3 Questions: Federated Bond Fund

12-07-2016

“3 Questions” delves into investment approaches used by Federated Investors strategists. This installment features Portfolio Manager Brian Ruffner.

Q: Could you briefly explain the Federated Bond Fund strategy? It’s all about U.S. corporate bonds, with investment-grade securities accounting for the majority of the portfolio and high-yield securities representing up to 35%, depending on economic conditions. When the economy is expanding, even at a slow and steady pace as is the case now, we typically have a higher allocation to high yield. When those conditions don’t exist, we tend to allocate less. In general, we believe an investment-grade focus with a strategic high-yield allocation provides an optimal mix for income and total return potential.

Our approach to portfolio construction is driven by a stringent bottom-up security-selection process; every candidate for the portfolio undergoes a fundamental analysis of its industry outlook, relative value, credit quality and structural characteristics.

Q: How is the sector performing, particularly in light of recent stronger growth and rising rates? Frankly, it’s been a good year for corporate credit—the category has experienced very positive returns despite a bumpy November for most bond sectors.

The reality is, credit sectors offer higher coupons than typical government bonds and may provide an income cushion to offset pressure on bond prices in rising-rate environments—as long as the increases are reflective of an improving economic environment, which is the current situation. Corporate profits have been solid, with the third quarter seeing a return to profit growth, while corporate balance sheets have stayed relatively healthy. All of this is good for corporate bonds. Moreover, while U.S. rates and yields remain relatively low historically, they are relatively high compared with other corners of the globe, which means we expect to continue to see strong demand from foreign buyers.

Q: What is the outlook and positioning for the strategy over the next 3 to 6 months? We would expect to retain our down-in-quality, up-in-coupon bias. While spreads—the gap between corporate bond yields and comparable-maturity Treasuries—are at or near historical medians for both investment grade and high yield, it’s typical in a cycle to see spreads narrow below medians, providing the potential for additional positive returns. We also believe the Trump administration and Republican Congress are likely to adopt some policies that are constructive for corporate bonds. For example, a reduction in corporate tax rates and a possible repatriation holiday could free up additional cash flow for U.S.-domiciled corporations, improving credit quality and benefitting bondholders via tighter credit spreads.

Thank you, Brian.