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Delaware Limited-Term Diversified Income Fund Quarterly commentary March 31, 2017

Overview

The Bloomberg Barclays US Aggregate Index recorded a positive return for the first 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. Most broad-market fixed income indices produced positive quarterly returns, with high yield corporate bonds and emerging market debt posting the strongest returns.

US economic indicators were generally stronger, with the Citigroup Economic Surprise Index ending the period near the highest levels since 2014. Nonfarm payroll growth, which has averaged about 200,000 a month since 2011, continued at about 210,000 a month during the first quarter. Meanwhile, core personal consumption expenditures or PCE (the Federal Reserve’s preferred inflation gauge) rose to 1.8% year-over-year while personal income and spending remained subdued. Until personal income and wage-and-salary income show greater evidence of accelerating, the consumer inflation trend is likely to remain muted.

The Trump administration got off to a rocky start on key policy initiatives; those stumbles, in turn, called into question expectations of faster economic growth. Tax reform is still on the table, however, and progress there will be critical if the popularity of the Trump reflation trade is to be maintained. Gross domestic product (GDP) forecasts that focus on sentiment-based leading indicators are showing solid growth while forecasts derived from current economic output and demand statistics are pointing to anemic growth.

With two rate increases in its last three meetings, the Federal Open Market Committee (FOMC) appears to be siding with the Trump reflation/improved sentiment side of the argument. The Fed’s talk of balance sheet management also has increased. As the Fed — and China’s central bank — have tightened policy in recent months, the fragile support system for asset prices that has been in place over the past seven-plus years may become less reliable. If the Fed and other central banks base near-term policy on hopes of a boost from fiscal initiatives, any failure on this politically driven front could result in major headwinds for economic growth and risk asset prices.

It seems that investors will have to decide where the Fed will take monetary policy. The reflation outlook means that markets are still in the early stages of a Fed tightening cycle and that there could be traditional overheating before the end of the cycle. Alternatively, if the economy doesn’t receive a reflation boost from fiscal policy, the Fed cycle could end prematurely as a very modest amount of tightening is applied to a slow-growth, fragile economy.

Within the Fund

The Fund’s outperformance for the period 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. Additionally, our security selection was beneficial, as the Fund’s corporate holdings returned 1.91% versus 0.65% for the sector within the Bloomberg Barclays 1–3 Year US Government/Credit Index. The Fund’s portfolio construction contributed to this performance as well. The Fund is structured as a barbell with short floating-rate asset-backed securities (ABS) and longer-dated corporate bonds. We find value in the 3–5 year part of the corporate curve, and the Fund’s 40% holding in floating-rate bonds allows for investments in that part of the curve while maintaining a duration relatively close to the benchmark index. This portfolio construction is underweight the 2-year part of the curve, which historically has been the most sensitive to Fed rate hikes. The Treasury curve reflected this, with short rates underperforming longer rates as the FOMC raised the federal funds rate at its March meeting.

Within the corporate bond component of the Fund’s portfolio, the strongest contributor was the financial sector in which the Fund has an 8-percentage-point overweight. This is a sector we continue to favor and in which we opportunistically added to the Fund’s exposure over the quarter, particularly in the new-issue market.

Outlook

The Fund has an income and yield advantage over the benchmark index due to its weightings in corporate bonds and structured product sectors. We expect to maintain these overweights and to continue to maintain the portfolio’s barbell structure to maintain this yield advantage.

We will need to see a continuation of these positive fundamental trends to support current valuations. Market valuations across fixed income are now trading through long-term averages. 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, should be watched carefully for signs of a broader pullback in demand that could have global implications on the world’s economies.

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

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

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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 (03/31/2017)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)0.58%0.58%1.53%1.41%0.86%3.13%4.88%11/24/1985
Class A (at offer)-2.18%-2.18%-1.25%0.49%0.30%2.85%4.79%
Institutional Class shares0.74%0.74%1.80%1.61%1.01%3.28%4.18%06/01/1992
Bloomberg Barclays 1-3 Year U.S. Government/Credit Index0.41%0.41%0.71%0.96%0.93%2.34%n/a

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)

Expense ratio
Class A (Gross)0.92%
Class A (Net)0.74%
Institutional Class shares (Gross)0.67%
Institutional Class shares (Net)0.59%

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.

Share class ticker symbols
Institutional ClassDTINX
Class ADTRIX
Class CDTICX
Class RDLTRX
Class R6DLTZX

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 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.

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