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Delaware Corporate Bond Fund Quarterly commentary December 31, 2016

Overview

The investment grade credit market posted its worst quarter on a total return basis since mid-2015 as the massive rate selloff following the U.S. election overwhelmed a modest narrowing in credit spreads. Donald Trump’s surprising victory and the Republican sweep of Congress not only took pollsters and the market by surprise, but also changed market expectations, driving the U.S. dollar to its highest level since December 2002 and 10-year Treasury rates up by 0.59 percentage points postelection. Expectations for a more aggressive Federal Reserve, combined with the fiscal policy implications of a new government regime, were the main drivers. The Fed’s rate-setting Federal Open Market Committee (FOMC) did not disappoint, raising the federal funds rate by 25 basis points in December and also accelerating the pace of policy normalization by raising its expectations for 2017 to three rate hikes, up from two in its September “dot plot.” Conversely, the European Central Bank (ECB) sent a mostly dovish message by extending its quantitative easing program through the end of 2017 while reducing the monthly pace of purchases to 60 billion euros, noting that the program’s size or duration could be expanded as needed.

The Bloomberg Barclays U.S. Corporate Investment Grade Index returned -2.83% for the quarter, outperforming duration-matched Treasury debt by 185 basis points. Energy and metals and mining were the strongest performing sectors, driven by a strong commodity price rally, with oil up 10.2% and iron ore up more than 29% for the quarter. The Organization of the Petroleum Exporting Countries (OPEC) surprised most critics with an agreement to cut production for the first time since 2008, pushing oil prices higher and spreads tighter across all energy subsectors. Interest rate-sensitive sectors such as banks and insurance also outperformed, benefiting from the surge in rates along with a favorable total loss-absorbing capacity (TLAC) resolution for domestic banks. Longer-duration sectors such as utilities and rails underperformed for the quarter, while the media and telecom space came under pressure from AT&T’s surprise deal to acquire Time Warner Inc. for $109 billion (Source: Bloomberg.)

Supply for the quarter declined 15% from last year, to $259 billion. However, year-to-date totals for 2016 set another record at $1.3 trillion, up 4% from the previous year’s record amount. Estimates for 2017 call for lower gross and net supply in the $1.06 trillion area, as higher rates and a smaller mergers-and-acquisitions (M&A) pipeline limit issuance (source: Bank of America). We believe limited supply should be a positive technical factor for secondary market prices. In addition, the potential for overseas cash repatriation (as part of broader corporate tax reform initiatives) could also reduce issuance needs, further supporting market technicals.

Within the Fund

For the fourth quarter of 2016, Delaware Corporate Bond Fund (Institutional Class shares and Class A shares at net asset value) posted a negative return but outperformed its benchmark, the Bloomberg Barclays U.S. Corporate Investment Grade Index.

What worked in the Fund:

  • Exposure to high yield, which was one of the better performing fixed income sectors during the quarter as it was less affected by the rise in 10-year U.S. Treasury rates, which climbed 0.77 percentage points over the quarter.
  • Security selection within technology and consumer cyclicals — specifically bank loans — and contributions from Dell/EMC secured bonds and from “fallen angel” CDK Global, whose credit rating was downgraded.
  • An underweight to consumer noncyclicals, as lower-beta (lower-risk) industries such as food-and-beverage, tobacco, and supermarkets were out of favor. Healthcare and pharmaceuticals also underperformed amid concerns over a potential repeal of the Affordable Care Act.

What did not work in the Fund:

  • An underweight to the energy sector, which was the strongest-performing industry in the benchmark index, posting a close to 4.25% excess return during the quarter. Oil prices were up 11% and finished close to their peak for the year after OPEC agreed to production cuts.
  • Exposure to emerging markets and foreign/local sovereigns, groups that suffered in the wake of the 2016 U.S. elections from uncertainty about possible protectionist policies and domestic fiscal stimulus and their potential effects.
  • Adverse security selection and a slight overweight within the banking sector, primarily to subordinated and hybrid securities that typically have higher durations. Duration is a measure of the sensitivity of the price of a fixed income investment to a change in interest rates. Duration is expressed as a number of years
  • An overweight within communications, as AT&T’s surprise bid for Time Warner Inc. pushed most spreads in the industry wider.

Outlook

Investors have become more optimistic regarding the longevity of the U.S. economic and credit cycle, given the possibility of a Trump spending plan to invigorate gross domestic product (GDP) growth. While we generally agree that this scenario could prolong the fourth-longest economic expansion cycle in U.S. history, we remain mindful of risks that could affect capital markets beyond higher interest rates, an already tight U.S. labor market, and potentially higher inflation.

In 2017, we are likely to witness higher volatility for credit spreads due to uncertainty regarding fiscal policy, trade, and regulatory changes, even as multiple geopolitical risks remain. Foreign demand for yield has supported U.S. credit technicals, but any sign of reflation abroad or material U.S. dollar weakness could threaten this dynamic. Populist movements overseas could also inject a significant amount of political uncertainty in global markets as voters in the Netherlands, France, and Germany head to the polls in the coming months. Finally, slowing growth in China and the broader emerging markets complex could resurface as additional dollar strengthening — and possible U.S. protectionism — could lead to renewed pressure on emerging markets, especially China.

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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 (12/31/2016)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)-2.70%5.44%5.44%3.35%4.68%6.22%6.51%09/15/1998
Class A (at offer)-7.10%0.75%0.75%1.80%3.71%5.73%6.24%
Institutional Class shares-2.63%5.70%5.70%3.61%4.95%6.51%6.77%09/15/1998
Bloomberg Barclays U.S. Corporate Investment Grade Index-2.83%6.11%6.11%4.23%4.14%5.47%n/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 4.50% 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.

Bloomberg Barclays U.S. Corporate Investment Grade Index (view definition)

Expense ratio
Class A (Gross)0.96%
Class A (Net)0.94%
Institutional Class shares (Gross)0.71%
Institutional Class shares (Net)0.69%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursements from Nov. 28, 2016 through Nov. 28, 2017. Please see the fee table in the Fund's prospectus for more information.

Share class ticker symbols
Institutional ClassDGCIX
Class ADGCAX
Class CDGCCX
Class RDGCRX

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.

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, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

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 derivatives 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.

All third-party marks cited are the property of their respective owners.

Not FDIC Insured | No Bank Guarantee | May Lose Value