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Delaware Limited-Term Diversified Income Fund Quarterly commentary June 30, 2017


Divergence was the watchword for the second quarter of 2017. A well-telegraphed June federal funds rate increase by the Federal Open Market Committee (FOMC) pushed money market rates higher, but 2-year yields barely moved while 10-year yields declined. The US dollar fell back to its pre-election levels, oil prices returned to the lower $40s range, and optimism around the Trump administration’s agenda waned, but risk assets rallied.

The Bloomberg Barclays US Aggregate Index recorded a positive return for the second quarter of 2017, with lower-quality, BBB-rated bonds outperforming the higher-rated investment grade credit tiers within that index on a total return basis. Although most broad-market fixed income indices produced positive returns, high yield corporate bonds, emerging market debt, and global Treasurys ex-US were the strongest performers for the quarter.

US economic indicators turned softer during the second quarter of 2017. The Citigroup Economic Surprise Index, for example, moved significantly lower, ending at its lowest level since the first half of 2015. Nonfarm payroll growth, which averaged about 200,000 a month since 2011, averaged just 149,000 a month in the second quarter. Meanwhile, core personal consumption expenditures or PCE (the US Federal Reserve’s preferred inflation gauge) fell to 1.4% year over year and the Consumer Price Index (Core CPI) moved consistently lower over the quarter as well. The Institute for Supply Management’s total Manufacturing and Non-Manufacturing New Orders Index also declined, unable to sustain the rebound from the previous two quarters. Sentiment indicators were slightly lower, but remained elevated throughout the quarter. The National Federation of Independent Business (NFIB) Small Business Optimism Index revealed that small business owners continue to feel comfortable with the economy.

Given the divergent data, it is important to understand the forces behind recent economic performance and the outlook for the ongoing expansion. After several years of similar results, it might seem logical to assume that gross domestic product (GDP) growth will strengthen over the remainder of 2017 after a seasonally weak first quarter. However, the pattern of weaker growth in the first quarter of 2017 (1.4% annualized versus 2.1% in the fourth quarter of 2016) doesn’t align with recent years. In past years, slower first quarter growth was based on weakness in government, inventory, and trade trends. But in 2017, softer first quarter growth was driven by weak consumer spending. In fact, capital expenditures, which could return to trend over the rest of the year, was a particularly strong factor in first quarter 2017 GDP. Muted consumer earnings growth (especially relative to even a small amount of inflation) and an expected setback in automobile production later this summer suggest to us that a strong GDP rebound is less likely in 2017. Additional support for this view comes from the recent moderation in optimism around the Trump reflation trade and the realization that China, which provided significant policy accommodation in the first half of 2016, is much more restrictive today.

Within the Fund

The Fund’s outperformance was driven primarily by its positioning in high grade corporate credit. Corporate bonds outperformed Treasurys, so the Fund’s overweight to the sector was additive to performance. Our security selection in the sector was also beneficial, with the Fund’s corporate positions returning 1.35% versus 0.54% for the sector within its benchmark, the Bloomberg Barclays 1–3 Year US Government/Credit Index. The Fund’s out-of-benchmark holdings in below-investment-grade credit, emerging market debt, and municipal bonds also aided returns, as these securities were all strong performers. Conversely, bank loan and noncorporate exposure were detractors as these securities underperformed the benchmark.


Beyond recent economic trends, we must seriously consider the outlook for the length of the current economic expansion and the possibility that this phase of the business cycle could end sooner than the markets expect. The Trump reflation trade (or the “hope” trade) is built on the view that fiscal stimulus could significantly extend the life of the expansion. We suggest that other signals may be warning of a nearer-term end. Historically, the most reliable indicator of an economic downturn has been an inverted yield curve. Though the curve in US fixed income markets is not yet inverted, 2-year Treasury notes now trade at 1.3%-plus while the Fed’s target range for the federal funds rate is 1.00% to 1.25%. In our view, the fact that 2-year Treasury notes are not factoring in any future Fed tightening is a signal in itself. Additionally, the recent restrictive policy in China has resulted in a curve inversion in that country, which is significant given China’s importance in driving global economic trends in recent years.

Other factors worth considering are centered on typical late-cycle trends. These include a tight labor market combined with a slowdown in hiring; pressure on company profitability caused by rising unit labor costs (in the current case, the result of modestly higher wages coupled with falling productivity); increasing late-cycle excesses, such as stress in subprime auto loans; and a strong rise in confidence similar to what took place after the US election. (Note that cycles usually end with overconfidence, not fear.) Finally, keep in mind that a forecast from the Fed is often unreliable. For example, consider the FOMC minutes from mid-2008 when inflation was the central bank’s biggest concern. We must make investment decisions while keeping in mind that the range of outcomes is not limited to the Fed’s view, or the consensus view.

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.

The Bloomberg Barclays US Aggregate Index is a broad composite that tracks the investment grade domestic bond market.

The NFIB Small Business Optimism Index is a survey asking small business owners a battery of questions related to their expectations for the future and their plans to hire, build inventory, borrow, and expand.

The Citigroup Economic Surprise Index is a rolling measure of beats and misses of indicators relative to consensus expectations.

Document must be used in its entirety.


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

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 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 US Government/Credit Index (view definition)

Net expense ratio reflects a contractual waiver of certain fees and/or expense reimbursement from May 1, 2017 through May 1, 2018. Please see the fee table in the Fund's prospectus for more information.

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.

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 US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

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.

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