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Delaware Dividend Income Fund Quarterly commentary December 31, 2013 Class A (DDIAX)

Within the Fund

For the fourth quarter of 2013, Delaware Dividend Income Fund (Class A shares at net asset value) posted a positive return, but trailed its benchmark, the S&P 500 Index.

Within the large-cap value equity portion of the Fund, stock selection hurt performance, and the largest drag on relative returns came in the energy sector. Stand-alone refiners, which are not represented in the Fund’s portfolio, had a strong quarter. Additionally, integrated oil major Exxon Mobil, which was not held in the portfolio, posted a double-digit return in the fourth quarter. In the Fund, exploration and production company Marathon Oil had the lowest return in the energy sector with a gain of 1.7%. For all of 2013, the Fund’s stock selection in healthcare was a large source of negative attribution. Diagnostic testing provider Quest Diagnostics was the weakest performer in the sector with a decline of 6% for 2013. The company continued to struggle with lower testing volumes, given weaker healthcare utilization trends, and lowered estimates for both sales and earnings during the year. Quest’s risk-reward profile remains attractive to us based on the stock’s valuation and the potential for better execution and an improvement in testing volumes.

The largest contribution to performance within the Fund’s large-cap value portion came from investments in consumer staples. Drug-store chain and pharmacy benefits manager CVS Caremark fared the best with a return of 27%. Last quarter’s sales and profits came in ahead of many analysts’ expectations; additionally, the company conservatively raised its guidance for 2014, and it announced a 22% dividend increase. Investments in consumer staples also boosted relative returns for 2013. The Fund’s holdings outperformed the broader sector, and an overweight allocation was also a plus. Grain processing and handling firm Archer-Daniels-Midland was the top contributor in the sector — its shares gained 62% for the year. The company rebounded from a difficult year in 2012 when drought conditions translated into higher input costs in its processing businesses and lower volumes in its agricultural services unit.

Within the equity real estate investment trust (REIT) portion of the Fund, stock selection within the lodging, regional malls, and diversified sectors had a negative effect. Lexington Realty Trust in the diversified REIT sector was a notable laggard for the quarter, declining more than 7%. As the company transforms from a multi-tenant lease company to a triple-net-lease company with longer leases, we believe investors may become more comfortable with the company’s cash-flow stability.

The Fund’s decreased allocation to healthcare REITs, the most expensive sector in the REIT universe, helped lessen the negative effects of the Fund’s investments in that sector. In addition, stock selection in the apartments and specialty sectors aided performance. Gladstone Land was a notable contributor in the specialty group, with a gain of more than 10% for the quarter.

Within the Fund’s high yield bond portion, the top sector contributors were basic industry, consumer cyclical, and energy bonds. Top individual contributors included FMG Resources (mining), First Data (transaction processing), and Algeco Scotsman (leasing). All three are in economically sensitive sectors and thus benefited from better-than-expected economic data released during the quarter.

Sectors that detracted from relative performance were financial services, gaming, and utilities securities. Impairing the Fund’s results the most were RadNet (diagnostic imaging), Equinix (internet infrastructure), and Woodside Homes (homebuilding), which were hurt by a varying combination of interest rate sensitivity, trading flows, and repricings due to new issuance.

We did not alter the Fund’s high yield bond holdings significantly during the quarter, although we continued to add to the Fund’s position in bank loans. Because bank loans are floating-rate securities, they can be defensive in rising rate environments. And as the most senior component in the capital structure of issuers (in contrast to high yield bonds, which typically are the most junior component), bank loans also may help defend against credit risk.

Outlook

Moving into the first quarter of 2014, several notable themes, possibilities, and developments bear monitoring. These include the following:

  • With REITs’ having underperformed in 2013, we could conclude that many investors have essentially voted that growth should continue and defensive yield sectors should underperform in a rising rate environment. As rising rates often signal an improving economy, management teams may gain confidence to increase spending, which should also improve employment. Rising rates can also create competition for high dividend-yielding investments, which weighed on the REIT sector in 2013. However, as a result of REITs’ underperformance, certain REIT sectors (such as malls) have become more attractive to us, and we are now finding what we believe to be solid values in the REIT universe.
  • While the prospective performance of high yield bonds and loans should be limited by range-bound interest rates and tight credit spreads, many of the ingredients that supported their strong relative performance in 2013 — moderate, noninflationary growth, low defaults, and strong investor demand — remain intact. Mid-single-digit returns are unappealing to us except when the alternatives are lower. Given that spreads remain wide to the historically narrow levels reached in the past, and given the potential for continued low default rates, we believe that high yield returns could largely be driven by the income component as we enter 2014.
  • U.S. stock market valuations remain a concern for us. We believed the broad market’s price multiples were on the high side at the beginning of 2013. Since then, they’ve expanded quite a bit. Approximately 70% of the S&P 500 Index’s 32% gain in 2013 was from multiple expansion; the balance came from earnings growth and dividends. (Source: Barclays Equity Research.) High indebtedness remains another concern for us. While the economy appears to be making measured progress in areas like employment, housing, business investment, and consumer spending, attitudes toward debt and leverage appear lax to us. Companies are carrying more debt. Exceptionally low interest rates have kept debt financing costs manageable, but absolute levels of debt have been rising and capital structures have become more leveraged. Furthermore, household debt-to-gross domestic product is still quite high, and over-indebtedness at the federal government level appears, in our view, to have no end in sight. A priority for the Fund is finding what we view as compellingly valued replacements for stocks nearing their price targets. We’re focusing on higher-quality attributes such as balance-sheet strength, cash flow consistency, and earnings predictability. Currently, we’re seeing potential for new opportunities in the technology, financial, industrial, and consumer discretionary sectors.

In light of these circumstances, we believe there is a strong argument for seeking companies that, in our view, have several of the following attributes: (1) appear undervalued, (2) have strong cash flows, (3) maintain manageable debt levels, (4) operate diversified businesses, and (5) deliver consistent dividends.

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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 (03/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)2.61%2.61%13.69%10.41%18.03%6.55%8.40%12/02/1996
Class A (at offer)-3.29%-3.29%7.10%8.27%16.63%5.92%8.03%
Institutional Class shares2.67%2.67%13.96%10.69%18.32%6.82%8.56%12/02/1996
S&P 500 Index1.81%1.81%21.86%14.66%21.16%7.42%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.

Prior to Oct. 1, 2003, the Fund had not engaged in a broad distribution of its shares and had been subject to limited redemption requests. The returns reflect expense limitations that were in effect during certain periods and which may have been lower than the Fund's current expenses. The returns would have been lower without expense limitations.

Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.

S&P 500® Index (view)

Expense ratio
Class A (Gross)1.12%
Class A (Net)1.12%
Institutional Class shares (Gross)0.87%
Institutional Class shares (Net)0.87%
Top 10 holdings as of 03/31/2014
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Edison International1.5%
Quest Diagnostics Inc.1.5%
Baxter International Inc.1.5%
AT&T Inc.1.5%
Bank of New York Mellon Corp.1.4%
ConocoPhillips1.4%
Johnson & Johnson1.4%
Halliburton Co.1.4%
Intel Corp.1.4%
Xerox Corp.1.4%
Total % Portfolio in Top 10 holdings14.4%

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.

The Fund may invest up to 45% of its net assets in high yield, higher-risk corporate bonds.

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.

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.

Not FDIC Insured | No Bank Guarantee | May Lose Value