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Delaware Value® Fund Quarterly commentary March 31, 2014 Class A (DDVAX)

Within the Fund

For the first quarter of 2014, Delaware Value Fund (Class A shares at net asset value) posted a positive return but slightly underperformed its benchmark, the Russell 1000® Value Index. Overall, stock selection results were modestly positive and were offset by sector allocation decisions.

The largest drag on relative returns in the first quarter came in the information technology and financial sectors. Stock selection was the main source of negative attribution in each. Xerox and Motorola Solutions were notable laggards, falling 7% and 4%, respectively. Xerox reported lower revenue for the fourth quarter and reaffirmed its guidance for 2014. Several downgrades from Wall Street analysts followed. Motorola Solutions reported higher sales and earnings for the fourth quarter, but took down revenue guidance for the current quarter and year. The team believes the challenges facing both Xerox and Motorola Solutions are temporary. In financials, property/casualty insurer Travelers was the weakest holding with a decline of 6%. While the company reported record earnings per share last quarter, many investors have become more concerned about a weaker insurance pricing environment following a period of relatively low catastrophic losses for the industry.

The largest contribution to relative performance came from investments in energy and industrials. Stock selection drove outperformance in both sectors. Energy services provider Halliburton was the top holding with a gain of 16%. Stronger revenue growth in its international operations helped offset more modest growth in the United States. Within industrials, defense contractors Raytheon and Northrop Grumman led the way, up 10% and 8%, respectively. Despite downward pressure on U.S. Defense Department spending, these companies have held up well by improving operating efficiency and expanding their non-U.S. and commercial operations.

There was one full-position sale and purchase in the portfolio during the first quarter. We sold the Fund’s position in property/casualty insurer Travelers and replaced it with BB&T, a regional bank based in North Carolina. Travelers was first added to the portfolio in October 2008 in the midst of the financial crisis when we were rebuilding the portfolio’s financial sector exposure, seeking higher quality and lower credit sensitivity. At that time, pressure throughout the financial sector and softness in the insurance pricing cycle made the company’s valuation look very attractive to us. During the holding period, Travelers benefited from a healthy pricing environment that allowed for premium increases, generally solid underwriting results, and a strong competitive position. The stock had reached its price target and appeared fully valued, in our view. Additionally, it had performed well since purchase. Nonetheless, the stock was trading near five-year highs on price-to-book and five-year lows on dividend yield (source: FactSet). We were concerned about softer pricing in the commercial property/casualty market. The potential for rising interest rates was also a concern because the company’s investment portfolio, like that of most insurance companies, consisted of predominantly fixed income instruments.

BB&T operates in 12 states, primarily in the Southeast, and has a diversified business mix that includes traditional retail and commercial lending, mortgage banking, insurance services, and financial services. By market cap and assets, BB&T is among the banking industry’s top 10, a position attained through organic growth and acquisitions. The bank’s credit quality has typically been better than that of its large and mid-sized peers, and a higher percentage of its operations have been in less capital-intensive businesses because of its more diversified business model (source: FactSet). Given the results of the March 2014 bank stress tests, prospects for dividend increases were favorable. Additionally, the bank’s debt was rated in the ‘A’ range by the three major credit rating agencies. While loan growth had been modest, ongoing improvement in the U.S. economy was expected to increase lending volumes. Also, the company operated in traditionally higher growth regions of the country. Should interest rates move higher (ideally at a gradual pace), BB&T would stand to potentially benefit from higher net interest margins, a key driver of bank profitability.

Outlook

The cyclical bull market is now more than five years old, having begun in March 2009. During this period, the broad market S&P 500® Index has amassed a cumulative total return of 205% (source: Bloomberg). Granted, low interest rates (low inflation, really), are supportive of higher price multiples. But, in the context of relatively soft underlying fundamentals for both the stock market and economy, current valuation appears stretched, in our view. We wonder if an uptick in inflation could be coming. To be sure, there are mixed signals. Inflationary developments such as an uptick in labor costs in the U.S., China, and Japan; rising food prices; and higher utility bills are being offset by a variety of things, including weakness in emerging market currencies, slower emerging market growth, falling industrial commodity prices, and a decline in private sector lending in the euro zone.

A priority for us is finding undervalued stocks to replace those nearing their price targets. We find ourselves in a bottom up (stock-by-stock) search because there are no compellingly inexpensive sectors. We’re seeing some value in parts of the technology sector and are working on specific ideas in consumer discretionary and industrials. Despite our recent transaction in financials, we’re doing work in that sector, as well. Given the caution we’re feeling about the stock market’s level and valuation, we remain focused on higher-quality attributes such as balance sheet strength, cash flow consistency, and earnings predictability.

The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the U.S. stock market.

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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)2.73%2.73%21.90%16.39%20.97%7.98%7.40%09/15/1998
Class A (at offer)-3.16%-3.16%14.87%14.11%19.54%7.34%6.99%
Institutional Class shares2.79%2.79%22.20%16.69%21.26%8.24%7.60%09/15/1998
Russell 1000 Value Index3.02%3.02%21.57%14.80%21.75%7.58%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.

Russell 1000® Value Index (view)

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

Expense ratio
Class A (Gross)1.02%
Class A (Net)1.02%
Institutional Class shares (Gross)0.77%
Institutional Class shares (Net)0.77%
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
Baxter International Inc.3.2%
Edison International3.2%
AT&T Inc.3.1%
Quest Diagnostics Inc.3.1%
Marathon Oil Corp.3.1%
Johnson Controls Inc.3.1%
Bank of New York Mellon Corp.3.0%
Halliburton Co.3.0%
Xerox Corp.3.0%
Northrop Grumman Corp.3.0%
Total % Portfolio in Top 10 holdings30.8%

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.

Holding a relatively concentrated portfolio of a limited number of securities may increase risk because each investment has a greater effect on the Fund's overall performance than would be the case for a more diversified fund.

Not FDIC Insured | No Bank Guarantee | May Lose Value