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Delaware Corporate Bond Fund Quarterly commentary December 31, 2017

Overview

Investment grade credit market performance was moderately positive over the fourth quarter as spreads moved tighter amid a positive market tone, anticipation of successful tax reform legislation, and strong demand from investors. The much anticipated tax reform legislation finally became reality with President Trump’s signing the bill into law. While its impact has been reflected more in the equity markets, investment grade spreads have already priced in the bill’s potential corporate benefits. The tax plan should be positive for both corporations and investment grade credit, with the financials and communications sectors and capital-expenditure (capex) companies in the transportation and energy space benefiting the most. Central banks also did little to upset markets over the quarter with both the European Central Bank (ECB) and the Federal Reserve delivering their respective messages in December that were in line with consensus expectations. However, regardless of projections, the current subdued inflation trends globally will likely mean a gradual approach to policy normalization.

The Bloomberg Barclays US Corporate Investment Grade Index returned 1.17% for the quarter, outperforming duration-matched Treasurys by 99 basis points. (One basis point equals one-hundredth of a percentage point.) Metals/mining and energy outperformed during the quarter as copper reached a three-year high and West Texas Intermediate oil prices improved almost 17% on supply cut extensions by the Organization of the Petroleum Exporting Countries (OPEC). Supermarkets also outperformed after Kroger reported solid earnings, allaying some fears around Amazon’s entrance into the space. Sector underperformance was largely driven by idiosyncratic events such as earnings weakness from General Electric and Teva, along with Mattel’s being downgraded to high yield amid a weak holiday sales forecast and deteriorating credit metrics.

Investment grade new-issuance volumes reached $1.37 trillion in 2017, surpassing the previous year’s record supply by 5.5%. Nonfinancial volumes drove issuance trends with the final split at roughly 60% nonfinancial and 40% financial. Mergers and acquisitions, as a use of proceeds, dropped to $185 billion, or 13.5% of total issuance in 2017, versus 2016’s record of $239 billion, or 18.5%. Media and telecom saw the largest year-over-year increase of any sector, up 86% ($85 billion versus $51 billion in 2016), driven by issuance out of the industry’s two largest names, AT&T and Verizon. Despite record volumes, new-issue concessions continue to compress as issuers were able to exert pricing power given the demand for credit. Volumes are projected to decline 9% in 2018, primarily due to reduced supply expectations on the back of corporate tax reform. The technology sector should sustain the largest decline given the impact of overseas cash repatriation for those names. Demand technicals that had been strong all year continued throughout the fourth quarter, ending at $119 billion of inflows for 2017 compared to $47 billion for all of 2016. (Sources: Bank of America, UBS, Lipper.)

Within the Fund

Contributors to performance:

  • Banking — Positive security selection was driven by subordinated and hybrid securities that outperformed senior bank debt amid strong earnings and continued spread compression in the senior-subordinated relationship. This theme that held steady from the previous quarter.
  • Consumer noncyclical — Security selection combined with an underweight to the sector benefited performance for the quarter. Specifically, our avoidance of names with deteriorating credit profiles proved beneficial, including:
    • Teva — The pharmaceutical company experienced pressure from generics competition.
    • Mattel — The toy manufacturer was downgraded to high yield in December amid weak operating performance and lowered expectations for the fourth quarter 2017 holiday season.
  • Technology — Avoiding negative credit events within the technology sector generated positive performance for the period. Spreads on Qualcomm (A1/A) widened after Broadcom announced its intention to acquire Qualcomm in a $130 billion leveraging transaction. The Fund had no exposure to Qualcomm during the quarter.
  • BBB-rated bonds — An overweight to BBB-rated bonds (averaging roughly 11 percentage points higher than the benchmark’s weighting), which we believe are attractively valued relative to higher-rated securities, added to performance during the quarter.

Detractors from performance:

  • High yield — The Fund’s fairly conservative positioning within this out-of-benchmark sector was a drag on performance as only the lowest-quality (and highest-risk) rating tiers (CC and lower) within high yield outperformed US investment grade debt.
  • Idiosyncratic events — Exposure to General Electric was a drag on performance after the company’s senior unsecured debt was downgraded to A2 and its junior subordinated debt was downgraded to Baa1 amid deterioration in the financial performance of its power segment and other business segments.
  • Electric — The Fund’s underweight spread duration at the long end of curve within the electric sector detracted from performance for the quarter as the Treasury curve flattened and 30-year rates declined.
  • Railroads — A lack of exposure to longer duration sectors such as railroads detracted from relative performance as these sectors outperformed amid the Treasury curve flattening over the period.

Outlook

We believe 2018 will be a transitional year in the US business cycle as the Fed embarks on a path of policy normalization and tax reform implementation begins. Some degree of caution is warranted, as the credit cycle enters the final stages of its record expansion. Valuations appear rich relative to leverage and duration metrics, with current spread levels near post-crisis tights. Leverage also remains high, and interest coverage continues to decline.

Corporate fundamentals were strong in the third quarter, with a 5.5% year-over-year growth in revenue and a 7.8% year-over-year increase in earnings in the S&P 500® Index. While easy comparisons and improved commodity prices have played a minor role in earnings strength, the results reflect overall improvement in economic conditions, particularly within the technology and industrial sectors.

We expect the modest growth scenario to continue, with the current macroeconomic outlook providing room for further expansion of the economic cycle through 2018. However, we believe central bank tightening (the ECB’s tapering of quantitative easing, the unwinding of the Fed’s balance sheet) and US political uncertainty (midterm elections) could increase asset price volatility, which we expect to weigh on the business and credit cycle by 2019, and begin returning credit valuations to mean levels.

Past performance is not an indicator of future results.

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 US stock market.

This document may mention bond ratings published by nationally recognized statistical rating organizations (NRSROs) Standard & Poor’s, Moody’s Investors Service, and Fitch, Inc. For securities rated by an NRSRO other than S&P, the rating is converted to the equivalent S&P credit rating. Bonds rated AAA are rated as having the highest quality and are generally considered to have the lowest degree of investment risk. Bonds rated AA are considered to be of high quality, but with a slightly higher degree of risk than bonds rated AAA. Bonds rated A are considered to have many favorable investment qualities, though they are somewhat more susceptible to adverse economic conditions. Bonds rated BBB are believed to be of medium-grade quality and generally riskier over the long term. Bonds rated BB, B, and CCC are regarded as having significant speculative characteristics, with BB indicating the least degree of speculation of the three.

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

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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.

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 delawarefunds.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.

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 US Corporate Investment Grade Index (view definition)

Institutional Class shares available only available to certain investors. See the prospectus for more information.

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 US 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.

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Not FDIC Insured | No Bank Guarantee | May Lose Value