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Delaware Corporate Bond Fund Quarterly commentary June 30, 2017

Overview

Investment grade markets posted strong performance for the second quarter, trailing only US equities, as the positive technical backdrop was further strengthened by a reduction in supply and continued robust global demand driven by the search for yield. Domestic political turmoil or dysfunction, a failed UK snap election by Prime Minister Theresa May, lackluster inflation, the failure of Banco Popular in Spain, and increased commodity volatility have had little effect on investment grade valuations. With credit fundamentals showing signs of modest improvement and the reach-for-yield technical signaling no signs of abating, it’s difficult to point to a near-term catalyst for a material weakening in investment grade corporate risk premiums (spreads). However, we believe current investment grade valuations that are through long-term averages should limit further compression, potentially providing investors income carry-dominated returns for the second half of 2017. As such, we are monitoring market risk factors such as delays in US fiscal policy; falling inflation or the return of US dollar strength; aggressive tightening actions by the US Federal Reserve; weakness in China amid elevated leverage and weakening financial conditions; and geopolitical risks (including North Korea and Syria) given the asymmetric return profile implied by market valuations.

The Fund’s benchmark, Bloomberg Barclays US Corporate Investment Grade Index, returned 2.54% for the quarter, outperforming duration-matched Treasurys by 112 basis points. (One basis point equals one-hundredth of a percentage point.) Sectors with longer duration profiles, such as railroads and cable/satellite, outperformed amid the ongoing Treasury curve flattening, with the 5-30 year segment down 14 basis points and the 2-30 year segment down 30 basis points. Disinflationary market sentiment has continued to drive the Treasury curve flatter, pushing long bond yields to the lowest level of the year. Subordinated bank debt also outperformed, driven by favorable first-quarter earnings and the continued compression in the senior-sub relationship. The Fed’s stress test results for US banks also confirmed the sector’s fundamental strength. Conversely, the auto sector lagged due to weak sales levels and a disappointing forward outlook. In addition, retail-focused real estate investment trust (REIT) issuers underperformed, and supermarkets came under pressure late in the quarter after Amazon’s bid for Whole Foods created uncertainty in the sector.

The record new-issue supply pace of the past few quarters finally eased with $322 billion of new issuance printed in the second quarter of 2017, down from $354 billion in the prior year. Year-to-date totals are still running slightly ahead of last year’s record pace, at $723 billion (+1.3% year over year). However, we believe supply should slow in the second half of the year driven by diminished merger-and-acquisition requirements and seasonal issuance patterns. This should serve to support the already strong investment grade market technical backdrop. In contrast, demand for US corporate debt has not subsided, with another $27 billion of inflows reported for investment grade funds for the quarter. Year-to-date inflow totals now stand at $64 billion compared to $47 billion for all of 2016. (Source: Bank of America, UBS, Lipper.)

Within the Fund

What worked in the Fund:

  • Banking — Positive security selection within the banking sector was driven by subordinated and hybrid securities that outperformed senior bank debt amid strong earnings and continued spread compression in the senior-sub relationship.
  • High yield — Defensive positioning in high yield benefited Fund performance as investors demonstrated a clear preference for higher-quality credits. Specifically, energy came under pressure again amid a 10% decline in crude oil prices over the quarter.
  • Communications — The Fund specifically benefited from exposure to aircraft leasing credits, one of which received full investment grade status upon being upgraded by the last of the three major credit rating agencies.

What did not work in the Fund:

  • Consumer noncyclical — The Fund was underweight the consumer noncyclical sector, which outperformed the overall benchmark, led by the pharmaceutical and healthcare groups that benefited from delays in healthcare reform legislation. We remain cautious on those industries, given valuations and the potential for further headline risk surrounding political events in coming months.
  • Electric utility and metals & mining — Within these industries, both of which have significantly longer duration than the benchmark, the Fund’s underweight to spread duration at the long end of the curve detracted from performance, with the Treasury curve flattening over the quarter.

Outlook

Corporate fundamentals have been improving, driven by the strength of first-quarter 2017 corporate earnings, due to stronger commodity prices year-over-year, a weaker US dollar, relatively easy year-over-year comparisons given the weakness in the first quarter of 2016, and improving sentiment from CFOs, which is positive for forward guidance. Although there remains a high degree of uncertainty regarding future deregulation and tax reform, any progress along those fronts should provide additional upside in asset valuations due to investment and productivity implications.

Nonfinancial leverage remains elevated but below the cycle peak, while debt levels have stabilized. Despite improving fundamentals, the main driver of the investment grade market continues to be the strong technical backdrop and global reach for yield. As euro-area growth and inflation improves, and prospects for a reduction in quantitative easing by the European Central Bank begin to grow, the threat to this dynamic only increases and remains one of the key risks ahead for investment grade credit. We continue to have a positive view on investment grade credit for 2017, but we believe volatility could increase, especially from current low levels going forward, warranting slightly higher portfolio cash balances to take advantage of potential opportunities. We believe current valuations imply carry-oriented income-based returns for investors in the second half of 2017.

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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 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.

Average annual total return as of quarter-end (06/30/2017)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)2.82%4.64%3.88%2.49%4.25%6.62%6.59%09/15/1998
Class A (at offer)-1.80%-0.10%-0.87%0.92%3.28%6.13%6.32%
Institutional Class shares2.88%4.77%4.14%2.74%4.51%6.90%6.85%09/15/1998
Bloomberg Barclays U.S. Corporate Investment Grade Index2.54%3.80%2.28%3.61%3.96%5.79%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 US 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. 

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 bond that is held by a portfolio will be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have 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.

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

Not FDIC Insured | No Bank Guarantee | May Lose Value