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Delaware Diversified Floating Rate Fund Quarterly commentary June 30, 2016

Overview

In response to ongoing support from global central banks, the Barclays U.S. Aggregate Index recorded a positive return for the second quarter of 2016, with lower-quality bonds outperforming higher-rated investment tiers within that index. Although most broad-market fixed income indices produced solid returns, high yield corporate bonds and global Treasurys ex-U.S. were the strongest performers, with the asset-backed securities (ABS) and mortgage-backed securities (MBS) sectors lagging during the quarter. Investment grade corporate bonds, as measured by the Barclays U.S. Corporate Investment Grade Index, returned 3.57% for the quarter, outperforming duration-matched Treasurys by 99 basis points, with the bulk of performance coming in June. (A basis point equals one hundredth of a percentage point.)

A brief bout of volatility in late June triggered by the British vote to exit the European Union raised the question of whether the so-called Brexit referendum will be the first of many such actions by various countries taken in an effort to preserve their nationalist goals at the expense of a global economic agenda. Regardless of the eventual answer, the issue is almost certain to increase market uncertainty — and thus volatility — for many quarters ahead. Meanwhile, the Federal Open Market Committee’s (FOMC’s) June meeting may have foreshadowed a major shift in domestic monetary policy in coming years, with members projecting fewer rate cuts this year and significantly lower policy rates for 2017 and 2018, relative to previous expectations. Federal Reserve Chairwoman Janet Yellen gave form and substance to the numbers, citing an aging population and relatively low productivity as structural forces that could make the current low level of rates a long-lasting phenomenon.

Lagging economic indicators painted a mixed picture of the U.S. economy, with corporate profits recovering but job growth slipping. On the inflation front, core personal consumption expenditures (the Fed’s preferred inflation gauge) fell slightly to 1.6%. Until personal income and wage-and-salary income show greater evidence of acceleration, the consumer inflation trend will remain muted. Combining these factors with growing global concerns and a strong U.S. dollar, our view is that the market has priced out any rate increases by the FOMC until the middle of 2018.

As the June quarter ended, a key question remained unanswered: Will asset prices fall to a level that reflects very weak economic growth, or will central bank policies finally succeed in pushing growth to much higher levels, and thus justify current asset prices? In recent months, bond prices for many weak or declining corporate credits have risen far more than their fundamental credit metrics would support. With higher, more normal rates of growth having failed to materialize deep into an economic expansion, it is reasonable to give serious consideration to the risks of continued slow global growth.

Within the Fund

For the second quarter of 2016, Delaware Diversified Floating Rate Fund (Institutional Class shares and Class A shares at net asset value) outperformed its benchmark, the BofA Merrill Lynch U.S. Dollar 3-Month Deposit Offered Rate Constant Maturity Index. Following is a brief discussion of the key drivers of Fund performance during the quarter:

Down-in-quality assets outperformed more-conservative investments; regardless of credit quality, however, all major asset classes produced returns in excess of the benchmark index. Utilities was the top-performing sector within high grade credit, due in part to the longer-dated nature of the securities. Industrials also generated positive returns, and basic industry and energy each outperformed the overall Fund return. Financials outperformed the benchmark as well, despite being affected by market volatility pertaining to Brexit concerns. Noncorporate exposure, including sovereigns and supranationals, returned 0.40%.

Below-investment-grade assets, including bank loans and high yield bonds, outperformed the benchmark index and contributed approximately 80 basis points of return to the Fund as investors continued to search for income. BB-rated holdings represented the largest allocation of below-investment-grade assets but generated the lowest return (1.90%) compared to the 5.97% gain for CCC-rated investments. The Fund’s 10% allocation to ABS returned nearly 0.30% and provided the Fund with a defensive source of liquidity.

We use interest rate swaps to hedge the cash flows on fixed-rate bonds in the Fund’s portfolio, to minimize interest rate sensitivity. Because interest rates declined during the period, these hedges would have detracted from Fund performance.

Outlook

We believe that an economic landscape fraught with fundamental and political uncertainty will continue to weigh heavily on domestic and global growth expectations. Globalization trends of the past 30 years are being called into question amid an increase in nationalistic leanings worldwide. These concerns should translate into an environment where corporate profits remain challenged and low interest rates present hurdles for the world’s financial companies.

Despite having spent a considerable portion of their monetary ammunition, we expect central banks to provide verbal support for markets and to take additional steps as warranted. Nevertheless, some central banks, including the Bank of Japan, have seen policies lead to unexpected outcomes that present additional challenges, rather than the expected solutions.

As always, the U.S. labor market will remain a key focus area for investors. After two months of softer payroll readings, we will look to incoming data for clues regarding wage growth, inflation expectations, and the willingness of consumers to provide additional economic support. It is our expectation that investors will continue searching for income opportunities wherever they might be found, which could lead to risk-reward dislocations across assets. In light of today’s demanding environment, we believe it is especially appropriate to maintain our longtime emphasis on a fundamental approach to investing in fixed income markets.

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

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 of the three.

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

The Barclays U.S. Corporate Investment Grade Index is composed of U.S. dollar–denominated, investment grade, SEC-registered corporate bonds issued by industrial, utility, and financial companies. All bonds in the index have at least one year to maturity.

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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 (06/30/2016)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)1.21%1.13%-0.64%0.68%1.26%n/a1.67%02/26/2010
Class A (at offer)-1.56%-1.62%-3.38%-0.25%0.71%n/a1.22%
Institutional Class shares1.27%1.26%-0.27%0.93%1.51%n/a1.92%02/26/2010
BofA ML USD 3Mo Deposit Offered Rate Constant Maturity Index0.16%0.31%0.41%0.30%0.34%n/an/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.

BofA Merrill Lynch U.S. Dollar 3-Month Deposit Offered Rate Constant Maturity Index (view definition)

Expense ratio
Class A (Gross)0.95%
Class A (Net)0.95%
Institutional Class shares (Gross)0.70%
Institutional Class shares (Net)0.70%

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 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 derivatives transaction depends upon the counterparties’ ability to fulfill their contractual obligations.

Because the Fund may invest in bank loans and other direct indebtedness, it is subject to the risk that the fund will not receive payment of principal, interest, and other amounts due in connection with these investments, which primarily depend on the financial condition of the borrower and the lending institution.

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