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Delaware Emerging Markets Fund Quarterly commentary December 31, 2014

Within the Fund

For the fourth quarter of 2014, Delaware Emerging Markets Fund (Class A and Institutional Class shares at net asset value) underperformed its benchmark, the MSCI Emerging Markets Index.

From a country perspective, the principal sources of underperformance included Brazil, China, and Russia. In Brazil, the Fund’s large overweight position was unfavorable, while stock selection was also negative. In particular, shares of Petrobras declined nearly 50% on concerns about the impact of lower oil prices, an investigation into alleged management corruption, and a delay in reporting of the company’s third-quarter financial report. Shares of online retailer B2W Cia Digital declined due to concerns about the weak Brazilian economy and depreciation of the real. Shares of mobile operator Tim Participacoes declined as the company is considering purchasing Oi, which contrasts with the market’s prior expectation of Tim Participacoes likely being acquired. In China, the Fund’s significant underweight in the financials sector detracted from performance as bank, insurance, and brokerage stocks all rallied in response to the Chinese central bank’s interest rate cut in November. In Russia, the ruble’s steep depreciation versus the U.S. dollar contributed to the underperformance of domestically oriented companies including Yandex, Sberbank, Mobile Telesystems, QIWI, MegaFon, and X5 Retail Group. Declining oil prices weighed on Rosneft’s share price.

Other countries detracting from performance included South Africa, Taiwan, India, and South Korea. In South Africa and Taiwan, the Fund’s underweight positions were unfavorable in light of the resilient performance from these markets. In India, Reliance Industries, in which the Fund holds an overweight position, underperformed as weaker global economic growth may limit upside to petrochemicals prices. In South Korea, shares of KCC declined as the company increased its stake in shipbuilder Hyundai Heavy Industries. Shares of Lotte Chilsung Beverage declined due to soft trends in domestic consumption and disappointing third-quarter profits.

On the positive side, Chinese search engine leader Baidu outperformed due to continued strength in sector growth. Also within the internet sector, shares of Sohu.com recovered due to its valuation merits, while Yahoo benefited from the strong share performance of Alibaba Group, in which Yahoo has retained a stake. In the healthcare sector, shares of Teva Pharmaceutical Industries rose as the market gained greater confidence in the company’s earnings outlook.

Among sectors, financials detracted the most from performance, largely due to the Fund’s underweight position in Chinese banks and insurance companies. Our long-term view on Chinese financial stocks remains cautious as we continue to see risks to asset quality. The energy sector also detracted from performance as declining oil prices affected several of our positions including Petrobras, Rosneft, YPF, and PetroChina. Our investments in these companies are based principally on individual company merits such as reserves, cost competitiveness, production growth, and valuation rather than expectations for rising oil prices. In the near term, lower oil prices will impact profitability, but we believe that current valuations excessively discount future growth opportunities for these companies. In the telecom sector, unfavorable stock selection contributed to underperformance. Shares of Orange Polska in Poland declined as the company’s third-quarter results illustrated continued competitive challenges. In South Korea, shares of SK Telecom and KT corrected on speculation that recent legislation limiting handset subsidies may be revised, potentially leading to increased marketing spending from mobile operators. In Russia, shares of Mobile Telesystems and MegaFon were affected by the ruble’s depreciation.

Sectors contributing positively to performance included technology and materials. In the technology sector, Chinese internet stocks Baidu and Sohu.com outperformed. Shares of Samsung Electronics also rose as the company is considering raising its dividend payout. In the materials sector, our underweight stance was favorable.

Outlook

Our outlook for emerging markets remains largely unchanged. As discussed in previous commentaries, we believe that the Chinese economy, global monetary policy, and politics will continue to influence the performance of emerging market equities.

China’s economy continues to transition from a growth model driven largely by fixed asset investment to a more sustainable consumption-oriented model. The process of digesting excessive capacity in certain sectors such as steel and property is underway, but we believe there is still more to come. We expect this to continue to be a headwind for short-term economic growth in China, and to have consequences outside of China for companies with high exposure to those sectors undergoing retrenchment. We remain constructive on other segments of the economy, however, driven by rising incomes and urbanization. Overall, we expect economic growth in China to stabilize, but the impact on broader emerging markets will be mixed in our view.

On the monetary policy front, again the picture is mixed. In the United States, the U.S. Federal Reserve gradually reduced accommodation throughout the past year and concluded its bond purchases in October. On the other hand, other developed market central banks including the Bank of Japan and the European Central Bank have loosened policy in response to slowing economic conditions and deflationary threats. We believe that overall global liquidity conditions will remain supportive, but as we have witnessed, any indication of monetary tightening from developed market central banks can swiftly affect emerging market capital flows. Monetary policy within emerging market countries also warrants consideration. While most central banks in emerging markets exhibited a tightening bias a year ago, these economies appear to be in different monetary phases heading into 2015. Some countries such as South Africa, Russia, and Brazil are likely to raise interest rates further, while others such as South Korea, India, and Poland may have an easing bias.

With respect to politics, 2014 witnessed several significant elections in emerging markets, and the results strongly impacted equity market performance. While the electoral calendar is substantially lighter in 2015, attention is likely to turn toward implementation of economic reforms. In our view, successful execution of the reform process represents a critical ingredient for long-term sustainable growth in emerging markets. Examples of key issues include infrastructure investment, reform of state-owned enterprises, and environmental sustainability. Countries we will be watching closely include those with recent elections such as India, Indonesia, Brazil, and Turkey, as well as those where reform has been a focus for some time such as China and Mexico.

More broadly, we expect geopolitics to remain in focus and to provide volatility to the market. Tensions between Russia and Ukraine appear to persist in 2015. In the Middle East, political uncertainty remains high. In Asia, the potential for unrest must be considered as well.

Overall, we retain our optimistic long-term view on emerging markets, but we believe that the current market environment warrants a selective approach to investing. We focus on identifying sustainable franchises that we believe can weather fluctuating market conditions and benefit from secular growth opportunities. We seek to invest in these companies at valuations that are significantly discounted to our assessment of their intrinsic value. Among countries, we hold overweight positions in South Korea and Brazil and underweight positions in Taiwan and South Africa. Among sectors, we find attractive opportunities in the information technology, telecommunications, and energy sectors, while we remain underweight in the financials sector.

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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 (12/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-10.80%-8.48%-8.48%6.60%2.60%8.47%7.85%06/10/1996
Class A (at offer)-15.91%-13.76%-13.76%4.51%1.39%7.83%7.51%
Institutional Class shares-10.66%-8.18%-8.18%6.90%2.87%8.74%8.14%06/10/1996
MSCI Emerging Markets Index (Gross)-4.44%-1.82%-1.82%4.41%2.11%8.78%n/a
MSCI Emerging Markets Index (Net)-4.50%-2.19%-2.19%4.04%1.78%8.43%n/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 5.75% 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.

MSCI Emerging Markets Index (view)

Expense ratio
Class A (Gross)1.71%
Class A (Net)1.71%
Institutional Class shares (Gross)1.46%
Institutional Class shares (Net)1.46%
Top 10 holdings as of 02/28/2015
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holdings based by issuer.
Holding% of portfolio
Samsung Electronics Co Ltd7.0%
Reliance Industries Ltd4.9%
China Mobile Ltd4.0%
SK Telecom Co Ltd3.5%
Baidu Inc3.3%
Petroleo Brasileiro SA3.2%
Sohu.com Inc3.1%
Grupo Televisa SAB2.7%
KCC Corp2.4%
SINA Corp/China2.3%
Total % Portfolio in Top 10 holdings36.4%

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.

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