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.

Erik R. Becker, CFA

Senior Vice President, 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 organization in 1999 as an equity investment analyst, covering industries in the consumer discretionary and industrials sectors.

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 joined the organization in 1998 as an equity investment analyst, covering industries in the consumer discretionary, industrials and information technology sectors. Mr. Zinn was assistant portfolio manager of 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 12/31/2017
(Returns for periods of less than 1-yr are not annualized)


QTD YTD 1YR 3YR 5YR 10YR
Core Equity - Gross 6.59% 21.85% 21.85% 8.56% 13.89% 8.81%
Core Equity - Net 6.40% 21.00% 21.00% 7.82% 13.16% 8.13%
S&P 500 Index 6.64% 21.83% 21.83% 11.41% 15.79% 8.50%

Calendar Year Returns1,2

  Core Equity Gross Core Equity Net S&P 500 Index
2017 21.85%  21.00%   21.83%  
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%

1Core Equity composite is comprised of 12 accounts that had $6,698.5 million in total assets as of 12/31/17. 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.

3QTD return from October 1, 2017 through December 31, 2017.

Data as of 12/31/2017

10 Largest Holdings

as a % of total assets

Microsoft Corp. 5.10%
Apple, Inc. 4.62%
Morgan Stanley 3.32%
PayPal, Inc. 3.20%
JPMorgan Chase & Co. 3.12%
Alphabet, Inc. Class A 3.10%
UnitedHealth Group, Inc. 3.08%
Bank of America Corp. 2.65%
Airbus SE 2.50%
JB Hunt Transport Services, Inc. 2.39%

Sector Diversification

as a % of equity assets

Information Technology 35.55%
Financials 15.40%
Industrials 11.71%
Health Care 10.91%
Consumer Staples 8.75%
Consumer Discretionary 7.37%
Energy 5.69%
Materials 4.61%

Composite Composition1

Domestic Common Stock 91.57%
Foreign Common Stock 7.66%
Cash and Cash Equivalents 0.77%

Composite Total Assets1

Assets ($M) $6,698.5
Number of Accounts 12

Supplemental data: The Core Equity holdings and sector diversification data shown are 1 of the 12 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 12 accounts that had $6,698.5 million in total assets as of 12/31/17. 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.

3QTD return from October 1, 2017 through December 31, 2017.

As of 12/31/2017

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

Portfolio Review

The S&P 500 increased 6.6% in the fourth quarter of 2017, capping a strong year in which the index increased 21.8% on a total return basis. (The Russell 1000 Index was also up 6.6% in the quarter and returned 21.7% for the year.) Consumer discretionary, information technology, and financials outperformed the broader index materially. The largest single catalyst in the quarter was the new tax bill signed at end of the year (but introduced and debated throughout the quarter). As details emerged for a 21% corporate tax rate to replace the previous 35%, domestic-oriented stocks (consumer and financial) led the rally. Bond yields increased, with the largest uptick in yields occurring in shorter-duration bonds. The yield on the 2-year Treasury note increased from 1.48% at the end of Q3 to 1.89% at the end of the year as the Federal Reserve continued on its path of normalizing short-term interest rates. Longer-term bond yields (10-year Treasury) moved up as well during the quarter, though only 8 basis points to end the year at 2.41%. The outlook for accelerating GDP with the signing of the tax bill drove these higher yields and contributed to the underperformance in the more defensive segments of the market: utilities, health care, and real estate. Our strategy slightly outperformed for the quarter with outperformance in health care and financials more than offsetting weak performance within our consumer discretionary holdings. Our sector positioning generally aided performance, led by our overweight in information technology and underweight of yield sensitive groups such as telecom and utilities. Stock selection was negative with disappointing results in consumer discretionary and some year-end “sell your winner” moves within the information technology sector.

Outlook

We believe the economic outlook in the U.S. provides a positive investment backdrop for our portfolio. As always, we are most focused on broad performance of S&P/Russell 1000 earnings growth, which we believe will accelerate in 2018 relative to a strong 2017. Most importantly, the enactment of new tax legislation in the U.S. is expected to have an +8-10% impact on 2018 growth in S&P 500 earnings, per consensus estimates. Largely domestic businesses like health care services, transportation, and financials are likely to have the strongest immediate impact from the new tax legislation, with many companies in this group seeing a 20%+ boost to earnings. Technology firms, while generally more multinational in nature, should also see meaningful earnings benefits though they will be driven more by the opportunity to repatriate large sums of cash to increase share buybacks and dividends. Financial accretion through M&A is also a likely avenue for many tech firms with increased access to their international cash balances. Beyond the immediate impact driven by a lower corporate tax rate, we expect declines in individual tax rates to have a stimulative impact to 2018 GDP levels in the U.S. of as much as 0.5-0.8%. For the first time this cycle, it appears that business confidence has improved to the point of finally driving a broad acceleration in capital expenditure levels. At the same time, consumer incomes are healthy with moderate job growth continuing, signs of a slow acceleration in wages, and robust wealth effects given strong asset appreciation in housing and financial markets. Importantly, broad-based strength is not limited to the United States as other economies continue to see new cycle high levels of industrial and consumer activity, particularly in the eurozone and in China. All told, we are confident that U.S. GDP will be closer to the 3% level over the next year than the 2-2.5% trend line through most of this cycle. S&P earnings growth could grow in the high teens, which would be the fastest pace since 2010. With our earnings-driven approach, we believe this provides a relatively fertile backdrop for stock picking.

As one would imagine, financial markets have already factored much of the immediate tax benefits into the valuations of most S&P/Russell 1000 constituents. Largely domestic businesses outperformed more multinational-oriented peers at the end of 2017. For many companies and industries, the immediate benefits of corporate tax reform are likely to be competed away over time. The benefit for banks will likely be limited as they compete against hundreds of domestic rivals on loan or deposit pricing. We believe much work has yet to be done in determining the truly sustainable impact of tax reform on American business, and we also believe this will provide our strategy significant opportunity going forward. We have a high level of conviction that with a significant “gift” from Republicans, most businesses will choose to use a significant portion of tax savings to invest in their own competitiveness. With capacity utilization still relatively low, much of this investment is likely to be in information technology in addition to hiring and retaining key personnel in an environment of tightening unemployment. So while not the initial darlings of tax reform, tech stocks could see some of the strongest and lasting effects of tax reform in the coming year, in which case our large overweight position would be poised to benefit.

Beyond information technology, we believe that the stimulative effects of the recent tax bill and robust consumption will have a continued positive effect on the financials sector. While we fully expect some of the immediate benefits of tax reform to be competed away, our portfolio of financials should benefit from a tightening economy and further effort to roll back Obama-era regulations that led to many years of subpar ROEs in the industry. The spring of 2018 will be the next opportunity for large banks to request accelerated levels of capital return through the annual “stress test” conducted by the Federal Reserve, which has become increasingly bank-friendly under President Trump. We expect payout ratios (buybacks + dividends) to rise meaningfully and provide a catalyst for many banks’ future earnings power and ROEs.

Finally, we believe the overall environment for our strategy continues to improve with prospects for accelerated U.S. growth, continued movement higher in market interest rates, declining levels of central bank intervention in global bond markets, and strong corporate earnings growth. These factors, we believe, will lead to highly differentiated sector moves that should present opportunities for earnings-focused strategies like ours. Further, we believe these factors will outweigh trends (both regulatory and performance-related) that favor further gains in passive investment flows.

We remain watchful for developments that could have a negative effect on financial markets and our portfolio, which at the moment has a positive cyclical tilt and some momentum characteristics, particularly in information technology. We think the most likely source of future volatility could be any signs that policymakers in the U.S. and overseas are “behind the curve” in battling an acceleration in inflation. In most businesses cycles, tightening monetary conditions generally set the stage for a reduction in future growth rates and even recessionary conditions. Inflation appears well-contained at the moment, however, with the consumer price index running <2% and wages broadly growing ~2.5%. Readings of >3% and 4-5%, respectively, would be of concern as they typically mark a more aggressive monetary policy stance. As always, we will work to drive positive returns over the next 12 months.

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, 2017 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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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