Institutional Strategies

Large Cap Value

The strategy invests in various types of U.S. equity securities of large capitalization companies. The portfolio manager seeks those companies believed to be undervalued or trading at a significant discount relative to the intrinsic value of the company and/or are out of favor in the financial markets but have a favorable outlook for capital appreciation.

Investment Philosophy

  • Mathematical fact - The present value of any investment is the sum of all its expected future cash flows discounted at some interest rate
  • Cash flow growth drives stock value over time. Changes in what investors pay for those cash flows drive excess investment returns

Long term excess returns can potentially be achieved by:

  • Fundamental research focused on sustainable cash flow generation which drives intrinsic value estimates
  • Disciplined focus on proprietary intrinsic value targets as well as persistent macro overlay minimizes big mistakes
  • Portfolio concentration enables best ideas to meaningfully impact performance

Investment Process

The Large Cap Value strategy aims to identify companies whose fundamental health is strong but whose stock price has declined due to transitory factors. Through consistent application of rigorous valuation analysis, the portfolio manager seeks to build a portfolio of companies that are currently trading at a notable discount to their valuation with identifiable catalysts to reach or exceed fair value. Generally, firms with market values of at least 30 percent less than their intrinsic value qualify as portfolio candidates.

The investment process begins with a universe of companies with market capitalizations generally in excess of $10 billion. Next, the universe is filtered/narrowed down to approximately 100 securities by screening a variety of fundamental factors:

  • Low relative valuation on standard valuation metrics
  • High and/or rising free cash flow yield
  • Prudent capital allocation
  • Durable business models

Within this narrowed universe more rigorous fundamental analysis is conducted looking at the origin of profit and cash flow drivers. To these companies, the manager applies a proprietary four step process to determine intrinsic value:

  1. In-depth, free cash flow analysis that incorporates more than a dozen financial statement metrics.
  2. Qualitative adjustment of those metrics − Example: Did inventories decline because strong sales outpaced production, or did management reduce production levels because of sluggish consumer interest?
  3. Normalizing those metrics to adjust for ebbs and flows in specific industry cycles, one-time events and the broader economic cycle.
  4. Discounting resulting cash flows at a proper rate to determine intrinsic value.

Firms considered for portfolio inclusion must meet the intrinsic value requirements and exhibit or have a reasonable expectation of a catalyst to cause the stock to appreciate towards its intrinsic value.

Through this process they seek to build a portfolio of 35-45 stocks each with an average holding period of two to three years. Throughout the holding period, both quantitative and qualitative factors are continually reevaluated to ensure their integrity. The reevaluation process may lower the manager’s intrinsic value estimate and thus compromise the stock’s capital appreciation potential, typically leading the manager to sell that particular holding. The manager uses similar analysis to evaluate price declines within the portfolio, thus trying to avoid "value traps."

Matthew T. Norris, CFA

Senior Vice President, Portfolio Manager

Mr. Norris is portfolio manager of the firm’s Large Cap Value investment strategy and has been in this role since 2003 when he joined the firm. From 2005 to 2010 he was the Director of Equity Research and responsible for the firm’s equity research team during that time. Mr. Norris held portfolio management responsibilities for the firm’s Small Cap Value investment strategy from 2010 to 2011.

Prior to joining Waddell & Reed, Mr. Norris was affiliated with Advantus Capital Management, Inc. in St. Paul, Minnesota from 1997 to 2003. He joined Advantus as an equity analyst and was appointed portfolio manager in 2000. Prior to joining Advantus, he was an equity analyst and portfolio manager for Norwest Investment Management, Inc. from 1994 to 1997.

Mr. Norris earned an MBA from the University of Nebraska and a BS in Cellular Biology from the University of Kansas. He is a CFA charterholder.

Joshua P. Brown

Assistant Vice President, Assistant Portfolio Manager

Mr. Brown is assistant portfolio manager of the firm’s Large Cap Value investment strategy and assists the portfolio manager in idea generation, research, portfolio construction, and risk management efforts. He has been a member of the team since 2017. He is also a member of the firm’s equity research team, covering industrials (air freight and logistics, airlines, marine, road and rail), consumer discretionary (auto components, automobiles, hotel resorts and cruise lines, and leisure products), and materials (chemicals, metals and mining).

Prior to joining Waddell & Reed in 2009 as an equity investment analyst, Mr. Brown spent five years as a broker for Citigroup - Smith Barney. As an investment analyst intern for Waddell & Reed Investment Management Company in 2008, he covered oil and gas master limited partnerships.

Mr. Brown earned an MBA with a concentration in Finance; specialization in Investment Management from the University of Texas at Austin, McCombs School of Business and a BBA; concentration in Finance from the University of Kansas.

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 Returns

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
Large Cap Value - Gross 2.94%  6.85% 21.53% 6.88% 14.59% 6.85%
Large Cap Value - Net 2.76%  6.48% 20.68% 6.17% 13.86% 6.19%
Russell 1000 Value Index 1.34%  4.66% 15.53% 7.36% 13.94% 5.57%

Calendar Year Returns

  Large Cap Value Gross Large Cap Value Net Russell 1000 Value Index
2016 12.34%  11.56%  17.34% 
2015 -3.00% -3.62% -3.83%
2014 11.94% 11.27% 13.45%
2013 37.46% 36.64% 32.53%
2012 20.05% 19.33% 17.51%
2011 -6.07% -6.63% 0.39%
2010 18.28% 17.58% 15.51%
2009 24.89% 24.16% 19.69%
2008 -31.97% -32.40% -36.85%
2007 3.88% 3.26% -0.17%

1Large Cap Value composite is comprised of 5 accounts that had $1,729.8 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.

2Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Ivy Investment Management Company (IICO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in IICO’s presentation thereof.

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

Data as of 6/30/2017

10 Largest Holdings

as a % of total assets

JPMorgan Chase & Co. 4.81%
Citigroup, Inc. 4.14%
Capital One Financial Corp. 3.84%
Synchrony Financial 3.68%
State Street Corp. 3.53%
Energy Transfer Partners L.P. 3.11%
Dow Chemical Co. (The) 3.03%
Cigna Corp. 2.98%
American International Group, Inc. 2.96%
MetLife, Inc. 2.90%

Sector Diversification

as a % of equity assets

Financials 34.48%
Health Care 14.11%
Energy 12.87%
Information Technology 8.83%
Consumer Discretionary 8.71%
Industrials 6.54%
Consumer Staples 4.94%
Utilities 3.32%
Materials 3.16%
Real Estate 3.04%

Composite Composition1

Domestic Common Stock 94.74%
Foreign Common Stock 1.99%
Cash and Cash Equivalents 3.26%

Composite Total Assets1

Assets ($M) $1,729.8
Number of Accounts 5

Supplemental data: The Large Cap Value holdings and sector diversification data shown are 1 of the 5 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Value composite as a whole or of any other Large Cap Value 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.

1Large Cap Value composite is comprised of 5 accounts that had $1,729.8 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.

2Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Ivy Investment Management Company (IICO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in IICO’s presentation thereof.

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

As of 6/30/2017

Portfolio Manager:
Matthew T. Norris, CFA

Portfolio Review

The market continued nudging higher, with many indexes setting new all-time highs in late June. Positives include a strong economy creating good company earnings, as well as few signs of inflation. The market is struggling with some negatives, however, including high valuations, lack of helpful political reform, and rising interest rates. The Russell 1000 Value Index return for the second quarter was +1.34%, which trailed both the broader S&P 500 Index as well as the growth style. Value did outperform growth in June, but we view this occurrence as part of the short-term ebb and flow rather than the start of a trend. As usual, we try to ignore short-term fluctuations and keep our focus longer-term.

In the second quarter, the Ivy Investments large cap value strategy outperformed the Russell 1000 Value, largely due to our individual stock selection. The best relative sector was Technology, followed by Financials and Telecommunications, where we won by not playing. This sector fell over 7% in the quarter, and the portfolio has no exposure.

There were few negatives in the quarter, with Real Estate the only sector detracting from relative performance.

For the quarter, the portfolio’s biggest overweights were in the Financials, Health Care and Consumer Discretionary sectors. We believe the U.S. banking system is strong and well capitalized, with many equities attractively priced. The Federal Reserve’s recent Comprehensive Capital Analysis and Review (CCAR) gave most large banks the ability to raise dividends and repurchase shares, adding to their appeal. In other sectors, our overweights are more a function of incidental names than any overall theme. Industries held include HMO’s, pharmaceuticals and cable television.

The portfolio’s major underweights in the quarter were Industrials, Consumer Staples and Telecommunications. We see very little value in these sectors, although there are some ideas in Industrials that we are interested in if an attractive price presents itself.

Outlook

After eight years and some stops and starts, the U.S. economy has recovered from the 2008 recession and seems to have settled into a low single-digit growth area. Recent data has been even more encouraging, with a recovery of jobs and capital expenditures in the Energy sector, and improvements in the labor market and manufacturing data. The next challenge will be for the Federal Reserve to tighten money policy back up. They have indicated a path to three rate hikes in 2017. Slowing the economy and inflation via rate hikes is a difficult job, however, one we liken to stepping on a rolling egg to stop it without breaking it. History shows a high probability of failure, particularly if interest rates rise too much thus helping create a recession. This is something we will watch carefully.

While the economic forces listed above are clearly important factors, the portfolio management team’s first approach is from the company level. We seek to find quality, growing companies whose stocks are trading below what we consider their intrinsic value. Often this is due to short-term negative factors, and we become larger owners of a company if we feel those negatives are about to dissipate. We continue to search for and make investments one company at a time, to benefit clients over the long run.

The opinions expressed in this commentary are those of the portfolio manager and are current through June 30, 2017. The manager's 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 6/1/2003
Benchmark Russell 1000 Value Index
Style Fundamental, Value
Target Alpha 200 bps above Index
Over full market cycles (3-5 years)
Peer Universe U.S. Large Cap Value Equity
Typical Tracking Error 300-500 bps
Holdings Range 35-45
Max Position Size Generally 7%
Sectors Greater of 2X Index weight or 40%
Investment Vehicles Institutional Separate Account
U.S. Mutual Fund: Institutional Share Class
Variable Insurance Portfolio