Asset allocation: What you should know

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1 Summer 2006 Delaware Digest Asset allocation: What you should know Asset allocation is an investment technique for diversifying investments across a variety of asset classes such as stocks, bonds, real estate, and cash to balance potential return and risk for your situation and investment goals. Because each asset class has unique risk and return characteristics, different investments may perform differently in certain market conditions. As such, diversification may help limit volatility in a portfolio of investments. It is a key concept in financial planning although it does not ensure a profit or protect against loss in a declining market. A landmark study* found that 90 percent of the variability within a portfolio s return over time is directly attributable to asset allocation. This means that the structure of your investment portfolio will have a substantial effect on your investment results. Your financial advisor can help you select an investment mix that is best suited to help you meet your financial goals. When constructing a diversified portfolio, think about what many consider the three most significant factors: your financial goals, tolerance for risk, and time horizon. Financial goals Your financial goals are unique and may change over time. As you speak with your advisor, you may want to think of the investment life cycle in four major phases. Consider how each of the following phases would be defined for you, given your personal situation. (continued on page 2) * Determinants of Portfolio Performance II by Gary P. Brinson, Randolph L. Hood, and Gilbert L. Beebower. Financial Analysts Journal, January/February Also in this issue Delaware Foundation Funds Delaware International Fund gains a global perspective

2 Asset allocation: What you should know (continued from front cover) Accumulation 1. Accumulation. This period of seeking capital appreciation is typically the longest stage for many people, starting when you save your first dollar. It typically ends in the period just before you achieve key financial goals or when protecting your assets becomes a priority. 2. Protection. During this stage you as an investor aim to protect accumulated assets, possibly by strategically reducing portfolio risks. Prior to retirement, for example, you may be likely to move assets into a more stable investment option. This strategy is intended to protect the assets from loss and short-term market fluctuations. 3. Income management. A time typically comes for most investors when the need to secure adequate current income becomes apparent. In retirement, for example, an investor may strive to maintain a steady stream of income but preserve as much principal as possible. 4. Transfer. Wealth is transferred from one individual to another during this stage. An advisor well-versed in estate planning can help you plan for when an inheritance gets passed from the original investor to the beneficiary. As you consider these broad phases, your advisor can help you define them in your particular situation based on your own risk tolerance and time horizon. Protection Income Management Transfer Risk tolerance Investments with greater potential for return also have greater levels of risk. Generally, the greater the potential for gain, the greater the potential for loss. Understanding the trade-off between risk and return is a key to building successful asset allocation strategies. It is important to work with your financial advisor to figure out your tolerance for risk before selecting investments. One way to determine your comfort level with risk may be to consider questions such as: How would I feel if I lost 10 percent of my principal investment? What about 25, 50, or 75 percent? Many financial advisors and planners use these and similar questions about clients financial situations and personalities to build detailed investment profiles. Be prepared to work with your advisor to answer questions and provide adequate information so that together you can gain a strong understanding of your tolerance for investment risk. Time horizon Investors save for a variety of reasons. Your goal might be to purchase a luxury item such as a new sports car, to finance a child s education, or to prepare for retirement. Whatever your goal, when you expect to attain it is something that needs to be defined. Many investors have multiple financial goals, which adds a degree of complexity to their personal situations. The time frame of each goal may be quite different, and your advisor can help you determine one or more investment strategies designed to meet those goals.

3 It is impossible to completely eliminate risk, but diversifying investments may reduce overall portfolio volatility. Financial advisors typically recommend less volatile investments for money that will be needed in shorter time periods and higher-risk investments for funds that won t be needed for 10 years or more. This strategy may decrease the risk that you could lose part or all of your principal that has been invested for shorter time frames while giving longer-term investments the potential to grow. Keeping balanced Shifting market conditions can change the percentage of your allocations over time, possibly leaving your portfolio out of kilter with your original investment plan. An out-of-balance portfolio may be susceptible to increased risk. Not only may financial goals change throughout your life cycle, but different investments also grow at different rates. Over time this could lead to an unbalanced asset allocation strategy. That s why it is prudent for investors to work with their financial advisors to periodically review their investment plans. An investor should always consider financial goals, risk tolerance, and time horizon when reviewing his or her investment mix, whether it be a first-time review or a periodic rebalance. n

4 Mutual fund spotlight: Delaware Foundation Funds Manager views expressed in this article were current as of April 2006, are subject to change, and may not reflect the Fund manager s current views. Views should not be considered a recommendation to buy or sell securities and should not be relied on as research or investment advice. Consult your financial advisor for advice on how to appropriately structure your portfolio. As noted in this quarter s newsletter, an investor s asset allocation strategy is important. To meet the changing needs of investors throughout their lives, Delaware Foundation Funds offer three different portfolios designed for investors who have specific goals and levels of tolerance for risk. These three portfolios offer varying levels of income and growth potential and corresponding variations of risk. Each portfolio relies on an active management approach to asset allocation and invests in a select group of Delaware Investments funds to best attain its investment objective. What are Foundation Funds? Each portfolio is a type of mutual fund known as a fund of funds. A fund of funds typically invests in other mutual funds rather than individual securities. At Delaware Investments, we believe that a fund of funds can be an efficient way to provide investors with active asset allocation services and to help meet investors specific needs at various stages of life and wealth accumulation. The potential benefits of such a strategy are three-fold. 1. By investing in a number of mutual funds, investors gain an extra layer of diversification* through broadly varied individual securities. 2. The structure also provides access to the investment expertise of multiple professional asset managers at a lower initial cost than may otherwise be possible ($1,000 is the minimum initial investment for Delaware Foundation Funds). 3. A professional portfolio manager makes the asset allocation decisions. Professional management of the asset allocation decision may be less attractive *Diversification does not assure a profit or protect against loss in a declining market. Portfolio name Delaware Aggressive Allocation Portfolio Fund invests primarily in In Delaware Investments equity funds and securities more so than in fixed income funds and securities. Typically, the portfolio will invest between 45% and 75% in U.S. equity funds or securities, between 10% and 30% of its net assets in international funds or securities, and between 5% and 35% in fixed income funds or securities. Delaware Moderate Allocation Portfolio Delaware Investments equity, fixed income, and international funds. Under normal circumstances, the portfolio will invest 35% to 65% of its net assets in equity funds and securities, between 25% of its net assets in fixed income funds and securities, and between 5% and 20% of net assets in international equity funds or securities. Delaware Conservative Allocation Portfolio Delaware Investments fixed income and equity funds. The portfolio will typically have a larger percentage of its assets allocated to fixed income funds and securities (between 20% and 50%) than to equity funds and securities (between 45% and 75%). The portfolio may allocate up to 10% to international funds and securities.

5 to some types of investors who wish to maintain greater control or rebalance their assets more frequently. You and your advisor ultimately must decide where control of the asset allocation decision should reside. For example, the Foundation Fund portfolios typically hold a variety of mutual funds, some of which invest in assets with specialized risks. While each portfolio is managed so that its aggregate risk meets a specific risk profile, investors seeking to avoid certain types of assets altogether may find a custom asset mix preferable or more suitable. Likewise, investors with very specific income needs or those favoring a hands-on approach may prefer a more personalized asset allocation. Plus, each of the underlying mutual funds within the Foundation Fund portfolios are subject to varying degrees of market risk. These risks should be discussed with your financial advisor when determining an appropriate investment portfolio. For instance, high-yielding, non-investmentgrade bonds ( junk bonds ) have a higher risk than investment-grade bonds. Adverse conditions may affect the bond issuer s ability to pay interest and principal on these securities. Mutual funds investing in small- or medium-sized company stocks typically involve greater risk, particularly in the short term, than funds investing in larger, more established companies. International investing also poses special risks, such as significant volatility in individual markets, currency fluctuations, and political and economical uncertainties. Furthermore, funds that invest in REITs are subject to many of the risks associated with direct real estate ownership and, as such, may be adversely affected by declines in real estate values, and general and local economic conditions. Funds that invest a significant portion of their assets in one industry or in related industries may involve greater risks than more diversified funds, including greater potential for volatility. Investing in emerging markets can be riskier than investing in wellestablished foreign markets. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value (continued on page 6) Best suited investors are Additional information In the earlier stage of wealth accumulation, generally with Class NASDAQ CUSIP Inception date higher risk tolerance. A DFGAX /31/97 Looking for the capital appreciation potential of the stock B DFGDX /31/97 market and who have no need for current income. C DFGCX /31/97 R DFGRX /02/03 In the wealth accumulation phase, generally with moderate risk tolerance. Looking for the capital appreciation potential of the stock market and the income potential of the bond market. A DFBAX /31/97 B DFBBX /31/97 C DFBCX /31/97 R DFBRX /02/03 In the wealth preservation phase, generally with lower risk tolerance. In the pre-retirement or retirement phase, looking for an increase in income. A DFIAX /31/97 B DFIDX /31/97 C DFICX /31/97 R DFIRX /02/03

6 Mutual fund spotlight: Delaware Foundation Funds (continued from page 5) of the investment at $1.00 per share, it is possible to lose money. Reaching goals through active management For Delaware Foundation Funds, active asset allocation strategy begins with an evaluation of three key factors: The expected return of specific asset classes such as equities or fixed income securities. The expected volatility or degree to which returns of each asset class has varied from one period to the next. The correlation of various asset classes (that is, the degree to which two asset classes move up or down together). After analyzing this information and determining how much of each portfolio will be allocated to a particular asset class, the managers then select specific Delaware Investments mutual funds for investment. For example, as of March 31, 2006, the management team had strategically positioned the portfolios to benefit from shorter-term cash instruments and large-cap, dividendpaying stocks in measures appropriate to the portfolio s objectives. According to Patrick P. Coyne, executive vice president, managing director, head of equity investments and senior portfolio manager for the Delaware Foundation Funds, conditions this past spring warranted a focus on money market instruments on the fixed income side and large-cap stocks on the equity side. We re currently holding overweight positions in equity-focused mutual funds for all three portfolios, compared to our target allocations said Mr. Coyne in April The 10-year Treasury bond is currently trading around 4.85% and shorter-term instruments are trading only slightly lower. At the same time, larger stocks, particularly those within the value universe, are offering strong dividend yields. The Foundation Funds management team meets regularly to discuss the asset allocation in light of such considerations. Note, however, that the team does not make dramatic portfolio moves and that it maintains exposure to all the major asset groups. The managers make incremental moves that they feel will add value when markets shift. According to Mr. Coyne, the most attractive benefit of Delaware Foundation Funds is that they offer professional allocation and, more importantly, diversification among many investment products. Furthermore, the Funds may help average investors maintain the discipline needed to stay fully invested during changing market conditions. Keep in mind that an investment in a Delaware Foundation Fund is not a complete investment program; it should be considered just one part of your total financial plan. Be sure to discuss these Funds with your financial advisor to determine whether they are an appropriate choice for you. n Delaware Investments mutual funds are sold only by prospectus. For a prospectus of any fund, which includes information about investment objectives, risks, charges, and expenses, talk to your financial advisor or call Delaware Investments at You should consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus for Delaware Foundation Funds contains this and other important information about the investment company. Read the prospectus carefully before you invest or send money. Investments are not FDIC or NCUSIF insured or guaranteed. Investors may lose principal.

7 Delaware International Fund gains a global perspective On December 15, 2005, the Board of Trustees approved changes to the Delaware International Small Cap Value Fund that will herald a new era for the Fund and the Delaware Investments international asset management capabilities. These changes, effective March 30, 2006, refocused the Fund s investment strategies and policies, welcomed new management to the Fund, and re-named the fund Delaware Global Value Fund to better reflect its modified investment strategy. Delaware Global Value Fund takes a global approach to value-style investing, selecting securities from among the U.S. markets as well as developed and emerging international markets. Foreign investments are subject Fundamental research and analysis are to risks not ordinarily associated the driving forces behind each security with domestic investments, such chosen by the Fund s portfolio managers. as currency, economic and Security selection is based on relative political risks, and different value comparisons, applying the team s accounting standards. understanding of industry cycles, global Funds that invest small- or midsize stocks typically have greater competitors, and company-specific variables. The investment process risk, particularly in the short term, combines quantitative valuation screens than those investing in larger, with traditional in-depth fundamental more established companies. analysis, experienced judgment, and patience. The new global focus also Investing in emerging markets allows the Fund s managers to invest in can be riskier than investing in both domestic and foreign securities, as well-established foreign markets. opposed to an international focus, which implies investing solely in non-u.s. securities. (continued on page 8) The Fund invests in both U.S. and foreign markets, taking a value-oriented approach to each.

8 Delaware International Fund gains a global perspective (continued from page 7) As of April 2006, the Fund held approximately 53% of its assets in international stocks, 44% in domestic U.S. stocks, and 3% in short-term cash instruments. The domestic portion of the Fund is co-managed by D. Tysen Nutt, Jordan L. Irving, Anthony A. Lombardi, and Robert A. Vogel Jr., of the Delaware Investments Large Cap Value Focus team. The international portion of the Fund is co-managed by Zoë A. Neale and Edward A. Gray of the Delaware Investments International Equity team. The Fund s portfolio managers believe that their dedication to bottom-up security selection, quantitative research, and a value-focused approach gives them insight into a security s true value, as well as the ability to achieve greater potential for returns. n Delaware Investments mutual funds are sold only by prospectus. For a prospectus of any fund, which includes information about investment objectives, risks, charges, and expenses, talk to your financial advisor or call Delaware Investments at You should consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus for Delaware Global Value Fund contains this and other important information about the investment company. Read the prospectus carefully before you invest or send money. Investments are not FDIC or NCUSIF insured or guaranteed. Investors may lose principal. How to contact us Online access to account and fund information Shareholder Service Monday through Friday 8:00 a.m. 7:00 p.m. ET Hearing Impaired Monday through Friday 8:00 a.m. 7:00 p.m. ET Delaphone Automated Phone Service FUND (3863) Touchtone access to account and fund information 24 hours a day 7 days a week Shareholder Service Center service@delinvest.com (Personal account information should not be sent by ) Account Deposits Delaware Investments PO Box Kansas City, MO Written Correspondence Delaware Investments PO Box Kansas City, MO Delaware edelivery Access your fund documents online Comments? Questions positioning@delinvest.com Editorial: Alaina Tweddale, Holly Powitzky, Roseann D Angelo, and Barry Slawter Design: Matthew Cummins Production: Donna Pendrak Delaware Investments is the marketing name for Delaware Management Holdings Inc. and its subsidiaries. Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates. For a prospectus of any Delaware Investments mutual fund, which includes information about investment objectives, risks, charges, and expenses, talk to your financial advisor or call Delaware Investments at Read the prospectus carefully before you invest or send money. Investments are not FDIC or NCUSIF insured, or not guaranteed. Investments may lose principal. (477) NEWS_0604_DGST PO10991 Delaware Distributors, L.P. ST-DIG [--] SP 06/06