As of 09-30-2018

Market Overview

During the third quarter of 2018, the S&P 500 Index returned 7.7%. Two extreme features continued year-to-date trends: U.S. equities outperforming outside U.S. (OUS) and growth outperforming value. Volatility levels declined despite continued weak trading in emerging markets, Europe, China, global financials, autos and homebuilders.

Fund Performance

The third quarter 2018 return for Federated Absolute Return Fund was -4.82% (Class A Shares at net asset value, or NAV). This was below both the benchmark return and the fund’s peer group median return. The median Lipper Absolute Return category fund return was 0.73% and the total return for the fund’s benchmark, the Bank of America Merrill Lynch 91-Day Treasury Bill Index, was 0.49%.

Performance data quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated. Other share classes may have experienced different returns than the share class presented. To view performance current to the most recent month-end and for after tax returns, click on the Performance tab. Performance does not reflect the maximum 5.5% sales charge for Class A Shares. If included, it would reduce the performance quoted.

Click the Performance tab for standard fund performance.

The fund’s return was driven by losses on short-equity holdings (including put option, short stock and ETF, and short index futures positions). The negative contribution from the short positions was larger than the positive return from long positions (including long stock and call option positions). The fund’s long-equity holdings returned 5.75% in the quarter, less than the S&P 500 return, while the short-equity holdings rose more than the S&P 500. The worst sectors for short stock picking were Consumer Discretionary and Technology.

Fixed-income short positions produced gains in the period driven by higher interest rates in the eurozone. The fund’s total return reflected actual cash flows, transaction costs and other expenses which were not reflected in the total return of the index.

Positioning and Strategy

The fund was positioned 41% net short equities to start the third quarter, with the vast majority of this coming from put options in the S&P 500 and Russell 2000 ETFs. This was based on fund management’s belief that weak performance of OUS equities (especially emerging markets and China) and key cyclical groups such as Financials, Homebuilders and Autos could spread to U.S. equities generally.

Equity markets moved higher in the quarter, as global central bankers in August were able to communicate a plan to gradually tighten monetary policy without hurting risk assets. The Fed and the ECB were well coordinated in their moves to tighten, which helped keep the U.S. dollar contained and helped key emerging market trades/risks stabilize in the quarter. Another salient feature was that lower-quality speculative stocks within the Consumer Discretionary and Technology sectors (which the fund had short exposure) moved significantly higher.

Fund management maintained a net short position until early August and then moved to a net long position for the remainder of the quarter as it became clear central bank policy was not going to derail risk assets in the short run. Although we had shifted a portion of the fund’s short positions to put options, there were significant losses on the put option holdings as stock prices moved higher and volatility moved lower.

In the quarter we reduced our OUS long equity positions. This exposure was replaced by exposure to precious metals (through closed-end funds that own gold and silver) and call options on precious metals mining stocks. Fund management believes our expected weakening of the U.S. dollar combined with market participants’ bearish positioning in precious metals make for a favorable risk/reward in that sector.

Fund management also decreased the exposure to individual short stock positions. We generally try to do more active shorting when the risk/reward backdrop is deemed to be negative for risk assets and less active shorting when the backdrop is deemed to be more positive, as was the case exiting the quarter.

The fund was positioned 45% net long equities to end the quarter. The fund also remained positioned to benefit from higher interest rates in the European Union (through short positions in European interest-rate futures), based on the belief tightening monetary policy by the European Central Bank will drive real interest rates higher from current negative levels.


Key Investment Team