Mid Cap Growth

For the Period Ending: 12/31/2018

Portfolio Managers:
Kimberly A. Scott, CFA
Nathan A. Brown, CFA

Market Update

Mid-cap growth stocks staged a dramatic 16% decline in the fourth quarter of 2018, erasing the year’s earlier gains and more, and landing the Russell Midcap Growth Index, the strategy’s benchmark, at an almost 5% deficit for the year. This was the first quarterly loss for the index in more than three years. The index had been on a streak of positive quarterly performances that started in the fourth quarter of 2015.

Outperformance within the index came from the Consumer Staples, Real Estate, Communication Services, Materials, Consumer Discretionary and Information Technology sectors. Only Consumer Staples and Real Estate showed any substantial outperformance versus the index as both sectors posted low single-digit declines. The other outperforming sectors were only slightly worse than the index in the quarter. Energy turned in the worst performance, falling 25%. Health Care, Industrials and Financials posted steep declines in the high teens.

Concerns over Federal Reserve (Fed) policy and the direction and level of interest rates, plus a shift in business confidence related to the trade and tariff uncertainty moved investors to a decided risk-off stance. The market’s valuation was rich, having discounted high expectations for the economy in recent years based on regulatory relief and tax reform. There was no tolerance for uncertainty, and stocks across all aspects of the mid cap universe – growth, core and value – traded off hard, with the indices all declining in sync, within 1% of each other.

Portfolio Review

After significantly outperforming the index over the course of 2018, the strategy slightly underperformed the index for the quarter ending Dec. 31, 2018. The Consumer Discretionary, Information Technology and Communications Services sectors drove much of the underperformance during the period.

Our Consumer Discretionary names had been a source of significant outperformance for much of 2018, and while many of our holdings fared relatively well in the quarter, three of our names were responsible for much of the group’s weakness. Our Information Technology exposure was weak relative compared to the index. We were underweight this sector in the quarter, as we have been much of the year. The underperformance from our Communications Services stocks came largely from a sizeable and long-standing position in the strategy.

Our Industrials sector underperformed. We were overweight this underperforming group and saw drawdowns across the group in the quarter that resulted in weakness relative to the sector in the index. Strategy outperformance in the quarter came from the Health Care, Financials and Energy sectors. Our Health Care names fared quite a bit better, on average, than the stocks in the index, which fell almost 20%.

Our Financials names largely withstood the thrashing characteristic of those in the index, and in fact, our exchange stocks both rose in price in the period. Our general lack of exposure to the capital markets and credit names was a plus for relative performance, and our bank holdings performed relatively well, with the exception of one holding that disappointed investors with soft guidance related to higher expenses. The company is also closely aligned with the Information Technology sector as its customer base, and generally performs poorly when the technology stocks are weak.


The market’s temperament changed dramatically as the first quarter developed, moving from impressive strength throughout 2017 and early 2018, to greater volatility and tortuous returns post the near-term peak in late January. The index sold off in January and then moved sideways until early May, only to rise to new highs in September before a dramatic 16% swoon through the fourth quarter.

Concerns about higher interest rates and worldwide trade wars rattled the markets, and investors careened between near-term confidence in the economy and corporate profits, and fear of the unknown related to interest rates and tariffs. Strong corporate earnings borne of the ongoing recovery post the Energy sector-led downturn in 2014 and 2015, buoyant business and consumer confidence, and economic growth worldwide underpinned the market’s move throughout 2017 and early 2018. Tax reform was the turbo booster. But the strong economic growth and buoyant job market in the U.S. and worldwide beget fear of inflation.

The Fed has raised rates nine times in three years in a bid to begin to normalize the interest rate environment and to head-off anticipated inflation. These interest rate increases came alongside a shrinking Fed balance sheet, of which we are unsure the Fed was fairly modeling the combined tightening impact on the economy and the market. Markets typically get a bit of indigestion as the tightening cycle ensues, and this time the tariff posturing of the Trump Administration has brought added concern as trade wars and the associated risk to free trade and corporate profitability can potentially impact investment returns. The uncertainty these factors bring can also negatively affect the level of business confidence, which is an important aspect behind economic growth or lack thereof. The investor revolt was dramatic and indiscriminate. The drawdown in the fourth quarter saw the Russell Midcap Growth, Core and Value Indices all fall within 1% of each other, between 15% and 16%.

It is not unusual to see a significant market correction during economic expansions, particularly as the economic cycle ages and growth may be downshifting from a higher rate, often as the Fed is tightening – and potentially overtightening – to get ahead of what it sees as inflationary trends. We see this as the case today, and the recent contraction in the valuation of the market, alongside the Fed’s more conciliatory tone give investors headroom for gains in the stocks of companies that are still growing in a buoyant economy. The consumer is benefiting from a healthy job market and solid wage gains, more discretionary income related to tax reform, and much lower energy prices than this time last year. Corporations continue to invest in innovation and efficiency. All of this underpins healthy demand in the economy, and an intact corporate profits cycle. We must be wary of weakness in other economies around the world, namely China and the eurozone, and the potential impact that weakness could have on the U.S. economy. We see the U.S. as not immune, but somewhat insulated from economic weakness in these other regions, given our stronger demographics and regulatory and tax law changes that have enhanced the business prospects in the U.S., specifically.

The strategy continues to express a more economically constructive and optimistic view, with a more assertive pro-growth, less defensive stance – although slightly less so than in 2017 or early 2018. While our portfolio represents an economically constructive point of view, our approach is essentially balanced based on stock selection as opposed to overt sector allocations. From a broader macroeconomic factor perspective, we expect a stable-to-rising rate environment to be generally positive for our approach, related to our focus on very profitable business models and sound capital structures. The time of quantitative easing was a challenge to our returns, as lower and lower interest rates played to the benefit of the stocks of companies with lesser quality business models and/or capital structures. We expect the change in trend to favor our investment style.

The opinions expressed are those of the portfolio manager(s) and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2018 and are subject to change due to market conditions or other factors. Any mention of investment performance refers to gross-of-fees performance, unless otherwise noted.

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Investment Team

Kimberly A. Scott, CFA

Senior Vice President, Portfolio Manager

Ms. Scott is co-portfolio manager of the firm's Mid Cap Growth investment strategy and has served as portfolio manager of the strategy since 2001. She has been co-portfolio manager of the firm's Ivy Mid Cap Income Opportunities Fund since 2014. She joined the organization in 1999 as an equity investment analyst, covering industries in the consumer discretionary, consumer staples and information technology sectors.

Ms. Scott's lengthy background in fundamental research contributed to her development of the firm's Mid Cap Growth philosophy in 2001. Her extensive experience at various levels of fundamental research in positions throughout her career date to 1987 with the following companies:  Bartlett & Company, NBD Bank, Johnson Investment Counsel, Inc. and the University of Cincinnati Medical Center. Ms. Scott provided sector coverage for consumer non-durables, technology, retail, food and beverage, and tobacco.

Ms. Scott earned an MBA in Finance from the University of Cincinnati and a BS in Microbiology from the University of Kansas.

Nathan A. Brown, CFA

Senior Vice President, Portfolio Manager

Mr. Brown is co-portfolio manager of the firm's Mid Cap Growth investment strategy, appointed to this role in 2016. He had served as assistant portfolio manager to the strategy since 2011. He has been co-portfolio manager of the firm's Ivy Mid Cap Income Opportunities Fund since 2014. He joined the organization in 2003 as an equity investment analyst, covering industries in the consumer discretionary, consumer staples and industrials sectors.

Prior to joining the firm, Mr. Brown interned with Morgan Keegan. From 1999 to 2001 he completed five rotations in General Electric-Aircraft Engine’s financial management program.

Mr. Brown earned an MBA with an emphasis in Finance from Vanderbilt University and a BBA from the University of Iowa.

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