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Delaware Limited-Term Diversified Income Fund Quarterly commentary March 31, 2014 Class A (DTRIX)

Overview

The first quarter of 2014 presented several hurdles to the U.S. economy and to business, consumer, and investor confidence. Ukraine tensions, China economic challenges, the Federal Reserve’s apparent consensus for a mid-2015 (or earlier) shift to a regime of policy tightening, and lingering fears of euro-zone deflation all created challenges for financial markets.

However, the likelihood that higher short-term rates could be in store in the not-too-distant future must be founded on economic data. Based on this, we believe it’s likely that an increase in U.S. benchmark interest rates will not come before the second quarter of 2015.

After two months of weak economic statistics — at least partly caused by severe winter weather across most parts of the country — U.S. economic indicators were generally solid in March.

During the quarter, the 10-year Treasury yield fell from 3.03% to 2.72%, and the 2-year Treasury yield rose from 0.38% to 0.42% (source: Bloomberg).

The Barclays U.S. Aggregate Index recorded a strong return for the quarter as corporate bonds and longer-duration sectors led the way. Meanwhile, BBB-rated corporates, high yield corporate bonds, and emerging market bonds produced strong returns.

Within the Fund

For the first quarter of 2014, 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.

  • The Fund’s overweight allocation to the high yield corporate sector, as well as strong security selection within the group, was the primary contributor to relative performance.
  • The Fund’s overweight allocation to high-quality corporate bonds also contributed. In particular, Fund holdings in the finance and banking sectors performed strongly.
  • The Fund’s overweight to emerging market bonds contributed as well. During the period, we favored U.S. dollar–denominated debt from the corporate (rather than sovereign) sector.
  • The Fund’s exposure to convertible bonds also contributed to outperformance. Given that the sector remains heavily influenced by the equity market, however, convertible debt was volatile amid a continued withdrawal of liquidity by the Fed.
  • We closely monitored credit quality in the corporate sector, particularly in new issuance. Volatility in the currency markets also was a factor in non-U.S. security selection.

Outlook

While focusing on Fed Chairwoman Janet Yellen’s “six months” estimate and the more aggressive path for short-term interest rates forecasted by the majority of Fed officials, many market participants may have missed the comment suggesting that “the stance of policy that will be appropriate...will involve somewhat lower than would be normal short-term interest rates.

Even before the Fed's March meeting, the consensus view in the bond market clearly anticipated higher short, intermediate, and long-term rates. Under traditional economic conditions during an early-to-mid-stage expansion, rising short-term rates would translate to higher rates across the yield curve and to only a modestly flatter curve. Typically, it has been only during a late-stage expansion that the pinch from ongoing Fed tightening significantly weakens the economic outlook and causes a yield-curve flattening or inversion as intermediate- and longer-term rates stop rising with short-term rates.

However, the Fed’s need to maintain “somewhat lower than normal rates” may point to an alternative scenario for the current cycle. In essence, it is possible that extreme levels of global debt (especially less-than-productive government debt), combined with high levels of excess capacity, could create underlying deflationary forces even as the economic expansion matures.

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

Bond ratings are determined by a nationally recognized statistical rating organization (NRSRO).

Per Standard & Poor’s credit rating agency, bonds rated below AAA are more susceptible to the adverse effects of changes in circumstances and economic conditions than those in higher-rated categories, but the obligor’s capacity to meet its financial commitment on the obligation is still strong. Bonds rated BBB exhibit adequate protection parameters, although adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments. Bonds rated BB, B, and CCC are regarded as having significant speculative characteristics with BB indicating the least degree of speculation.

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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 877 693-3546 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 877 693-3546. 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