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 as an equity investment analyst in 1999 and covered industries in the Consumer Discretionary and Industrials sectors. Mr. Becker had previously been 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 the organization 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 9/30/2017
(Returns for periods of less than 1-yr are not annualized)


QTD YTD 1YR 3YR 5YR 10YR
Core Equity - Gross 7.10% 14.32% 14.36% 7.41% 12.58% 8.07%
Core Equity - Net 6.92% 13.72% 13.56% 6.69% 11.86% 7.40%
S&P 500 Index 4.48% 14.24% 18.61% 10.81% 14.22% 7.44%

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 13 accounts that had $6,864.1 million in total assets as of 9/30/17. 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.

3QTD return from July 1, 2017 through September 30, 2017.

Data as of 9/30/2017

10 Largest Holdings

as a % of total assets

Apple, Inc. 4.51%
Microsoft Corp. 4.49%
Morgan Stanley 3.26%
Alphabet, Inc. Class A 3.23%
JPMorgan Chase & Co. 2.98%
UnitedHealth Group, Inc. 2.92%
PayPal, Inc. 2.78%
Applied Materials, Inc. 2.64%
Monster Beverage Corp. 2.49%
Broadcom Ltd. 2.49%

Sector Diversification

as a % of equity assets

Information Technology 37.32%
Financials 15.60%
Health Care 11.90%
Industrials 9.97%
Consumer Staples 9.45%
Consumer Discretionary 7.54%
Energy 4.35%
Materials 3.87%

Composite Composition1

Domestic Common Stock 92.56%
Foreign Common Stock 5.98%
Cash and Cash Equivalents 1.45%

Composite Total Assets1

Assets ($M) $6,864.1
Number of Accounts 13

Supplemental data: The Core Equity holdings and sector diversification data shown are 1 of the 13 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 13 accounts that had $6,864.1 million in total assets as of 9/30/17. 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.

3QTD return from July 1, 2017 through September 30, 2017.

As of 9/30/2017

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

Portfolio Review

The third quarter of 2017 continued to show strong upward momentum in the U.S. equity market, with the S&P 500 Index rising 4.5%. While six of the past seven quarters have posted positive S&P 500 returns, this quarter’s returns differed in that they were relatively balanced across sectors. Only one sector had a negative return (Consumer Staples down just over 1%), and no sector had returns greater than 10%. The Information Technology sector continued its year-to-date leadership with returns of 8.6% for the quarter. With the balanced sector performance and our only material overweight being Information Technology, our portfolio was well-positioned to outperform this quarter. The Ivy Investments Core Equity portfolio returned 7.1% in the quarter, comfortably outperforming its benchmarks. Over 70% of the outperformance came from stock selection, primarily within Information Technology. Sector allocation also aided performance with the aforementioned Information Technology overweight. The positive stock selection was driven by better decision-making, but also by an important market change that we have been expecting for some time. For the past few years, many stocks moved for reasons other than earnings, including high dividend yields as interest rates fell, and perceived stability in the largest companies. Thankfully, this environment now seems to be ending. With valuations elevated and interest rates slowly grinding higher, we believe that changes in future earnings power is now reemerging as the dominant driver of stock performance. We have high conviction that our process is well-situated for this new environment, and we are cautiously optimistic it will gain momentum over the upcoming quarters.

Without a big sea change in the overall economy, our strategy continues to look for secular changes within sectors where we think certain companies’ earnings can benefit from over a multi-year period. Information Technology continues to be the sector where we see the most significant innovations, those that are disrupting business models in many industries. Specifically, we have targeted companies acting as disruptors in commerce, connectivity and cloud computing. More than other sectors, Information Technology requires constant innovation to create value for company shareholders. This is because tech prices fall continually, and new products and services are required to grow revenues against such a deflationary backdrop. Put simply, in order to flourish, the Information Technology sector needs to continually develop products with broad market appeal. In past years the growth of smart phones drove innovation, but that product cycle has now matured. Now, emerging growth in areas of mobile commerce, autonomous driving and machine learning are driving the need for leading edge technology, and these developments benefit a number of our portfolio holdings. Valuations have surely expanded for companies in these markets, but we believe valuations are still relatively low given the scale of technology disruption that is now occurring. We expect continued disruption will lead us to more opportunities within Information Technology. We also expect our understanding of disruptive technology will help us avoid areas of the market where such trends will damage the ability of some companies to achieve their expected long-term earnings power.

The portfolio remains relatively balanced across sectors with the exception of our Information Technology overweight, which results in a growth tilt for the portfolio as a whole. After an eight-year bull market, the most attractive valuations in the market are usually areas facing significant secular pressures. An obvious example is retail, where stocks are down significantly. Valuations are attractive but secular risks abound, especially the risk of continued market share loss and expense pressure due to ecommerce. We expect the growth tilt in our portfolio to continue, as well as the modest overweight to the Financials sector, which we view as relatively cheap. There are some pockets of the value universe that show promise, and we may look to selectively add to our value-oriented holdings. The foundation of our investment process is finding companies where we believe the longer-term earnings power is underestimated.

Outlook

In the short term, we expect the market’s bias for higher levels to continue. The combination of an improving economic outlook, coupled with some renewed hope around tax reform and continued deregulation, have increased the prospects for companies more exposed to economic growth. Due to valuation levels which have remained historically elevated in the more stable areas of the market, we believe the recent leadership from Information Technology and Financials is likely to continue in upcoming quarters. We acknowledge that predicting political outcomes has proven very difficult in 2017, but we are still inclined to believe that moves to lessen regulation and simplify the corporate tax code can increase corporate confidence in the year ahead.

The economy continues to improve and may benefit in coming quarters from recent hurricane rebuilding activity. Still, we don’t believe the pace of improvement will be significant enough to shift the existing economic narrative. The 10-year U.S. Treasury yield supports this belief, as it remained relatively flat throughout the third quarter. While duration of this economic expansion is nearing record territory, it is important to remember that recent expansion has been very different from traditional recoveries. Growth has been only about half that of a typical recovery, and has been mainly driven by consumer deleveraging since the financial crisis. In predicting the next economic downturn, therefore, it is worth recalling that recessions are generally caused by three circumstances: 1) Growing inflation to the point where the central bank feels compelled to intervene; 2) A policy error of some sort; or 3) An exogenous event. The second and third reasons are hard to predict, so the equity market tends to focus its attention on the prospect of increasing inflation. One contributor to overall inflation is wage growth, which gets particularly worrisome when it rises to around 4%. Today’s level in the mid-2% range gives us comfort that wages won’t soon become a major recessionary influence. We expect the U.S. Federal Reserve to continue its slow and steady pace on interest rate hikes, with one more expected for 2017 and two or three throughout 2018.

As we think that stocks are increasingly being driven by changes in earnings expectations, we are optimistic about the current environment and believe it is supportive of our process.

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 September 30, 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