Institutional Strategies

Core Equity

A concentrated portfolio of primarily U.S. domestic companies that generally invests across the valuation and large- to mid-cap spectrum opportunistically. The goal is a portfolio of companies expected to produce long-term earnings power above expectations. As an actively managed approach, the strategy strives to outperform the S&P 500 Index over full market cycles.

Investment Philosophy

The Core Equity investment process is driven by the core belief that changes in expectations for long-term earnings power drive stock prices. Therefore, the goal is a relatively concentrated portfolio of companies expected to produce long-term earnings power above expectations and stable to improving competitive advantages. Sources of competitive advantage include, but are not limited to, superior technology, brand, scale and capital advantages. The managers believe that focusing on companies with such advantages increases the likelihood that an earnings catalyst is likely to materialize and helps to manage downside risk.

Investment Process

The selection process begins with a broad universe of all securities above $5 billion in market capitalization. They focus on companies with a 2-3 year earnings power that they believe is significantly better than market expectations. Attractive stocks are identified when they have an earnings power story that is thought to be underappreciated and have a strong competitive position which increases the probability that these forecasts can be achieved.
 
The managers focus on two distinct groups of companies that they feel are likely to produce long-term earnings in excess of expectations.

The first group of companies are the dominant participants in an underappreciated theme and are expected to produce long-term earnings power in excess of market expectations. Examples of such themes include industries at cyclical inflection points, major macro-economic/political forces, changes in consumer behavior and shifts in technology.

The second group of companies benefit from company-specific drivers which the managers believe are likely to cause the firm to exceed earnings forecasts on a multi-year basis. Company-specific drivers include, but are not limited to, new products, cost restructuring, improved management execution and positive cyclical changes in business trends.

The team utilizes analysis from daily morning meetings with the entire equity staff to assist in idea generation and identification of new opportunities. In addition, research analysts prepare formal action reports for the portfolio management team to assist in company-specific research.

Regardless of whether ideas come from company specific stories or thematic views, each company in the portfolio will have an expected long-term (2 to 3 year) earnings forecast that in the managers’ view is a significant premium to market.

The result is a relatively concentrated portfolio of approximately 40-50 securities expected to produce long-term earnings power above expectations.

John Maxwell

Portfolio Manager

Mr. Becker is co-portfolio manager of the firm’s Core Equity investment strategy and has served in this role since 2006. He has been affiliated with the strategy since 2003 when he assumed assistant portfolio manager responsibilities. He joined the firm as an equity investment analyst in 1999 and covered industries in the Consumer Discretionary and Industrials sectors.

Prior to joining Waddell & Reed in 1999, Mr. Becker was affiliated with Nicholas Company, Inc. as a research analyst intern.

Mr. Becker earned a MS in Finance and a BBA in Finance from the University of Wisconsin-Madison. He is a CFA charterholder.

Gus Zinn, CFA

Senior Vice President, Portfolio Manager

Mr. Zinn is co-portfolio manager of the firm’s Core Equity investment strategy and has served in this role since 2006. He began his career with Waddell & Reed in 1998 as an equity investment analyst and covered industries in the Consumer Discretionary, Industrials and Information Technology sectors. Mr. Zinn assumed assistant portfolio manager responsibilities for the firm’s Science and Technology mutual funds from 2003 to mid-2006.

Mr. Zinn earned a Masters in Finance and a BBA in Finance from the University of Wisconsin-Madison. He is a CFA charterholder.

3 years, 5 years, 10 years annualized. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Past performance is no guarantee of future results. Please inquire for more current performance information.

Total Returns1,2,3

Average Annual Total Returns as of 6/30/2017
(Returns for periods of less than 1-yr are not annualized)


QTD YTD 1YR 3YR 5YR 10YR
Core Equity - Gross 1.72% 6.73% 11.78% 5.03% 12.55% 8.00%
Core Equity - Net 1.54% 6.36% 11.00% 4.33% 11.83% 7.33%
S&P 500 Index 3.09% 9.34% 17.90% 9.61% 14.63% 7.18%

Calendar Year Returns1,2

  Core Equity Gross Core Equity Net S&P 500 Index
2016 4.51% 3.79% 11.96%
2015 0.46% -0.19% 1.38%
2014 10.61% 9.95% 13.69%
2013 35.42% 34.61% 32.39%
2012 19.61% 18.90% 16.00%
2011 1.90% 1.29% 2.11%
2010 21.63% 20.91% 15.06%
2009 23.47% 22.74% 26.46%
2008 -33.70% -34.11% -37.00%
2007 15.24% 14.56% 5.49%

1Core Equity composite is comprised of 19 accounts that had $7,498.9 million in total assets as of 6/30/17. Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2The S&P 500 Index is a product of S&P Dow Jones Indices LLC (“SPDJI”), and has been licensed for use by Ivy Investment Management Company (IICO). Standard & Poor’s®, S&P® and S&P 500 Index are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by IICO. IICO's products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index. 500 Index.

3QTD return from April 1, 2017 through June 30, 2017.

Data as of 6/30/2017

10 Largest Holdings

as a % of total assets

Apple, Inc. 3.76%
Microsoft Corp. 3.53%
Alphabet, Inc. Class A 3.42%
Morgan Stanley 3.17%
JPMorgan Chase & Co. 3.00%
UnitedHealth Group, Inc. 2.91%
Philip Morris International, Inc. 2.87%
Kraft Heinz Co. (The) 2.69%
Home Depot, Inc. (The) 2.64%
Adobe Systems, Inc. 2.48%

Sector Diversification

as a % of equity assets

Information Technology x.xx%
Financials %
Consumer Discretionary %
Health Care %
Energy %
Industrials %
Consumer Staples %
Materials x.xx%

Composite Composition1

Domestic Common Stock 91.35%
Foreign Common Stock 7.33%
Cash and Cash Equivalents 1.32%

Composite Total Assets1

Assets ($M) $7,498.9
Number of Accounts 19

Supplemental data: The Core Equity holdings and sector diversification data shown are 1 of the 19 composite accounts without client specific investment restrictions and may not be reflective of the Core Equity composite as a whole or of any other Core Equity account currently, or in the future, included in such composite. The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.

1Core Equity composite is comprised of 19 accounts that had $7,498.9 million in total assets as of 6/30/17. Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2The S&P 500 Index is a product of S&P Dow Jones Indices LLC (“SPDJI”), and has been licensed for use by Ivy Investment Management Company (IICO). Standard & Poor’s®, S&P® and S&P 500 Index are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by IICO. IICO's products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index. 500 Index.

3QTD return from April 1, 2017 through June 30, 2017.

As of 3/31/2017

Portfolio Managers:
Erik R. Becker, CFA
Gus C. Zinn, CFA

Portfolio Review

The S&P 500 Index had another solid quarter, starting 2017 with a first quarter return of just over 6%. The makeup of the market’s performance was much different than beginning of the year predictions. Underperforming sectors included those that had benefitted initially from President Trump’s election, including energy, financials and industrials. Instead, the market favored more secular growth areas, with technology leading the way up over 12% in the quarter. Despite this shifting market leadership and volatile political environment, market volatility was extremely low. In fact, there were only two days in the quarter that saw greater than 1% moves for the S&P 500, the lowest for a first quarter in over 35 years. Even with shifting sector leadership, the underlying bid for U.S. equities remained strong. Clearly, the change in relative sector performance of the U.S. equity market reflected a realization that the execution of President Trump’s pro-growth agenda – including tax reform, deregulation and fiscal stimulus – would not be easy. Because President Trump’s agenda contains big changes with many new people involved, the market is keenly focused on the administration’s progress or lack thereof. The market is judging progress on a daily basis until a pattern emerges. An obvious key negative event in the quarter for the Trump agenda was the inability to bring to vote to repeal and replace the Affordable Care Act. While additional setbacks are likely, we see President Trump’s administration willing to make the necessary adjustments to have some important wins in the year ahead.

Currently, our portfolio is constructed to benefit from President Trump having more successes than failures and we are looking to tax reform as the next important milestone. Energy was the only sector to post absolute negative returns for the quarter, as supply fears intensified causing the commodity price and energy stocks to decline. Financials sector performance suffered as investors tempered their expectations for a continued rise in interest rates. Reflecting this sentiment, the yield of the U.S. Treasury 10-year note finished the quarter about where it started at 2.4%. We believe the financials underperformance is a normal pause post-significant outperformance in the second half of 2016. In the coming years, we think the sector could materially benefit from a successful Trump agenda that brings higher economic growth and rising interest rates.

Our portfolio trailed the benchmark by a little more than 1% during the quarter, with the primary detractor on a relative basis our overweight in the energy sector. While the market is currently worried about the restarting of U.S. supply growth, we remain constructive with the longer-term view that oil production outside the U.S. will have a hard time growing much more than a few hundred thousand barrels per year. If roughly true, this will require close to a million barrels of growth from U.S. producers assuming conservative demand growth. While shorter-term mismatches of supply and demand have created recent pressure on the sector, we have high conviction that low cost U.S. producers will be the winners over the coming years. We expect that several of the portfolio’s key energy holdings will disproportionately benefit from U.S. supply growth. Of course, all energy stocks suffer when oil prices decline, a relationship that contributed to our underperformance thus far in 2017. We think a rebound to oil prices in the $50s is quite achievable, however, and that prices at this level would incentivize companies to grow supply, especially the low cost U.S. producers.

We think the portfolio will continue to benefit from significant exposure to the technology sector. The combination of strong outlooks for more well-known areas such as smartphone product cycles and e-commerce, combined with emerging trends including autonomous driving, virtual reality and digitization, are all leading to strong secular growth. Many U.S. companies continue to lead the way in these areas, and their competitive advantages in many cases are material. While valuations in these areas are always at the higher end of the market and recent outperformance has been significant, the long-term outlooks for the leaders in these areas remain positive.

Our pro-cyclical tilt throughout the portfolio remains intact, based both on our view of overall health in the economy as well as continued elevated valuation levels for less cyclical sectors, those historically regarded as “safe.” Supporting our view in the first quarter were several key economic readings, including the ISM New Orders Index that reached cycle highs in the mid 60s. Additionally, broad-based business and consumer confidence readings remain at constructive levels. While consumption data in the first quarter was a bit more mixed, there seems to be a variety of temporary factors affecting the data. Issues such as delayed tax returns, warmer weather, and calendar shifts have depressed recent readings, but we expect all of these conditions to normalize.

In addition, the ongoing shift to e-commerce is a secular force skewing consumption data. But unlike the temporary factors mentioned earlier, e-commerce seems to be only picking up momentum and exacerbating weakness for companies that are losing market share. Our forecast is for overall consumption to improve and real gross domestic product (GDP) growth to accelerate toward 3% by the end 2017. We expect consumption improvement to be spurred by income growth resulting from growth in the labor force and modest wage inflation. All in, we could see end of the year nominal GDP growth (a traditional driver of corporate revenue growth) of close to 5%, which would be a cycle high since the financial crisis.

Outlook

We believe overall economic growth and the resulting corporate revenue growth will be an important driver for earnings and equity returns in the coming year. This is because at this point in the economic cycle, companies have largely completed any cost-cutting or balance sheet refinancing, and now revenue growth is required for increased earnings. With valuations elevated across the market and interest rates expected to rise in the coming year, we believe companies with multi-year earnings drivers should outperform. As most of you are aware, such companies have been the focus of our process since its inception. Our portfolio repositioning since the election has not yet helped relative performance, but we believe the combination of improving economic growth and progress of President Trump’s economic agenda will be favorable for our portfolio in 2017.

The opinions expressed in this commentary are those of the portfolio managers and are current through March 31, 2017. The managers' views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.  Any mention of investment performance refers to gross-of-fees performance, unless otherwise noted. 
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Key Features

Composite Performance History Since 1/1/1995
Benchmark S&P 500 Index
Style Fundamental, Core: Growth and Value
Target Alpha 200 bps above Index
Over full market cycles (3-5 years)
Peer Universe U.S. Large Cap Core Equity
Typical Tracking Error 300-500 bps
Holdings Range 40-50
Max Position Size Greater of 6% or 2.5X Index
Sectors Generally range from 1/2 to 2X the Index weights and are highly dependent on emphasized themes
Investment Vehicles Institutional Separate Account
Collective Investment Trust
U.S. Mutual Fund: Institutional Share Class
Variable Insurance Portfolio