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The first quarter of 2016 started with a sell-off that led to the market’s worst five-day start ever. Fears surrounding negative earnings growth, the global growth slowdown and a lack of confidence in central banks’ stimulus programs were key contributors. This set the tone for a lingering bearish sentiment that plagued the market throughout the rest of the quarter. Global markets became nervous as Chinese officials further devalued the yuan, causing recession fears, similar to the pattern in the August 2015 sell-off. Macro concerns led to lower oil prices, which added to deflationary worries by central banks, causing many to bolster monetary stimulus programs, mainly outside of the U.S. These negative headlines drove investors to typical haven assets such as gold, fixed income and value stocks. However, positive economic data led to a steady rebound in commodities and the U.S. stock market back to positive territory for the quarter. This macro-focused quarter of fear left Federated Kaufmann Large Cap Fund to underperform its benchmark Russell 1000 Growth Index during the first quarter of 2016.
Large-cap value stocks outperformed the large-cap growth stocks for the first time since the fourth quarter of 2014. The Russell Midcap Index, representing mid-cap stocks, returned 2.23%, followed by the Russell 1000 Index, representing large-cap stocks, which returned 1.17%, followed by the Russell 2000 Index, representing small-cap stocks, which returned -1.53%. The best-performing sector in the Russell Large-Cap Growth Index was Telecom Services, up 16.71%, followed by Utilities, up 10.61%, and Consumer Staples, up 5.68%. The worst-performing sectors were Health Care, down 8.98%, followed by Energy, down 8.01%, followed by Financials, down 1.23% for the quarter.
Stocks eventually rebounded from the dramatic sell-off that started the year. The global sell-off impacted the Federal Reserve’s decision to hold off its rate hike timetable to potentially wait for data to support further hikes. Credit-market worries subsided as the commodity sell-off abated along with the market rebound. We remain positive on the U.S. economy, which is driven by a consumer helped by depressed energy prices and a low unemployment rate along with still historically-low interest rates.
For the first quarter of 2016, Federated Kaufmann Large Cap Fund returned -3.19% (A Shares at NAV) while its benchmark Russell 1000 Growth Index returned 0.74%. Stock selection was the primary contributor to underperformance, but sector weighting also drove underperformance according to our attribution analysis. Despite the fund’s well-performing assets, multiple compression from macro concerns had a material impact on many holdings. Sectors that have historically been significant contributors for the strategy, Information Technology, Health Care and Financials, had very poor absolute and relative performance. An approximate allocation of 6.77% to cash, on average, had a positive impact on fund 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 Class A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance
Stocks that contributed to performance were from the Consumer Discretionary and Material sectors. Those stocks included Whirlpool Corporation, Vantiv, Sherwin Williams, Facebook Inc. and TJX Cos. Specific to Sherwin Williams, the largest U.S. paint and coatings producer, investors responded favorably to a positive earnings report along with the company’s announced intention to acquire a large competitor, Valspar. If approved, this would be the largest acquisition in the company’s history. Another major contributor to performance was Facebook. Facebook’s reported earnings exhibited its dominance in the social media space with advertising growth of more than 60% year-over-year and a mid-teen daily active user base, of which were positively embraced by investors.
Laggard companies that hurt performance during the quarter were primarily from the pharmaceutical and biotech subsectors. These included: Shire Pharmaceuticals, Allergan Plc., Alexion Pharmaceuticals, Incyte Pharmaceuticals and Vertex Pharmaceuticals. The Health Care sector, and more specifically the pharmaceutical and biotech subsectors, have been under pressure for a number of months after serving as significant positive contributors to performance for a number of years. Recent political posturing during the election campaigns, negative news headlines from mismanaged competitors and overall aversion to riskier assets contributed to the continued pressure on the group.
Click on the Portfolio Characteristics tab for the fund’s top 10 holdings
Our mission at Federated Kaufmann is to pursue superior long-term performance by investing in promising large cap 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 weighting.
This quarter approximately 79% of the portfolio was invested in four sectors: Health Care, Information Technology, Consumer Discretionary and Financials. These sectors have historically provided good opportunities for bottom-up growth investors. However, the aversion to riskier asset classes during the first quarter negatively impacted these groups with the exception of Consumer Discretionary. The pull-back in some of the fund’s holdings created buying opportunities and allowed fund management to deploy capital to specific holdings.
The fund’s average cash position during the quarter was approximately 6.77%. The portfolio started the year with approximately 10% in cash but ended the quarter with approximately 2%. The change in cash levels was primarily driven by fund managers deploying capital judiciously to new and current holdings that they believed offered significant value given their depressed prices.
We continue to seek attractive large-cap 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. We believe that such strong growth companies, if purchased at attractive prices, can provide investors with the opportunity for superior returns over the long term.