Delaware Investments: A proprietary, independent view of credit research

There has been much discussion within the investment industry in recent years about ratings agencies and their culpability when they issue ratings that prove to be inaccurate. At Delaware Investments, we prefer to rely on our own focused, independent credit research.

In some corners of the securities markets, ratings agencies have been considered key perpetrators of the financial meltdown of 2008, and they remain in the crosshairs today. In fact, the list of legal proceedings slated for the second half of 2013 includes plaintiffs such as the state of California’s pension system, the U.S. Department of Justice, financial services provider IMF Australia, and Italian dairy giant Parmalat.

In such litigation, agencies are being admonished for issuing AAA (highest quality) ratings on mortgage-backed securities that ultimately became worthless and precipitated a debt crisis. In light of such reprimands, it’s not surprising that, in our opinion, levels of criticism aimed at the agencies outweighs any notions of support, as indicated below:

Criticism

  • Agency decisions lag the real world; they are based on information that is already known to investors at large.
  • Credit ratings are unlikely to influence investor sentiment in any significant way.
  • Ratings agencies are, first and foremost, businesses. They are commercial organizations responsible for generating profits. As such, they are not as independent or unbiased as the public might believe.

Support

  • Ratings agencies are essential to protecting the public interest.
  • Ratings help set guidelines that investors can use to determine which types of securities can be held in their portfolios.

Despite what many see as the apparent need for some type of reform, the status quo remains firmly in place. Ratings agencies have been operating in much the same way for more than a century, so any rapid change seems unlikely to us.

Striking a balance

That said, it’s important for us to keep a balanced perspective on this debate. Is the harsh spotlight totally justified? We believe the answer is partly yes, but also partly no. Ultimately, bond markets benefit from some sort of third-party benchmark to help categorize different levels of credit quality, even if it is an imperfect system. As such, ratings agencies are a necessary fixture in the industry, at least until a compelling alternative comes along.

A preference for in-house research

When it comes to our day-to-day portfolio management responsibilities, however, rating agencies play a small role in our investment process. We rely instead on our focused, independent research. We conduct a rigorous evaluation of each issuer’s attributes and overall creditworthiness, regardless of what the ratings agencies have had to say. Ultimately, we prefer to draw our own conclusions, relying on our in-house team of professional analysts that puts together a clear picture of each issuer’s current condition and future prospects.

The views expressed represent the Manager’s assessment of the market environment as of September 2013, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATION

Investing involves risk, including the possible loss of principal.

Fixed income securities can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder a issuer’s ability to make interest and principal payments on its debt.

The Fund may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.

Bonds are rated by Nationally recognized statistical rating agencies that include Standard & Poor’s, Moody’s Investors Services, and Fitch, Inc. Bonds rated AAA represent highest quality; however, the security’s credit rating does not eliminate risk.

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