- The Fund posted a healthy absolute return for the third quarter.
- International fixed income markets were whipped around by the changing outlook for U.S. monetary policy.
- Emerging markets remained a distressed asset class.
- Investment grade corporate credit and selected high yield instruments, particularly bank loans, represent the Fund’s core positioning.
The investment climate as of late has been dominated by changes in guidance from the U.S. Federal Reserve. Investors had been told during May and June 2013 to expect a winding back (or “tapering”) of the Fed’s so-called quantitative easing program. Interest rates rose and risk markets (defined as all securities other than U.S. Treasurys) came under pressure. While this shift was not anticipated, the ultimate price action was largely “textbook.” With markets primed and relaxed about the impending change, a perhaps equal shock was delivered from the deliberations of the September 17-18 Fed meeting, which ended in a decision to delay the tapering of its quantitative easing program. In addition, Fed officials lowered their longer-term forecasts for growth and inflation and softened the “triggers” on employment that markets had begun to use as a guide to possible forward changes in monetary policy. The net result was that interest rate markets globally were shocked twice in just four months — leaving many investors confused and sidelined.
Quarterly data reveal that yields on 10-year U.S. Treasurys rose just 12 basis points* (to 2.61%) and rates on European benchmark bonds (10-year German Bunds) rose by just 5 basis points (to 1.78%). However, this masks the reality that U.S. rates touched 3% during the quarter and that German rates traded through 2%. Elsewhere, moves were more dramatic, with (1) U.K. 10-year rates ending the quarter 28 basis points higher on stronger-than-expected growth and (2) Japanese 10-year rates falling 17 basis points as quantitative easing began to impose its effects. But the biggest shock was through emerging markets, where average 10-year rates ended 21 basis points higher for the quarter, though the quarter-end level of 6.32% masks the September 5 high of 6.75%. (Data: Dow Jones, Barclays).
Currency markets were likewise put on a roller coaster, with the U.S. dollar ending the quarter weaker against G-10 nations** (although there was a significant rally in the months leading up to the September Fed meeting). In addition, emerging market currencies were under persistent downside pressure throughout the quarter, with only a brief respite after the Fed’s about-face in September.
All that said, the reversal of both the rise in interest rates and the turnaround in the dollar’s strength was good news for international fixed income funds.
*One basis point equals 1/100 of one percentage point.
**The Group of Ten (G-10) refers to ten developed nations that work together on international financial issues.
Within the Fund
Delaware International Bond Fund (Class A shares at net asset value), underperformed its benchmark index, the Barclays Global Aggregate ex-USD Index in the third quarter. The Fund’s Class A shares generated an absolute return of +2.26% for the quarter, while the Fund’s benchmark advanced by 4.38% for the period.
Key developments within the Fund during the third quarter:
- Credit Investment grade spreads narrowed during the quarter, but most of the narrowing of U.S. corporate spreads occurred very early in the quarter while European corporate bonds outperformed. The outperformance by European corporate bonds was in line with a general theme that caused peripheral European sovereign spreads to narrow: An improving economic environment and increased confidence in financial stability of the sovereigns. Wider European spreads attracted domestic flows in particular, but international investors also seized the opportunity. That said, European banks remained a sector where name selection was key, because the sector remained highly leveraged and exposed to the changing regulatory environment. Core credit fundamentals did not change much during the quarter, but activity in the telecommunications sector again highlighted the increased risk of merger-and-acquisition activity that can have significant credit implications (both positive and negative). Default risk is expected to remain relatively benign, and we are therefore comfortable with the Fund’s exposure to corporate credit markets, although we have reduced exposure to high-beta names — or companies that tend to follow the overall market to a high degree.
With increased medium-term risk over the path of U.S. monetary policy (and the outlook for interest rates), the Fund has increased its exposure to bank loans. This has been done on a selective basis, and we believe it delivers attractive yield while lowering the average duration exposure.
- Emerging markets During the second quarter of 2013, the Fund had significantly pared down exposure to emerging market debt. Despite evidence of stability across many emerging markets during the third quarter, the Fund did not increase its exposure. Average emerging market rates rose 21 basis points during the quarter, a more pronounced move than seen in 10-year Treasurys. Emerging markets remained vulnerable to a reversal of the huge inflows of the previous year and to the reality that at some point in the future, U.S. monetary policy is likely to be normalized. These fears were manifested in a differentiated fashion across emerging market countries during the third quarter.
- Developed sovereign The Fund has maintained a below-benchmark exposure to developed sovereign debt, reflecting particular concern about the fiscal, debt, and growth dynamics of peripheral Europe and Japan. Our preference has been to find more attractive exposure in investment grade corporate debt. That said, the Fund increased its exposure to peripheral European bonds during the third quarter, encouraged by improving growth signals but more importantly by efforts of structural reform in countries such as Spain and Ireland. The Fund holds Italian Treasury bonds at a modest level of conviction, seeing political and reform weakness as persistent problems but with overall risk mitigated by the European Central Bank’s efforts to underpin liquidity and confidence in the European Union. Elsewhere, we have maintained a large overweight exposure to Australian state government AAA-rated debt.
- Foreign exchange During the quarter, foreign currency hedging was active within the Fund, initially mitigating the surge in the U.S. dollar then rebalancing toward the euro, yen, pound sterling, and dollar-bloc currencies, such as the Australian dollar and the New Zealand dollar. For July and August, our foreign exchange hedging simply kept pace with the movement of the index in terms of return performance. In September, the Fund was slow to rebalance in the euro and the yen, which dragged on overall performance. However, this was partly offset by moving from underweight Australian and New Zealand dollar positions to overweight, and capturing the strong turnaround in those currencies late in the quarter. We expect the Fund to maintain an active approach to foreign exchange hedging in the light of divergent central bank policies around the globe.
The shutdown of the U.S. government and the approach of debt ceiling negotiations are giving investors greater confidence that the Federal Reserve will persist with its quantitative easing policy at least into 2014. The general recovery in Treasurys has provided a positive backdrop for sovereign bond markets around the world in recent weeks. However, the investment climate is far from stable.
In Europe, where the European Central Bank balance sheet has rapidly reduced due to banks repaying the 3-year loans extended in 2011 and 2012, we see potential for another lending facility to be initiated to assist the various peripheral governments with their 2014 funding schedules. This, accompanied by evidence that Europe is returning to growth (albeit very modestly) should underpin most sovereign spreads.
Japan will continue to be of interest as the acceleration in the Bank of Japan’s balance sheet has clearly lent support to the domestic bond market, though it has not had the expected negative effects on the yen. The outlook is clouded by the announced changes in fiscal strategy that embrace fiscal stimulus at the same time as a significant increase in the consumption tax.
The duration of the Fund is now biased to be short of benchmark. This reflects a medium-term view that the Fed could again find itself under pressure in 2014 to begin the normalization of monetary policy.
This backdrop of policy uncertainty and divergence in economic growth has been a challenge for foreign exchange markets. We do not expect the picture to clear as we approach the end of 2013. We therefore expect to be taking modest positions relative to the benchmark until we receive clearer signals.
After a difficult second quarter, Delaware International Bond Fund posted a healthy positive return for the third quarter. We continue to believe that the Fund’s core investments should be maintained in corporate credit and selected sovereign governments, but we also see that higher-beta risk is likely to remain under pressure given the uncertainty of the Fed’s move toward its exit strategy. In particular, we expect the Fund to remain defensive on duration and to maintain an active approach to hedging foreign exchange exposure.
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.
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 (09/30/2013)|
|YTD||1 year||3 year||5 year||10 year||Lifetime||Inception|
|Class A (NAV)||2.26%||-7.26%||-7.17%||0.55%||4.84%||5.28%||5.82%||04/11/1997|
|Class A (at offer)||-2.31%||-11.43%||-11.33%||-0.99%||3.88%||4.80%||5.53%|
|Institutional class shares||2.16%||-7.13%||-6.99%||n/a||n/a||n/a||-1.74%||07/28/2011|
|Barclays Global Aggregate ex-USD Index||4.38%||-2.38%||-3.39%||n/a||n/a||n/a||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.
Global Aggregate ex-USD Index (view)
|Class A (Gross)||2.89%|
|Class A (Net)||1.10%|
|Institutional class shares (Gross)||2.64%|
|Institutional class shares (Net)||0.85%|
Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursements from Feb. 28, 2013 to Feb. 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.
On Nov. 7, 2013, the Board of Trustees of Delaware Group® Adviser Funds approved the liquidation of Delaware International Bond Fund; accordingly, as of that date, the
Fund is closed to new and existing investors. Please see the Fund’s current prospectus or summary
prospectus as supplemented for additional information.
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.
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.
“Nondiversified” funds may allocate more of their net assets to investments in single securities than “diversified” Funds. Resulting adverse effects may subject these Funds to greater risks and volatility.
Not FDIC Insured | No Bank Guarantee | May Lose Value