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Delaware Dividend Income Fund Quarterly commentary September 30, 2014

Within the Fund

For the third quarter of 2014, Delaware Dividend Income Fund (Class A and Institutional Class shares at net asset value) underperformed its benchmark, the S&P 500® Index.

Within the large-cap value equity portion of the Fund, relative performance benefited from investments in industrials and information technology. Stock selection in both sectors, as well as an overweight in technology, had positive effects. As a group, the portfolio’s three industrial stocks rose 9.6%, led by defense contractors Northrop Grumman (up 10.8%) and Raytheon (up 10.7%). In general, defense stocks benefited from expanding military activity in the Middle East, and from a rotation out of more-cyclical industrial companies, whose revenues have come under pressure because of slowing global growth. In technology, semiconductor manufacturer Intel led with a 13.5% increase. In July, the company reported second-quarter results that were ahead of levels it preannounced in June, which had also lifted the shares. Elsewhere in the portfolio, grain processing and servicing company Archer-Daniels-Midland was the top performer, up 16.4%. The company has been benefiting from abundant crop supplies as well as restructuring and cost-saving initiatives.

The largest drags on performance within the large-cap value equity portion of the Fund came from investments in financials. Shares of regional bank BB&T dropped -5.0% after the company announced second-quarter results that missed expectations. Loan growth was better than expected but net interest income remained under pressure and the bank’s progress on expense reductions has been slow. Energy was the next-weakest sector from an attribution standpoint. Each of the Fund’s holdings had a negative return owing to a stronger U.S. dollar, rising supply in the United States, and concerns about softening global demand. Exploration and production company ConocoPhillips fared the worst, declining -10.0%. Other weak performers in the large-cap value equity portion of the portfolio included Johnson Controls (down -­11.5%), a manufacturer of automotive interiors, batteries, and building control systems, and snack food maker Mondelez International (down -8.5%). Both companies have been contending with slowing product demand, primarily in emerging markets, where each has meaningful exposure.

Within the equity real estate investment trust (REIT) portion of the Fund, stock selection in the specialty, regional malls, and mixed sectors detracted from Fund performance. In the specialty sector, Fund holding EPR Properties underperformed as the company issued equity to pay down lines of credit that funded year-to-date acquisitions. We think EPR is now quite attractively valued, and we added to the position in September.

Stock selection in the diversified, lodging, and freestanding REIT sectors aided Fund performance. Fundamentals in the lodging sector are improving given limited supply and increasing demand from both corporate and leisure customers. Additionally, the sector has finally been able to sustain higher rates for hosting groups. Fund holding DiamondRock Hospitality has forecasted strong gains in revenue per available room (RevPAR) as its two-year renovation projects have begun to bear fruit. We think this bodes well for full-service hotel companies in general.

Within the Fund’s high yield bond portion, the top sector contributors were basic industry, financial services, and gaming. The top individual contributors were Salix Pharmaceuticals (gastrointestinal drugs), BWAY Holding (metal/plastic containers), and Hanesbrands (apparel). Salix gained on successful drug trials and merger-and-acquisition activity, BWAY launched a new debt issue that traded to a premium over issue price, and Hanesbrands gained on expanding margins and an accretive acquisition.

Sectors that detracted from performance included energy, media, and retail sectors. Bottom individual credits were Hercules Offshore (energy contract driller), Caesars Growth Properties (casino operator), and Midstates Petroleum (energy exploration and production). Hercules declined due to the unexpected loss of several drilling contracts, Caesars declined due to debt-restructuring negotiations at an affiliate, and Midstates declined due to the nearly $15-a-barrel decline in oil prices since mid-June.

Outlook

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

  • The fourth quarter, especially the latter part, has historically been a good one for equities. Given the improving trajectory of the U.S. economy and lack of favorable investment alternatives, we believe stocks could gain strength and move higher from here. Seasonality aside, some of the risks currently facing the market could continue to dampen investor enthusiasm and keep stock prices in check. These risks include the end of quantitative-easing stimulus, the likelihood that the U.S. Federal Reserve moves short-term interest rates up from zero next year, slowing economic activity in some key regions outside the U.S., and rising geopolitical conflicts. Our concerns about equity valuations and potential market risks mean that we remain defensively oriented with a focus on what we view as higher-quality businesses with relatively low price multiples and attractive risk-return profiles.
  • The volatility in interest rates, global equity markets, and currencies presents a challenge for long-term investment decision making in real estate equities. We have implemented a process that takes into account both real estate fundamentals and capital markets. Given that capital moves across borders daily, real estate investing has become about more than just local supply and demand. We believe short-term volatility should not obscure the potential long-term benefits of owning real estate equities: (1) stable and rising dividends, (2) inflation protection, and (3) diversification when holding these securities over the long term.
  • Given the world’s political and economic uncertainties, we believe “risk-off” trades and elevated volatility in the high yield bond market will continue, particularly as we approach year end when underwriters try to lock in gains and trading liquidity tends to experience normal seasonal erosion. Thus, technical conditions should remain challenging. However, with the U.S. economy on a moderate, noninflationary growth track, and with a majority of new high yield issuance dedicated to refinancing, we believe stable credit trends and the current low default environment should persist well into 2015.

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

Diversification may not protect against market risk.

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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 (09/30/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-0.66%6.29%12.66%16.13%12.34%6.83%8.37%12/02/1996
Class A (at offer)-6.34%n/a6.17%13.87%11.02%6.20%8.01%
Institutional Class shares-0.60%6.49%12.94%16.46%12.62%7.10%8.54%12/02/1996
S&P 500 Index1.13%8.34%19.73%22.99%15.70%8.11%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.

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 11/30/2014
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Microsoft Corp.1.7%
Intel Corp.1.5%
Archer-Daniels-Midland Co.1.5%
Lowe's Cos. Inc.1.5%
Broadcom Corp.1.5%
CVS Health Corp.1.5%
Northrop Grumman Corp.1.5%
Johnson Controls Inc.1.5%
Cardinal Health Inc.1.5%
Cisco Systems Inc.1.4%
Total % Portfolio in Top 10 holdings15.1%

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