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Delaware Small Cap Value Fund Quarterly commentary September 30, 2014

Within the Fund

Delaware Small Cap Value Fund (Class A and Institutional Class shares at net asset value) posted a negative return but outperformed its benchmark, the Russell 2000® Value Index, in the third quarter of 2014. Stock selection in the technology, healthcare, and energy sectors contributed the most to the Fund’s outperformance. Stock selection and an underweight allocation to real estate investment trusts (REITs) detracted from performance during the quarter as the sector generally held up better than most. On a relative basis, stock selection in consumer cyclical and utilities stocks detracted from performance.

Several stocks within the Fund contributed to outperformance during the quarter. Brocade Communications Systems, a provider of Fibre Channel for storage area networks and Ethernet switching, rose 19%. The company reported stronger-than-expected third quarter earnings with Fibre Channel product revenue coming in above expectations, driven by international sales, Gen 5 Fibre Channel adoption, and good contribution from Ethernet switches. Additionally, the company is making progress with its product solutions in the area of Network Function Virtualization. We maintained the Fund’s position in Brocade as the company remains committed to generating solid free cash flow and to returning cash to shareholders.

H&E Equipment Services is focused on heavy construction and industrial equipment. The company rents, sells, and provides parts and service support to clients along the Gulf Coast and Intermountain regions. The company beat second quarter earnings both on the top- and bottom-line which contributed to the stock’s return of 12% during the quarter. Equipment rentals in the company’s primary geographies strengthened and contributed nicely to revenue. We increased the Fund’s weighting of the stock during the quarter as we believe end-user markets could continue to strengthen and cash flow could improve.

Shares of contact lens maker Cooper Companies rose 15% during the quarter. In August, the company announced the completion of its acquisition of U.K. based Sauflon Pharmaceuticals, a competing contact lens company. We believe the acquisition could be accretive to earnings and could enhance Cooper’s entry into daily silicone hydrogel lenses, a quickly growing market. We maintained the Fund’s position in Cooper during the quarter as we believe fundamentals remain solid and cash flow may be poised to increase.

Among the individual stocks that detracted from the Fund’s performance was Stone Energy, an independent oil and gas exploration and production company with primary operations in the Gulf of Mexico and Marcellus Shale areas. The stock declined 33% during the quarter as second quarter earnings came in below expectations and the company drilled a dry hole in the Gulf of Mexico following four consecutive successful wells. We added to the Fund’s position during the quarter due to the relative valuation versus other exploration companies, as well as the significant increase in oil production that is expected during the next two years.

Standard Motor Products, a manufacturer of automotive aftermarket parts, fell 23% during the quarter. After performing well in the second quarter, the stock gave back its gains as softer-than-expected performance from Standard’s Engine Management division caused an earnings miss. Inventory overhang caused the shortfall which we believe should be corrected over the next couple of quarters. Additionally, the company’s Temperature Control division was affected by a cool summer across much of the United States. We maintained the Fund’s position in Standard Motor Products as we believe the company’s valuation looks attractive to us while cash flow and fundamental operating performance remain solid.

H.B. Fuller Company formulates, manufactures, and markets adhesives, sealants, and other specialty chemical products for worldwide distribution. The stock fell 17% during the quarter after reporting weaker-than-expected earnings. While volume growth has generally been good, the company missed earnings due to higher costs and delays in an information technology system implementation in North America and a restructuring program in Europe. Both projects contributed to the earnings shortfall and weighed on the company’s margins. We maintained the Fund’s position as we believe that while these issues delay near-term profitability targets, our thesis is likely still intact and valuation remains attractive to us.

Outlook

We believe that the outlook for the economy and equities is favorable. While small-cap stocks did not perform well in the third quarter and have struggled relative to large-cap equities, we believe that the recent selloff may be partially explained by the very strong small-cap performance in the previous two years. We believe that the economy should continue to grow at a moderate pace as employment trends, manufacturing data, consumer confidence levels, and bank lending continue to improve. Additionally, we continue to believe that Fed policy may present a favorable backdrop for equities.

Through the third quarter, we have seen additional signs that investor sentiment is shifting from lower-quality equities to higher-quality equities. We believe that in this type of environment, stocks with strong free cash flow and solid balance sheets may have the potential to outperform more speculative areas of the market. The Fund’s positioning remains largely the same with overweights in capital spending, basic industry, and technology. We remain underweight traditionally defensive sectors including REITs, utilities, and consumer staples, where we do not view valuations as attractive.

We will continue to focus on finding what we view as high-quality stocks with an emphasis on companies that have the potential to generate strong free cash flow, have a healthy balance sheet, and are likely to deploy their cash in shareholder-friendly ways such as dividends or share repurchases.

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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)-5.29%1.03%10.20%20.67%15.82%9.04%11.58%06/24/1987
Class A (at offer)-10.74%n/a3.86%18.32%14.46%8.39%11.34%
Institutional Class shares-5.24%1.20%10.45%20.98%16.11%9.32%11.83%11/09/1992
Russell 2000 Value Index-8.58%-4.74%4.13%20.61%13.03%7.25%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.

Russell 2000® Value Index (view)

Expense ratio
Class A (Gross)1.25%
Class A (Net)1.25%
Institutional Class shares (Gross)1.00%
Institutional Class shares (Net)1.00%
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
East West Bancorp Inc.2.5%
ITT Corp.1.9%
Synopsys Inc.1.8%
Platinum Underwriters Holdings Ltd.1.7%
Chemtura Corp.1.6%
Helix Energy Solutions Group Inc.1.5%
HB Fuller Co.1.5%
Hancock Holding Co.1.4%
Webster Financial Corp.1.4%
STERIS Corp.1.3%
Total % Portfolio in Top 10 holdings16.6%

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.

Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.

Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors.

REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations.

Not FDIC Insured | No Bank Guarantee | May Lose Value