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Managing risk takes on increased importance as markets correct, volatility increases - February 2010

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

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Through February 2010, our primary concerns surround valuation in emerging markets, specifically with respect to significant policy risk in China, India and Brazil – markets that were looking so inexpensive with policy changes coming at least on the margin. In response, we’ve taken decisive action in restructuring the portfolio to manage risk, preserve capital and capitalize on emerging opportunities.

Policy risk drives market volatility, portfolio restructuring

We see the primary issues in emerging markets coming from the fact that the Chinese and the Indians are now raising reserve requirements and there’s talk out of the Brazilians about interest rate hikes. Perhaps even more important is the rhetoric out of China on hard loan quotas and slowing loan growth. In addition, not having valuation as a tailwind has led to a pretty steep and quick downdraft in those markets. Collectively, these issues have all been very disruptive in emerging markets.

We have previously discussed our intention to remove some of our emerging markets exposure and become more focused on developed markets and more domiciled in our equity exposure. We felt we do have valuation as a tailwind in some of our global multinational companies. If you took a snapshot of the portfolio today, you would see more of that reflected. The biggest substantial change in the last month is that our net equity exposure is down significantly. As the year began, we were of the mind-set that we would be doing more hedging this year than we did in the second half of 2009, and we have indeed done that. Our net equity exposure today is down substantially from the first or second week of January.

To reiterate our long-standing strategy, we tend to run higher cash balances when we have a higher futures position because we do not leverage this Fund. We want to have ready cash available in case the market moves higher and cash requirement positions for the futures also move up. Gold bullion is another area in which we’ve been more active. Today the Fund’s percentage in bullion is down a bit from a month ago.

A few items we’d like to expand upon are risk and valuation. The greatest risk we see to the markets is policy risk as central banks reduce quantitative easing and reduce policy measures. The questions are, can markets stand on their own, and how will they react? We think it’s wise to be more valuation sensitive in this period. We still believe in the profitability story and that the market is going to bias itself toward cheap, so it makes sense to have valuation as a tailwind in our equity universe as well as our fixed income universe. That’s still the strategy we are employing within the Fund.

Agility, active management are key

We’d also like to caution, as we have before, against falling in love with our current allocation – i.e., the heavy use of futures we have on the Fund. We think this is going to be an exceptionally volatile year, and we think we are going to have to be more active in managing the equity portfolio, primarily by being in futures, and in reducing our hedging exposure when valuation looks attractive to us. We will add to our futures exposure when valuation becomes less attractive. We think we’re currently in a trading range with some pretty sloppy volatility, and what we’re trying to do first and foremost is manage the risk associated with the portfolio. We believe on a three-year basis that the growth in emerging markets is THE story of the markets. However, that comes with a lot of volatility and at times with risk of loss of capital. We are focused on capital preservation, but we will be looking to add equity exposure when valuation looks attractive.

Corrections anticipated, and a re-setting of the base

If you look at markets around the globe, you’ll see we’ve come a fairly long way fairly quickly, especially in emerging markets. The Hong Kong market is down about 20 percent from its peak in November. Historical corrections in China when policy starts to tighten have been anywhere from 20 to 30 percent. This leads us to believe we’re on the low end of what you would expect out of a correction. In other words, we think this will be a fairly normal correction in China, with a 20 percent to 30 percent pullback. We may be looking to add some exposure if we get a little more pullback. Europe, on a currency-adjusted basis, has been awful, down 20 percent, and on a static basis down over 13 percent. Again, the issue with Greece, Portugal, Ireland and Italy is at the forefront; what’s happening there is what happened to the dollar last year: a weakening currency and an attack on the debt structure. We think this is what will happen with most of the developing countries. With respect to the Unites States, Great Britain, Europe and Japan, we think we’ll see a continuation of policy with these rolling deficit issues and debt refunding issues. Given our outlook for profitability, we don’t think this is the start of another W-shaped market, a downdraft or another test of lows. We think this is a resetting of the base.

Spreads have corrected, derivatives play increasing role

The Fund currently has little exposure to fixed income. Spreads within the fixed-income markets have corrected, broadly speaking, but we’re still seeing robust issuance among corporates, especially in the United States. In all of 2009 we saw a record $1.2 trillion in issuance, and so far in 2010 we’ve seen over $150 billion issued, so we’re on pace for another breakneck year. In terms of spreads in investment grade bonds, we’ve seen widening of about 10 basis points. We’ve seen spreads widen about 50 basis points in high-yield and emerging-market corporate. Some of that spread action is a function of the rally we’ve seen in Treasuries, about 20 to 30 basis points across the curve, but there’s definitely some risk coming off the table. Due to the low-yield environment and with valuations still being rich, we still have that low material allocation.

Past performance is not a guarantee of future results. The opinions expressed are those of the Fund managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through February 25, 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.

Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus containing this and other information for the Ivy Funds, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus carefully before investing.