Q: Nancy, will you explain the fund's origin and the mission? A: The Dividend Income Fund was started with the internal resources of Delaware in 1996. Since October 2003, the fund has been open to the public. The investment strategy of the fund is to provide a stable income stream and competitive total return to investors over a variety of market cycles. The fully invested fund does not time the markets in four sectors that we invest in. The fund has four categories of assets: 40% of the fund is in large cap value equity securities, 25% in high yield bonds, 20% in REITs, and 15% in convertible securities. We arrived at this allocation based on the analysis of the historical data on asset classes and an understanding of the volatility of each. Each of the sleeves in the fund has relatively low correlation with other asset classes in the fund. This feature offsets dramatic market swings and helps the fund ride out the volatile market cycles. Since the inception, the fund has not had a down year when measured on total return basis. The fund's stable returns are explained by the diversification across four asset classes. The four sleeves in the fund are managed by three senior managers. I am responsible for the large cap value sleeve in the fund. Q: How do you manage the Large Cap Value sector for this fund? What are your investment criteria? A: We manage all the sectors in the fund using our extensive research capabilities. At Delaware, we have thirteen equity analysts in the large cap value area organized by economic sectors. We use their work to determine the optimal holdings for the fund. We are looking for large cap companies that have the wherewithal to generate excess cash flow to pay dividends to investors or to repurchase stock. We are focused on companies that are shareholder-focused and are attractively valued when measured on cash flow, EBITDA and price-to-earnings ratio. In general, we have between 25 and 40 stocks. As of this interview, we had 33 stocks, diversified across sectors. The equity performance is measured against Russell 1000 Value Index. We use financial models to evaluate each company's ability to generate cash and project future growth. Our stock selection process is one stock at a time. Q: Can you describe your research process? A: Our goal is to identify stocks of companies that have predictable and consistent cash flow. During our selection process we do not use any forecasts in favor or against the economic outlook that aren't confirmed by the underlying fundamentals of the companies being considered. We are looking to buy companies that have a dividend yield above the market yield or repurchase a meaningful amount of their shares. We identify these companies through our fundamental and quantitative analysis. We gather our information through management meetings, competitive analysis, company visits, and industry shows. We use financial models to understand the cash flow and impact on the cash flows in various economic and market cycles. We are looking for companies that have stable cash flow during various cycles. In meeting with management, we try to understand the macro business outlook and temperament of the management. The outcome of the meetings and financial modeling is our estimation of fair value for the stock, and this is our method of the stock selection. Q: Will you discuss some of your recent stock picks? Why did you choose these stocks? A: Last fall, we brought Kerr McGee into the portfolio. At the time the company had the attractive dividend yield of 4.5%. We have been following the company for several years at Delaware, and we have a good knowledge of its energy asset base in the Gulf Basin area. We had a different view on the company's stock price since we understood its Exploration and Production capabilities. The company had increased their exploration success rate, and the dividend looked safe. We viewed the catalyst for the stock as the better recognition by investors of the value of its asset base and better management of the properties and the potential spin off of the paint-related chemical business. Our extensive research helped us to have a different perspective on the company, which led us to reap investment gains. Q: Can you share another success story? A: Pepsico Inc. has been in the fund for at least two years. During 1999 and 2000, our dividend-based investing approach was not fashionable. We viewed the company as a good corporate citizen, and we liked the fact that the company had a 46% increase in the dividend in one year. The company has a steady cash flow to support the growth in dividends. Pepsi stock was out of favor when the company had short-term disruption in volume growth at the Frito Lay division. During that time, we added the stock to the portfolio. Since 2001, stocks with reasonable dividend payouts have done better than the market, and we have been rewarded for our disciplined investing approach. Q: How do you measure and control investment risk? A: We monitor securities risk at the sub-industry level across the complete fund and pay attention to sector allocation. We keep the fund diversified among sectors similar to S&P 500 and Russell 1000 indexes. The high-yield portion of the fund has more than 100 bonds. They have 20 credit analysts, and a deep research team. There is higher level of turnover than in the rest of the fund. They take a sector-neutral approach, and BB and lower ratings are selected for the fund. Q: Damon, what is your REIT investing philosophy? A: We are a total return-focused investor. We do not stretch for the higher-yielding REITs just to get income. Since all REITs generate higher dividends than the broad market, we can focus on higher quality companies and still get good dividend yield. Q: Can you describe your research approach? A: We conduct research at three levels: financial analysis, property analysis, and qualitative analysis. During the financial analysis, which is focused on the balance sheet and income statement, we are looking for a strong balance sheet that is not heavily leveraged. We also try to understand the quality and recurrence of cash flows. While conducting property-level analysis we look at the property portfolio. We differentiate the real estate quality from the cash flow quality. Lower-quality cash flow implies higher credit risk, but lower real estate quality does not imply higher risk. We think that kind of real estate is just a different real estate class. In the right market environment Class B property can produce higher returns than the Class A property. So we try to focus on understanding the real estate quality in addition to the competitiveness of the properties that our companies hold. Our qualitative analysis is focused on the corporate structure and management ability to formulate and execute long-term plans that will add shareholder value. Our focus is also to diversify across property types, such as multi-family, hotels, office and industrial properties, and geographic regions. Q: Can you discuss how you pick a REIT and share with us one of your recent picks? A: We are focused on finding companies that meet our criteria on the three research aspects I just described. We focus on the company, not the sector. Duke Realty is a company focused on office and industrial properties in the Midwest. The company continued to outperform during the late nineties even when the California-focused REITs were in demand. The Midwest is a relatively slow growth market. But even with that, the company continued to deliver strong revenue and earnings growth and above-average R.O.E. They have highly sought-after real estate development expertise and have a very competitive portfolio of properties in their markets. Even while their markets have below-average rental growth and high vacancy levels, their assets significantly outperformed the market. This is because of management strength, the competitiveness of their portfolio, and their development expertise. Q: Are you a long-term investor? A: We generally manage with low turnover and invest for the longer-term in quality REITs. However, we are price-target driven and not time-frame driven. Q: The popular perception is that rising interest rates will hurt the REIT business. What are your views on that? A: The basic demand for REITs is coming from economic health, job and wage increases and population growth in specific markets. In our view, we are entering in a long period of rising rates. When they start to rise, the important issue will be the magnitude and the severity of the increases. Currently rates are moving very slowly, and that is positive for REITs. Dividend growth rate for the last seven years has been about 7%. This offsets the interest rates fear. Some people fear that REITs have a lot of variable debt, but the reality is different. Most REITs have little or no variable debt. I believe that the coming period of rising interest rate will also reflect higher level of vitality in the economic environment. Q: Why are convertible securities in the fund? A: Convertible securities form 15% of the fund with approximately 25 securities. They are less volatile relative to the bond and equities and have the upside participation of the equities. The convertibles allows us to have exposure to other parts of the market that we can not get through REITs, high yield bonds, or large cap value. It also allows us to leverage the expertise of the research that we have in other sectors such as mid- and large-cap equities. For example, Constellation Brands is a small cap company. We have this company's convertible bonds, and we believe that we will have 75% or more of the upside when the company's common stock appreciates. The company is one of the largest distributors of imported alcoholic beverages from Mexico and Australia. The fund is designed for the risk-adverse investor who is looking to round out the well-diversified portfolio, who has high need for income, and who demands lower price volatility. Q: Tim, how is the High Yield sector contributing to the fund? A: This portion of the fund has 100 to 150 securities in the portfolio that are non-investment grade bonds, that versus the Bear Stearns High Yield index have slightly higher credit risk so the portfolio outyields the benchmark. We base our investment process on security selection to generate alpha, therefore relying less on macro level analysis to effect performance. Our average position is 0.75%, which gives us ample diversification, but a focused enough portfolio to allow our bottom-up philosophy to work. In the past, we have underweighted healthcare because of the fundamentals and underweighted gaming because of the yield in the sector. We have not owned airline bonds, but inside the transportation sector we have been in shipping bonds because it has more stable cash flow than the airline sector.