Recent volatility impacts performance

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 Strategy Fund - May 2010
 
 
Global markets have seen tremendous volatility as Europe struggles to iron out its sovereign debt problems in the face of escalating concern about the health of its banking system. Factor in China’s decisive action to slow its galloping economy, and geopolitical tensions in North Korea and we believe we have a recipe for equity market decline.
 
As far back as late 2009, we were very clear in communicating that investors should anticipate that Asset Strategy Fund would, in the face of increasing volatility, act more like a global growth equity product. On a gross basis, Asset Strategy Fund at this point in time looks similar to the Morgan Stanley Capital International (MSCI) World Index, both in terms of country exposure and performance. What’s driving recent Fund underperformance is our active bet in Asia, which represents about 35 percent on a gross basis.
 
This volatility may be unsettling, but we see it as opportunity to exploit the controversy in the Chinese market and capitalize on valuation, which we see as very attractive right now, by adding exposure. The downdraft in Europe did affect the Fund for about a day and a half, but the real downside pull has come from the growth exposure to Asia. We do not know when Asia will begin to perform well, but we continue to be table-pounding buyers of China—specifically in the most depressed sectors (financials, property and insurance).
 
The recent volatility has some investors questioning whether the Fund will be more volatile going forward than it has been historically. Our answer is, over the long term, likely not; however, over a six-month basis, it is very likely that heightened volatility will continue to be a factor due to our overweight position in Asia and China specifically.
 
Managing downside risk
We are increasingly being asked why the Fund has been so volatile if we are effectively managing downside risk. We must reiterate: the volatility in the Fund in recent weeks is tied to its Asian/China exposure, which is unhedged and in our view is the probable source of future performance. We have not been overly impacted by the debt crisis across developed European markets, which is making headlines and shaking global confidence.
 
That said, this question provides us with an opportunity to explain how we use hedging to manage downside risk. Our hedging strategy is actually pretty straightforward. There are two things we look at specifically—policy risks from a top-down point of view, globally, and valuation with respect to either reducing or adding beta, a measure which reflects the sensitivity of the fund’s return to fluctuations in the market index. For example, as concerns about Europe intensified earlier this month, we decided to hedge our exposure there. The trigger had nothing to do with whether or not Europe was facing a debt crisis; it was because of what was happening to the European banks. We were moving from a debt crisis to a banking crisis, and we felt the European Central Bank (ECB) needed to be ahead of the curve or we’d be in for a full-blown banking panic. The ECB did in fact come to the table with a rescue plan, in our mind getting ahead of the curve in stemming the crisis. The point is, we had the protective hedges in place. With that issue largely resolved, at least for the moment, we subsequently took down some of that hedging.
 
Although this hedging strategy helped to some degree, what didn’t work so well was our decision to remove some of the hedging in Europe and use more currency shorting (the euro). We moved into the euro, which is helping the Fund, but not nearly enough right now to offset weak European stock performance. We understand completely the European issues and how they could spread (hence our short position on the euro) and we continue to try to navigate an extremely complex market with massive policy risk. Against that backdrop, we are diligently working to protect the downside and maintaining a portfolio with a three-year view.
 
Research and stock selection process
Although we have been talking a lot lately about Asia and China in particular, we would like to reiterate, as we have many times, that we are less concerned with where a company is domiciled than we are in identifying the steady growth companies that fit our criteria for sustainable competitive advantage. This plays well into our investment theme that we’ve emphasized for some time—our belief in the opportunities presented by the emerging middle class as the global economy rebalances.
 
Our process in finding those stocks is both disciplined and focused. Depending on the outlook for U.S. and global economies, we make allocations among stocks, bonds, cash, precious metals and currency markets around the world.
 
First, we look at the global environment, which includes a thorough analysis of macroeconomics and the political, social and cultural environments in each market. Next, we focus on market sectors to determine which ones we believe are positioned to outperform over the next two to three years (not two to three months). We do not make sector calls, but rather pay attention to the emerging middle class theme that is at the heart of our investment strategy. We look for companies that are providing (or could provide) products or services that will help societies move from one phase to the next. Stock selection, then, the final step in our process, is the result of our team’s fundamental research and analysis with respect to our thematic calls.
 
Our resources at work for investors
It is important to note that the Asset Strategy portfolio management team has the entire Ivy Investment Management Division as a resource in researching and developing the ideas in which the Fund may invest. The Asset Strategy process, in effect, is a reflection of the firm’s entire investing style, as we invite ideas and share ideas from among our sector analysts, economists and other portfolio managers. We act on the ones we feel are most appropriate and that fit with the global themes we’ve identified.
 
That is in excess of 60 people, with the portfolio managers among them carrying an average of 20 years of industry experience, backing up the Fund. This is an illustration of the resources at work for Ivy Asset Strategy Fund investors, and part of the reason that our capacity to manage the fund should not be in question. The commitment of your co-portfolio managers, and of the entire Ivy Funds investment team, is to continue to provide a highly competitive investment product, capturing opportunity and seeking to protect investors from downside risk. Short-term volatility will always be a challenge, but our resources and our daily focus on our goals have not changed.
 
Look to the past
We’ve long advised investors to view Fund performance with a long-term perspective. We caution investors to never let a short-term market event disrupt their long-term strategy; this is advice we not only give, but stringently follow ourselves in managing the Fund.
 
To that end, consider the rolling 3-year results for Ivy Asset Strategy, Class A, for 1-month increments during the past 10 years (ending April 30, 2010): 
  • The median down capture ratio (a statistical measure of an investment manager’s overall performance in down markets) for Ivy asset Strategy in those rolling 3-year windows was 29.09 percent.
  • In only 21 of the 85 rolling 3-year periods did Ivy Asset Strategy’s down capture ratio exceed 50 percent. In other words, during periods of declining markets, Ivy Asset Strategy managed, three quarters of the time, to keep is losses to less than half of those incurred by the S&P 500 Index.  
These numbers speak to the ability of the Fund to meet its stated mandate of protecting client assets over the long term. Meanwhile, returns measured during the same rolling 3-year periods over the past decade also speak to the Fund’s ability to meet its stated mandate of achieving sound returns for clients. 
  • In 83 of the 85 rolling 3-year periods during the past 10 years, Ivy Asset Strategy outperformed its S&P 500 benchmark.
  • Ivy Asset Strategy’s average 3-year rolling return in those 85 periods was 12.39 percent, almost a full 1,000 basis points more than the S&P 500’s 2.56 percent return.
  • Ivy Asset Strategy generally has achieved its outperformance of the S&P 500 with less volatility than the index. The Fund’s standard deviation (a measure of how volatile a fund’s returns are) in the same 85 rolling 3-year periods was 12.02 percent, compared with 14.97 percent for the index.  
(All performance indicated above does not take into account the maximum sales charges of 5.75 percent, and if it had, performance shown would have been lower.)
 
Fund Performance
 
 
 
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. Click here for the Fund’s most recent month-end performance. • Class A share performance, including sales charges, reflects the maximum applicable front-end sales load of 5.75 percent. Performance at net asset value (NAV) does not include the effect of sales charges. • For Class C shares, a 1 percent CDSC applies to the lesser of amount invested or redemption value of shares redeemed within 12 months after the purchase date. Accordingly, these returns reflect no CDSC since it only applies to Class C shares held for 12 months or less.
 
S&P 500 is an unmanaged index of common stocks. Citigroup Certificate of Deposit 1-Month is an unmanaged index of certificates of deposits maturing in one month. Citigroup Broad Investment Grade is an unmanaged index comprised of securities that represent the bond market.
 
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 May 24, 2010, and are subject to change due to market conditions or other factors. • 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.
 
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