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Delaware Healthcare Fund Quarterly commentary March 31, 2016

Within the Fund

Healthcare stocks declined sharply during the first quarter of 2016 as shares of many biotechnology and specialty pharmaceutical companies sold off. In particular, Canadian drug-maker Valeant dominated the healthcare industry headlines during the quarter over concerns that included overpricing of its medications and the departure of its CEO.

During the first quarter, Delaware Healthcare Fund (Institutional Class shares and Class A shares at net asset value) outperformed its benchmark, the Russell 3000® Healthcare Index. The Fund benefited from both favorable asset allocation and security selection versus the benchmark.

Among sectors, the Fund’s holdings in biotechnology contributed the most to relative performance due to positive stock selection. The Fund’s overweight position in Dyax outperformed after Shire acquired the company. Additionally, underweight positions in Alexion Pharmaceuticals and Alkermes were positive for the Fund in terms of asset allocation, as both of these companies underperformed the benchmark. This performance was somewhat mitigated, however, by the Fund’s overweight stance in ImmunoGen, which succumbed to the broad selloff of small-cap biotechnology companies this quarter. However, we believe that Immunogen’s product pipeline, including its late-stage antibody-drug therapy, remains promising.

Other non-healthcare stocks that contributed to performance included Tim Participacoes in Brazil. Shares of the company benefited from currency appreciation and positive sentiment towards Brazilian equities as a whole. The ongoing investigation into money laundering and corruption, dubbed “Operation Car Wash,” appears to have further weakened the political standing of President Dilma Rousseff, raising the likelihood of policy changes and potentially her resignation.

Elsewhere, in the small-, mid-cap medical products sectors, the Fund’s underweight position in Allergan was favorable in terms of asset allocation. Shares of the company declined on speculation that its reverse buyout deal with Pfizer would be called off. In addition, Allergan delayed divesting its generic drug unit to Teva Pharmaceutical. These gains were negated, however, by the Fund’s overweight positions in Mylan and Morphosys. Shares of Mylan declined in sympathy with other specialty pharmaceutical companies. However, we believe that the company’s fundamentals remain intact and that it is trading at a discount to its intrinsic value. The Fund’s holding of Morphosys, based in Germany and specializing in biotechnology and the development and research of antibodies, declined during the quarter. Shares fell after its fourth-quarter earnings estimates were revised downward. We believe Morphosys is poised for further growth as the company plans to broaden its proprietary pipeline and increase spending on drug developments in 2016.

The Fund’s holdings in the blue-chip medical products sector detracted the most from performance. A significant underweight position in Johnson & Johnson also was unfavorable for the Fund. Shares of J&J rose on speculation that the company will acquire medical-device manufacturer Stryker. Additionally, J&J’s psoriasis drugs, Remicade and Stelara, experienced strong demand. The Fund’s overweight position in U.K.-based GlaxoSmithKline was a bright spot, however. Shares of the company rose after announcing a deal in December to acquire Bristol-Myers Squibb’s HIV portfolio.

Outlook

Despite the struggles that healthcare equities experienced in the quarter, long-term performance of the sector remains positive. Healthcare has been one of the better-performing sectors within the S&P 500® Index over the past several years. Several events transpired that have shaped our view as we enter 2016:

  • The Affordable Care Act (ACA). The insurance exchanges created by the ACA, now entering its third year, witnessed enrollment rise to 8.3 million by December 2015. Although the success of the ACA is mixed and debated, it appears that the healthcare industry has responded well. There are still plenty of unknowns related to the ACA, and we will be monitoring developments closely, paying attention to any implications for asset prices.
  • Manufacturers of brand-name drugs were challenged as patents expired. Patent expiration means that successful brand-name drugs started losing ground to generic formulations. This has been an important shift, because brand-name drugs produced by companies like Bristol-Myers Squibb and Amgen (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. We favor companies that exhibit such traits as: 

  • proven competitiveness,
  • seasoned management teams, and
  • 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.

Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.

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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 (03/31/2016)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-6.53%-6.53%-2.45%16.04%15.52%n/a16.83%09/28/2007
Class A (at offer)-11.89%-11.89%-8.05%13.77%14.16%n/a16.02%
Institutional Class shares-6.41%-6.41%-2.20%16.34%15.81%n/a17.05%09/28/2007
Russell 3000 Healthcare Index-7.05%-7.05%-7.62%15.51%17.25%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 definition)

Expense ratio
Class A (Gross)1.36%
Class A (Net)1.36%
Institutional Class shares (Gross)1.11%
Institutional Class shares (Net)1.11%
Top 10 holdings as of 04/30/2016
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Sanofi7.0%
Bristol-Myers Squibb Co.6.9%
SINA Corp/China6.5%
Eli Lilly & Co.6.0%
Sanofi5.2%
Chugai Pharmaceutical Co. Ltd.4.5%
GlaxoSmithKline PLC4.4%
Quest Diagnostics Inc.3.7%
Boston Scientific Corp.3.4%
Sohu.com Inc.3.3%
Total % Portfolio in Top 10 holdings50.9%

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.

Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.

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