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Delaware Limited-Term Diversified Income Fund Quarterly commentary March 31, 2016

Overview

The fixed income market aggressively sold risk assets over the first half of the quarter and then turned on a “Draghi dime” and bought risk assets through the end of the period. The first wave of risk-buying in late February gained traction after European Central Bank (ECB) President Mario Draghi made it clear that the ECB would not hesitate to further loosen monetary policy, and U.S. Federal Reserve Chairwoman Janet Yellen described a combination of tightening U.S. financial conditions and increased global risks. Risk assets received an additional boost in March after the ECB acted on Draghi’s proposals and Yellen amplified her dovish comments. Significant swings in oil prices and the U.S. dollar contributed to volatility as well.

For the quarter, the Barclays U.S. Aggregate Index recorded a positive return, with lower-quality bonds outperforming the higher-rated investment tiers within that index. Although most broad-market fixed income indices produced solid returns, non-U.S. Treasurys and emerging market bonds were the strongest performers, with the asset-backed securities (ABS) and mortgage-backed securities (MBS) sectors lagging. Over the full period, yields on 10-year Treasurys fell from 2.27% to 1.77% while yields on the 2-year Treasury note, the security most sensitive to monetary policy, declined from 1.05% to 0.73%.

The decline in bond yields occurred against a mixed economic backdrop. In March, U.S. gross domestic product (GDP) growth for the fourth quarter of 2015 was revised upward to a 1.4% annualized pace due to a jump in consumer spending. However, corporate profits fell 7.8% during the quarter, the biggest decline since the first quarter of 2011 (-9.2%). Profits have fallen in four of the last five quarters and are down 11.5% from a year earlier, the worst year-on-year drop since the Great Recession. Among the more positive trends, jobless claims, which have averaged about 275,000 for the past year, suggest continued strength in the pace of hiring. Until personal income and wage-and-salary income accelerate, however, consumer inflation should remain muted. Combining these factors with concerns over the pace of global economic growth, lower oil prices, and a strong U.S. dollar raises the hurdle for the next Federal Open Market Committee (FOMC) policy rate action.

With investors in perpetual Fed-watch mode, recent statements by Fed officials (other than Yellen) that appear to lean more toward a near-term tightening have been a source of uncertainty. This leaning may be the result of recent signs that inflation expectations are finally approaching the Fed’s 2% target. Though the last official Fed communication suggested two additional quarter-percentage-point increases in the federal funds rate this year, the markets are discounting only one increase in the fourth quarter of 2016. We are inclined to favor the market’s “one increase” view but believe it could come as early as summer.

Within the Fund

Delaware Limited-Term Diversified Income Fund (Institutional Class shares and Class A shares at net asset value) outperformed its benchmark, the Barclays 1–3 Year U.S. Government/Credit Index, for the first quarter of 2016.

The Fund’s overweight allocation to corporate bonds was the primary driver of performance for the period. Out-of-benchmark allocations in MBS, commercial mortgage-backed securities (CMBS), high yield bonds, and emerging market debt also were positive contributors, as these sectors outperformed the return of the benchmark. Meanwhile, small exposures within municipal bonds and bank loans detracted from relative performance.

Outlook

We believe that the U.S. economic expansion will continue at a modest pace. With more than $7 trillion of sovereign debt around the world now trading with a negative yield, U.S. markets should continue to see interest from overseas investors.

However, we must stay vigilant and closely monitor various risks associated with divergent central bank policies, a challenging economic landscape for emerging markets, and a general lack of pricing power around the globe. We also expect markets to remain volatile, particularly if the Fed’s somewhat manic behavior of focusing on domestic and global issues results in additional communication challenges as it moves toward normalizing rates.

We believe it is important to recognize that deflationary influences can change the nature of the economic cycle. As such, investors must consider the possibility that the current economic cycle may play out differently than any cycle in the postwar period.

The Barclays U.S. Aggregate Index is a broad composite that tracks the investment grade domestic bond market.

[16407]

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 (03/31/2016)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)1.46%1.46%0.84%0.56%1.33%3.51%5.00%11/24/1985
Class A (at offer)-1.35%-1.35%-1.90%-0.38%0.77%3.22%4.90%
Institutional Class shares1.38%1.38%0.88%0.70%1.46%3.65%4.28%06/01/1992
Barclays 1-3 Year U.S. Government/Credit Index0.98%0.98%1.04%0.95%1.14%2.80%n/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 2.75% 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.

Barclays 1-3 Year U.S. Government/Credit Index (view definition)

Expense ratio
Class A (Gross)0.92%
Class A (Net)0.82%
Institutional Class shares (Gross)0.67%
Institutional Class shares (Net)0.67%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement from April 29, 2016 through May 1, 2017. 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.

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.

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 derivatives 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.

Diversification may not protect against market risk.

All third-party marks cited are the property of their respective owners.

Not FDIC Insured | No Bank Guarantee | May Lose Value