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Delaware Corporate Bond Fund Quarterly commentary March 31, 2016

Overview

The fixed income market aggressively sold risk assets over the first half of the quarter and then turned on a “Draghi dime” and bought risk assets through the end of the period. The first wave of risk-buying in late February gained traction after European Central Bank (ECB) President Mario Draghi made it clear that the ECB would not hesitate to further loosen monetary policy and Federal Reserve Chairwoman Janet Yellen mentioned tightening U.S. financial conditions and increased global risks. Risk assets received an additional boost in March after the ECB acted on Draghi’s proposals and Yellen amplified her dovish comments. Significant swings in oil prices and the U.S. dollar contributed to volatility as well.

Investment grade bond markets witnessed a dramatic recovery in risk premiums and sentiment during the quarter, driven by the rally in oil prices back into the low $40s from a decade bottom of $28, continued global central bank accommodation, and better domestic economic data relative to expectations (measured by the improvement in the Citigroup U.S. Economic Surprise Index). However, downside risks remain and we expect credit risk premiums to remain volatile due to a (still) heavy new-issue supply calendar, new realities in terms of market liquidity, further global growth concerns, and commodity price uncertainty. The Barclays U.S. Corporate Investment Grade Index returned 3.97% for the quarter, outperforming duration-matched Treasurys by 16 basis points, with the majority of the performance generated in March. (A basis point equals one hundredth of a percentage point.) Metals and mining outpaced all other sectors within the index, posting an 11.2% return for the quarter, driven by the corresponding rally in commodity prices, with iron ore up more than 20% for the period and copper up 10% from its mid-January lows, although we question the sustainability of such improvement in the face of weak global growth. Drillers and financials, particularly subordinated bank debt, were the underperformers during the quarter. Investment grade bond supply ended the quarter at $360 billion, slightly ahead of last year”s record pace (the first quarter of 2015 was the second highest on record) but still historically high as the mergers-and-acquisitions funding pipeline from 2015 remains intact (source: Bank of America).

High yield bonds, as measured by the BofA Merrill Lynch High Yield Cash Pay Index, returned +3.23% during the first quarter, snapping a string of three consecutive quarterly losses for the asset class. Through mid-February the market appeared on track for yet another significant loss; however, the increase in oil prices carried high yield and most other risk assets well into positive territory for the period. Unsurprisingly, energy bonds (13% of the BofA Merrill Lynch High Yield Cash Pay Index) experienced the widest price swing, falling 20% along with oil and then recovering 25% to finish with a 2.7% total return. Mutual fund flows contributed to the price action, with $5 billion leaving the high yield market through mid-February followed by nearly $14 billion of inflows over the balance of the quarter as investors chased returns. The market yield fell 40 basis points to 8.3%, while the spread rose 21 basis points to 710 basis points.

In March, U.S. gross domestic product (GDP) growth for the fourth quarter of 2015 was revised upward to a 1.4% annualized pace due to a jump in consumer spending. However, corporate profits fell 7.8% during the quarter, the biggest decline since the first quarter of 2011 (-9.2%). Profits have fallen in four of the last five quarters and are down 11.5% from a year earlier, the worst year-on-year drop since the Great Recession. Among the more positive trends, jobless claims, which have averaged about 275,000 for the past year, suggest continued strength in the pace of hiring. Until personal income and wage-and-salary income accelerate, however, consumer inflation should remain muted. Combining these factors with concerns over the pace of global economic growth, lower oil prices, and a strong U.S. dollar raises the hurdle for the next Federal Open Market Committee (FOMC) policy rate action.

With investors in perpetual Fed-watch mode, recent statements by Fed officials (other than Yellen) that appear to lean more toward a near-term tightening have been a source of uncertainty. This leaning may be the result of recent signs that inflation expectations are finally approaching the Fed”s 2% target. Though the last official Fed communication suggested two additional quarter-percentage-point increases in the federal funds rate this year, the markets are discounting only one increase in the fourth quarter of 2016. We are inclined to favor the market”s “one increase” view but believe it could come as early as summer.

Within the Fund

For the first quarter of 2016, Delaware Corporate Bond Fund (Institutional Class shares and Class A shares at net asset value) underperformed its benchmark, the Barclays U.S. Corporate Investment Grade Index. The Fund”s performance was negatively affected by a lack of exposure to higher-beta (higher-risk), lower-quality energy names, as well as by an underweight to the energy sector overall. Energy exposure represented an average of about 3.5% of the Fund’s portfolio for the period. Exposure to hybrid and euro bank debt also detracted from performance as financials, once considered a relative safe haven, came under pressure amid poor earnings results and negative headlines from European issuers.

From a duration standpoint, the Fund”s overweight to the intermediate segment (the “belly” of the curve) and a corresponding underweight to the long end, benefited performance. Amid cautious investor sentiment, dovish Fed sentiment, additional global central bank accommodation and expanding negative rate policies in Europe, the Treasury curve bull steepened over the period in the 5- to 30-year portion of the curve — a move in which rates in the short to intermediate end of the curve go down by a greater degree than those in the long end.

Outlook

Fundamentals within nonfinancials remain under pressure as rising leverage and increased use of financial engineering via accommodative policy have deteriorated credit metrics. Many multinational companies are expecting top- and bottom-line pressure in the upcoming quarter from the strength of the U.S. dollar. A decline in earnings per share driven by a decline in revenue would be a slight credit negative, as it implies a modest deceleration in growth, although we do not expect a meaningful move in spreads or credit quality, as our outlook for growth remains similar to what we”ve seen over the past few years (approximately 2%) which is generally supportive of credit. Technicals remain mixed as heavy new-issue supply has prevented secondary spreads from tightening and overall liquidity remains constrained, while institutional and foreign demand should continue to provide support to the asset class. Furthermore, the ECB”s purchase of corporate bonds should drive more European investors to the U.S. markets in search of yield as well as push some issuance overseas in the form of reverse Yankee issuance.

The recent moves in investment grade bond credit valuations (and the commodity space in particular) have been volatile, which we have seen become the new norm in capital markets. Fundamentally, signals of sluggish global growth have not changed since the beginning of the year and as a result, the large swings in bond prices we have witnessed recently are likely due to technicals (predominantly the lack of liquidity on Wall Street causing incredible price discovery, along with short-coverings). We believe this kind of volatility may continue for the foreseeable future, regardless of any material changes in fundamental or macroeconomic views. For the year, we believe investment grade credit could generate positive total and excess returns, but that volatility will remain and may create attractive entry points. We believe our credit portfolios are positioned to take advantage of such opportunities.

The BofA Merrill Lynch High Yield Cash Pay Index provides a general measure of the performance of fixed-rate, coupon-bearing bonds with an outstanding par of at least $50 million and a maturity range greater than or equal to one year. To be included in the index, bonds must be rated lower than BBB/Baa3.

The Citigroup Economic Surprise Index is a rolling measure of beats and misses of indicators relative to consensus expectations.

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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)2.81%2.81%-1.82%2.00%5.30%6.69%6.64%09/15/1998
Class A (at offer)-1.76%-1.76%-6.19%0.46%4.32%6.20%6.36%
Institutional Class shares2.87%2.87%-1.58%2.25%5.56%6.95%6.91%09/15/1998
Barclays U.S. Corporate Investment Grade Index3.97%3.97%0.92%3.03%5.17%5.82%n/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 4.50% and are subject to an annual distribution fee.

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

Barclays U.S. Corporate Investment Grade Index (view definition)

Expense ratio
Class A (Gross)0.95%
Class A (Net)0.94%
Institutional Class shares (Gross)0.70%
Institutional Class shares (Net)0.69%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursements from Nov. 27, 2015 through Nov. 28, 2016. Please see the fee table in the Fund's prospectus for more information.

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.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an 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.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

The Fund may invest in derivatives, which may involve additional expenses and are subject to risk, including the risk that an underlying security or securities index moves in the opposite direction from what the portfolio manager anticipated. A derivatives transaction depends upon the counterparties’ ability to fulfill their contractual obligations.

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.

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

Not FDIC Insured | No Bank Guarantee | May Lose Value