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Delaware Healthcare Fund Quarterly commentary December 31, 2013 Class A (DLHAX)

Within the Fund

Delaware Healthcare Fund (Class A shares at net asset value) posted a positive return for the fourth quarter of 2013 but trailed its benchmark, the Russell 3000 Healthcare Index.

In terms of performance attribution across the Fund’s portfolio as a whole, sector allocation weights resulted in underperformance versus the index. These effects were combined with the mildly negative effects of security selection.

At the sector level, softness was recorded in small-to-mid-cap medical products, as well as in the unclassified segment. In the medical products category, Avon Products was among the notable detractors, as its shares declined by more than 15%. The stock underperformed after the company announced worse-than-expected quarterly sales, leading investors to question the effectiveness of implementing Avon’s proposed turnaround program, which aimed to cut costs and improve operations. In addition, outstanding regulatory investigations into the company’s past practices remain an overhang. While we did not position the size of our holding in Avon well, we believe the fundamentals of the company are intact and the business is inherently defensive. The stock is trading at a significant discount to its intrinsic value, based on our estimations of its earnings power. In the unclassified group, underperformance was posted by Sohu.com, a top Chinese Internet company that has leading products in gaming, news, entertainment, search, and video. Sohu’s websites and mobile apps are an important part of Chinese internet users’ daily lives. Sohu shares began feeling pressure in October when the company announced weaker-than-expected fourth quarter earnings guidance for its gaming business. Nonetheless, we believe that Sohu continues to trade at a significant discount to the sum of its parts and that the market is not fully appreciating the value of its individual assets, particularly the rapidly growing video business.

The underperformance noted above was partially offset by the positive effects of the Fund’s holdings in the biotechnology sector. The Fund’s slight underweight allocation versus the benchmark, together with the positive effects of stock selection, contributed to positive results. Individual holdings that made substantial contributions included Idenix Pharmaceuticals and Ligand Pharmaceuticals. Both companies saw their shares advance by double digits, and the Fund’s overweight in both positions amplified their contributions. Idenix shares moved higher after the company reported promising results (as well as good momentum) during research trials for its compound to treat hepatitis C. Ligand’s stock rose as the company received regulatory approval to market a therapy to treat hot flashes and osteoporosis.

Outlook

Healthcare equities have ended a year of strong performance. Within the S&P 500® Index, for instance, the healthcare sector was the second-strongest performer for 2013. This run-up in prices wasn’t the only news, of course. Other events transpired that shape our view as we head into the first quarter of 2014:

  • The rollout of the Affordable Care Act (ACA) began in earnest. The legislation remained controversial as many would-be subscribers were unable to enroll for coverage, and the program’s shortcomings created much noise and media attention. There are still plenty of unknowns related to the ACA, and we will be monitoring developments closely, paying close attention to any implications for asset prices.
  • Manufacturers of brand-name drugs were challenged as patents expired. Patent expiration meant that successful brand-name drugs have started losing ground to generic formulations. This was an important shift, because brand-name drugs produced by companies like Pfizer and Merck (to name just two) have long enjoyed impressive sales records and a significant share of their respective markets. Such firms will continue to face so-called “patent cliffs” in 2014.

In light of factors like those 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:

  • proven competitiveness
  • seasoned management teams
  • stock valuations that are discounted meaningfully from our estimates of intrinsic value.

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 stocks weighted by market value, and is often used to represent performance of the U.S. stock market.

[11998]

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 (03/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)7.38%7.38%37.65%21.92%30.60%n/a20.18%09/28/2007
Class A (at offer)1.20%1.20%29.72%19.53%29.08%n/a19.09%
Institutional Class shares7.41%7.41%37.97%22.21%30.87%n/a20.37%09/28/2007
Russell 3000 Healthcare Index5.77%5.77%30.56%23.36%22.68%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)1.38%
Class A (Net)1.38%
Institutional Class shares (Gross)1.13%
Institutional Class shares (Net)1.13%

Net expense ratio reflects (i) a contractual waiver of certain fees and/or expense reimbursements from Jan. 28, 2013 to Jan. 28, 2014 and (ii) a contractual waiver of distribution fees for Class A shares from Jan. 28, 2013 to Jan. 28, 2014. Please see the fee table in the Fund’s prospectus for more information.

Top 10 holdings as of 03/31/2014
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Eli Lilly & Co.8.1%
Teva Pharmaceutical Industries Ltd.6.9%
WellPoint Inc.5.6%
UCB S.A.5.0%
Quest Diagnostics Inc.4.5%
Pfizer Inc.3.3%
Bristol-Myers Squibb Co.3.3%
Chugai Pharmaceutical Co. Ltd.3.1%
SINA Corp/China3.0%
News Corp.3.0%
Total % Portfolio in Top 10 holdings45.8%

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