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Delaware Corporate Bond Fund Quarterly commentary September 30, 2017

Overview

Investment grade markets performed reasonably well during the third quarter as strong corporate earnings, a rebound in commodities, and healthy demand for credit drove performance despite heavy supply and rising geopolitical tensions. Political gridlock remains an ongoing theme after the latest Republican effort to repeal the Affordable Care Act failed amid opposition from within the party’s own ranks. Investors now are looking ahead to tax reform legislation, but given the broad implications of a revamped tax code and a lack of consensus on how to offset tax cuts, tax reform appears likely to be far from a fait accompli. Finally, the US Federal Reserve’s exit from quantitative easing (QE) as it begins to normalize its balance sheet has had little impact on credit markets since being officially announced. The Fed’s 2% inflation target remains elusive, and while Fed Chairwoman Janet Yellen has acknowledged as much, we remain watchful for indications that the Fed will aggressively raise rates in a soft inflation–moderate economic growth environment, which could have negative implications for corporate spreads and performance.

The Bloomberg Barclays US Corporate Investment Grade Index returned 1.34% for the quarter, outperforming duration-matched Treasurys by 0.87 percentage points. Metals-and-mining and energy led the way as West Texas Intermediate oil reached $52 a barrel amid supportive headlines from the Organization of the Petroleum Exporting Countries (OPEC) and strong demand growth, while base metals such as copper reached a three-year high in response to optimism in China and a weakening US dollar. Sector underperformance was driven largely by idiosyncratic events. Cable underperformed as the mergers and acquisitions overhang (a rumored bid by Altice to acquire Charter Communications) weighed on the sector. Lodging also underperformed after Wyndham Worldwide announced plans to spin off its hotel unit into a new publicly traded company. Finally, supermarkets lagged as Amazon announced plans to reduce prices at Whole Foods, adding further pressure and disruption to the space.

Investment grade new-issuance volumes were robust for the third quarter, at $354 billion. Expectations for tighter monetary policy, low funding costs, and political angst has driven more mergers and acquisitions volume with several large deals coming to market, including AT&T’s $22.5 billion offering to fund its pending acquisition of Time Warner Inc. However, as in prior quarters, heavy issuance was met with equally robust investor interest, although the market has experienced some bouts of supply indigestion. Fund inflows topped $25 billion over the quarter and year-to-date inflows have reached $92 billion, compared to $47 billion for all of 2016. (Sources: Bank of America, UBS, Lipper.)

We believe these technical factors should remain supportive of investment grade credit in the near term, but we remain cautious of risks, including rising inflation or higher yields in Asia and Europe, an increase in hedging costs that could weaken foreign demand, US dollar weakness, and political volatility in the United States driving risk-off sentiment.

Within the Fund

What worked in the Fund:

  • Banking — Positive security selection was driven by subordinated and hybrid securities that outperformed senior bank debt amid strong earnings and continued spread compression in the senior-sub relationship. This is a theme that held steady from last quarter as well.
  • High yield and emerging markets — Despite the Fund’s fairly conservative positioning within these out-of-benchmark sectors, any allocation to these asset classes was additive (relative to US investment grade returns), as higher-beta (higher-risk) securities outperformed lower-beta (lower-risk) over the quarter.
  • Utilities — A modest overweight to this sector aided performance, as utilities was one of the better performing industries during the quarter.
  • BBB-rated bonds — An overweight to BBB-rated bonds (averaging roughly 12 percentage points higher than the benchmark’s weighting), which we believe are attractively valued relative to higher-rated securities, added to performance during the quarter.

What did not work in the Fund:

  • Metals and mining — An underweight to spread duration at the long end of the yield curve detracted from performance due to momentum from Treasury curve flattening as well as from an overall rally across several commodities.
  • Energy — The Fund’s underweight exposure to the better-performing energy sub-industries (specifically, refining and oilfield services, which we believe to be fundamentally less attractive) resulted in relative underperformance.
  • Idiosyncratic events — Several events had one-off adverse effects on performance during the quarter, including:
    • The Fund’s overweight to cable-satellite companies detracted, as rumors that Altice would make an offer for rival Charter Communications weighed on the sector.
    • Amazon’s purchase of Whole Foods negatively affected the Fund’s small exposure to the grocery space.
    • Wyndham Worldwide’s surprise announcement that it would spin off its hotel assets detracted from performance, given the Fund’s small exposure to this name.

Outlook

Second-quarter 2017 earnings showed a significant improvement over prior quarters, driven by strong earnings before interest, taxes, depreciation, and amortization (EBITDA) and revenue trends, easy year-over-year comparisons given weak growth in the first half of 2016, a recovery in commodity prices, and a stronger global macro backdrop. Furthermore, 43 companies in the S&P 500® Index issued positive earnings guidance for the upcoming third quarter earnings season, well above the five-year average of 27 and the highest absolute level since the fourth quarter of 2010 (source: FactSet).

However, while fundamentals have improved, there are signs of a plateau as leverage remains well above historical levels and interest coverage is declining. We believe the investment grade market continues to be driven primarily by technical factors stemming from fund flows. As euro-area growth and inflation improves, and prospects for a reduction in QE by the European Central Bank (ECB) begin to grow, the threat to this dynamic only increases and remains a risk for US investment grade credit. Further political volatility, disappointing domestic economic data, and increasing hedging costs also have the potential to erode foreign demand, which has been resilient but is not immune to global forces.

Other potential hazards we see ahead include an overaggressive Fed, inflation and macro data weakness, protectionism, and tightening financial conditions in China. Despite these concerns, we continue to have a positive view on investment grade credit for the remainder of 2017, but anticipate bouts of volatility, especially from current low valuation levels. To be clear, we believe investment grade corporate valuations imply carry-oriented, income-based returns for investors for the remainder of 2017 under current conditions.

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

[283798] 10/17

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.

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.

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)

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.

Institutional Class shares available 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 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 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.

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Not FDIC Insured | No Bank Guarantee | May Lose Value