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Delaware Limited-Term Diversified Income Fund Quarterly commentary September 30, 2016

Overview

The Bloomberg Barclays U.S. Aggregate Index recorded a positive return in the third quarter as risk assets continued to respond positively to the unflinching support of global central banks. However, yields rose on short- and intermediate U.S. Treasury maturities amid frequent shifts in the outlook for Federal Reserve policy, declining volatility following the “ Brexit” vote in June, and selling by central banks (especially China) related to reserve management programs. Meanwhile, domestic bond markets were supported by non-U.S. investors fleeing the negative sovereign yields on offer overseas. Although most broad-market fixed income indices produced positive returns, high yield corporate bonds and emerging market debt were the strongest performers, with the high-quality AAA-rated credit and asset-backed securities (ABS) sectors lagging during the quarter.

In the United States, the economic scorecard was decidedly mixed. Second-quarter gross domestic product growth was reported at 1.4% by the U.S. Commerce Department, a modest improvement from the downwardly revised 0.8% growth in the first quarter. There was some evidence of further healing in the labor market, with jobless claims remaining low while nonfarm payrolls rebounded from the depressed levels of the second quarter. On the inflation front, the core personal consumption expenditures (the Fed’s preferred inflation gauge) rose 1.7% year-over-year, up from 1.6% at the end of the previous quarter. Both personal income and consumer spending remained subdued, though slightly improved from three months earlier. Elsewhere, the Institute for Supply Management’s total manufacturing and nonmanufacturing new orders fell from 58.6 to 50.25, the lowest level since 2009.

Given the uneven economic data, it was no surprise to investors that the Fed held off on tightening monetary policy. Notably, the rate-setting Federal Open Market Committee (FOMC) further scaled back its forecast for how high rates will rise in coming years. At its September meeting, the FOMC lowered its expectations for 2016 from two hikes to one, lowered 2017 expectations from three hikes to two, and kept expectations for 2018 unchanged at three. Additionally, policy makers trimmed growth and inflation forecasts for the current year. As the quarter ended, investors were discounting only one rate hike in December for the remainder of 2016. However, a sharp rise in the 3-month London interbank offered rate (Libor) — combined with the selling of Treasury securities by foreign central banks — raised the possibility that some degree of monetary tightening might already be under way, even as the Fed remained on the sidelines.

Within the Fund

Delaware Limited-Term Diversified Income Fund (Institutional Class shares and Class A shares at net asset value) outperformed its benchmark, the Bloomberg Barclays 1–3 Year U.S. Government/Credit Index, for the third quarter of 2016.

The Fund’s overweight allocation to investment grade corporate bonds, combined with strong security selection in the investment grade sector, were the primary drivers of performance for the period. Out-of-benchmark allocations in mortgage-backed securities (MBS), commercial mortgage-backed securities (CMBS), high yield bonds, and emerging market debt also contributed to relative performance, as these sectors outperformed the return of the benchmark. Conversely, the Fund’s small allocation to municipal bonds detracted from relative performance.

Outlook

We believe both domestic and global growth will likely remain mired in a lower-for-longer track as a pattern of synchronous stagnation continues to grip the developed world. China remains burdened by massive excess capacity, poor bank asset quality, and the dampening effect of economic restructuring that has led to plummeting commodity prices and slowing growth across all natural resource–based economies. Europe remains hobbled by the structural and policy limitations of a single-currency European Union (EU), a failure to rapidly address bank capital levels and funding mechanisms in the aftermath of the financial crisis, and persistently high unemployment and economic inefficiency across its southern tier. In the U.S., job gains have been centered in low-wage sectors, structural unemployment remains high, overall wage growth has been stagnant, and personal spending is subdued. With corporate and government spending muted and bank lending stabilizing below pre-crisis levels, the American economy is stuck on a sub-2% growth track. Finally, global central bank policy tools have entered the stage of diminishing returns, while in the U.S. a vacillating central bank desperate to get benchmark rates off zero fears that a premature move will choke off the tepid recovery, thus making every Fed meeting a catalyst for volatility in a market addicted to easy money.

Futures markets and Fed statements seem to make it clear that, barring unforeseen deterioration in the growth or employment outlook, a December rate hike is in the offing. While we concur with that view, we have also seen this “movie” before, and believe that nothing can be taken for granted in a world burdened by debt and facing the growth challenges described above.

With global risk-free rates at record low levels and most spread sectors trading at or inside long-term averages, we think it is reasonable to assume that investor demand for yield will remain intense, valuations will become stretched, and trading liquidity will be inadequate in the face of unforeseen market moves. We believe that our active, fundamental, research-based approach to fixed income investing provides the potential for investors to navigate the extraordinary market conditions that we currently face.

The Bloomberg 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.

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.

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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 (09/30/2016)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)0.55%3.09%2.77%1.87%0.99%3.38%4.97%11/24/1985
Class A (at offer)-2.19%n/a-0.06%0.93%0.42%3.09%4.87%
Institutional Class shares0.59%3.20%2.93%2.06%1.14%3.53%4.27%06/01/1992
Bloomberg Barclays 1-3 Year U.S. Government/Credit Index0.02%1.68%1.31%1.09%1.05%2.59%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.

Bloomberg Barclays 1-3 Year U.S. Government/Credit Index (view definition)

Expense ratio
Class A (Gross)0.92%
Class A (Net)0.74%
Institutional Class shares (Gross)0.67%
Institutional Class shares (Net)0.59%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement from April 29, 2016 through May 1, 2017. Please see the fee table in the Fund's prospectus for more information.

Share class ticker symbols
Institutional ClassDTINX
Class ADTRIX
Class CDTICX
Class RDLTRX

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 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.

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.

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.

Diversification may not protect against market risk.

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

Not FDIC Insured | No Bank Guarantee | May Lose Value