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Delaware Diversified Income Fund Quarterly commentary June 30, 2015


During the second quarter of 2015, fixed income markets experienced a significant setback as rates rose across the yield curve — both in Treasury investments and other global sovereign bonds — and spreads widened in several key sectors. Intermediate and long maturities led the rate rise as liquidity was a problem at times, especially for sovereign bonds. With regulatory blockages, a shrinking repo market, smaller capital commitments at many key trading counterparties, and ongoing market volatility, liquidity will likely continue to be a periodic challenge. Past experience shows that liquidity-based market setbacks tend to be sharp but brief without the sustained impact of deteriorating fundamentals. During the quarter, the Federal Reserve pointed to slightly more upbeat growth conditions and relatively balanced risks while seemingly headed toward an initial rate increase in the second half of 2015. This “most likely” Fed scenario still seems potentially off track as it would come despite recent U.S. dollar strength, lower commodity prices, and below-target inflation statistics. Rarely has the Fed begun to tighten in the face of these factors.

While the “liftoff date” for the initial rate hike has been the policy question of the year, the trajectory of any increases is quickly becoming the more important focus. It seems highly probable that the Fed will raise rates in a gradual way during its next tightening. The Fed’s caution may be based on the continued struggle to break out of the “muddle along” 2%-plus recovery but it may also be driven by its recognition that other factors have already started the tightening process, such as the stabilization of its balance sheet and the strength of the U.S. dollar. Recently, economic forecasters have begun talking about U.S. growth accelerating into the 2.0–2.5% range in the second half of 2015. If this is the accepted acceleration story, the Fed has good reason to be cautious. The Fed’s own forecasts should also be a warning, as members of the Federal Open Market Committee (FOMC) recently reduced their 2015 gross domestic product (GDP) forecast to a range of 1.8–2.0% growth, while sticking with their 2015 inflation outlook of 0.6–0.8%.

The Barclays U.S. Aggregate Index recorded a negative return in the second quarter as the poor returns from Treasury securities turned out to be better than those from corporate bonds. Financials were stronger than other investment grade sectors, with utilities significantly underperforming. U.S. dollar emerging market bonds and asset-backed securities (ABS) produced modest positive returns for the period.

Within the Fund

Delaware Diversified Income Fund (Institutional Class shares and Class A shares at net asset value) outperformed its benchmark, the Barclays U.S. Aggregate Index, for the second quarter of 2015.

  • The U.S. Treasury sector sold off in a typical bear-steepening environment. Longer maturities increased in yield more than shorter maturities, as small signs of a growth recovery in the U.S. economy influenced rates. The Fund’s low exposure to Treasurys contributed to its relative return, despite the longer maturity profile in this segment of the Fund’s portfolio.
  • The Fund’s position in mortgage-backed securities (MBS) outperformed the index subsector and contributed to relative returns for the quarter. Our coupon and curve selections — we maintained our bias toward 30-year agency mortgages — influenced the Fund’s general outperformance of the MBS portfolio versus the index during the quarter.
  • The Fund’s investments in commercial mortgage-backed securities — though negative — contributed to relative performance. The high-quality income in the sector led us to an overweight allocation versus the index. The move toward AA exposure in this sector helped to add extra income with a small sacrifice of liquidity.
  • The Fund’s continued overweight in investment grade corporate bonds boosted relative performance during the quarter. Our positions in the utility sector added to the Fund’s returns, as we tend to prefer lower average maturities than those of the index subsector and these performed well in the rate move. Some of the Fund’s holdings are in lower-quality operating company paper (BBB-rated securities) that trades somewhat cheap compared to peers.
  • The Fund’s high yield corporate investments hurt performance in the second quarter. We have maintained a high-quality bias in this area of the Fund’s portfolio, in an attempt to control risk and add liquidity.
  • Developed market bonds and currency hedging had a negative effect on the portfolio in the second quarter. Investments in U.K. gilts and Italian, German, and Australian government bonds declined in value as a move toward higher rates was triggered by a significant unwind of positions in the European bond market.


Our broad investment concern is the current disconnect between below-trend global economic growth and the quantitative easing–induced increase in financial asset values. Though the ultimate reconnection will most likely come through a sharp decline in asset values (fundamentals will prevail), predicting its timing is beyond difficult and carries its own risks. While bond markets will certainly feel the adjustment, stock markets will probably be at the center of the move.

Interestingly, a number of “outside the box” market factors are warning that this decline in asset values could come in the near future. In no particular order, U.S. equity markets have recently seen a meaningful reduction in the level of new highs, while an old but frequently worthy indicator shows that the Dow Jones Industrial Average recently reached new highs while transports were making new lows. “Confirmation” is critical in momentum-based markets and may now be waning. Also, while the Shanghai Stock Exchange Composite Index has sustained an almost 20% pullback after a historic rally, the Japanese yen recently broke through key support and could be headed to much weaker levels. The connection here, of course, is that economic growth in China (and Asia as a whole) would be hurt by a further sharp decline in the yen. Finally, despite the apparent bounce in U.S. economic statistics over the past two months, a “relative to expectations” statistic, the Citigroup Economic Surprise Index, is pointing to weakness in U.S. data. In this very uncertain and volatile market environment, our goal is to position our client portfolios with prudent levels of risk.

Mortgage-backed securities are fixed income securities that represent pools of mortgages, with investors receiving principal and interest payments as the underlying mortgage loans are paid back. Many are issued and guaranteed against default by the U.S. government or its agencies or instrumentalities, such as Freddie Mac, Fannie Mae, and Ginnie Mae. Others are issued by private financial institutions, with some fully collateralized by certificates issued or guaranteed by the U.S. government or its agencies or instrumentalities.

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

Per Standard & Poor’s credit rating agency, bonds rated below AAA 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 Dow Jones Industrial Average is an often-quoted market indicator that comprises 30 widely held blue-chip stocks.

The Shanghai Stock Exchange Composite Index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange.

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


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 (09/30/2015)
YTD1 year3 year5 year10 yearLifetimeInception
Class A (NAV)-0.28%0.03%0.59%1.40%3.28%5.85%7.03%12/29/1997
Class A (at offer)-4.80%n/a-3.98%-0.16%2.33%5.36%6.75%
Institutional Class shares-0.33%0.10%0.73%1.62%3.52%6.10%6.91%10/28/2002
Barclays U.S. Aggregate Index1.23%1.13%2.94%1.71%3.10%4.64%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.

Barclays U.S. Aggregate Index (view definition)

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

Expense ratio
Class A (Gross)0.90%
Class A (Net)0.90%
Institutional Class shares (Gross)0.65%
Institutional Class shares (Net)0.65%

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, 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.

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.

If and when the Fund invests in forward foreign currency contracts or uses other investments to hedge against currency risks, the Fund will be subject to special risks, including counterparty risk.

The Fund may experience portfolio turnover in excess of 100%, which could result in higher transaction costs and tax liability.

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