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Delaware Limited-Term Diversified Income Fund Quarterly commentary December 31, 2013 Class A (DTRIX)

Overview

In the fourth quarter of 2013, heartening progress was made on both the economic and political fronts. For instance, payroll statistics improved, economic growth accelerated, and Congress was able to agree on a federal budget. As a result, equities rose and interest rates pushed higher, reaching their peak for all of 2013. In addition, on Dec. 18, the Federal Reserve decided to begin tapering its asset-purchasing program (to be implemented in January 2014), and it announced a likely series of deliberate steps to end the program late in 2014.

Growth in U.S. gross domestic product was revised upward in December, to a 4.1% annual rate for the third quarter. Although core prices moved modestly and consistently higher during the quarter, inflation was weaker (and more volatile), primarily due to energy prices. The Fed continued to maintain its target range of zero to 0.25% on short-term interest rates.

During the fourth quarter, the 10-year Treasury yield rose from 2.61% to 3.03%, and the 2-year Treasury rose from 0.32% to 0.38%. Interest rates fell early in the quarter but rose steadily after that.

The Barclays U.S. Aggregate Index lost 0.14% for the quarter, with Treasurys and mortgage-backed securities (MBS) the biggest losers. However, commercial mortgage-backed securities (CMBS) and corporate bonds helped offset the decline. Financials and BBB-rated corporates produced particularly good results. High yield corporate and emerging market bonds likewise performed strongly.

Within the Fund

For the fourth quarter of 2013, 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.

Notes on relative performance at the sector level:

  • The Fund’s underweighted allocations to Treasurys, which lagged other sectors, enhanced the Fund’s returns. Conversely, the Fund’s focus on intermediate maturities detracted from results, because 5- to 10-year Treasury yields rose the most.
  • The Fund’s government MBS, with 15- and 30-year maturities, trailed the benchmark. The Fund’s asset-backed securities (ABS), especially the Fund’s short-maturity and floating-rate issues, outperformed. The Fund’s CMBS performed generally in line with the benchmark.
  • The Fund’s continued overweight allocation to investment grade corporate bonds boosted relative performance, benefiting from tighter credit spreads. Security selection was positive, offset somewhat by the Fund’s focus on the intermediate part of the yield curve.
  • The Fund’s high yield holdings were among the strongest contributors to performance, enhanced by our security selection. Investments in bank loans were moderately positive.
  • Positions in emerging market bonds added extra return. Both U.S. dollar–based and local currency–denominated issues outperformed. Corporate issues experienced modest spread volatility.
  • The Fund’s holdings in non-dollar developed market securities produced mixed results, with the related interest rate exposure hurting performance. Currency hedging positions had little effect.

Outlook

Federal Reserve forecasts still suggest that short-term rates should stay low through 2015. This, along with a modest inflation outlook, should help keep 10-year Treasury yields below 3.50% in early 2014. Stronger-than-expected economic growth could result in a test of this threshold, while any return by bond investors to a so-called “flight to quality” could generate a rally, which could lower yields to 2.50% or even 2.00%. We believe that Treasury inflation-protected securities (TIPS) are still close to full value, given the potential for a continuing softness in inflation.

We continue to see value in agency MBS, which offer attractive risk-adjusted yields versus those of other bonds. Although there remains debate on how long the Fed will continue to buy MBS at the current rate, the technical picture remains positive: MBS new issuance is down considerably due to the rise in interest rates and, in our judgment, is unlikely to increase in the near term.

As we see it, macroeconomic risks trump fundamental risks in the bond market. Credit spreads should move in tandem with interest rate volatility and macroeconomic issues in the coming quarter. We continue to believe that credit spreads can tighten further from current levels and that the performance of investment grade securities remains highly dependent on the direction of interest rates. We expect the investment grade market to be subject to bouts of volatility in the near term, as investors look for cues from factors that include: (1) the timing of any future Fed tapering actions, (2) the policies of new Fed chair Janet Yellen, (3) federal debt ceiling and budget negotiations, (4) risks related to China’s economic prospects, (5) the pace of merger and acquisition activity, (6) global geopolitics, and (7) the course of recovery in Europe.

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

[11955]

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 (03/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)0.65%0.65%-1.03%1.31%3.66%3.47%5.26%11/24/1985
Class A (at offer)-2.10%-2.10%-3.76%0.38%3.09%3.18%5.16%
Institutional Class shares0.57%0.57%-0.89%1.42%3.79%3.61%5.40%06/01/1992
Barclays 1-3 Year U.S. Government/Credit Index0.23%0.23%0.68%1.18%1.95%2.81%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)0.91%
Class A (Net)0.81%
Institutional Class shares (Gross)0.66%
Institutional Class shares (Net)0.66%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement from April 30, 2013 through April 30, 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.

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