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Delaware Healthcare Fund Quarterly commentary December 31, 2014

Within the Fund

During the fourth quarter of 2014, Delaware Healthcare Fund (Class A and Institutional Class shares at net asset value) posted a positive return but underperformed its benchmark, the Russell 3000® Healthcare Index. In terms of performance attribution across the Fund’s portfolio as a whole, both security selection and sector allocations were the main drivers of underperformance versus the benchmark index.

Although the Fund struggled across most sectors during the quarter, certain selections performed well when compared to the benchmark index. Within the blue-chip medical products sector, the Fund benefited from its underweight positioning in Johnson & Johnson, which accounts for more than 9% of the benchmark’s overall weighting, as the stock fell just over 1% in the quarter. In October 2014, Johnson & Johnson’s DePuy unit of orthopedic and neuro products came under fire amid reports pointing to failure rates among its Pinnacle hip implants — this seemed to cause concern for investors about potential settlement payments.

The Fund’s overweighting in Dyax within the biotechnology sector performed quite well during the quarter. The Massachusetts-based firm benefited as the spread resulting from projected earnings losses became narrower, resulting in more optimism for the med-biomed/gene company. The company’s success has resulted from proprietary research to create successful treatment for acute attacks of hereditary angioedema (HAE) under the marketing name Kalbitor.

Belgium-based UCB, a global biopharmaceutical company, struggled during the quarter as losses were exacerbated due to our high conviction. Patent risks for certain UCB products came to the forefront as many investors seemed concerned about diminishing growth drivers, in addition to adding to its pipeline of pharmaceutical offerings.  During the quarter, UCB announced the sale of its U.S. generic drug business, Kremers Urban Pharmaceuticals, to private equity firms, much to the delight of investors as UCB attempted to focus on its core products. However, in light of regulatory concerns about Kremer’s version of the Concerta pill, the deal was called off, causing more pressure on the stock price. We feel UCB’s core offerings of pharmaceuticals, along with promising early phase testing for new products, should benefit the firm going forward.

Within the blue-chip medical products sector, the Fund’s holding of Japan-based Chugai Pharmaceutical detracted from performance. Early in the quarter, Chugai faced inventory concerns over its rheumatoid arthritis treatment drug, Actemra, from parent company Roche. While sales were brisk for the drug, they fell short of export targets. Chugai was affected residually as well when Roche announced a disappointing study regarding results for first-line therapy treatment for breast cancer. As a result, sales forecasts were adjusted downward causing more strain for Chugai. In our view, Chugai still remains well positioned, offering global products such as Tamiflu in addition to its alliance with Roche.

Outlook

Healthcare equities continue their strong performance in 2014. Within the S&P 500® Index, for instance, the healthcare sector was the second-strongest performer during the year. This run-up in prices wasn’t the only news, of course. Other events transpired that shape our view as we head into 2015:

In light of factors like those mentioned above, we continue putting a premium on disciplined, intensive research when analyzing investment opportunities for the Fund’s portfolio. We favor companies that exhibit such traits as: 

These characteristics are part of our daily considerations as we follow our conservative, stock-by-stock approach to portfolio management.

The S&P 500 Index measures the performance of 500 mostly large-cap stock s weighted by market value, and is often used to represent performance of the U.S. stock market.

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The views expressed represent the Manager's assessment of the Fund and market environment as of the date indicated, 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. Information is as of the date indicated and subject to change.

Document must be used in its entirety.

Performance

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.

Performance data current to the most recent month end may be obtained by calling 800 523-1918 or visiting delawareinvestments.com/performance.

Total returns may reflect waivers and/or expense reimbursements by the manager and/or distributor for some or all of the periods shown. Performance would have been lower without such waivers and reimbursements.

Average annual total return as of quarter-end (12/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)2.39%17.04%17.04%28.02%20.09%n/a19.33%09/28/2007
Class A (at offer)-3.51%10.31%10.31%25.52%18.67%n/a18.36%
Institutional Class shares2.47%17.32%17.32%28.34%20.39%n/a19.54%09/28/2007
Russell 3000 Healthcare Index8.58%25.37%25.37%28.86%20.20%n/an/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 5.75% and are subject to an annual distribution fee.

Prior to January 28, 2010, the Fund had not engaged in a broad distribution effort of its shares and had been subject to limited redemption requests. The returns reflect expense limitations that were in effect during certain periods and which may have been lower than the Fund's current expenses. The returns would have been lower without expense limitations.

Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.

Russell 3000® Healthcare Index (view)

Expense ratio
Class A (Gross)1.35%
Class A (Net)1.35%
Institutional Class shares (Gross)1.10%
Institutional Class shares (Net)1.10%
Top 10 holdings as of 12/31/2014
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Eli Lilly & Co.8.5%
Teva Pharmaceutical Industries Ltd.5.8%
Sanofi5.8%
Bristol-Myers Squibb Co.4.5%
UCB S.A.4.2%
Fresenius Medical Care AG & Co. KGaA3.8%
GlaxoSmithKline PLC3.8%
Quest Diagnostics Inc.3.3%
Chugai Pharmaceutical Co. Ltd.3.3%
SINA Corp/China3.2%
Total % Portfolio in Top 10 holdings46.2%

Institutional Class shares are only available to certain investors. See the prospectus for more information. 

All third-party marks cited are the property of their respective owners.

Carefully consider the Fund’s investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Fund’s prospectus and its summary prospectus, which may be obtained by clicking the prospectus link located in the right-hand sidebar or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

Investing involves risk, including the possible loss of principal.

Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors.

Healthcare companies are subject to extensive government regulation and their profitability can be affected by restrictions on government reimbursement for medical expenses, rising costs of medical products and services, pricing pressure, and malpractice or other litigation.

International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.

“Nondiversified” funds may allocate more of their net assets to investments in single securities than “diversified” funds. Resulting adverse effects may subject these funds to greater risks and volatility.

Not FDIC Insured | No Bank Guarantee | May Lose Value