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Delaware Extended Duration Bond Fund Quarterly commentary March 31, 2017

Overview

The Bloomberg Barclays Long US Corporate Index returned 1.36% for the first quarter of 2017, outperforming duration-matched Treasurys by 2 basis points (a basis point is one-hundredth of a percentage point) but lagging most other risk asset classes, such as high yield, emerging market debt, and US equities. Metals and mining was the strongest performing sector for the quarter, driven by further improvement in base metal commodities such as iron ore (+1.9% quarter over quarter) and copper (+5.5%).

Overall, investment grade credit performed well as risk premiums tightened; however, the long end of the corporate curve underperformed the “belly” or intermediate part of the curve from an excess return perspective due to the steepening of the 10-year/30-year Treasurys relationship. The recently failed healthcare reform bill has highlighted the risk related to the Trump administration’s ability to pass tax reform legislation and other growth initiatives, which is a key component of our constructive outlook for credit in 2017. Another component of our outlook is strong demand driven by a global reach for yield, which remains intact.

Markets showed little reaction to the United Kingdom’s formal triggering of Brexit, as the move had been broadly telegraphed, while Dutch voters let some air out of the global populist movement by backing the Liberal Party in March elections. France will be the next key election to watch despite the current low odds of a Marine Le Pen victory, given the tail-risk consequences of a populist government and the potential for France to exit the European Union (EU).

Improving global growth, combined with supportive leading indicators coming out of the election, seem to set the stage for risk assets to perform well as we transitioned into 2017. Favorable earnings momentum during the third quarter of 2016 spilled over into the fourth quarter, signifying to us that the earnings recession of the prior five reporting periods had been arrested, a positive for credit fundamentals. In many ways, markets surprised investors during the first quarter of 2017.

Central banks remain an integral component in these markets, as their influence has global implications. The US Federal Reserve’s successful rate increase in March — after market participants had assigned a very low probability of a hike just two weeks prior — demonstrates the possibility that investors are becoming more accepting of rate hikes. Furthermore, investors’ interest rate expectations for the balance of the year and into 2018 now closely mirror the Fed’s forecast after deviating the past several years. We will continue to monitor the European Central Bank’s (ECB’s) policies as economic data across the euro zone are improving as well. This has led to more speculation regarding nonstandard monetary policy measures by the ECB, including the current monthly pace of corporate purchases under the corporate sector purchase programme (CSPP), declining from €80 billion to €60 billion.

Market valuations across fixed income are now trading through long-term averages and we will need to see a continuation of positive fundamental trends to support current valuations. A weaker dollar more recently should contribute to another positive quarter for fundamentals. We expect the search for global yield to remain an important component of flows. However, policies in countries that have continued to experience debt-fueled growth, such as China, must be watched carefully for signs of a broader pullback in demand that could affect the world’s economies.

Within the Fund

What worked in the Fund:

  • Security selection was strong across a number of the sectors of the Fund’s benchmark, the Bloomberg Barclays Long US Corporate Index. In particular, consumer noncyclicals (the Fund returned 2.54% versus 1.30% for the benchmark), technology (2.40% versus 1.24%), banking (2.06% versus 1.39%) and brokerage-asset managers (6.52% versus 4.72%) contributed meaningfully to the Fund’s performance.
  • Although allocations to high yield and emerging market debt were relatively small, outsized gains from these sectors (4.31% for high yield and 9.39% for emerging markets) was additive to the Fund’s performance.
  • Underweight allocations to the wireline and retail industries, which were among the weakest performing sectors within the benchmark, was additive to performance.
  • Security selection and exposure to hybrid and junior subordinated securities issued by financials contributed to Fund performance.

What did not work in the Fund:

  • Security selection and sector allocation to the metals and mining sector, especially to higher-beta (higher-risk) issuers detracted from Fund performance, as the industry was one of the strongest performers during the quarter.
  • The Fund’s exposure to US Treasurys, primarily as a duration placeholder as we looked for attractive opportunities in credit, detracted from performance given positive excess returns generated by corporate risk.
  • Security selection and sector allocation to energy, especially to the lower-beta, higher-quality integrated subsector, negatively affected the Fund’s performance.

Outlook

Credit fundamentals have shown signs of modest improvement, a trend that we expect to continue in 2017 and one that we believe is necessary to support current risk-adjusted valuations. Specifically, the fourth quarter earnings season was solid, highlighted by positive earnings trends (+5.8% year over year), including the first two quarters of consecutive earnings growth since the first quarter of 2015 (source: Bloomberg) and fundamental stabilization. Though growth in nonfinancial leverage has stabilized it remains at peak levels and highlights that we remain in the late phase of the economic and credit cycle, which poses a risk to market stability.

From a risk compensation standpoint, investment grade valuations are currently through long-term averages, although fundamental improvement and the market technical related to the global reach for yield provides support for spread premiums. We remain mindful of the current risk-reward dynamics provided by various pockets of the credit market and continue to watch for signposts and levels that indicate valuations are becoming overstretched.

Finally, in addition to domestic political risks associated with the Trump administration’s agenda, other risks to our view include an aggressive Fed (relative to market expectations), weakness in China’s growth trajectory, tightening credit conditions, overseas inflation leading to reduced foreign demand for US fixed income assets, and geopolitical risks (including the French election).

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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)4.85%6.81%3.39%4.02%5.54%9.06%8.10%09/15/1998
Class A (at offer)0.11%1.93%-1.26%2.44%4.58%8.55%7.83%
Institutional Class shares4.76%6.79%3.49%4.22%5.77%9.30%8.35%09/15/1998
Bloomberg Barclays Long U.S. Corporate Index4.94%6.36%3.61%5.42%5.56%7.68%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.

Bloomberg Barclays Long US Corporate 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.

Expense ratio
Class A (Gross)1.00%
Class A (Net)0.96%
Institutional Class shares (Gross)0.75%
Institutional Class shares (Net)0.71%

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement 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 ClassDEEIX
Class ADEEAX
Class CDEECX
Class RDEERX
Class R6DEZRX

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 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