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Delaware Limited-Term Diversified Income Fund Quarterly commentary June 30, 2014 Class A (DTRIX)

Overview

After a surprisingly weak first quarter, U.S. economic indicators were generally solid during the second quarter of 2014. Data for employment, manufacturing, auto sales, and housing all showed strength although consumption statistics came in at a softer pace. Overall, the U.S. economy has modest momentum entering the third quarter. However, core prices moved meaningfully higher while headline inflation was even stronger, due primarily to energy prices.

The Barclays U.S. Aggregate Index recorded another strong return in the second quarter as corporate bonds — especially lower-quality and longer-duration sectors — led the way. Given the shift in the Treasury yield curve, short-to-intermediate sectors produced more-moderate returns, although mortgage-backed securities (MBS) were relatively strong. Meanwhile, BBB-rated corporates, high yield corporate bonds, and emerging market bonds produced strong excess returns.

Yields were lower on longer maturities during the second quarter of 2014, with 10- to 30-year Treasury bonds showing the biggest drop in rates during the period (-0.20%). Responding to a slight improvement in economic momentum, short-term yields during the quarter were slightly higher. The 2-year/10-year Treasury curve flattened by 0.23 percentage points, to 2.07%. Ten-year Treasury inflation-protected securities (TIPS) yields followed nominals as break-even inflation rates rose from 2.14% to 2.28% and real yields fell from 0.58% to 0.25%.

Within the Fund

For the second quarter of 2014, Delaware Limited-Term Diversified Income Fund (Class A shares at net asset value) generated a positive total return that outperformed its benchmark, the Barclays 1–3 Year U.S. Government/Credit Index.

  • The Fund’s underweight positions in Treasury securities had a positive impact on relative returns as Treasury bonds lagged other benchmark sectors.
  • The high yield bond market was among the strongest sources of performance during the quarter, though Fund investments in bank loans showed moderately positive results.
  • The Fund’s positions in emerging market debt contributed to relative performance for the quarter. U.S. dollar–based issues were the primary source of the outperformance.
  • Non-dollar developed markets, while representing only a small allocation, produced solid returns as interest rate exposures benefited performance. Currency hedging had a modest positive effect as well.

Outlook

Federal Reserve forecasts suggest that short-term rates should stay near zero until at least the second quarter of 2015 and move higher at a slower-than-normal pace after that. This factor, along with still moderate inflation, should help keep 10-year Treasury yields below 3.5% during 2014. Stronger-than-expected economic growth could cause a test of this upper band, while any reasons for a return to a flight-to-quality or liquidity sentiment could create a rally that tests yield levels below 2.5% or even 2.0%. So far, the market reaction to the actual tapering in asset purchases of $10 billion per month has been rather modest. We believe that TIPS are still at full value given the potential for a continuing softness in inflation.

Bond ratings are determined by a nationally recognized statistical rating organization (NRSRO).

Per Standard & Poor’s credit rating agency, bonds rated below AAA, including A, 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.

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 (06/30/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)0.62%1.27%1.84%0.86%2.83%3.67%5.23%11/24/1985
Class A (at offer)-2.12%-1.50%-0.93%-0.06%2.26%3.38%5.13%
Institutional Class shares0.77%1.34%2.11%1.01%2.98%3.83%5.38%06/01/1992
Barclays 1-3 Year U.S. Government/Credit Index0.33%0.56%1.14%1.00%1.73%2.96%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)

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 30, 2014 through April 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.

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.

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.

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 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.

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