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Delaware Diversified Floating Rate Fund Quarterly commentary December 31, 2015


Financial markets finally took the Federal Reserve at its word during the fourth quarter of 2015 and discounted a December “liftoff” of benchmark interest rates. With investors assuring the Fed that it would be appropriate to raise rates, the actual increase in December caused only modest and brief volatility. Going forward, the markets likely will go back into “Fed-watch” mode to anticipate the trajectory of further rate increases over the next 12 to 24 months. Fed “dots” suggest four more 0.25-percentage-point increases in 2016, though the markets look for only two such increases. We lean in favor of the markets’ current view (fewer rather than more increases) and will continue to watch for signs of economic and financial stress that could put the Fed back on hold.

Energy prices suffered another leg down during the quarter while U.S. gross domestic product (GDP) and inflation statistics will likely, once again, come in on the low side for the full year. Annual inflation statistics are widely expected to bounce higher by late spring 2016, as the sharp drop in energy prices from early 2015 fall out of the year-over-year numbers. Given continuing headwinds from various global trade factors, however, a best-case outcome for GDP growth in 2016 is likely to be another year of just muddling through. There is a clear divergence between the U.S. manufacturing (recession-like conditions) and service (decent growth conditions) sectors, which could point to more challenging and volatile economic results in the near term.

In past business cycles, challenging and uncertain underlying economic conditions often have accompanied weak risk-asset performance. During the current cycle, however, this connection has been less relevant because financial asset prices have been driven higher by global central bank stimulus. Making fundamentally based investment decisions in recent years often has been out of sync with the markets, as risk asset prices were pushed higher simply by the widespread printing of money. Some portfolio managers who chose to take less risk in recent years due to below-target economic growth often were punished by the central bank– sponsored rise in risk asset prices. Today, with the European Central Bank (ECB) and the Bank of Japan (BoJ) still providing significant monetary stimulus, risk-off trades could still be at risk of underperformance. However, risk asset prices did not follow that pattern as closely in 2015, which raises the question: has something changed? The Fed has ended quantitative easing (QE), but we believe the totality of its actions have not meaningfully offset policies of the ECB and the BoJ.

Instead, central banks in emerging markets (EMCBs) could be the swing factor. Up until mid-2014, EMCBs were clearly part of the stimulus actions via asset purchases. Since then, EMCBs have been withdrawing liquidity by selling assets, a policy shift large enough to completely offset the asset purchases of central banks in the developed world. The change in central bank actions should result in a realignment of risk asset prices with economic fundamentals. In that scenario, the risk asset price volatility in 2015 could become even more pervasive in 2016. It may well be that reserve conditions in emerging markets will finally neutralize the ability of global central banks to keep pushing asset prices higher.

Domestic economic indicators showed mixed results throughout the fourth quarter. On the plus side, U.S. nonfarm payrolls increased by 271,000 in October, far exceeding expectations and helping to quell worries that the pace of employment growth was slowing. Overall, housing data and consumer confidence were positive as well. Although there was a slight downward revision to the third-quarter GDP estimate in December to 2.0% (from the previous reading of 2.1%), data indicated that household purchases boosted demand during the quarter as employment improved and fuel prices remained low. Conversely, U.S. Services Purchasing Managers’ Index (PMI) business activity and manufacturing indicators continued to signal areas of weakness. While more recent U.S. economic indicators were favorable, these could easily be offset by continued weakness in China, Europe, and emerging market economies, and by subsequent volatility in the equity and commodity markets.

Within the Fund

For the fourth quarter of 2015, Delaware Diversified Floating Rate Fund (Institutional Class shares and Class A shares at net asset value) underperformed its benchmark, the BofA Merrill Lynch U.S. Dollar 3-Month Deposit Offered Rate Constant Maturity Index.

Following is a discussion of the key drivers of Fund performance during the quarter:

Investment grade corporate credit

Credit spread volatility continued as idiosyncratic risks remained elevated. However, performance stabilized relative to earlier in the year, and most sectors generated a positive return.

  • A meaningful reduction in energy-related issuers the prior quarter contributed favorably to Fund performance in the industrial sector. However, despite reducing risk to energy, the Fund’s exposure to independent and midstream issuers was a negative factor.
  • To reduce issuer-specific risks associated with merger and acquisitions or shareholder- friendly activity, the Fund continued to have about 14% exposure to financials, a sector that contributed positively to performance.
  • A small allocation to utilities — including AES Gener — detracted from performance. Additionally, the Fund’s position in Integrys Holding was a significant underperforming asset.
  • A small tactical allocation to municipals such as Oklahoma Student Loan Authority and Missouri State Higher Education Loan Authority provided diversification and returns in excess of the Fund.

High yield and bank loans

The performance of assets rated below investment grade was generally negative during the period.

  • The Fund’s high yield assets were the weakest-performing performing asset class. The main detractor was Chesapeake Energy, which impacted the Fund by about 0.09%. As of year-end, the Fund did not have any exposure to this issuer.
  • Food and beverage company JBS Investments underperformed, due in part to weakness in Brazil. However, this underperformance was somewhat offset by price stability in Constellation Brands after the company posted strong quarterly earnings.
  • The price weakness within bank loans in the third quarter accelerated toward year end. As expected, higher-quality names outperformed lower-quality names during the fourth quarter.
    • Bank loans within the Fund generated a -1.16% total return, subtracting nearly 0.35% from performance but materially outperforming the loan market return of -2.23% for the period. The Fund’s average allocation to the asset class was 29%; however, the Fund finished the year with an allocation of just less than 26%.
    • Most of the largest detractors from Fund performance were largely attributed to loans, including iHeartCommunications, Avaya, and Scientific Games International.

Structured products

  • The Fund’s allocation to structured products continued to increase during the quarter and reached 13% at year end. Although the return for the asset class was flat for the period, it provided a source of diversification and reduced price volatility for the Fund.
  • Despite the volatility experienced in the loan market, the Fund’s exposure to collateralized loan obligations generated a positive return of 0.52%.


  • Interest rates generally moved higher during the quarter; consequently, the Fund’s exposure to interest rate swaps used for hedging interest rate risk was additive to performance. However, that source of outperformance was somewhat offset due to the decline in swaps spreads.
  • The Fund’s exposure to credit hedges, including iTraxx European Crossover, investment grade CDX, and high yield CDX, were not material to performance.


Though the Fed has taken the first step toward “normalizing” monetary policy by raising the federal funds target rate by a quarter percentage point, the move didn’t settle the outstanding issue regarding the pace of rate hikes in 2016.

As investors continue to grapple with divergent views, we should anticipate that volatility will remain elevated. The fact that the Fed is raising rates at a time when most of the developed world continues to practice nontraditional monetary policies such as quantitative easing, we think will only add to speculation surrounding the risk of a policy mistake. Additionally, the retreat in global commodity prices is demonstrating the fallout of a super-commodity cycle fueled by excess liquidity and exorbitant leverage, leading to overinvestment in important economies like China, and ultimately a downward revision in global growth expectations.

We expect the U.S. economic expansion to continue at a modest pace with the upside and downside risks to our growth forecast roughly equal. At this time, we see the Fed’s goal of raising rates four times in 2016 as a lofty one. Furthermore, we believe that currency volatility will remain a central theme in 2016. Manufacturing likely will continue to experience headwinds as global demand remains under pressure. We believe the path to the Fed’s target of 2% inflation level will be challenged — particularly in the second half of the coming year.

Moving into 2016, we expect that reduced Treasury supply, coupled with low inflation and competitively low global yields, should help to limit upside surprises for domestic interest rates. Finally, the impact of central banks’ and sovereign wealth funds’ selling assets should not be underestimated or ignored.

The U.S. Services Purchasing Managers’ Index or PMI, published by Markit Group, captures business conditions in the U.S. services sector.


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.


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

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)
YTD1 year3 year5 year10 yearLifetimeInception
Class A (NAV)-0.08%-0.08%-1.63%0.07%1.07%n/a1.53%02/26/2010
Class A (at offer)-2.80%-2.80%-4.34%-0.87%0.51%n/a1.07%
Institutional Class shares-0.01%-0.01%-1.27%0.36%1.32%n/a1.79%02/26/2010
BofA ML USD 3Mo Deposit Offered Rate Constant Maturity Index0.15%0.15%0.33%0.28%0.32%n/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 Deposit Offered Rate Constant Maturity Index (view definition)

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

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 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.

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 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.

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