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Delaware Extended Duration Bond Fund Quarterly commentary March 31, 2014 Class A (DEEAX)

Overview

Despite ongoing uncertainty from emerging market volatility, geopolitical concerns (Russia/Ukraine), and constantly evolving Federal Reserve policy expectations, investment grade corporate bonds, as represented by the Barclays U.S. Corporate Investment Grade Index, returned 2.94% for the quarter. Returns were led by the media-cable, packaging, and media-noncable sectors, while financials and construction machinery underperformed.

Spreads on the Barclays U.S. Corporate Investment Grade Index tightened by 8 basis points during the quarter to end at 106 basis points over Treasurys (a basis point equals one one-hundredth of a percentage point). We continued to view BBB-rated bonds as having the best relative value, although the gap between BBB and A-rated industrials has continued to narrow. As of the end of the quarter it stood at 50 basis points, the lowest level since the end of 2007 (source: Barclays, Bloomberg).

Market technicals remained strong amid robust demand for high-quality credit. Investment grade bonds have been a relative safe haven from global volatility, particularly during recent turmoil in emerging markets. Despite significant supply, new-issue concessions have been minimal, demonstrating the depth of demand for investment grade credit.

Interest rates, merger and acquisition (M&A) activity, share buybacks, and financial supply all are wildcards that could influence ultimate supply levels in coming months.

Within the Fund

For the first quarter of 2014, Delaware Extended Duration Bond Fund (Class A shares at net asset value) generated a positive total return that outperformed its benchmark, the Barclays Long U.S. Corporate Index.

The Fund’s holdings in high yield and emerging market bonds — both of which generated strong returns — were mainly responsible for its outperformance. The Fund also benefited from an overweight to BBB-rated securities, a sector which outperformed the overall index.

A flatter Treasury curve detracted from performance, given the Fund’s overweight to the 10-year and underweight to the 30-year portion of the yield curve. Over the quarter, rates on 10-year bonds declined by 31 basis points while 30-year rates declined by 41 basis points (source: Bloomberg).

Outlook

Even before the Fed's March meeting, the consensus view in the bond market clearly anticipated higher short, intermediate, and long-term rates. Under traditional economic conditions during an early-to-mid-stage expansion, rising short-term rates would translate to higher rates across the yield curve and to only a modestly flatter curve. Typically, it has been only during a late-stage expansion that the pinch from ongoing Fed tightening significantly weakens the economic outlook and causes a yield-curve flattening or inversion as intermediate- and longer-term rates stop rising with short-term rates.

However, the Fed’s need to maintain “somewhat lower than normal rates” may point to an alternative scenario for the current cycle. In essence, it is possible that extreme levels of global debt (especially less-than-productive government debt), combined with high levels of excess capacity, could create underlying deflationary forces even as the economic expansion matures.

The M&A–event risk theme for 2014 is very much alive in credit markets. Months of rumor and speculation regarding Charter Communications’ acquisition of Time Warner Cable were finally trumped by Comcast’s $45 billion all-stock offer. Another theme that could play out in 2014 is consolidation within the pharmaceutical sector, as midsized players look for scale and generic players look for smaller acquisitions to fold into their existing divisions. Finally, while the leveraged buyout wave that many investors expected last year never materialized, private equity does have significant “dry powder” on the sidelines that could eventually lead to deals.

The Barclays U.S. Corporate Investment Grade Index is composed of U.S. dollar–denominated, investment grade, SEC-registered corporate bonds issued by industrial, utility, and financial companies. All bonds in the index have at least one year to maturity.

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.

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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 (03/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)6.47%6.47%2.38%11.13%16.17%8.43%8.66%09/15/1998
Class A (at offer)1.74%1.74%-2.28%9.42%15.11%7.92%8.34%
Institutional Class shares6.55%6.55%2.64%11.42%16.43%8.69%8.93%09/15/1998
Barclays Long U.S. Corporate Index6.17%6.17%2.01%9.18%13.32%6.54%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 Long U.S. Corporate Index (view)

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)0.99%
Class A (Net)0.96%
Institutional Class shares (Gross)0.74%
Institutional Class shares (Net)0.71%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement from Nov. 27, 2013 through Nov. 28, 2014. 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.

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.

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

Diversification may not protect against market risk.

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.

Not FDIC Insured | No Bank Guarantee | May Lose Value