Q: What is the history of the fund and how is it different from its peers? A: After conducting an extensive review of investment options available to investors, we introduced a multi-sector, diversified approach as a potential solution to address the risk to fixed income portfolios due to rising rates. Typically when investors invest in floating rate products the initial asset class of choice has been to invest in a bank loan fund. Rather than introducing another product that mirrored what our competitors were providing, we took a step back and asked ourselves how we could leverage our existing business model and provide a more flexible alternative to address rising rates for our investors. To answer this question, we looked at our flagship fund, Delaware Diversified Income Fund, which seeks the best risk-adjusted total returns by investing globally in a variety of fixed-income securities. Our solution was to create a sister fund that applied the same investment process but delivered an investment choice that minimized price volatility due to changing interest rates. We launched Delaware Diversified Floating Rate Fund in early 2010. It’s very different to what we would consider to be our peer group, due to our diversified approach and limit of 50% to below-investment grade assets. The Fund currently has about $400 million in assets. Q: What is your investment philosophy? A: We approach the fixed income markets with the belief that they are efficient with respect to interest rate risk but regularly misprice securities that are exposed to credit prepayment, liquidity, and currency risk. It is our job to exploit these inefficiencies and attempt to provide our clients with the consistent excess returns over the long term. We run a diversified portfolio rather than a single asset class strategy. Traditionally a bank loan floating rate fund would be comprised primarily of bank loans. Bank loans are generally rated below-investment-grade and are usually issued by domestic companies. Furthermore the asset class can be subject to extreme market volatility and is ordinarily callable at any time, which could result in a principal loss if the investor paid a price above par and the loan is called. We approach risk by managing a 2diversified portfolio including asset classes such as investment-grade corporates, high yield corporate bonds, municipals, emerging markets, and international bonds, as well as bank loans We also use derivatives for risk management purposes, and we cannot employ leverage. Derivatives are primarily used to hedge out interest rate risk when we have chosen to invest in a fixed-rate bond by using an interest rate swap to create a cash flow profile for the issuer that mirrors a floating rate instrument. . Delaware Diversified Floating Rate Fund is not a bank loan fund. We invest in bank loans when we think the asset class offers good value. If we do not particularly like valuations, or the market technicals aren’t favorable, then we will find other sectors that we believe offer better risk-adjusted return opportunities. We focus on optimal security selection by employing a bottom-up approach that emphasizes spread sectors such as investment grade corporate bonds, asset-backed securities and bank loans Our research, trading and portfolio management teams collaborate to construct portfolios that we consider to have attractive risk-reward characteristics. Our primary investment objective is total return, while many of our peers are focused on income. We believe it is important to manage for total return because we want to maintain principal during periods of heightened volatility. Maintaining and growing principal to generate future income is paramount. Lastly, an important part of running a business is recognizing that turnover is inevitable. We want to build a strong team with a flat organizational structure that promotes a deep bench, which is an important component of being able to implement and support an investment process. For instance, we have a process in place that allows junior research analysts to be able to learn and gain valuable knowledge and insight by having multiple touch points across several industries, while being guided by a senior member of the research group. Q: What is your investment strategy? A: Our investment strategy is dominated by bottom-up research focused on security selection; we build portfolios one idea at a time. This bottom-up approach is complemented by reviewing macro-related drivers, in part, to confirm what our fundamental analysis is telling us. We classify our investments into four major types including core holdings, upgrade candidates, undervalued bonds, and opportunistic bonds. The core holdings generally make up 50% to 70% of the fund. Those are the best-i- class companies that have management teams with experience managing the business through multiple market cycles, supported by free cash flow generation and financial flexibility. We actively seek to identify issuers that we believe to be upgrade candidates. Although the investment opportunities have been limited since the crisis, our proprietary research staff of more than 40 individuals supports this goal. The third category is undervalued bonds. By conducting our bottom-up analysis our team identifies special situations, industry consolidations, mortgage-backed securities collateral mispricing and credit curve anomalies that we believe to be undervalued relative to the fundamentals. The last, and arguably the smallest component of a portfolio’s overall risk in market value terms would be opportunistic investments. This includes mispriced securities, liquidity induced imbalances or sponsorship imbalances that are short-term investments in nature. What is important about our security selection process is every investment is assigned one of these four major types of investment categories, making risk management more transparent and disciplined. We look at every line item in the portfolio to determine why we own it and what our exit strategy will be. Curve positioning is very important from both an interest rate and credit investment perspective. We build and manage portfolios with hundreds of securities and it’s critical not to look at risk in isolation, and we must understand how the portfolio will perform as changes in interest rates and credit curves impact prices. Liquidity is an important consideration when we make investment decisions because securities in a more liquid portfolio will trade more often and, as a result, may experience more price volatility. However, we believe that liquidity, particularly in a market environment plagued with uncertainty, provides the flexibility to rebalance the portfolio and reflect the team’s view in a more cost-efficient manner. We always consider liquidity when making investment decisions. We can see that when we look at our conclusions regarding the relative value of financials when compared to the rest of the market. For a long time after the economic crisis, financials were valued at a discount to industrial companies. We believed that before we could see any type of enduring, fundamental and economic improvement, we needed to see the banking sector’s financial health improve. During this time, senior subordinated-level bank paper was trading with a larger risk premium than senior holding company bonds, despite being senior in the capital structure. Although we believed this anomaly should not exist, when we factored in the liquidity risk of owning subordinated bank paper, we chose instead to forgo the incremental yield increase for liquidity. Diversification is another differentiating factor between Delaware Diversified Floating Rate Fund and many of our competitors. Diversification provides us with the flexibility to do things that other managers can’t accomplish due their single asset class approach. If market volatility is increasing and there is limited liquidity in the bank loan market, we don’t have to sell bank loans; we can look to sell other assets to meet changing market conditions. This allows us to be a provider of liquidity rather than a taker of liquidity during periods of market stress. Our job is to create a portfolio that generates excess returns over the benchmark, which is LIBOR. However we need to do that in a risk-controlled manner, and diversification is one tool we use to accomplish that. Diversification is the foundation of the portfolio construction. The portfolio looks to avoid asset class concentrations. For instance we can only have 50% below investment-grade, so it will have a very different risk profile from a traditional bank loan fund that would have a below investment-grade average credit quality and not necessarily meet the risk tolerance of the investor. Industry concentration is also important. If we were building a portfolio of investment-grade corporate floaters, we would find ourselves having to own primarily financial floaters since financial companies issue the majority of floating-rate product. To avoid industry concentration risk, we diversify across multiple asset classes and, when appropriate, utilize derivatives to help us accomplish this goal. Taking a step back and looking at the risk positioning today, one would observe about 30% onto bank loans, 6% onto structured product, and several percent onto convertibles. However, the balance is primarily in investment-grade corporate credit, diversified by geography and industry. The portfolio currently has about 2% cash. Additionally about 20% of the portfolio is fixed rate bonds that we have hedged using interest rate swaps to help us meet our objective of total return and diversification. There are many risks within the loan market that investors must understand. Most of the bank loans in the market today have LIBOR floors that will prevent investors from realizing additional income until LIBOR moves above the stated floor. Furthermore, bank loans are generally callable any time. This can create challenges for portfolio managers and investors alike. Additionally, the below investment grade credit profile of the loan market requires a dynamic risk management process that has the flexibility to meet changing markets. Our job is to make every effort to ensure we are getting paid for these and other risks and to minimize downside risk for our shareholders by managing a diversified portfolio. We do not want to be forced into buying a bank loan that’s trading at premium with the risk that the loan could get called away tomorrow at par, essentially resulting in a transfer of wealth right back to the issuer. We have greater flexibility to avoid these dynamics by using derivatives as part of our strategy. For instance we can move into investment-grade corporate bonds that aren’t callable and, if our analysis is correct, the price appreciation accrues directly to the shareholder rather than right back to the issuer. At the same time we do not get called out of an asset and have to struggle to try and stay invested all the time. That flexibility allows us to entertain a lot of different investment ideas across multiple asset classes. Q: What is your research process and how do you look for opportunities? A: We would characterize research as the foundation of our business. We have 85 investment professionals on the fixed income team, of which, more than 40 support the research function. One of the unique ways that we approach analysis is by having our research team cover the entire credit rating spectrum from the highest rated AAA bonds down to the lowest rated CCC bonds. We believe this is beneficial because it allows analysts to analyze credits through their lifecycles. Many of our competitors have specific research teams that only analyze high yield credits. We think it’s important that analysts understand these high yield companies as well as their higher-quality investment-grade counterparts, because many of these companies will actually dictate pricing within the industry. Although this example is somewhat dated, it clearly demonstrates how our investment process for the fund leverages our research team’s effort to achieve diversification and meet the total return objective. Dow Chemical is a commodity-based company whose cash flows were very cyclical because of the nature of its business. In 2009 Dow acquired a specialty chemical company called Rohm & Haas The nature of Rohm & Hass’ cash flows were complimentary to Dow’s, in our opinion. When Dow purchased the company the market was concerned about the aggressive multiple paid relative to where we were in the economic cycle. The rating agencies in part agreed at the time because they put Dow Chemical on negative watch. We thought that this was a proven management team, which is one of the key things we look for when we are making an investment recommendation for a portfolio. We believed there were synergies to be realized that would allow the company to reduce leverage sooner than the market was anticipating. Furthermore the company had been generating free cash flow through the entire market cycle, which is very important to bond investors because at the end of the day, we want to make sure the companies we invest in can pay their coupons and meet any principal payments in a timely manner. After we conducted our due diligence, we determined that we wanted to own this name in our funds. At the time, however, if we elected to buy this issuer in the floating rate fund that we are talking about today we would have been limited to a short-dated floating rate note and the total return opportunity would be limited by the maturity of the bond. Since we have the flexibility to use fixed rate bonds, we would have solicited input from our traders for their recommendation for the best total return opportunity across the curve. We would have then purchase a fixed-rate bond and use an interest rate swap to create the cash flows of a floating rate Dow bond. In 2010 we ultimately purchased the 10-year Dow bond in the portfolio. This allowed us to source a credit that we thought was fundamentally improving, provided diversification in an investment grade sector other than financials and permitted us to diversify away from bank loans, which is a below investment-grade asset class. Q: How do you define and manage risk? A: There are multiple portfolio managers on the fund. I am the lead portfolio manager but we leverage each individual’s strengths and asset class expertise. This team approach adds an additional layer of risk management at the portfolio level. However, it is my responsibility as the lead portfolio manager of the strategy to assimilate the different components to create the portfolio and manage the risks in their entirety. We enter all investments with an exit strategy in place. The sell discipline is probably the most difficult part of the risk management process. When we enter into a trade, there are four key reasons we may sell the holding. One is for relative value reasons, meaning it no longer offers the value we thought it did when compared to other investment opportunities. The second is for technical reasons, such as the bank loan market earlier this year when significant inflows were driving prices above par. The technical factors in that marketplace had driven the asset valuations to levels that we did not think offered as much value. We sold into that rally so we could put ourselves in a position to be a provider of liquidity rather than a taker of liquidity. The third reason is the investment has hit our predetermined price target. Lastly there may have been a shift in the underlying fundamentals associated with the issuer. Despite the difficulty of adhering to a strong sell discipline, the inability to do so makes the investment process susceptible and difficult to repeat. Q: How has your investment posture changed over the last five years since the financial market crisis? A: Coming out of the crisis we have certainly learned a lot but several questions remain. . Today we are in the midst of a grand experiment regarding monetary and fiscal policy where the outcome remains unknown. With that said, however, the one thing that hasn’t changed is the investment process. It was our discipline and adherence to the investment process that got us through the crisis in the first place. One of my key takeaways of the crisis is to never underestimate the will of a politician. It’s in the best interests of a politician to kick the can down the road. A politician will in fact kick the can down the road, not necessarily as far as possible, but certainly as long as possible. This will result in the fundamentals taking much longer to play out than otherwise would have been the case. I would say, in general, human nature is to sell at the bottom and buy at the top. This is why a solid investment process that applies discipline is critical. Approaching rising rates through in a diversified strategy is an attractive opportunity for fixed income investors concerned about the impact rate increases will have on their portfolios.