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Delaware Diversified Income Fund Quarterly commentary December 31, 2017

Market Review

The past year was marked by strong capital market gains across the investment spectrum as central banks provided significant liquidity. The S&P 500® Index gained 20% in 2017. Risk premiums on virtually all fixed income sectors declined. Investors easily absorbed the significant issuance in investment grade corporate bonds during the year. Somewhat weak economic growth in the first quarter of 2017 was followed by two strong quarters of growth in the United States. The euro zone experienced improving growth in 2017 as well. The year ended with the promise of continued economic growth as President Trump and Congress passed a tax reform bill that will lower the tax burden for corporations and individuals.

Corporations recovered from the earnings and revenue recession in late 2015 and early 2016. Estimated year-on-year earnings growth of nearly 10% for 2017 has been supportive of the high asset valuations. Companies have decreased leverage and slowed merger and acquisition activity. The fundamental backdrop created a good environment to absorb the heavy issuance calendar.

Bond market participants and prognosticators were somewhat surprised by an interest rate environment that included three US Federal Reserve rate hikes, with a flatter yield curve. As this phenomenon progressed, financiers worried about the implications of the flattening yield curve. Our opinion is that the ample central bank liquidity and easier financial market conditions should offset the yield curve move for now. The yield on the 2-year maturity US Treasury note increased by 0.70 percentage points. The 30-year Treasury bond had a yield decline of 0.33 percentage points in the year.

Another surprise outcome has been the progress on business-friendly legislation and deregulation that the Trump administration and Congress have made in 2017. Companies within the energy, finance, and industrial sectors have and will benefit from moves to deregulate their businesses. As we noted earlier, the year ended with the promise of more improvement in the business climate as President Trump and Congress passed a tax reform bill that will lower the tax burden for corporations.

The Fed also announced a much-anticipated schedule regarding the tapering of the reinvestment of US Treasury and agency mortgage-backed securities (MBS) investment income, and of maturities that reside on its balance sheet. This will eventually shrink the central bank balance sheet. If the balance sheet’s final size is $2.5 trillion to $3.0 trillion, as Fed Governor Jerome Powell suggests, the reduction of reinvestments should stop sometime near mid-2020 to early 2021. Of course, the Fed noted that if economic conditions change it can alter the size and composition of the balance sheet as it sees fit. The large US Treasury maturities in 2018 means that the Fed’s buying activity will still be significant.

Within the Fund

Contributors to performance:

  • An overweight allocation and security selection in bank and finance companies contributed to performance versus the Fund’s benchmark, the Bloomberg Barclays US Aggregate Index, during the quarter. Continued small earnings improvements and the possibility of some regulatory relief made bank debt more attractive as risk premiums declined.
  • The Fund’s allocation to collateralized mortgage obligations (CMOs) contributed to relative performance during the quarter as the yield advantage in CMOs, along with a favorable prepayment environment, yielded solid results for these investments.
  • The Fund’s allocation to high yield corporate bonds contributed to relative performance as yield premiums continued to decline. Security selection within the basic industry and energy sectors was an important contributor to performance.
  • The Fund’s allocation to bank loans contributed to returns, as the refinancing wave slowed and investor demand helped returns.

Detractors from performance:

  • Investments in fixed rate agency pass-through MBS detracted from returns. Our security selection suffered as high coupon investments of 4% and 4.5% lagged as the curve flattened.
  • Security selection within industrials detracted from relative returns as bonds from Broadcom and Energy Transfer Partners had small corrections.
  • Interest rate hedging detracted from relative returns.

Outlook

The Fund has an income advantage over the benchmark index due to its exposure to the corporate, emerging market, and structured product sectors. At year end, this income advantage was more than one percentage point (before expenses). Central bank actions to keep rates low and to buy corporate bonds had set a favorable environment for exposure away from US Treasury investments in 2017. Fundamental factors are also supporting this exposure. We expect to keep this credit exposure and income advantage in the Fund over the near term.

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.

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

[406079] 01/18

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.

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.

Bloomberg Barclays US Aggregate Index (view definition)

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

Institutional Class shares available 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.

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.

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 experience portfolio turnover in excess of 100%, which could result in higher transaction costs and tax liability.

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