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Delaware Healthcare Fund Quarterly commentary September 30, 2014

Within the Fund

During the third 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, security selection and sector allocations were both responsible for underperformance versus the index.

At the sector level, healthcare services was the Fund’s strongest sector performer, mainly driven by Tenet Healthcare and WellPoint. Both companies reported favorable earnings during the quarter and raised their guidance as a result. Tenet Healthcare, the largest private hospital operator in the United States, strengthened with the acquisition of Emanuel Medical Center as well as securing long-term deals with a variety of healthcare providers. WellPoint, the health benefits provider, announced plans to change its name to Anthem (subject to a November 2014 shareholder vote) as it prepares to reveal a more consumer-focused identity. WellPoint has experienced a surge in membership in recent years (largely by benefiting from Medicaid expansion into the government segment) and this quarter was no exception.

In the biotechnology sector, shares of Regeneron Pharmaceuticals advanced during the quarter primarily due to surpassed expectations of its eye drug, Eylea. The gains came despite a missed earnings forecast that was announced during the quarter. We believe revenue from Eylea could increase further, particularly in light of recent FDA approvals for enhanced uses of the drug.

Despite the Fund’s positive return during the quarter, underperformance was noted within the so-called unclassified group. The Fund’s investments in SINA and Sohu.com detracted from performance as SINA faced regulatory challenges regarding content on its video site, while Sohu’s gaming business has slowed down as key games have reached maturity. 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.

Among the Fund’s higher-profile and well-known holdings (so-called blue chip holdings), GlaxoSmithKline, one of the Fund’s relatively bigger positions, underperformed in the wake of a U.S. anti-bribery probe concerning the Chinese consumer healthcare business. A Chinese court has found GlaxoSmithKline guilty of bribery and has fined the company nearly $500 million as a result. Investors continued to show concern during the quarter, largely because the company has been unable to participate in the recent European healthcare boon.

Outlook

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

  • One-year anniversary of insurance exchanges enacted by the Affordable Care Act (ACA).  Exactly one year ago, the ACA insurance exchanges opened, and 7.3 million people have purchased insurance since then. Although the overall success of the ACA is mixed and debated, it appears the healthcare industry has done its part reasonably well, and the healthcare segment within the S&P 500 Index is up more than 28% for the one-year period ended Sept. 30, 2014. There are still plenty of unknowns related to the ACA, and we will be monitoring developments closely, paying attention to their implications for asset prices.
  • Manufacturers of brand-name drugs were challenged as patents expired. Patent expiration means that successful brand-name drugs are starting to lose ground to generic formulations. This is an important shift, because brand-name drugs produced by companies like GlaxoSmithKline and Eli Lilly (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 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 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 (09/30/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)1.13%14.31%22.68%30.01%22.26%n/a19.69%09/28/2007
Class A (at offer)-4.67%n/a15.62%27.47%20.83%n/a18.68%
Institutional Class shares1.17%14.49%23.00%30.33%22.54%n/a19.89%09/28/2007
Russell 3000 Healthcare Index4.61%15.46%26.87%29.38%20.11%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%
Top 10 holdings as of 09/30/2014
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Eli Lilly & Co.8.9%
Teva Pharmaceutical Industries Ltd.6.3%
GlaxoSmithKline PLC5.6%
Pfizer Inc.5.4%
UCB S.A.5.2%
Bristol-Myers Squibb Co.4.0%
Fresenius Medical Care AG & Co. KGaA3.7%
Chugai Pharmaceutical Co. Ltd.3.4%
WellPoint Inc.3.3%
SINA Corp/China3.1%
Total % Portfolio in Top 10 holdings48.9%

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