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Delaware Corporate Bond Fund Quarterly commentary March 31, 2017

Market review

Investment grade credit performed modestly well during the first quarter as the policy-driven gains earned earlier in the year faded on the heels of cooling enthusiasm for the Trump reflationary trade. The recently failed healthcare reform bill has cast doubt on the Trump administration’s ability to pass tax reform legislation and other growth initiatives, driving some of the near-term market weakness. This demonstrates the new post-election reality in investment grade markets where, despite improving credit fundamentals and strong demand technicals, the market remains driven by global political and monetary policies.

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).

The Bloomberg Barclays US Corporate Investment Grade Index returned 1.22% for the quarter, outperforming duration-matched Treasurys by 38 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%).

Retailers were the laggards for the quarter, with the sector under continued pressure from ecommerce disruption and shifting consumer preferences. Wirelines also underperformed amid supply pressures and merger and acquisition risk. The energy sector, particularly the high-quality integrated issuers, similarly underperformed as oil prices have faded from recent highs on a supply glut (West Texas Intermediate declined 5.8% over the quarter). Returns were inversely correlated with quality, with BBB-rated credits outperforming higher-quality bonds. Longer duration also outperformed shorter duration as the curve flattened with the 2-year to 30-year part of the curve down 12 basis points during the quarter.

Supply continues to flow at a record pace with $401 billion of new-issue printing over the quarter, up 10% year over year. Financial supply in particular was heavy — above what historically would be a strong issuance quarter for banks — as total loss-absorbing capacity (TLAC) regulatory requirements have created large issuance needs. Financial supply comprised 45% of total issuance for the quarter, compared to the first-quarter average of 40% over the past several years. In contrast, M&A has been a minor part of current supply levels — just 5% for the quarter. Regardless of the source, this heavy supply continues to be met with strong demand. Investment grade fund inflows for the quarter reached $39 billion, compared to $47 billion of inflows for all of 2016. Foreign demand remains strong as well but bears monitoring, with the European Central Bank and Bank of Japan still in easing mode, for now at least, and foreign exchange hedging costs moderating.

Sources: Bank of America, UBS, Lipper, J.P. Morgan.

Within the Fund

What worked in the Fund:

  • Security selection — Selection was strong, especially in subordinated and hybrid securities with which we’re comfortable in the banking, utilities, and asset management industries.
  • High yield and emerging market debt — Though we consider these to be more defensive credits, exposure to these strong-performing asset classes benefited Fund performance.
  • Finance companies — 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:

  • Metals and mining, and paper — The Fund didn’t have as much exposure to higher-beta (higher-risk) names in these areas, which were the two strongest- performing industries during the quarter.
  • Consumer cyclical — The Fund was underweight industries in this sector (including home construction, automotive, and lodging), which we largely viewed as fairly valued for this point in the business and economic cycle.
  • Communications — New supply from two of the largest names in its benchmark, the Bloomberg Barclays US Corporate Investment Grade Index, as well as investor concerns around potential M&A, pressured secondary spreads in this industry.

Outlook

Credit fundamentals have shown signs of modest improvement, a trend that we expect to continue in 2017 and which is necessary to support current risk-adjusted valuations. Specifically, the fourth quarter 2016 earnings season was solid, highlighted by positive earnings trends (+5.8% year over year), marking the first series of consecutive earnings growth since the first quarter of 2015 and a driver of fundamental stabilization (source: Bloomberg). Growth in nonfinancial leverage has stabilized but it remains at peak levels; this highlights the fact 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 US Federal Reserve (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.

The Bloomberg Barclays US Corporate Investment Grade Index (formerly known as the Barclays US Corporate Investment Grade Index) is composed of US dollar-­denominated, investment grade, SEC-­registered corporate bonds issued by industrial, utility, and financial companies. All bonds have at least one year to maturity.

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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)1.78%1.78%4.38%2.72%4.28%6.25%6.52%09/15/1998
Class A (at offer)-2.83%-2.83%-0.34%1.17%3.33%5.75%6.25%
Institutional Class shares1.84%1.84%4.64%2.98%4.54%6.53%6.79%09/15/1998
Bloomberg Barclays U.S. Corporate Investment Grade Index1.22%1.22%3.31%3.65%3.96%5.44%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