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European bets help Delaware team grab top Lipper award

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[March 27, 2014]  By Tim McLaughlin

(Reuters)  Bets on financial companies and Europe's beat-up economy helped maintain a decade-long winning streak at the Delaware Extended Duration Bond Fund rolling in 2013.

The $603 million Delaware fund recently received the U.S. Lipper 2014 Excellence in Fund Management award. It swept Lipper's 3-year, 5-year and 10-year categories for corporate debt BBB-rated funds.

The fund has been the top dog in a field with some big stars, including Dan Fuss, whose track record at Loomis Sayles has earned him the nickname "The Buffett of Bonds."

"The fixed income team at Delaware has done an outstanding job delivering top performance in a field crowded with talent," said Jeff Tjornehoj, head of Lipper Americas Research. He also cited Mark Kiesel at Pimco as a tough competitor.

Tjornehoj said the Delaware fund dives into longer maturities and emerges with terrific results.

"Relative to many of its peers, it's not the smoothest ride for investors," Tjornehoj said. "But over the long run, they've actually delivered less volatility than the fund's benchmark while still beating it substantially by almost two percentage points per year over the last ten years."

The Delaware fund can also be contrarian, not unlike a stock picker who looks for value in places that other investors flee, said Tom Chow, senior vice president and chief investment officer of corporate credit at Delaware Investments. The company is part of Macquarie Group Ltd.

"We know what's in the benchmark. But we don't just invest in names in the benchmark. We do our own homework," Chow said.

In the fiscal year ended July 31, the fund had plenty of exposure to Europe, despite its instability. The fund benefited from investments in Spanish telecommunications provider Telefonica and Italian wireless operator Wind Telecom as it focused on industries with defensive credit characteristics, such as steady cash flow.

"Credit markets are a fascinating place," Chow said. "There are all shades of colors, rather than black and white. It's what keeps things interesting."

The fund's average annual return over the past 10 years was 8.3 percent as of March 25, easily beating the 5.15 percent return on the Barclays Long U.S. Corporate Index. The fund's net expense ratio is 0.96 percent on an annual basis.

As an investor in corporate debt, the fund looks for stability and consistency, Chow said.

"We don't necessarily need growth for the company to meet their obligations to us," Chow said.

The fund says it takes a bond-by-bond approach to find undervalued issuers but stays away from debt with unattractive risk-return profiles.

Over the past year, the fund saw strength in the financial sector. Bonds of U.K.-based bank Lloyds TSB Bank Plc and U.S. insurance companies American International Group Inc and MetLife Inc helped lift the fund's performance. Another U.S. insurance provider, Prudential Financial Inc, also boosted the fund's results, according to disclosures to investors.

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The fund is supported by what Chow describes as a flat organization of 85 people. Portfolio managers, traders and researchers work together constantly to protect the fund from being whipsawed by risk.

They have conversations about bond credit quality daily, if not hourly, Chow said.

As the U.S. economy stabilizes, Chow has been watching how some corporate management teams become more preferential toward stock investors versus debtholders. Examples include borrowing money at historically low interest rates to repurchase company stock or for corporate takeovers.

Those kinds of moves can boost shareholder value and won't likely become a problem for debtholders in A-rated companies, even if the economy sours or operations encounter headwinds. But companies with higher leverage and less resources may not be as resilient, Chow said.

"If operations slow down, you generate less cash. That can turn into a problem for bondholders," he said.

During the 2013 fiscal year, the fund was hurt by exposure to Barrick Gold Corp, the world's biggest gold miner. A 28 percent dive in bullion prices caught producers by surprise, putting balance sheets under stress.

Delaware bond funds, including the extended duration fund, sidestepped some of Barrick's problems by being nimble.

"We actively managed the funds' positions in these holdings, periodically increasing the funds' exposure at lower prices while reducing the funds' allocations as the securities began to recover," Delaware Investments said in its annual report to bond fund investors.

(Reporting by Tim McLaughlin; editing by Lauren Young and Jeffrey Benkoe)

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