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Delaware Inflation Protected Bond Fund Quarterly commentary September 30, 2014

Overview

The third quarter of 2014 reflected multiple shifts in bond market attitudes as well as the points of focus on economic growth, U.S. Federal Reserve policy, and geopolitical fronts. By mid-July, geopolitical risks had heated up and high-quality bonds benefited as many investors went in search of safety. Beyond the safety factor, the bond market seemed to be pulled in both directions by signs of improving U.S. growth being offset by pockets of weakening global growth.

Economic data for U.S. employment, consumer demand, and housing varied from month to month. Manufacturing was also choppy but auto sales were consistently strong. Overall, the U.S. economy has decent momentum entering the fourth quarter.

During the third quarter of 2014, yields on 10-year Treasurys fell from 2.53% to 2.49%, and yields on 2-year Treasurys rose from 0.46% to 0.57%. Rates fell during the first half of the quarter but then retraced much of this decline. The 3-month T-bill / 10-year T-note curve flattened 4 basis points to 2.47% by the end of the quarter. (A basis point equals one one-hundredth of a percentage point.) The 1-month London interbank offered rate (Libor) held steady, ending the quarter at 0.15%. (Data: Bloomberg.)

The Barclays U.S. Aggregate Index recorded a virtually flat return in the third quarter as higher-quality bonds and longer-duration sectors led the way. Given the shift in the Treasury yield curve, short-to-intermediate focused sectors produced negative returns, although mortgage-backed securities (MBS) were relatively strong. BBB-rated corporates, high yield corporate bonds, and emerging market bonds produced negative returns.

Within the Fund

For the third quarter of 2014, Delaware Inflation Protected Bond Fund (Class A and Institutional Class shares at net asset value) posted a negative total return and underperformed its benchmark, the Barclays U.S. TIPS Index.

The TIPS market performed poorly during the quarter as real interest rates rose far more than nominal interest rates. This occurred as breakeven inflation rates fell significantly due primarily to the drop in energy prices. The Fund’s intermediate duration focus was beneficial as real rates rose but our exposure to breakeven rate risk in longer maturity TIPS bonds more than offset this positive.

The Fund is maintaining its intermediate duration target to encourage lower real rate sensitivity over a full rate cycle. The Fund is in the process of realigning the source of its breakeven rate exposure in order to reduce future sensitivity to large shifts in this factor.

Outlook

Whether evaluating current bond prices or the range of forecasts for 2015, a Fed tightening in the second or third quarter of 2015 appears to be viewed as a “high probability.” Many market analysts express concern that the Fed is already behind the curve. However, we believe that current conditions may actually support the opposite conclusion. Given the Fed’s history of tightening policy when the Consumer Price Index is soft, oil is falling, and the U.S. dollar is rising, a 2015 tightening could end up being ahead of the curve (and a policy mistake). Sluggish global growth — which results mostly from weak consumption — seems to support this view, as does the recent sharp decline in Treasury inflation-protected securities’ (TIPS’) break-even rates (that is, inflation premiums).

On balance, weak global growth should keep real rates at very low levels, and deflationary pockets in key world markets should keep nominal rates low as well. Market forecasts for significantly higher rates and a steeper yield curve seem to be misplaced, and if anything, forecasts should be acknowledging the potential for a return to 10-year Treasury rates in the low 2% range.

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.

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.

The Barclays U.S. Aggregate Index is a broad composite that tracks the investment grade domestic bond 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 (09/30/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-2.85%1.07%-1.04%-2.38%1.92%n/a3.46%12/01/2004
Class A (at offer)-7.18%n/a-5.49%-3.85%1.00%n/a2.97%
Institutional Class shares-2.81%1.29%-0.81%-2.14%2.17%n/a3.70%12/01/2004
Barclays U.S. TIPS Index-2.04%3.67%1.59%1.34%4.48%n/an/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.

Prior to May 1, 2005, the Fund had not engaged in a broad distribution effort of its shares and had been subject to limited redemption requests. The returns reflect expense limitations that were in effect during certain periods and which may have been lower than the Fund's current expenses. The returns would have been lower without such expense limitations.

Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 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)0.98%
Class A (Net)0.84%
Institutional Class shares (Gross)0.73%
Institutional Class shares (Net)0.59%

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.

Prior to May 1, 2005, the Fund had not engaged in a broad distribution effort of its shares and had been subject to limited redemption requests. The returns reflect expense limitations that were in effect during certain periods and which may have been lower than the Fund's current expenses. The returns would have been lower without such expense limitations.

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.

Interest payments on inflation-indexed debt securities will vary as the principal and/or interest is adjusted for inflation.

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

The Funds 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.

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.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

Diversification may not protect against market risk.

Not FDIC Insured | No Bank Guarantee | May Lose Value