As of 09-30-2017

Market Overview

During the third quarter of 2017, the S&P 500 returned 4.5% as global risk assets ended the period higher. Despite a period of geopolitically induced volatility mid-quarter, risk assets rebounded and ended the period solidly higher. The notable feature across asset classes was near-record-low volatility.

Fund Performance

The third-quarter return for Federated Absolute Return Fund was 0.21% (Class A Shares at net asset value, or NAV). This was slightly below the benchmark return and below the fund’s peer group median return. The median Lipper Absolute Return category fund return was 1.13% and the total return for the fund’s benchmark, the Bank of America Merrill Lynch 91-Day Treasury Bill Index, was 0.27% for the same period.

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 helped by net gains on the long/short equity holdings. The gains from long equity and call-option positions were greater than the losses from short equity positions (including put options and short index futures). The Information Technology stock holdings were responsible for the majority of the fund’s equity-related gains.

Fixed income short positions produced modest losses in the period driven by slightly lower 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

Fund management positioned the fund 33% net long equities to begin the quarter. Fund management believed that equity markets set up well for positive returns due to low credit spreads and volatility levels, attractive free cash-flow yields in various segments of the equity market and low expectations for global economic growth and corporate earnings.

While global markets ended the period much as fund management had expected, the path was more volatile. Geopolitical tensions around North Korea caused volatility to rise and risk assets to underperform in the middle of the period. Because our macro framework is respectful of risk indicators, we reduced the fund’s equity positioning in the middle of the period, actually moving net short at one point. However, risk assets responded favorably and were able to shrug off geopolitical risks and lack of progress in Washington to move to new highs.

As it became evident market internals (relative performance of small caps, transports, emerging markets and credit markets) were improving later in the period, fund management increased the fund’s equity positioning to end the period 31% net long equities.

The thesis and positioning for the non-equity portion of the portfolio did not change materially during the quarter. We continue to be positioned to benefit from increases in European interest rates and increases in the U.S. dollar versus various developed-market currencies. The rationale for the interest rate view is that global central bankers (most notably in Europe) have suppressed interest rates below normal levels with massive bond-purchase programs. Now that the U.S. Federal Reserve has ceased new bond purchases and has a plan to slow reinvestment, we believe other global central bankers will follow with a lag, which will pressure interest rates upward. The view on the U.S. dollar is partly based on fund management’s belief that positioning is too bearish in the U.S. dollar and the tendency will be for it to move higher going forward.

With market volatility near record lows exiting the period, we continue to maintain put-option positions in the portfolio that are designed to help reduce our equity-market exposure should the market decline materially for any reason. Fund management feels that return strategies that systematically short volatility (essentially writing market insurance) have become a crowded trade that could quickly unravel if risk markets were to decline abruptly for any reason. This means that volatility could spike very high at some point, which would increase the value of the fund’s put-option holdings, all else equal. Federal regulations of the financial markets after the financial crisis have moved the chief market risk from capital requirements of large financial institutions to market liquidity, in the opinion of fund management, as large financial companies devote much less capital to making markets and more to bolstering their balance sheets.

Key Investment Team