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Delaware Diversified Floating Rate Fund Quarterly commentary September 30, 2014

Overview

The third quarter of 2014 reflected multiple shifts in bond market attitudes as well as the points of focus on economic growth, Federal Reserve policy, and geopolitical fronts. By mid-July, geopolitical risks had heated up and high-quality bonds benefited as many investors went in search of safety. Beyond the safety factor, the bond market seemed to be pulled in both directions by signs of improving U.S. growth being offset by pockets of weakening global growth.

Economic data for U.S. employment, consumer demand, and housing varied from month to month. Manufacturing was also choppy, but auto sales were consistently strong. Overall, the U.S. economy has decent momentum entering the fourth quarter.

The Barclays U.S. Aggregate Index recorded a virtually flat return in the third quarter as higher-quality bonds and longer-duration sectors led the way. Short-to-intermediate-focused sectors produced negative returns, although mortgage-backed securities (MBS) were relatively strong. Meanwhile, BBB-rated corporates, high yield corporate bonds, and emerging market bonds produced negative returns.

Within the Fund

For the third quarter of 2014, Delaware Diversified Floating Rate Fund (Class A and Institutional Class shares at net asset value) generated a slight negative total return that underperformed that of its benchmark, the BofA Merrill Lynch U.S. Dollar 3-Month LIBOR Constant Maturity Index.

During the period, higher-quality assets were additive to the Fund’s performance. Investment grade corporate credit averaged 53% of the portfolio’s assets, with all four key sectors generating positive returns. Although the utility sector generated the highest total return, the Fund’s modest sector exposure of 4% added just 2 basis points to performance. (One basis point equals one one-hundredth of a percentage point.) Investment grade industrials represented more than 30% of the total portfolio and contributed nearly 6 basis points to the period return. The Fund also had about 15% of the portfolio invested in high grade financials, which returned 26 basis points, on average.

Assets rated below-investment-grade experienced heightened volatility during the quarter. High yield corporate bonds were one of the worst performing sectors in the Fund’s portfolio, returning -1.02% and detracting from the Fund’s performance by nearly 3 basis points.

Once again, bank loans experienced selling pressure as investors liquidated the asset class. During the quarter, however, the Fund was generally invested in higher-quality loans relative to the market. As a result, the loans within the Fund’s portfolio outperformed the broader loan market but were still a slight detractor from the Fund’s performance relative to its benchmark. Risk premiums of the collateralized loan obligations in the portfolio compressed slightly, leading to a positive return for the quarter.

Higher-quality assets, such as the Fund’s exposure to asset-backed securities (ABS), contributed favorably toward performance by generally earning the income from the assets, but with little price change.

The same concerns mentioned in the Fund’s second-quarter discussion remain in place as uncertainty around global growth trends, geopolitical risks, and central bank policies will likely preoccupy investors again as they position their portfolios. Because of these unanswered questions, we continue to maintain the Fund’s higher-quality bias and look to reduce risk positions further on market strength.

Outlook

Whether evaluating current bond prices or the range of forecasts for 2015, a Fed tightening in the second or third quarter of 2015 appears to be viewed as a “high probability.” Many market analysts express concern that the Fed is already behind the curve. However, current conditions may actually support the opposite conclusion. Given the Fed’s history of refraining from tightening policy when the Consumer Price Index is soft, oil is falling, and the U.S. dollar is rising, a 2015 tightening could end up being ahead of the curve (and a policy mistake). Sluggish global growth — which results mostly from weak consumption — seems to support this view, as does the recent sharp decline in Treasury inflation-protected securities’ (TIPS’) break-even rates (that is, inflation premiums).

On balance, weak global growth should keep real rates at very low levels, and deflationary pockets in key world markets should keep nominal rates low as well. In our opinion, market forecasts for significantly higher rates and a steeper yield curve seem to be misplaced, and, if anything, forecasts should be acknowledging the potential for a return to 10-year Treasury rates in the low 2% range.

Bond ratings are determined by a nationally recognized statistical rating organization (NRSRO).

Per Standard & Poor’s credit rating agency, bonds rated below AAA, including A, are more susceptible to the adverse effects of changes in circumstances and economic conditions than those in higher-rated categories, but the obligor’s capacity to meet its financial commitment on the obligation is still strong. Bonds rated BBB exhibit adequate protection parameters, although adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments. Bonds rated BB, B, and CCC are regarded as having significant speculative characteristics with BB indicating the least degree of speculation.

The U.S. Consumer Price Index is a measure of inflation that is calculated by the U.S. Department of Labor, representing changes in prices of all goods and services purchased for consumption by urban households.

The Barclays U.S. Aggregate Index is a broad composite that tracks the investment grade domestic bond market.

Diversification may not protect against market risk.

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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)-0.18%1.19%2.20%3.15%n/an/a2.44%02/26/2010
Class A (at offer)-2.88%n/a-0.59%2.18%n/an/a1.82%
Institutional Class shares-0.23%1.25%2.33%3.37%n/an/a2.67%02/26/2010
BofA Merrill Lynch USD 3-Month LIBOR Constant Maturity Index0.06%0.18%0.24%0.35%n/an/an/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 2.75% 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.

BofA Merrill Lynch U.S. Dollar 3-Month LIBOR Constant Maturity Index (view)

Expense ratio
Class A (Gross)1.01%
Class A (Net)1.01%
Institutional Class shares (Gross)0.76%
Institutional Class shares (Net)0.76%

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, noninvestment grade bonds (junk bonds) involve higher risk than investment grade bonds.

The high yield secondary market is particularly susceptible to liquidity problems when institutional investors, such as mutual funds and certain other financial institutions, temporarily stop buying bonds for regulatory, financial, or other reasons. In addition, a less liquid secondary market makes it more difficult for the Fund to obtain precise valuations of the high yield securities in its portfolio.

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.

The Funds 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 derivative transaction depends upon the counterparties’ ability to fulfill their contractual obligations.

Because the Fund may invest in bank loans and other direct indebtedness, it is subject to the risk that the fund will not receive payment of principal, interest, and other amounts due in connection with these investments, which primarily depend on the financial condition of the borrower and the lending institution.

Not FDIC Insured | No Bank Guarantee | May Lose Value