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The fourth quarter of 2016 took investors by surprise as the U.S. presidential election produced a largely unexpected outcome. Not only had the Republican Party retained control of both houses of Congress by a wider-than-expected margin, but real estate mogul and Washington outsider Donald J. Trump beat the heavily favored former Secretary of State and first lady, Hilary Clinton. Trump’s pro-business stance, combined with improving U.S. economic data, shifted the lingering investor uncertainty of 2016 to end the year on a positive note.
The surprising election outcome turned investors’ focus to macro topics such as changes in policies and their potential impacts on markets and the economy. Strong expectations of policy changes had many equity investors chasing sectors that may benefit from those perceived changes. Therefore, the fund’s strategy of fundamental analysis of company-specific growth catalysts led Federated Kaufmann Large Cap Fund to underperform its benchmark, the Russell 1000 Growth Index in the fourth quarter of 2016.
A strong dollar, higher interest rates and U.S. fiscal stimulus talk drove both value and small-cap stocks higher in the quarter. Mid-cap value stocks outperformed mid-cap growth stocks, continuing the trend from the first part of the year. Small-cap stocks continued their outperformance for another quarter with the Russell 2000 Index outperforming the Russell Mid Cap Index, the Russell 1000 as well as S&P 500 Index, by gaining 8.82%. The Russell 1000 Index, representing large-cap stocks, and the S&P 500 Index both gained 3.82%. The Russell Midcap Index, representing mid-cap stocks, gained 3.2%.
The best-performing sectors in the Russell Large-Cap Growth Index were Industrials, up 6.9%, followed by Financials, up 6.68%, and Telecom, up 4.55%. The worst-performing sectors were Real Estate, down 5.25%, followed by Health Care, down 3.54%, and Energy, down 0.89% for the fourth quarter of 2016.
During the fourth quarter of 2016, most developed-country stock markets had positive returns as positive economic data pushed inflation and interest rates higher from record lows earlier in the year. The data from the U.S. economy boosted U.S. stocks as gross domestic product (GDP) was revised higher for the third quarter. The University of Michigan’s consumer sentiment index surged to its second highest reading since 2004, and building permits for single family homes rose to their highest level in nine years. The European markets also benefited from encouraging data as German manufacturing orders and retail sales surged and French business sentiment rose to its highest level since 2011. Most large economies remained in expansionary mode, with global PMI’s continuing to accelerate from the swoon seen last year. Oil and commodity prices continued their rally after OPEC and Russia agreed to production cuts in the future. The U.S. economy picked up as businesses reacted to better economic data as well as potential policy changes that could impact productivity investment which has lagged during the current recovery. All of these positive factors underscored the fund’s positive stance on equities.
Federated Kaufmann Large Cap Fund returned 0.10% (A shares at NAV) while its benchmark, the Russell 1000 Growth Index, returned 1.01% during the fourth quarter of 2016. Stock selection was the primary contributor to underperformance according to our attribution analysis. Having approximately 8.23% in cash, on average, also had a negative impact on the fund’s relative performance.
Performance 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 A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
The fourth quarter displayed a dramatic shift in sentiment and heightened volatility that created opportunities for fund management to deploy cash into investments that included Regeneron, Incyte, Bristol-Myers, Tenaris, Raytheon, Edward Life Sciences and Constellation Brands.
Fund management exited positions in Medtronic, CVS Health and Dexcom during the quarter.
Stocks that contributed positively to performance included: JP Morgan Chase, T-Mobile US, Inc, Hilton Worldwide, CBRE Group and American International Group. Companies that hurt performance during the quarter included: Dexcom, Medtronic, Alibaba Group, Facebook and Amazon.
Click on the Portfolio Characteristics tab for the fund’s top 10 holdings.
Fund Positioning and Strategy
Our mission at Federated Kaufmann is to invest in promising growth companies trading at attractive valuations through proprietary fundamental research. The sector weightings of the portfolio is a byproduct of our bottom-up stock selection strategy with a team of sector-specialist portfolio managers. We seek to find companies that have company-specific catalysts for growth rather than develop macro themes to construct a sector weightings.
During the fourth quarter of 2016, approximately 72% of the portfolio was invested in four sectors: Health Care, Information Technology, Consumer Discretionary and Industrials. These sectors have historically provided good opportunities for bottom-up growth investors. The fund’s average cash position was approximately 8.23% during the quarter, which had a negative impact on the fund’s relative performance.
We continued to find attractive growth investment opportunities—companies that are dominant competitors and that have strengthening fundamentals delivering both near-term and long-term growth in sales and earnings.