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Delaware High-Yield Opportunities Fund Quarterly commentary June 30, 2014 Class A (DHOAX)

Overview

High yield bonds, as measured by the BofA Merrill Lynch U.S. High Yield Constrained Index, returned 2.6% for the second quarter, bringing year-to-date returns to 5.6%. Loans returned 1.3% for the quarter and 2.4% year-to-date (data: J.P. Morgan). Bond returns were driven by falling interest rates, surging stock prices, generally supportive economic data, and sustained investor demand. These factors generally offset otherwise negative Mideast geopolitical events.

Bond performance was correlated with quality, as the interest-rate-sensitive BB sector led at 2.7%, followed by B-rated bonds and CCC-rated bonds at 2.2%. Every industry category posted positive returns during the quarter, with utilities (4.0%) and energy (3.2%) leading, and consumer products (1.2%) and paper (1.5%) lagging. Loan returns were correlated with risk, with CCC-rated loans returning 4.1% followed by B-rated loans at 1.2% and BB issues at 0.9%.

High yield bond yields fell 23 basis points to 5.17%, while spreads fell 14 basis points to 399 basis points. Loan yields (calculated to a 3-year takeout) fell 24 basis points to 4.96%, while spreads tightened 26 basis points to 399 basis points. (A basis point equals one one-hundredth of a percentage point.)

Within the Fund

For the second quarter of 2014, Delaware High-Yield Opportunities Fund (Class A shares at net asset value) generated a positive total return that underperformed that of its benchmark, the BofA Merrill Lynch U.S. High Yield Constrained Index.

Top sector contributors were technology, media, and energy. Top individual contributors included First Data (transaction processing), Nuveen Investments (mutual funds), and Midstates Petroleum (oil exploration and production). First Data gained on news that equity sponsor KKR arranged a $3.5 billion private placement to help the company refinance high-cost debt. Nuveen gained on news of its acquisition by TIAA-CREF, and Midstates gained on the spike in oil prices caused by the tensions in Iraq.

Sectors that detracted most on a relative basis during the second quarter were consumer cyclicals, utilities, and financial services. The Fund’s largest detractors were David’s Bridal (retail bridal gowns), Algeco Scotsman (modular trailer leasing), and Quiksilver (outdoor sports retailer). David’s Bridal and Algeco declined on weaker-than-expected first-quarter earnings, while Quiksilver underperformed due to weak second-quarter numbers and Moody’s decision to place its credit ratings on negative outlook.

Outlook

While the near-perfect confluence of factors that supported the market during the first half of the year are unlikely to remain fully intact, we believe the key elements — moderate, noninflationary growth, low interest rates, stable credit trends, and strong demand for yield — are likely to persist for some time. In such an environment, investors need to distinguish between the valuation cycle and the credit cycle. At 3.99 percentage points off Treasurys, high yield values are full — though not stretched. Additional spread compression is certainly possible, and on a historical basis, even likely. However, spread compression should not be assumed, and expected high yield returns are likely, in our view, to consist largely of income. At present, the credit cycle remains in an expansionary phase, with abundant borrower access to both bank and public market credit.

Most importantly, a majority of new high-yield issuance remains devoted to refinancing rather than to leveraged buyouts or other activities that tend to result in higher systemic leverage and inflated asset prices. So long as this trend stays intact, and the current economic backdrop persists, credit should remain abundant and asset valuations should remain reasonable, supporting an extended below-average default environment. There has never been a high yield bear market under such conditions, although the reduced spread cushion implies vulnerability to episodic repricing in response to “risk-off” trades or interest rate shocks. However, given the market’s strong fundamental characteristics, and its high relative yield, investor demand for the leveraged finance asset class should remain firm as well.

We also expect loan demand to remain strong, supported by a high current income compared to many other parts of fixed income, lower volatility versus high yield and equities, low default risk, positive credit fundamentals, protection from rising interest rates, and a resilient U.S. economy.

By credit quality, we continue to find B-rated loans to offer the best value. In our opinion, this approach to positioning can allow an investor to carry a competitive yield while also potentially offering a degree of protection against volatility from economic and political surprises. While good fundamentals and low expected default rates support an overweight to CCC-rated loans, valuations, global growth concerns, and poor liquidity more than offset the higher yields from moving far down the credit spectrum. 

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 (06/30/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)2.46%5.30%12.55%9.31%13.72%8.70%7.69%12/30/1996
Class A (at offer)-2.20%0.68%7.44%7.62%12.68%8.19%7.41%
Institutional Class shares2.53%5.43%12.84%9.62%14.05%9.02%7.99%12/30/1996
BofA Merrill Lynch U.S. High Yield Constrained Index2.57%5.64%11.79%9.25%13.89%8.91%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)1.06%
Institutional Class shares (Gross)0.86%
Institutional Class shares (Net)0.81%

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.

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