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Delaware High-Yield Opportunities Fund Quarterly commentary December 31, 2014

Overview

High yield bonds returned -1.0% during the fourth quarter of 2014, pulling down year-to-date returns to just 2.45%. Despite a backdrop of lower interest rates and rallying equity prices, falling oil prices continued to take their toll, driving the market’s largest sector down 6.6% in December and down 11.4% for the quarter. The declines accelerated fund outflows during the final month of the quarter, which led to selling pressure and price drops across all industry sectors. Returns were correlated with credit quality during the period, with BB-rated issues returning 0.4%, followed by B-rated issues at -1.9%, and CCC-rated issues at -3.8%. High yield bond yields rose 73 basis points to 7.13%, while spreads rose 79 basis points to 571 basis points. (A basis point equals one one-hundredth of a percentage point.)

While higher-quality U.S. bonds and equities enjoyed a strong fourth quarter, it was a “risk-off” period for high yield and lower-quality non-U.S. debt and equities. With economic data continuing to support modest, noninflationary growth in the United States, and with the U.S. Federal Reserve signaling continued patience on rates, the 10-year Treasury gained 3.63%, investment grade bonds returned 1.82%, and the S&P 500® Index rose 4.93%. In contrast, U.S. high yield, global high yield, emerging market debt, and emerging market equities returned -1.5%, -2.1%, -1.7%, and -4.6%, respectively.

While overseas markets suffered from (and U.S. markets benefited from) a flight to quality triggered by low euro-zone growth, slowing China growth, Russian financial and geopolitical turmoil, and the relative attractiveness of Treasury yields, for U.S. high yield the story was all about energy. Oil was down $12.99 a barrel in December, and down nearly $38 a barrel, or 42%, during all of 2014, which dragged high yield energy bonds down 6.6% in December and down nearly 19% since the end of August. With an index weight (within the J.P. Morgan Domestic High Yield Index) of 17.6%, declines of this magnitude can drive overall returns into negative territory, spark retail fund redemptions, and trigger more widespread price declines as fund managers tap liquid issues and sectors to raise cash. Investors redeemed $6.9 billion in December alone, which coincided with weak seasonal liquidity in the market to help close the quarter in negative territory. (Data: Barclays, Bloomberg.)

Within the Fund

For the fourth quarter of 2014, Delaware High-Yield Opportunities Fund (Class A and Institutional Class shares at net asset value) underperformed its benchmark, the BofA Merrill Lynch U.S. High Yield Constrained Index.

The Fund’s leading sector contributors were media, leisure, and consumer goods, while the leading individual contributors were DS Services (mineral water), Cablevision Systems (cable TV), and The Pantry (convenience stores). DS Services gained on the closing of its acquisition by Cott Corporation, Cablevision Systems gained on strong third-quarter cash flow generation, and The Pantry gained on news of its acquisition by Couche-Tard.

Meanwhile, the Fund’s largest detractors on a relative basis during the fourth quarter were energy, healthcare, and telecommunications. Bottom individual names were Midstates Petroleum (energy exploration and production), Key Energy (oilfield services), and SandRidge Energy (energy E&P). Midstates, Key Energy, and Sandridge all declined due to the nearly 50% drop in oil prices since mid-June.

Outlook

The collapse in the price of oil has a number of implications for the high yield market. First, it should help anchor inflation and give the Fed cover to remain patient on rates, while also providing a modest stimulus to consumer spending. This supports a moderate, noninflationary growth outlook that is positive overall for profits and stocks, and benign for interest rates. Historically, these conditions have been constructive for high yield bonds.

However, sustained low oil prices also will likely mean depressed energy sector profits and capital spending, and for overleveraged high yield energy names, particularly smaller companies with less financial flexibility and/or less attractive asset bases, this will likely mean a rise in defaults.

High yield spreads currently point to a 10% default rate in energy and a 5% default rate for the market as a whole. Assuming the economy stays on the course described above, we believe we are likely to see significant value in nonenergy sectors of the market and, selectively, among specific energy names with the capitalization and flexibility to ride out this stage of the cycle.

The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the U.S. stock market.

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.

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 of the three.

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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 (12/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-3.31%-0.47%-0.47%8.32%8.54%7.00%7.13%12/30/1996
Class A (at offer)-7.61%-4.85%-4.85%6.70%7.56%6.51%6.86%
Institutional Class shares-3.49%-0.47%-0.47%8.53%8.79%7.28%7.42%12/30/1996
BofA Merrill Lynch U.S. High Yield Constrained Index-1.06%2.51%2.51%8.36%8.85%7.61%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)

Expense ratio
Class A (Gross)1.11%
Class A (Net)1.05%
Institutional Class shares (Gross)0.86%
Institutional Class shares (Net)0.80%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement from Nov. 28, 2014 through Nov. 30, 2015. 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, 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.

Not FDIC Insured | No Bank Guarantee | May Lose Value