Evolution in global economy

The term “emerging markets” was coined in 1981 to change the perception of economies and markets in developing countries, which make up 80% of the world’s population and 75% of its geographic area.

In general, we think there are four main features in emerging markets that differentiate them from developed economies:

• low household incomes,
• ongoing structural changes, such as modernization of infrastructure
• progress in economic development reforms,
• less-mature markets in terms of regulation and liquidity.

As household incomes rise, more people are moving into the middle class in emerging markets. Their spending patterns tend to change with the rising income, going beyond subsistence into discretionary goods. By 2030, there could be 5 billion consumers in the world with the majority in emerging markets.^¹ Those consumers already are having a significant impact on global consumption and the demand for energy, technology, housing, health care, education and more.

Variety of supporting factors

A combination of factors has prompted investor interest in emerging market equities in recent months. An end to the U.S. dollar rally and a slow recovery in energy prices have provided two strong tailwinds. Those were joined by uncertainty after the U.K.'s vote in June to leave the European Union ("Brexit"), the onset of negative rates on an estimated $13 trillion of sovereign bonds, and persistently low inflation with slow growth in the U.S. and other key developed markets. In addition, emerging market equities valuations still are trading at a discount to developed markets, compared with historical averages. For example, emerging market equities on average recently traded at about 10.9 times projected 2017 earnings versus about 14.6 times earnings for developed market equities.^²

That means many emerging market equities are trading at what we still consider attractive valuations while many developed market equities are trading above historical means. History shows that the gap is likely to narrow at some point, but we believe the current levels create opportunities now.

As we look at countries around the world in more detail, we believe geopolitical events will continue to cause market volatility through the balance of the year. The resolution of the Brexit issue, the pace of future interest rate increases by the U.S. Federal Reserve (Fed) and the U.S. presidential election are likely to be among the most important influences on emerging markets in the near term. It's worth noting that we do not think the Fed will increase interest rates in the foreseeable future.

We remain selective in investments in China, where President Xi Jinping’s ongoing anti-corruption campaign is delaying the implementation of broad-based reforms in the state-owned enterprises (SOE). We think these are needed to continue to build opportunities for business to develop outside the SOE structure. We are watching the SOEs for signs of a policy change.

We expect the stabilization in oil prices will be particularly beneficial for oil-exporting countries. In our view, Russia and Brazil can begin to generate positive gross domestic product growth in the coming quarters as a result of steadier oil and other economic improvements in each country. It also appears that inflation has peaked in Russia, where the central bank has begun to cut interest rates. We believe Brazil is only about six months behind in this process.

A closer look at the fund

We are pursuing several key themes as we research and select securities for the Fund now, including:

• The burgeoning middle classes in emerging market economies.
• The growing levels of consumption that accompany that trend.
• The updating and expansion of new growth drivers such as energy, new energy vehicles, health care, biosimilar pharmaceuticals, technology and education.

There is a tendency to think of emerging markets as a single potential investment option, but there are many variations among these countries. We think it’s critical to analyze each country’s fundamentals and idiosyncratic risks, and to analyze it sector by sector in order to make an investment decision.

We think potential opportunities may continue in the near term from lower oil prices and ongoing reform programs in many emerging market countries. Given the variations and volatility of each individual market, we believe an active management approach is the best way to invest in equities in these markets.

¹Source: Brookings Institution Press, “China’s Emerging Middle Class: Beyond Economic Transformation”

²Source: Bloomberg.com market data

Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s portfolio 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 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

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

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. 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 magni?ed in emerging markets. Investments in countries with emerging economies or securities markets may carry greater risk than investments in more developed countries. Political and economic structures in many such countries may be undergoing signi?cant evolution and rapid development, and such countries may lack the social, political and economic stability characteristics of more developed countries. Investments in securities issued in these countries may be more volatile and less liquid than securities issued in more developed countries. 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.

IVY INVESTMENTS^SM refers to the financial services offered by Ivy Distributors, Inc., a FINRA member broker dealer and the distributor of IVY FUNDS® mutual funds, and those financial services offered by its affiliates.

It’s difficult to find clarity and predictability in today’s markets. The signals from currencies, equities and fixed income markets are confounding, to say the least.

Throw in market reactions to central bank meetings, the upcoming U.S. election, economic data reports and violence around the world, and one could get dizzy from the ups and downs. A month ago, we would have included the U.K.’s referendum on membership in the European Union, but even the surprise vote to “Brexit” was digested by markets within only a few days. The full economic and political ramifications of the vote still hang in the balance, but no matter. While we continue to believe the risks of the precarious foundation of global debt are real, the timing of a potential upheaval is less clear and markets seem content to shrug off the risks and grind higher. In the meantime, they will continue to take their cues from high-frequency economic data, potential central bank policy responses to the data and China’s stance on domestic investment.

Seeking safety in equities

Despite new highs in equity markets and record lows in developed sovereign bond yields, there is still enough investor anxiety to pile into “safe” assets and these are some of the best performers year to date. The factors that have been rewarded and have momentum are quality, dividend yield and low volatility. While these are desirable qualities, the sectors with these attributes – consumer staples, utilities and telecoms – typically are not considered growth sectors and normally don’t lead the market higher in non-recessionary times.

While the headwinds from the stronger U.S. dollar year over year may be easing and could improve from here, earnings growth still is tough to come by, causing price/earnings multiples to increase. Identifying “value” is more difficult. Second-quarter earnings reports are just getting under way, but some investment banks have had better-than-expected results as fixed income and currency trading benefitted greatly from the Brexit volatility.

We think the dollar is worth watching now since it is no longer weakening; multinationals could see a renewed struggle post-Brexit. Although the aggregate reaction seems muted, some companies – particularly in areas of machinery/ construction – are taking a “wait-and-see” approach and postponing their spending plans until conviction about the environment increases.

Fixed income yields: all about flows

Credit markets are just as confounding as equities. Early in the third quarter, Bloomberg reported that roughly $10 trillion of sovereign global debt had a negative yield. The U.S. Federal Reserve has not ruled out implementing a negative interest rate policy in dire economic circumstances in an effort to stimulate demand. Global central banks have purposefully suppressed the risk-free rate in the years following the financial crisis by using their balance sheets to purchase bonds and, in the case of the Bank of Japan, real estate investment trusts and exchange-traded funds. These actions were meant to suppress interest rates to a level that pushed investors into riskier assets to find yield. As we can see from the performance of equities during this period, investors have been rewarded for that move.

In addition to lowering the risk-free rate, the European Central Bank (ECB) now is compressing credit spreads. At the end of the second quarter, the ECB began buying European corporate bonds as an expansion of its quantitative easing (QE) program. It also announced a Corporate Sector Purchase Program in March as an extension of its asset purchases. That may in part be because the ECB cannot purchase bonds lower than –40 basis points and there is concern the number of sovereign bonds available for purchase is dwindling. Since the ECB is now targeting investmentgrade euro-denominated debt with this program, we think the perceived risk by credit investors will surely be lower.

It has become more difficult to interpret the signal of narrowing credit spreads in this environment. Typically credit spreads narrow when the default risk is reduced and that usually happens during an expansion. Today, the magnitude of flows from pension plans and insurance companies into the U.S. bond market is causing a similar result.

Credit deals were extremely quiet in the days ahead of Brexit and spreads immediately following the vote did not widen as much as expected. Since then, both investment grade and high yield deals have generally traded tighter. The demand is clear in the completed deals that were several times oversubscribed, and in the squeeze on yields. U.S. credit spreads in both investment grade and high yield are at the tightest levels in two years.

All of this means global bond yields could remain lower for the foreseeable future, especially at the long end. They seem expensive to us and we’re not ready to dive in, though we are keeping a close watch.

Portfolio approach

Given this backdrop, the Fund’s allocations are similar to those at the end of the second quarter: just over 55% in equities, 12% in U.S. Treasuries, 7% in gold and 25% in cash.

Although a U.S. recovery in some ways appears long in the tooth, it is hard to argue against a growth rate of around 2% for the medium term. The state of U.S. consumers continues to improve on solid, if slowing, payroll growth; decent and perhaps slightly accelerating wage growth; and cleaner balance sheets. We see from the housing data that demand is there from consumers because of low mortgage interest rates, lower household leverage and more willingness by banks to lend. The issue is a lack of supply, which also keeps rent prices elevated, though those increases have slowed recently.

The Fund continues to suffer from the market's emphasis on lowvolatility investment strategies and the outperformance of “bond proxies” within U.S. equities – stocks most correlated with the 10-year U.S. Treasury yield. Those stocks have attained relative valuations rarely seen in history while their growth counterparts have become cheap by comparison. We are hesitant to capitulate and believe the relative tailwind these stocks have felt is unlikely to continue indefinitely. We see greater relative value in solid growth stocks with attractive free cash yields.

Fund Detail Page

Past performance is no guarantee of future results.The opinions expressed are those of the Fund’s portfolio managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. The Fund may allocate from 0 to 100% of its assets between stocks, bonds and short-term instruments of issuers around the globe, as well as investments in precious metals and investments with exposure to various 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 seek to hedge market risk on various securities, increase exposure to various markets, manage exposure to various foreign currencies, precious metals and various markets, and seek to hedge certain event risks on positions held by the Fund via the use of derivative instruments. Such investments involve additional risks, as the fluctuations in the values of the 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 commodities is generally considered speculative because of the significant potential for investment loss due to cyclical economic conditions, sudden political events, and adverse international monetary policies. Markets for commodities are likely to be volatile and the Fund may pay more to store and accurately value its commodity holdings than it does 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.

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

Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which may be obtained at www.waddell.com or from a financial advisor. Read it carefully before investing.

The crude oil market is a clear reflection of supply and demand for a major world commodity. Changes in key factors can happen quickly or develop slowly over time, but they eventually are reflected in prices. We now believe the oil market is very close to a global supply/demand balance.

Supply/demand overview

We think a global oil oversupply of about 2% on a total of 95 million barrels per day (bpd) of global oil demand prompted the initial plunge in prices, but that compares with 9-10% in prior oil-price cycles. That means it won’t take much to get the world market back in balance. Global demand recently again has grown significantly in response to falling prices and economic growth. Most of that demand growth still is from emerging market countries. We estimate annual demand growth during the next five years will average 1 million bpd.

On the supply side, we believe U.S. output peaked at about 9.6 million bpd and will stabilize at about 8 million bpd. We think onshore U.S. producers offer the best opportunity for revenue growth, and these companies remain a focus for the Fund.

There are key influences on supply outside of the U.S., too. Political turmoil in Venezuela has affected the oil industry there and production has fallen nearly 400,000 bpd since the beginning of the year. We think Nigeria’s production may have fallen by 600,000 bpd. In addition, China’s production is down almost 15%, Mexico is down 10% and Russia has been flat this year. There also are ongoing problems for the oil industry in Libya. We estimate the decline in production overall at 1.5 million bpd.

Higher-than-expected demand and lower-than-expected supply helps confirm our view that the market overall will be in balance more quickly than many market participants now forecast.

We also think crude oil inventories will fall more quickly than many in the market now expect. Inventories are basically at a 30-year high. That's going to be some cushion as we start to balance the market and withdraw inventories, but new supply won’t come back online quickly. We think the cost curve for producing oil has shifted lower and has become more flat, so we now have more oil production available at a lower price. That’s true for production from the Organization of Petroleum Exporting Countries (OPEC) and from U.S. shale, where companies have continued to improve productivity and efficiency.

Direction of oil prices

We believe the oil market has bottomed. West Texas Intermediate crude oil — the U.S. price benchmark — reached a low of about $26 per barrel in February, which basically is the level of cash costs. In our view, that’s a price level that provided an incentive for supply to fall and we already have seen that decline, especially in the U.S. The price recovered to $50 in just over four months, a relevantly short period. We’re now watching for an indication of the price needed to prompt meaningful production growth in the U.S. again. It will be needed to satisfy the forecast demand of the next several years.

With oil at $50, we are starting to see evidence of an end to declines in the oil rig count – an important measure for the industry and markets. The rig count was down 80% in the U.S. during the past 18-24 months, and it will take significant time and spending to grow production again. The extended period of low prices caused companies to cut capital spending for two years in a row, effectively cancelling 5 million barrels worth of projects that had been planned for 2018-2020. This has happened before: the price falls, capital spending is cut, supply begins to decline and then demand increases on the back of cheaper oil plus economic growth. We believe it’s possible that an undersupply issue may develop in the coming years as companies struggle to ramp up production to meet growing demand.

One popular topic of the moment in the media relates to drilled but uncompleted wells, or “DUCs.” The view from some in the media and the investment community is that the number of DUCs available, primarily in the U.S., will mean a quick increase in supply is possible. Although DUCs certainly will be a part of the production increase equation, we do not believe the effect will be as meaningful as some reports contend. Many DUCs are located on the periphery of shale plays, meaning they produce relatively less crude oil and at a greater cost than higher-producing wells near the core of shale plays. Job layoffs in the sector also have been substantial, so companies do not have the staffing available to immediately begin new production.

We also think it’s important to note OPEC’s current approach. In November 2014, the organization made a key policy change in which it no longer would play the role of balancing the market. Instead, OPEC made it clear it would take market share and try to maximize production. It now appears that OPEC feels this goal has been accomplished, as it has indicated it does not plan to increase production further going forward.

Barring a surprise from OPEC or elsewhere, we think the price of oil will be in a range of $60-65 per barrel by year-end and probably reach $70-75 next year. We also think the oil market will be volatile in the future and more volatile than the past several years. OPEC has made it clear that it is unwilling to hold large-scale spare capacity. In our view, less spare capacity and a greater requirement for producers to moderate supply is likely to create more price volatility.

Portfolio review

When it comes to active versus passive indices, one differentiating factor is that many passive indices contain a high weighting in integrated oil companies, mainly Exxon Mobil Corp. and Chevron Corp.* We think it's important to know that in times of rising prices, the integrated oil companies historically have underperformed. We believe in active management and focus on companies that we think can grow in this “upcycle.” We want to have less investment now in integrated firms — unlike the indexes — and instead own the stocks of low-cost service companies and exploration & production (E&P) companies that we think are well positioned to benefit from higher prices and can grow.

Examples in the Fund include EOG Resources, Inc., Pioneer Natural Resources Co. and others that have good shale assets and are low-cost producers.* We think these firms have solid balance sheets and the ability to increase production. We think these high-quality companies will be among the first to start growing and that is why they are a focus in the Fund.

As we analyze master limited partnerships (MLPs) for the Fund, we think the biggest risk is that production still is declining and growth will be slow to restart. That means the industry is moving less product through the pipelines operated by MLPs. Pipeline capacity will be needed when substantial growth starts again, but we don’t believe we are at that point yet. In our view, E&P companies will show growth first, followed by oil services firms and later by MLPs.

In our view, alternative energy works when oil prices are high because then alternatives become more economical. Prices on alternative fuels also have tended to be volatile. The Fund now does not have much investment in alternatives. Alternative energy makes up about 1% of what the world consumes. We think that will quadruple in the next five to 10 years. By comparison, energy based on hydrocarbons makes up more than 80% of world consumption and we think that will continue. We do expect fewer nuclear power plants and less use of hydroelectric power because of environmental concerns.

^{* Pioneer Natural Resources Co.: 3.95%; EOG Resources, Inc.: 3.84%; Exxon Mobil Corp., 2.60%; Chevron Corp., 1.00% of net assets as of 06/30/2016.}

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Past performance is no guarantee of future results.The opinions expressed are those of the Fund’s portfolio 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 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

Risk factors:The value of the Fund’s shares will change, and you could lose money on your investment. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. Investing in the energy sector 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 energy companies in complying with environmental safety regulations. 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.

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

Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which can be obtained at www.waddell.com or from a financial advisor. Read it carefully before investing.

Zachary Shafran, portfolio manager of Waddell & Reed Advisors Science and Technology Fund, discusses how innovative technology creates investment opportunities and challenges.

We are excited about the innovation and growth taking place across the globe, and believe many stocks in the information technology sector remain relatively inexpensive and are well positioned going forward. Despite our optimistic outlook, we think it is important to understand why and how the Fund underperformed recently.

2015 was a challenging year for the markets. A time period we don’t believe many would characterize as a momentumdriven market, but nevertheless, that’s exactly what it was. The market was driven by a small number of securities, specifically that common acronym that became very popular last year known as FANG (Facebook, Amazon, Netflix and Google). We would also add Microsoft to the mix. All five of these stocks are large constituents in our benchmark index, the S&P North American Technology Sector Index. When you review performance of the index for calendar year 2015, the index was up 9.91%. Meanwhile, the performance of those five stocks contributed 10.45% to performance last year. When you net out those holdings relative to the benchmark, the performance would have been slightly in the red for the year. The result was a very narrow market for outperformance. While the Fund had sizable positions in Facebook and Google, its relative underweight in these positions compared to the benchmark index and its lack of exposure to Amazon and Netflix had a negative impact on Fund performance.

2016 year-to-date is a very different tale; we have largely underperformed because of our exposure to health care — a sector not included in the benchmark. The Fund’s allocation to health care has typically benefitted performance, especially during times of distress in the technology sector. Historically, when the Fund’s allocation to technology has struggled, the defensive nature of the health care sector has often provided a buffer to portfolio performance during those downturns. This has not been the case year-to-date as the industry has been hard hit by headline risks. Continued fears around the U.S. election and potential impact on health care reimbursement/drug pricing have pressured the sector.

We do not expect this trend to continue, and believe the Fund’s investment philosophy of seeking innovation as a catalyst for change across the market cap spectrum will create growth opportunities over the long run. As such, we maintain our high conviction in portfolio holdings.

We think Universal Display Corp. is good example of our investment philosophy at work. This small cap company specializes in OLED (organic light-emitting diodes) technology, which you may have recently seen in new product rollouts. OLED is a screen technology we have spent a lot of time researching and analyzing. We traveled to South Korea and met with company management and the original developers of the technology to ensure Universal Display’s patents and the trajectory and ability to manufacture the technology was sound.

If you look at OLED technology compared to the current industry standard LED (light-emitting diode) technology, we believe the picture quality and contrast is second to none. And you’re starting to see early adopters of OLED technology. The recently released Samsung Galaxy S7 smart phone boasts this innovative screen. If you ever have an opportunity to compare a Galaxy S7 to an iPhone, we believe you can immediately see the advantage. As a result, we think you are going to see a lot more traction and proliferation of the technology over the next couple of years. We think Apple Inc. has recognized the advantage as well, and it is widely speculated the company will have OLED screens across its product line by 2018. The combination of these effects has us excited about the potential growth for Universal Display. The growth has started in mobility, but ultimately we believe the technology will become prevalent across TVs and similar devices.

Another good example would be NXP Semiconductors. NXP is the recognized leader in secure semiconductor solutions for the implementation of EMV (chips in cards) and mobile payments. The company has the largest intellectual property portfolio in secured payment technology and recently licensed this technology to Apple Inc. The company has an emphasis on security of the connected vehicle and the growing Internet of Things. As such, the company’s products are used in a wide range of smart automotive, identification, wired and wireless infrastructure, lighting, industrial, consumer, mobile and computing applications.

Attractive Valuations in Health Care

Despite short-term setbacks in the health care sector, we believe this is one of the sectors with the greatest opportunity for innovation and growth going forward. In our view, current health care holdings are exceedingly undervalued as they have leading science to create novel new therapies to dramatically improve outcomes to address unmet medical needs. As such, the Fund has maintained its approximate 15-20% exposure to the sector.

In terms of specific holdings, take Vertex Pharmaceuticals as an example. The company has seen its fair share of recent controversy, yet we think the outlook for Vertex continues to be bright. The stock was originally purchased in 2009 based on its position as the undisputed leader in addressing hepatitis. More recently, this biotechnology company enjoyed positive results from a late-stage cystic fibrosis treatment shown to significantly improve patient lung function. These results, as well as our view that Vertex continues to maintain a very compelling pipeline of new therapies, is why the stock is in the portfolio today.

We think the stock has substantial upside. It’s that kind of indepth fundamental analysis that over time we believe will make these difficult times pay off.

Looking Across Sectors for Innovative Ideas

We continue to find and be excited about opportunities well beyond the traditional realm of science and technology. As we’ve said in the past, in a difficult economic environment, we believe these kinds of companies are disproportionate beneficiaries. We think Bioamber is a good example of our applied science investment approach at work. The company has developed a methodology for converting feedstocks into succinic acid and other key chemicals that are used in everyday products like paints, food additives and cosmetics. Rather than utilizing fossil fuels as the core input, Bioamber uses sustainable sources, thus preserving natural resources while, in our view, producing a higher quality end product. At scale, we think this process is economical and has meaningful positive environmental implications, which bodes well for the company going forward.

Cautiously Optimistic

Over the short term, lingering fiscal concerns and other geopolitical risks have resulted in a rather muted growth outlook. That said, in mixed economic environments, we believe there are many potential investment opportunities – especially in biotechnology, data, mobility and health care – around the world. As we look at the securities of such companies, we are focused on what we believe are good growth prospects and sound capital structures. We believe there will be a modest improvement in capital spending trends, and we are looking for a continuation of an active mergers-and-acquisition environment. As always, we will carefully monitor the macroeconomic environment, but our focus remains primarily on security-specific fundamental research. Going forward, we believe this attention to bottom-up research, coupled with the innovation and transformation under way across the globe, will provide investment opportunities for the Fund.

Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s portfolio 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 June 30, 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. The information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance, and time horizon.

Top 10 Equity Holdings as a percent of net assets as of 06/30/2016: Aspen Technology, Inc. 5.6%, Alliance Data Systems Corp. 4.5%, Micron Technology, Inc. 4.5%, Euronet Worldwide, Inc. 4.1%, Vertex Pharmaceuticals, Inc. 3.9%, Microsoft Corp. 3.8%, Cerner Corp. 3.6%, Facebook, Inc., Class A 3.6%, WNS (Holdings) Ltd. ADR 3.5% and ACI Worldwide, Inc. 3.5%.

The S&P North American Technology Index is an unmanaged index comprised of securities that represent the technology sector of the stock market.

Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Because the Fund invests more than 25% of its total assets in the science and technology industry, the Fund’s performance may be more susceptible to a single economic, regulatory or technological occurrence than a fund that does not concentrate its investments in this industry. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market. In addition, the Fund’s performance may be more volatile than an investment in a portfolio of broad market securities and may underperform the market as a whole, due to the relatively limited number of issuers of science and technology related securities. Investment risks associated with investing in science and technology securities, in addition to other risks, include: operating in rapidly changing fields, abrupt or erratic market movements, limited product lines, markets or financial resources, management that is dependent on a limited number of people, short product cycles, aggressive pricing of products and services, new market entrants and obsolescence of existing technology. 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.

The interest rate outlook is less clear than it has been since the late 1970s. The U.S. Federal Reserve (Fed) raised rates in December 2015 but the timing and amount of future increases still is uncertain.

As rates move higher, low-yielding securities — those viewed by most investors as the “safest” since they are deemed the most likely to be repaid — still face interest rate risk, or the risk that higher future rates will reduce the value of lower-yielding securities. By contrast, the highest-yielding securities may present unacceptably high risk to some investors or, in some cases, may not be accessible to typical individual investors.

In this environment, it may be time to consider multi-asset funds, which can combine multiple asset classes and investment strategies within a single fund.

Impact of low rates

For many investors, the primary risk associated with fixed income investing has been credit risk, or the risk that the bond issuer will not be able to repay its debts. Yield levels are largely determined by the amount of credit risk a bond buyer is willing to assume. Lower-rated credits, such as junk bonds, pay higher yields because they are viewed as having more credit risk than higher-rated bonds, such as those issued by the U.S. Treasury.

In addition to credit risk, however, investors take on interest rate risk. Sensitivity to interest rate risk is measured as “duration,” which is based on yield and maturity. Lower duration equates to less vulnerability to rising rates while higher duration equates to greater vulnerability.

For more than 30 years, income investing strategies seemed relatively simple. With overall bond market yields trending gradually lower, investors became conditioned to believe that bonds would hold their value since the yields on similarly structured bonds issued in the months and years to come would be lower — and thus less attractive.

That ended when interest rates tumbled to historic lows as the Fed dropped its key short-term interest rate to zero in 2008. With the Fed pledging to hold rates low in a bid to stimulate the economy, many income investors responded by increasing allocations to higher-yielding junk bonds, accepting the increased potential risk in a bid for higher returns and yield.

Changing market leadership

Given the scope of recent market volatility, it can be easy to forget that markets have always been unpredictable. History shows that a mix of investments offers the potential to take advantage of return differences among asset classes and investment types. This diversified approach also can help protect an investor from extreme price swings in a single type of security. While diversification does not ensure a profit or protect against loss, it can help reduce the overall risk and volatility of a portfolio.

Multi-asset funds pursue such a diversified strategy through allocations to multiple asset classes in a single product. A review of annual performance over the past 20 years makes it clear that there is no discernible pattern regarding how individual asset classes perform — another indicator that favors a diversified investment approach.

In an effort to stabilize performance across market cycles, investors may seek to diversify in asset classes that are not closely related. One way to examine asset class relationships is through correlation, which is a statistical measure of how two securities move in relation to each other. A correlation of +1 implies the securities moved in lockstep through a specific time period. The chart below shows that stocks and investment grade bonds can exhibit low correlation. By contrast, high-yield bonds and stocks are more closely correlated.

Multi-Asset approach

One way to understand the potential of a multi-asset strategy versus a single-asset strategy might be to compare historical risk/return data of combined indexes. For example, based on five-year data, a combination of 50% high-yield bonds and 50% dividend-paying stocks offered a higher level of return than many fixed-income indexes, but with a lower level of volatility than dividend paying stocks alone.* A 50% blend of high-yield bonds and global bonds exhibited slightly lower returns and volatility. It is important to note that this is index performance and is not representative of the performance of a specific fund.

* As measured by standard deviation, a measure of the degree to which a fund’s or an index’s returns vary from its previous returns or from the average of all similar funds or indexes. The larger the standard deviation, the greater the likelihood (and risk) that a security’s performance will fluctuate from the average return.

Past performance is not a guarantee of future results.The opinions expressed are those of Ivy Distributors, Inc., and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. The information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance, and time horizon.

Investment return and principal value will fluctuate, and it is 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. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Funds may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds.

THE FIRST HALF OF 2016 provided a choppy ride for investors. They faced continued concerns about global economic growth, uncertainty about interest rates, slowly rising oil prices and the prospect of a contentious U.S. presidential election. Stock market volatility spiked higher early in the year, fell off at the close of the first quarter and then increased again. We think several of these factors will persist in the near term and have identified six issues to watch for the remainder of the year.

Six Issues to Watch Now

Economic growth still slow We expect modest economic growth to continue in the global economy in 2016.

Interest rate uncertainty The direction and timing of interest rate changes in the U.S. and other countries is unsettling global markets.

Impact of oil prices Stock prices are likely to follow unsettled crude oil prices through the remainder of the year.

Market volatility continues The roller coaster ride in stocks is not finished and volatility is likely to continue, although we expect moderate positive returns for the year.

Key stock sectors to consider Several sectors may offer potential for investors through 2016: Health care, technology, consumer discretionary and real estate.

Looming U.S. presidential race A contentious campaign is under way; several critical issues that are central to U.S. economic growth will face the next president.

Economic growth still slow

We expect modest economic growth to continue in the global economy in 2016, with a slight slowing from the rates recorded overall in the last two years. The International Monetary Fund’s (IMF) World Economic Outlook in April forecast what it called “modest” global growth for the year of 3.2%, down from its 3.4% estimate in January. Low commodity prices continue to pressure developing countries with economies that depend on commodities exports.

Among the developed markets, we think the U.S. will slow but achieve a better growth rate than the U.K. and the eurozone in general, especially following the U.K.’s “Brexit” vote (see page 4). We also expect Japan’s growth to drop off. Earlier this year, the Bank of Japan (BOJ) introduced negative short-term interest rates to boost inflation. However, the action has resulted in a stronger yen and could impair bank lending going forward.

The U.S. economy still is seen as a safe haven globally and we think it will continue to attract funds from outside the country. While the U.S. economy is growing, it’s doing so at a slow rate. U.S. gross domestic product (GDP) growth in the first quarter this year was reported at the snail’s pace of an annualized 0.5%. That was a slowdown from 1.4% in the final quarter of 2015. However, revisions to U.S. economic data are common and the growth rate in June was revised to 1.1%.

“Based on our analysis, we think second-quarter GDP growth, which will be reported in late July, is tracking at about 2.5%,” says Global Economist Derek Hamilton. The data indicate the U.S. economy still is performing better than most other developed markets. Questions also remain about China’s growth prospects. Its economic data have strengthened recently in response to policy changes to stimulate investment in housing and certain areas within infrastructure. The People’s Bank of China has aggressively added liquidity to the banking system and credit availability has begun to accelerate. Despite what was widely seen as the mistake of 2009 – a credit-driven buildup in manufacturing capacity that caused a dramatic increase in the ratio of debt to GDP – China again is moving down a similar path to reignite growth. Early indicators in China suggest some traction.

Interest rate uncertainty

Speculation began almost immediately about the timing of the next interest rate hike after the Fed in December 2015 raised short-term interest rates by 25 basis points. That marked the first increase in seven years. The Fed has been unclear about the timing of future rate hikes because of what it considers risks to the global economy. Mark Beischel, CFA, Global Director of Fixed Income, says the results of the Brexit vote have raised new questions about whether the Fed will take any action in 2016. In general, Beischel says he expects the Fed’s current approach to mean interest rates “will stay lower, longer.”

The Fed made it clear that it will closely watch U.S. employment and inflation in considering the timing of future rate hikes. But news reports show that all Fed governors don’t agree on the appropriate timing for the next change, so it isn’t a simple matter of watching government reports.

For labor-market data, the Fed focuses on the U.S. Labor Department’s monthly jobs report released the first Friday of every month. The U.S. added more than 160,000 jobs in April and the unemployment rate was unchanged at 5.0% -- within the Fed’s target range. But May’s report threw a curve: Employers added the fewest number of workers since September 2010 and the unemployment rate dropped to 4.7%, the lowest since November 2007. That decline was attributed to workers leaving the labor force.

In judging inflation, the Fed watches the price index for personal consumption expenditures (PCE). This measure is done as “headline” and “core” figures. Headline inflation – usually reported on an annualized basis – is not adjusted for seasonality or for volatile food and energy prices, which are removed from the core data. The headline and core PCE rose 0.9% year over year (y/y) and 1.6% y/y in May, respectively. The Fed has stated that its target for inflation is 2%.

Even with the ongoing uncertainty about interest rates and assuming there is no decline into recession, Beischel says he believes there still are opportunities for investors in high-yield debt securities, emerging-market sovereign bonds and investment-grade corporate debt. There also has been action outside the U.S. affecting interest rates and the markets. As noted, the BOJ moved to a negative interest rate policy that we think will make the country less competitive and have a negative economic effect. In addition, Japan announced in early June that a planned 2017 sales tax increase has been postponed to 2019, which actually supported the yen’s value in global currency markets.

The European Central Bank (ECB) cut interest rates again in March and expanded its quantitative easing (QE) facility, which provided support for the euro. Corporate credit now is part of that QE program. Inflation in Europe generally is stable and the overall economic recovery still is improving.

The U.K. on June 23 voted to leave the European Union (EU) by a 52% to 48% margin. Global markets had been nervous about a “Brexit” and stocks around the world plunged in response to the result. While we think continued volatility is likely in the short term, we believe it is important for investors to keep a long-term view.

The U.K. now must begin formal negotiations to withdraw from the EU – expected to be a difficult two-year process – which should provide more clarity on the ultimate impact. The Brexit vote has added uncertainty about U.K. economic growth, however, and we believe the decision to leave the EU could push the U.K. into recession in the latter half of the year. The U.K. will need to set new trade deals with the EU and the rest of world, resulting in potential losses in exports and investment flows.

Given the shock from Brexit, we also think the Bank of England is increasingly likely to ease policy including cutting interest rates, increasing quantitative easing and providing liquidity.

The Brexit vote highlights rising nationalism globally and sets the stage for the U.K. to establish its own immigration and trade policies. It also could open the door to other countries questioning their membership in the EU and potentially do harm to Europe’s economy overall.

Impact of oil prices

Stocks have followed volatile crude oil prices this year. In early May, the International Energy Agency (IEA) said global energy inventories were likely to continue to rise in the first half of 2016 but would decline dramatically in the second half of the year. The IEA blamed the decline on strong demand and falling supply. Investors have struggled to track supply/demand and its impact on both oil prices and stocks more broadly, and we think that is likely to continue.

An oversupply that peaked at about 2.0% of global production led to the price decline that continues to affect the industry and markets. That oversupply equaled less than 30 minutes of global demand and is a much smaller oversupply than in prior cycles, according to David Ginther, CPA, portfolio manager of Waddell & Reed Advisors Energy Fund and Ivy Energy Fund. The resulting lower prices have caused slower production worldwide. In December 2015, oil output in the continental U.S. fell on a year-over-year basis – a first since the onset of the shale renaissance. We now estimate oil demand will add about 1.0 million barrels per day (bpd) to today’s 95 million bpd. Total U.S. output is 8–9 million bpd, including 3 million from shale, versus consumption of 20 million bpd. However, demand can spike when oil is “cheap.” Demand growth in 2015 was nearly double the historical average, and oil demand continues to rising in emerging markets. In addition, U.S. drivers have taken advantage of cheaper gasoline prices by driving more.

Ginther says slowing production and rising demand will mean a supply/demand balance this year and could drive oil prices higher in coming years. Prices already have rebounded from their lows, with both Brent and West Texas Intermediate crude oil – the market benchmarks – topping $50 per barrel in late May. The U.S. reported a sharp decline in crude oil stocks in May, with inventories down 4.2 million barrels from a record high of 540 million. Expectations for a continued drop in inventories through the summer have helped prices recover, and wildfires in Canada and political problems in Nigeria have trimmed production.

In addition, Iran’s is resuming production but we do not expect Iran to hurt oil prices in the long term. We think Iran will add 500,000 bpd by year end. We project future demand will grow at about the rate Iran will add supply, meaning the world will need Iran’s oil to avoid sudden changes in the global supply/demand picture.

Hamilton notes that the price bounce may also indicate a reduction in headwinds for shale oil producers because they again may find it worthwhile to make capital investments in oil rigs and drilling operations. Despite the potential energy price hike to consumers that follow higher crude oil prices, eliminating that headwind could be mildly beneficial to the U.S. economy, Hamilton says.

Market volatility continues

Concerns about slow economic growth and the direction of interest rates have made investors skittish about any change in economic indicators. That attitude often is exaggerated when it shows up in the stock and bond markets, says Chief Investment Officer Phil Sanders, CFA. Investors are looking for any hint of a slowdown, stronger recovery or clarity on the timing of interest rate changes, he says.

Stock market investors definitely have endured a wild ride in 2016. That ride became even more unsettling when the results of the U.K.’s Brexit vote were announced. The CBOE Volatility Index (VIX) has spiked above 18 – the index’s 10-year average – on 10 occasions in the last 10 months, reaching levels not seen since the European debt crisis in 2012. And from its extreme points this year, the VIX has fallen 53% and subsequently climbed 97%. Overall, the VIX has moved higher or lower by at least 10% in a day a total of 17 times this year.¹

We think the issues outlined in our Outlook, along with other market factors, are likely to mean the roller coaster ride is not finished and volatility will continue. That said, we think the U.S. market may retain its relative appeal, with domestically focused stocks likely to get support relative to multinationals because of the added uncertainty of the Brexit vote. We also still expect moderate positive returns in stocks for the year.

We encourage investors to avoid overreacting to current market influences. We believe the markets have proven to be resilient during the past decade, despite significant bouts of volatility and ongoing macroeconomic and geopolitical headwinds.

Key stock sectors to consider

We believe there are a several specific stock sectors that may offer potential for investors through 2016: Health care: Sector valuations have been depressed for an extended period. We think biotechnology companies in particular offer significant potential for profit growth. In developing markets, we think the demand for quality health care should increase with the standard of living. We are paying particular attention to medical technology, biotechnology, medical records and pharmaceuticals, which often are innovators and early adopters of new technology.

Technology: While the “FANG” stocks (Facebook, Amazon, Netflix and Google) have been responsible for much of the gain in the sector, our research is identifying additional companies exploiting innovation to drive growth. We believe many of the stocks in the information technology space remain relatively inexpensive and are well-positioned going forward. Consumer discretionary: U.S. consumer spending rose 1% in April, marking the biggest one-month increase in six years, according to the latest Commerce Department report. Low interest rates, low energy prices and improving wages continue to drive consumer spending, creating additional opportunities.

Real estate: We expect more opportunities as existing publicly traded real estate companies grow, new companies come to market and additional countries develop real estate securities markets. Publicly traded real estate comprised 330 companies and totaled $1.3 trillion at the end of 2015, up more than 20% from the end of 2013.2 Here’s another way to look at it: Public real estate securities comprise less than 8% of the total value of investable real estate around the globe. We think that translates into opportunities for continued long-term expansion.

Sanders says growth stocks are likely to continue to lead the market in the mid to long term. “In the short term, we think value stocks may continue to outperform,” Sanders says. “However, many value stocks are priced for significant economic distress, especially if their revenues are exposed to global commodity market tends. After these distressed valuations improve, we expect the growth stock cycle to resume.”

Looming U.S. presidential race

While neither major party has concluded its nominating process, it appears that presumptive nominees Hillary Clinton for the Democrats and Donald Trump for the Republicans are the likely presidential candidates.

Several key issues remain central to the growth of the U.S. economy and we think they will be critical topics for the next president.

Disappointing growth in domestic demand during the latest economic recovery has been the result of a variety of factors, including the country’s demographics, the debt overhang, residual effects from the global financial crisis and weak external demand. We summarize these issues as Demand, Demographics and Debt:

• Demand: Domestic demand is something that the government can directly impact. We believe the federal government will need to walk a fine line between productive investments and spending that boosts demand in the short term but hinders demand in the future. This is especially true given the federal government’s high level of debt.
• Demographics: Many developed countries are experiencing population declines, while the U.S. population is expected to continue to grow. Even so, the aging U.S. population will put pressure on federal spending. We think it is likely to mean a combination of entitlement cuts and tax increases.
• Debt: Private debt has fallen since the global financial crisis, but it is still relatively high versus historical levels. That debt is likely to be constraining economic activity. A high level of government debt also could have a dampening effect on private demand as consumers and businesses assume that taxes could rise in the future or benefits could be cut.

As the municipal bond market has taken hits from large bonds trading at default prices or facing the risk of default in the past year, bond quality ratings continue to be an area of focus across the credit markets with extra focus on the volatility in the corporate high yield markets. Questions are being asked about how to gauge which municipal bonds to invest in, and how big of a factor the credit quality of a fund really is. Below Michael Walls, the Portfolio Manager for the Waddell & Reed Advisors Municipal High Income Fund, discusses how a rating is determined, how he views ratings and his outlook for the municipal bond market.

When reviewing the holdings of funds with a municipal bond component, one thing most people will look for early on is the credit ratings of the underlying investments in the fund.

And this would seem to make sense. You can gauge the potential risk of any fund based on the level of bonds rated at various levels. Any investments listed as “junk bonds” could bring higher returns – but also carry a higher level of risk. A municipal bond issuance that isn’t rated at all should then be considered the riskiest of investments, right? Not so fast.

A bond can be considered unrated for various reasons, not all of which are related to the risk or return associated with the issuance.

Depending on what ratings companies the fund works with, they may simply not know the rating for certain bonds. There are three main companies that supply ratings for municipal bond offerings: Standard & Poor’s, Moody’s and Fitch’s. Each company charges for a bond to be reviewed and a rating issued. Many issuers may only pay for one or two companies to rate their bonds. When that happens, if you subscribe to the third company, that bond will show as “unrated.”

Here is an example. City A wants to issue some general obligation bonds. They contract with Moody’s to review and rate their offering. Moody’s gives them an AA rating. If an investor looks at the information for this issuance on the website for any rating company except Moody’s, this will not show as an AA rating, however – it will show as unrated. The same holds true when that bond is part of a larger fund.

Because it costs to be reviewed and rated, some municipal bonds choose not to be rated at all. Examples of this would be issues from schools, hospitals and smaller governments. For many smaller issuances, it can be deemed not fiscally responsible to pay for a rating.

In addition, some purchases would be for land deals. Because the actual investment is undeveloped land, there would be no rating available. So why buy these bonds? Because the belief is that, someday, that land will be slated for development. When that happens, the bonds will be “pre-refunded”, which will potentially result in an enhanced credit quality and improved valuation, due to escrowed Triple-A U.S. Treasury securities that secure the pre-refunded bonds.??

Portfolio Positioning

As portfolio manager for the Waddell & Reed Advisors Municipal High Income Fund, I believe strongly in investing in issuances that make sense in the long run. With the current market offering few new opportunities of any size or substance, it is even more important now to stick with offerings we know and include a cash component in case of a market downturn for municipal bonds. I see the current market as an issuers market, with no truly attractive large deals available right now. Although we have always included non-rated issuances in the Fund, this fact is a large part of why we have looked to the non-rated market for recent purchases. While many funds have bought high-quality municipal bonds that they lever up using a line of credit or inverse floaters, we don’t feel the market is attractive enough to do that right now. The demand for what is available is so strong that these offerings are being broken up into small allotments and the rates decreased because of the demand. While it can be considered standard practice to leverage investments in order to show a credit rating, the Fund does not do that. We feel there is more transparency for the investor if we simply show what we have invested in, rated or not. 

So where have we put our focus? Not in all the typical places. We’re underweight against our benchmark in hospitals and healthcare because we are still trying to determine the full cost of the Affordable Care Act and how that could affect bonds in this arena. We have less than 4% exposure to Puerto Rico. We have put the majority of the bonds we own in revenue-specific projects that are not tied to a specific state. 

Is this the correct approach? None of us have a crystal ball, but I believe it’s the right path given the opportunities we see in the current environment.

Waddell & Reed Advisors Energy Fund is 10 years old. It has been a noteworthy decade for the Fund and the energy market. Let’s take a look at some highlights for both, and an update on the Fund’s current positioning.

1. Oil price volatility has been significant since the Fund’s inception. West Texas Intermediate crude oil, the U.S. benchmark, was priced in the high $60s per barrel in April 2006. It then soared as high as $145 before falling to $30 in 2008. The price bounced between $75 and $115 in 2011-15, then plunged to the mid-$20s early this year.
2. Portfolio Manager David Ginther has managed the Fund since its inception. His tenure on the Fund is longer than 77% of its Morningstar category peers.* But Ginther’s experience in energy extends well beyond his time managing the Fund.
3. More than 21 years of industry experience plus a decade with a major oil company have given Ginther a unique perspective as a portfolio manager. His assignments in the oil industry included postings in Chicago, Houston and other U.S. cities as well as time in North Africa. The combination has provided him with valuable experience on the operations side of the energy sector that he can apply to his decisions in the Fund.
4. The major oil-producing cartel’s influence has declined in a decade. Headlines about the Organization of Petroleum Exporting Countries (OPEC) that would cause a minor reaction today had the power 10 years ago to move oil dramatically in a day. But OPEC has become more fractured, with vast political differences across the group. It showed again this month at a meeting in Doha, Qatar, that it is difficult for member nations to reach consistent agreement. The world still needs OPEC oil to meet global demand, but there is a counterbalance to OPEC’s absolute power because of new technology: shale oil.
5. U.S. shale oil production has had a major impact on both the industry and the market overall. Hydraulic fracturing combined with horizontal drilling has made boom towns in areas once thought “dry.” Current prices have forced cutbacks in shale output, but we believe the situation will be temporary. Shale production is more flexible than other methods, and U.S. political stability is unique among major oil producers.
6. New Exploration & Production (E&P) companies have emerged and may benefit from any increase in oil prices, especially if they drill in high-quality shale acreage. Quality can vary, even in the same shale region. Those with drilling rights in the “core” of a shale basin may be profitable with oil priced at $30 per barrel. A competitor only 15 miles away may need oil at two or three times that price to survive. A focus for the Fund within the E&P sector is on companies with access to what we consider the best shale acreage. We think these companies can survive the current depressed prices and have the potential to thrive if prices rise in the future.
7. We think higher oil prices are likely. An oversupply of about 2.0% of global production led to the price decline that now affects the industry and markets. That oversupply equals less than 30 minutes of global demand and is a much smaller oversupply than in prior cycles. The lower prices caused slower production worldwide. In December 2015, oil output in the continental U.S. fell on a year-over-year basis – a first since the onset of the shale renaissance. We now estimate oil demand will add about 1.0 million barrels per day (mbpd) to today’s 95 million bpd. However, demand can spike when oil is “cheap.” Demand growth in 2015 was nearly double the historical average. We think slowing production and rising demand will mean a supply/demand balance in third-quarter 2016 and could drive oil prices higher in coming years.
8. Iran’s production is coming online. But we do not expect Iran to hurt oil prices in the long term. We think Iran will add 500,000 bpd by year end. We project future demand will grow at about the rate Iran will add supply this year. In our view, this means the world needs Iran’s oil to avoid a sudden change in the global supply/demand picture. Rapid hikes in oil prices often do not get fully priced into stocks and any gains may quickly reverse. Our deep-dive analysis process is central to selecting stocks for the Fund.
9. The Fund has maintained a low turnover ratio. A long-term perspective in a commodity-focused fund is uncommon, but not in the Fund. Many investors attempt to time the market and play the price of the underlying commodity. Instead, the Fund seeks companies that have competitive advantages, access to preferred drilling acreage or other unique factors versus their peers. That approach has led to a turnover ratio that has rarely exceeded 25% on an annual basis.
10. The Fund has shined relative to peers when oil prices have risen. Eight times since the Fund’s inception, WTI crude oil experienced a rise of 15% or more from trough to peak (see table). In seven of those eight periods, the Fund outperformed its Morningstar peer category average. In 100% of those periods, the Fund outperformed its passive benchmark, the S&P 1500 Energy Index. Because the Fund historically has been underweight versus the benchmark in integrated oil & gas companies – or “oil majors” – it typically has outperformed when oil prices rise. Many indices have a 30-50% allocation to oil majors, while the Fund’s allocation generally does not exceed 10%. Integrated companies often pay dividends, rather than focus on growth, which is one reason they are viewed as a defensive play in the energy sector. Investors seeking additional energy exposure now because of low oil prices may unintentionally get a large allocation to these defensive names through funds that mirror a benchmark index. In addition, we think the lack of focus on shale by oil majors may hurt their defensive behavior in future downturns. These companies are meaningfully behind in an area of the oil market that stands to grow in significance in the future. Given this outlook, we prefer the Fund’s company-specific exposure in a variety of industries within the energy sector and believe it is again well positioned to participate if oil prices move into the upward part of the cycle.

Waddell & Reed Advisors Energy Fund has shined relative to peer group when oil prices have risen

(Cumulative percentage return in each period)

Sources: U.S. Energy Administration, Morningstar Direct. Trough to peak periods where West Texas Intermediate (WTI) Crude Oil, the benchmark for U.S. crude oil prices, advanced more than 15% since Ivy Energy Fund's inception. The S&P 1500 Energy Sector Index represents companies in the energy sector of the stock market. The Morningstar Equity Energy Category includes portfolios that invest primarily in equity securities of U.S. or non-U.S. companies that conduct business primarily in energy-related industries.

Fund Performance

* - Based on the listed manager tenure for 31 funds in the Morningstar Equity Energy category, March 2006-March 2016

Past performance is not a guarantee of future results. The opinions are those of the Fund’s portfolio 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 April 2016, are subject to change at any time based on market conditions or other factors, and no forecasts can be guaranteed.

Risk factors. The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. Investing in the energy sector 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 energy companies in complying with environmental safety regulations. These and other risks are more fully described in the Fund’s prospectus.

The simple answer is financial markets dislike uncertainty. This year we are faced with significant uncertainty around numerous issues, including:

• Central bank actions;
• politics in the U.S., specifically surrounding the presidential election;
• credit concerns in the energy sector;
• very slow growth in Europe and Japan;
• credit quality issues in important emerging economies, including China;
• the U.K.’s June vote on exiting the European Union;
• fluctuations in currencies.

For investors, here are our key thoughts as we look ahead:

Stock appreciation is dependent on growth in corporate profits. Profits on the aggregate contracted modestly in the first quarter, with weakness concentrated in energy and multi-nationals.

In this environment, stock selection is paramount. Our investment team’s daily market analysis and global research are dedicated to identifying where profits are rising versus falling.

Specific sectors we see showing attractive profit trends currently

• Health care;where biotechnology companies in particular offer significant potential growth in profits.
• Technology;while the FANGs (Facebook, Amazon, Netflix and Google) have driven much of the growth in the sector, our research is identifying companies exploiting innovation to drive growth.
• Consumer discretionary;low interest rates, low energy prices and improving wages are driving consumer spending.

Yields on fixed income investments in the U.S. remain higher than in other developed economies. High yield bonds started the year slowly but turned upward more recently. Fixed income investors may want to diversify to take advantage of relatively attractive opportunities in high yield.

When interest rates in the U.S. will rise, and by how much, remains an area of focus for the financial markets. Markets reacted negatively when the Federal Reserve raised rates slightly in December and seemed to imply more increases were likely. Since then, the Fed seems to have moderated its tightening plans. It’s clear the Fed has become attuned to very sluggish global growth. Future rate increases in the U.S. will be very slow to develop, with job growth and inflation being most important determinants of central bank policy.

Overseas, the European Central Bank and Bank of Japan are actively engaged in aggressive easing. As yet, these steps are not leading to strengthening economic activity.

China, in the face of economic softening, has turned toward more aggressive stimulus. We believe moderate economic acceleration is likely in China this year, which should be beneficial to broader global growth.

While volatility is likely to continue, we believe that we’ll see moderate positive returns for stocks. Bond returns are likely to be very modest.

For investors, identifying ideas and opportunities that align with your goals remains key. We believe active investment managers who have independent, differentiated ideas and an understanding of the implications of ongoing market activity can make a meaningful difference when selecting investments and specific allocations.

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

Past performance is not a guarantee of future results.The opinions expressed in this article are those of Mr. Herrmann and are current through April 2016. 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.

The S&P 500 Index is composed of 500 selected common stocks chosen for market size, liquidity, and industry grouping, among other factors. Investments cannot be made directly in an index.

Diversification is a method used to manage risk. It cannot ensure a profit or protect against loss in a declining market.

The 2016 U.S. presidential election has drawn more potential candidates, more controversy and perhaps more media coverage than any election in modern U.S. history. It also has been said that this year’s presidential contest is the most important of our time.* The same argument could be made from an economic perspective.

This campaign season has already been full of surprises. The unexpected popularity of Donald Trump and Bernie Sanders as potential presidential candidates has caused consternation and excitement. There is talk that the race for the Republican nomination won’t be decided until the Republican National Convention in Cleveland, OH, later this summer. Some even speculate that we could have a “brokered convention,” in which no single candidate has enough delegates at the start of the convention to lock up the nomination.

It still is too early to know who the nominees will be from the two major parties and the races for both nominations continue at a fever pitch. However, recent polls show that Hillary Clinton for the Democrats and Donald Trump for the Republicans are the likely presidential candidates.

As we consider the candidates and the upcoming election, we think it’s important to review the economic issues that the next occupant of the White House and the country will face in the coming years.

DEMAND, DEMOGRAPHICS AND DEBT

Disappointing growth in domestic demand during the latest economic recovery has been the result of a variety of factors, including the country’s demographics, the debt overhang, residual effects from the global financial crisis and weak external demand. We think a few of these key issues have largely been ignored in the current presidential campaign.

Domestic demand is something that the government can directly impact. We believe the federal government will need to walk a fine line between productive investments and spending that boosts demand in the short term but hinders demand in the future. This is especially true given the federal government’s high level of debt, both on an absolute basis and relative to the size of the economy.

In the past, we have written about the benefits of a plan to upgrade and invest in the nation’s infrastructure. Not only would this boost demand in the short-term, but it also is likely to allow an increase in U.S. economic growth potential via an improvement in productivity growth. In addition, promoting investment in new technologies would foster new development and jobs in the high-technology industry. While government debt levels are high, we believe that officials could prioritize spending towards more productive areas.

Demographics will be a key issue for the next administration. Many developed countries are experiencing population declines, while the U.S. population is expected to continue to grow. Even so, the aging U.S. population will put pressure on federal spending. The Congressional Budget Office estimates that “mandatory” federal spending, which is mostly comprised of entitlement spending, will rise by more than $1.5 trillion during the period 2016-2026. This increase equates to more than 1.5% of gross domestic product (GDP).

We believe government leaders and the next president will have several options, including:

• Cut entitlement spending, which would be politically difficult.
• Raise taxes, but current federal revenues are just over 18% of GDP and historically have not been able to sustainably get above 19% of GDP given the current tax structure.
• Cut so-called “discretionary” spending. But “discretionary” federal spending, which is everything outside of mandatory spending and interest, is at near-record lows relative to the size of the economy following recent budget cuts.

We think it is likely that the demographic pressures on the federal budget will be dealt with through a combination of entitlement cuts and tax increases, but the choices will not be easy.

Debt is a topic we have discussed in the past. Until the global financial crisis, private debt in the U.S. increased steadily for a number of years. While that debt has been reduced, it is still at relatively high historical levels, which is likely to be constraining economic activity. A high level of government debt also could have a dampening effect on private demand as consumers and businesses assume that taxes could rise in the future or benefits could be cut.

There is a perception that the wealthiest Americans continue to see strong gains in income as most U.S. households deal with debt in an environment in which incomes are relatively stagnant. This so-called “income gap” or “wealth gap” has been brought up by some presidential candidates during this campaign. The debt issue for these lower income households is unlikely to go away in the short-term and could be an overhang on domestic demand going forward.

What will the federal government do to control its growing debt loads? Will the government decide to implement policies that discourage increasing levels of private debt, or encourage a further buildup in private debt with promises to cancel portions of that debt? Answers to these questions could have important implications for individual consumers and the U.S. economy overall.

BRINGING KEY ISSUES INTO FOCUS

We have identified three key issues but there are other important issues getting attention in the current campaign. However, the issues of demand, demographics and debt are central to the growth of the U.S. economy going forward and in some cases are not receiving the attention we think they deserve. They are among the critical topics for the next president and will be increasingly difficult to ignore.

^{* Source: Bloomberg Businessweek, “Why 2016 May Be the Most Important Election of Our Lifetime,” Nov. 5, 2015}

Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are current through April 2016. These views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.

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

In most credit cycles, the market hits a point when credit rating downgrades far exceed upgrades. This ratings migration process can significantly impact the valuations of securities, particularly when credits are downgraded from a rating of investment grade to high yield. Companies that go through such a downgrade often are referred to as “fallen angels.” The price dislocation that occurs as companies and sectors transition from investment grade to high yield can present significant opportunity for experienced investors in what is termed a “cross-over market.”

Cross-over market opportunity

There are several reasons the cross-over market and fallen angels have offered investors willing to accept the additional risks the potential for excess returns. But the forced selling that often results from these credit downgrades is the primary driver.

With fallen angels, many investment managers who focus on investment grade securities have mandates with limits based on credit ratings. In general, the higher the credit rating, the larger the position size can be in a specific credit. When a credit gets downgraded to high yield, a manager invested in that security often must reduce the position to get within the mandate’s limits — and that means forced selling.

In addition, the investment grade market is approximately five times larger than the high yield market. Forced selling thus often occurs into the much smaller market and the resulting price often adjusts lower as the ratings transition happens. Fallen angels also tend to be much larger companies with more debt outstanding when compared to companies rated high yield, which adds to the transition challenges from a larger to a smaller market. In general, the more downgrades that occur over a short period of time, the more attractive the potential opportunities become on a risk-reward basis.

Market factors at work now

The energy and metals sectors have been under extreme pressure for several quarters because of ongoing low commodity prices. These sectors are cyclical and typically are managed accordingly. However, the severity of the current commodities cycle is taking its toll on the financial condition of virtually every company in these sectors.

As a result, rating agencies are downgrading most of the companies in these sectors. It is likely that many will be downgraded from investment grade to high yield and become fallen angels. Much of the ratings migration process is expected to occur in the first half of 2016, with estimates for tens of billions of dollars of debt getting a downgrade to high

As of February 2016, for example, $449 billion of corporate bonds with low BBB ratings were marked as under review for potential downgrade or negative credit outlooks by Moody’s Investor Service and Standard & Poor’s Rating Services. By comparison, the market value represented by the Barclays U.S. High Yield Corporate Index is about $1.2 trillion.

We think the magnitude of potential future downgrades is likely to cause significant price dislocations in fallen angels in coming months and provide an opportunity for attractive returns.

Historical returns offer a guide

Although the cross-over market is not widely discussed as a distinct market, it has been recognized with its own returns and statistics for more than 20 years. The total return history of the cross-over market compares favorably to both higher- and lower-quality credit during that time.

For example, the annualized return for the cross-over market was 6.76% in 2010-2015, compared with 6.14% for high yield and 5.20% for investment grade.¹ In 2009, the last time cross-over downgrades were material relative to upgrades, the annualized return was 48.05%.² Although it may be unrealistic to expect a repeat of 2009’s total return, we think the magnitude of expected downgrades in 2016 is comparable. On a risk-adjusted return basis for the period 2010-2015 using the Sharpe Ratio, the cross-over result of 1.46 also exceeded high yield at 1.04 and investment grade at 1.31.³

Low correlation with interest rate moves

One way to examine the relationship between securities or among factors is through “correlation” – a statistical measure of how two securities move in relation to each other. A correlation of +1 indicates the securities moved in lockstep through a specific time period.

Securities in the cross-over market historically have not been highly correlated to interest rate changes, as typically has been the case with investment grade credit. In fact, the correlation between U.S. Treasuries and cross-overs is only 0.13 since 1984, compared with 0.79 for investment grade.

Based on this historical relationship, we believe cross-overs are not likely to be materially affected as interest rates rise. In each of the seven years since the onset of the global financial crisis, cross-overs have not had a single year in which they underperformed both investment grade and high yield, based on returns in the Barclays indexes.

Pursuing the potential now

In our view, investments in the cross-over market offers the potential for higher risk-adjusted returns versus the high yield market without the high correlation to interest rate changes of investment grade credit. That’s an important consideration in the current environment since the U.S. Federal Reserve has made an initial move taking rates higher.

History also shows that the cross-over market has been most attractive at the end of a credit cycle, when rating dislocations were at their peak. For these reasons, we think 2016-2017 offers a potential opportunity in the cross-over credit market.

Past performance is not a guarantee of future results.The opinions expressed are those of Waddell & Reed and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through March 2016, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.

Risk factors: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 value of fixed-income securities may fall as interest rates rise. Investing in below-investment-grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. An investment in a mutual 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 a fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.