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Delaware High-Yield Opportunities Fund Quarterly commentary December 31, 2015

Overview

High yield bonds, as represented by the J.P. Morgan Domestic High Yield Index, returned -2.79% during the fourth quarter, marking the third consecutive quarterly loss for the asset class and bringing 2015 returns to -5.0%. Prices were pressured by a mix of fundamental and technical factors, principal among them the continuing price decline among energy (-30% year-to-date) and other industrial commodities, which affected issuers constituting approximately 20% (by dollar value) of high yield indices. In addition, broader concerns over slowing Chinese and emerging markets growth, the unknown impact of rising short-term rates in the United States (courtesy of the Federal Reserve), volatile global equity prices, and poor seasonal high yield liquidity coalesced into a "risk-off" sentiment that led to $10 billion of self-reinforcing fund redemptions during November and December. High yield bond yields rose 66 basis points to 8.68%, while spreads widened by 31 basis points to 689 basis points, both levels the widest since early 2012. (A basis point equals one-hundredth of a percentage point.)

Market returns were correlated with credit quality, with BB-rated bonds leading at -0.3%, followed by B-rated bonds at -2.54%, and CCC-rated bonds at -9.1%. Not surprisingly, two of the quarter's biggest declines came in the commodity-related sectors of energy (-13.5%) and metals and mining (-11.82%), followed by transportation (-4.5%). Meanwhile, leaders resided in the relatively defensive and/or fundamentally positive sectors of cable TV (+2.80%), food and beverage (+1.34%), and telecom (+1.89%).

Within the Fund

During the fourth quarter, Delaware High-Yield Opportunities Fund (Institutional Class shares and Class A shares at net asset value) posted negative returns and underperformed its benchmark, the BofA Merrill Lynch U.S. High Yield Constrained Index.

The Fund’s strongest sector contributors were energy, banking, and leisure. Our strongest individual contributors were Cablevision Systems (Cable TV), Sinclair Television (local TV broadcasting), and Rite Aid (retail drug stores). Cablevision gained after its announced acquisition by Altice, Sinclair gained on improving operating metrics, and Rite Aid gained after its announced acquisition by Walgreens.

Conversely, the Fund’s largest sector detractors on a relative basis were telecom, healthcare, and automotive. The biggest individual detractors were Neiman Marcus (retail stores), Intelsat (satellite operator), and TPC Group (chemical manufacturer). Neiman Marcus, Intelsat, and TPC all declined due to unexpectedly poor operating results.

Outlook

In our view, several general observations about the high yield market in 2016 can be made. Prolonged oil prices at less than $50 a barrel means that defaults will likely rise significantly relative to recent years, but should remain largely confined to the energy and commodity sectors. Second, due to the age of the credit cycle, recent market performance, and regulatory scrutiny, refinancing risk is growing across all sectors for lower-rated companies exhibiting excessive leverage and/or credit deterioration, implying elevated idiosyncratic risk and elevated spreads in general compared to the past several years. Finally, we believe the strongest technical strength will likely be found among high-quality, noncommodity B-rated and BB-rated issuers.

Ultimately, high yield performance in 2016 may rest on the outcome of several competing forces: (1) the degree to which fundamental weakness remains confined to the energy and commodity sectors, reinforced by the otherwise simulative effect of cheap oil, or (2) that it broadens, perhaps through the channel of slowing global growth and intensifying capital market weakness, into other areas of the economy; (3) the extent to which fourth-quarter selling pressure has abated and demand for the asset class, whether from yield-hungry retail investors or institutional entities sensing a good entry point, solidifies to support sentiment, valuations, and new issuance. Given those factors, base-case returns in 2016 should likely be range-bound around the coupon.

Our portfolio strategy is aimed at capital preservation versus capital appreciation. Accordingly, the Fund is focused on the B and BB rating tiers, and on underweighting CCC-rated bonds. Within sectors, we are avoiding the energy space, significantly underweighting industrial commodities, and focusing instead on defensive and/or fundamentally positive sectors such as healthcare, financial services, and media. In each instance, we favor what we believe are well-capitalized large-cap names that exhibit strong, predictable cash flows, ample liquidity, noncomplex capital structures, and minimal refinancing risk. We believe this Fund can achieve positive performance under the conditions described above by delivering a competitive income stream while minimizing both volatility and downside risk relative to the market as a whole.

The J.P. Morgan Domestic High Yield Index is designed to mirror the investable universe of the U.S.-dollar domestic high yield corporate debt market.

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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 (12/31/2015)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-2.80%-6.72%-6.72%0.33%3.85%5.94%6.35%12/30/1996
Class A (at offer)-7.06%-10.91%-10.91%-1.19%2.88%5.45%6.10%
Institutional Class shares-3.01%-6.52%-6.52%0.50%4.08%6.21%6.64%12/30/1996
BofA Merrill Lynch U.S. High Yield Constrained Index-2.16%-4.61%-4.61%1.65%4.84%6.81%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.

BofA Merrill Lynch U.S. High Yield Constrained Index (view definition)

Expense ratio
Class A (Gross)1.12%
Class A (Net)1.05%
Institutional Class shares (Gross)0.87%
Institutional Class shares (Net)0.80%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement 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 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.

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