook for China and India economic growth on a relative basis continues to be positive. We do, however, expect a slowdown as their respective policy makers attempt to pare the growth rate and manage inflation. We continue to focus on emerging markets where we can see growing prosperity, and we continue to focus on security selection, looking for highly profitable companies with good levels of free cash flow generation.
 
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund 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 July 28, 2011, and are subject to change due to market conditions or other factors. Unless specifically noted within the text, holdings mentioned within this perspectives are as of June 30, 2011.
 
The Fund allocates from 0–100% of its assets primarily among stocks, bonds, and short-term instruments, across domestic and foreign securities. • 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. • With regards to fixed-income securities in which the fund may invest, these are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. • Because the Fund may concentrate its investments, the Fund may experience greater volatility than an investment with greater diversification. • The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk. • Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the Fund’s prospectus. • Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.  
 

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.

]]> <![CDATA[Congress bumps into the debt ceiling (again)]]> Congress bumps into the debt ceiling (again)

Ivy Funds Market Perspective - July 2011


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There is perhaps no issue that divides the nation’s two major political parties more than their respective views on how the government generates its revenue and how those funds are spent. When Congress is asked to raise the federal debt limit, the debate can become particularly intense as politicians seek to leverage the pressure created by potential default by adding stipulations related to taxes and spending. Although it is broadly expected that the issue will be resolved before the deadline, understanding the issue from a historical perspective may prove beneficial and offer a suggestion of what may lie ahead, both in the near future and over the long-term.
 
Much has been said since Treasury Secretary Tim Geithner’s May announcement that the U.S. government would hit its debt ceiling on Aug. 2. In the absence of a quick compromise, former White House Budget Director Peter Orszag suggested that markets would have to first exhibit signs of turbulence before Congress would reach an agreement in raising the debt ceiling. Soon after, credit rating agencies suggested they would lower the government’s debt rating with Standard & Poor’s saying in late June that it would drop U.S. debt from its top-level AAA rating to D in the event of a default. More recently, Moody’s said it would downgrade at least 7,000 top-rated municipal credits affecting $130 billion in municipal debt linked directly to the federal government. There have also been statements that even if there is a deal to raise the debt ceiling, the government could still lose the AAA rating if the agreement does not appear “credible.”
Not a new issue
 
Despite the recent rhetoric, increasing the government debt ceiling has been a fairly regular occurrence in the U.S. for decades. Since 1962, Congress has enacted more than 70 measures that have altered the federal debt limit. Since 2001, Congress has increased the limit 10 times including two increases in both 2008 and 2009 when the deficit swelled as the nation dealt with a financial crisis and a recession.
 
Although the debt ceiling issue has come before Congress frequently, there has never been a case where the U.S. has defaulted on its debt. Extended Congressional debate, however, has created challenges for the U.S. Treasury, which has to employ various measures to keep government borrowing below the cap. In the current debate, many of those steps have already been taken to push the deadline back to Aug. 2. Theoretically, the government could also sell assets acquired under the Troubled Asset Relief Program, but Geithner has said that option is not viable because taxpayers would suffer losses in a fire sale environment.
What next? Default seems unlikely
 
Either a government default or the sale of government assets to prevent a default would have major ramifications. In recent days market watchers and commentators have made cases for many – and sometimes opposing – outcomes under either scenario. So far, however, there has been little clear evidence of the debt ceiling debate having an impact on the markets. While one-year credit-default swaps on U.S. debt have moved higher, from 7 basis points in early April to around 40 in June and the mid-50s by mid-July, even at these levels they imply a 0.05 percent chance of a default within one year, according to Moody’s analytics.
 
In the days to come, there might be some benefit for both lawmakers and investors to keep a couple of points in mind:
 
  • Lessons from the past: When the House voted down the $700 billion financial-rescue package in September 2008, stocks went into a virtual free fall with the Dow dropping more than 700 points as markets worried that Congress would not take steps to thaw frozen credit markets. The Wall Street Journal called it “The Beltway Crash” – a reference to Washington’s “inside-the-Beltway” policymakers making investors jittery. Not surprisingly, legislation was approved only a few days later.
 
  • Looking to the future: Some budget experts are concerned that a slow recovery could keep federal revenues below trendline for several years. That view, along with the history of the debt ceiling, suggests this may be a frequent issue for Congress for some time to come.
 
 
Past performance is not a guarantee of future results. The opinions expressed represent those of Ivy Investment Management Company and are no guarantee of the future performance of any particular Ivy Funds product, nor are they intended to serve as investment advice.
 
Investment return and principal value will fluctuate, and it is possible to lose money by investing. Consider all factors. 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 high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds.
 
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 any of the ivy Funds, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
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