Federated Prudent DollarBear Fund (A) PSAFX
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|C IS||Mutual Fund||Alternative and Objective-Based||World Bond|
The first quarter of 2014 provided a continuation of extraordinary global policymaking, economic and market backdrops. Global risk markets traded with more of a “risk off” tenor during the reporting period’s initial weeks, before an abrupt reversal saw the reemergence of the prevailing “risk on” speculative dynamic.
Overall, U.S. equities posted gains for the fifth consecutive quarter, although stocks were somewhat outdone by the ongoing strong performance of U.S. credit. Global bond markets for the most part enjoyed solid first-quarter gains. Many emerging markets were notably robust in the face of ongoing headwinds, perhaps somewhat fueled by short covering. Positive sentiment continued to support major advances in European periphery bonds, although European currency performance was mixed. Crosscurrents were prevalent across global risk markets. While bond markets benefited from the perception that global disinflationary forces were gaining the upper hand, many commodities enjoyed strong first-quarter bounces.
Since September 2008, the Federal Reserve’s (the Fed’s) balance sheet has ballooned from about $900 billion to over $4.2 trillion. If tapering runs its expected course, quantitative easing (QE) will end late in 2014 with the Fed’s balance sheet near $4.5 trillion. This would leave the latest round of QE totaling almost $1.7 TN, with the Fed’s balance sheet having expanded 60% in two years. Fed assets will have grown $3.6 trillion, or 400%, over the past six years.
From the management team’s perspective, global markets have been distorted by a prolonged period of unprecedented monetary stimulus. Central bank liquidity backstops have for years incentivized risk-taking and speculation. An extended period of strong returns has spurred increasingly conspicuous excess along with deep-seated complacency. A perception has taken hold that market or economic weakness will be met with only more policy stimulus. As the managers see it, ebullient markets have too readily accepted recent negative developments in a positive light.
The consensus view holds that heightened financial and economic vulnerability in China will surely be met with another round of aggressive fiscal and monetary stimulus. The dovish Yellen Fed will retreat from tapering and further delay rate increases at the first indication of stress. Moreover, the Fed’s mandate will likely dictate another round of QE to combat insufficient consumer inflation. Markets also anticipate that the European Central Bank will soon adopt quantitative easing in its battle against deflation. Similar expectations have the Bank of Japan erring on the side of ramping up its “money-printing” operations.
The management team believes the global market backdrop has been heavily influenced by an unstable “risk-on/risk-off” speculative dynamic. Over-liquefied markets have generally been content to disregard important fundamental developments. The managers believe the Chinese economy and credit system are more vulnerable than is generally perceived. There remains considerable uncertainty associated with Chinese policymaking, from the perspective of fiscal stimulus, monetary policy and currency management. Furthermore, the managers see the Ukraine crisis as symptomatic of an alarming deterioration in the geopolitical backdrop.
The managers also believe a more hawkish ethos is taking shape at the Fed. While the dovish contingent appears undeterred, an increasingly vocal group of Fed officials view quantitative easing in terms of diminished benefits outweighed by escalating risks. Led by Federal Reserve Bank of Dallas President Richard Fisher, an emboldened faction appears determined to transition back to more traditional monetary policy. While this would be expected to unfold over months, the managers anticipate a more restrained Fed reluctant to use its balance sheet to bolster the markets.
Throughout the reporting period, currency markets were again buffeted by an array of policy, market and economic crosscurrents. The US Dollar Index (USD Index) ended the reporting period about unchanged, although there was volatility throughout the quarter. In general, currency markets remained unsettled with a wide dispersion of currency returns.
For the first quarter of 2014, the USD Index increased 0.08%. The euro posted a small 0.19% gain versus the dollar. The Japanese yen gained 2.01% and the Singapore dollar increased 0.44%. The British pound gained 0.63% and the Swiss franc increased 0.94%. The Norwegian krone increased 1.39%, while the Swedish krona declined 0.54%. The commodity currencies were mixed. The Canadian dollar declined 3.86%, while the Australian dollar gained 3.89% and the New Zealand dollar increased 5.47% against the U.S. currency.
The first quarter 2014 return for Federated Prudent DollarBear Fund was 0.27% (Class A Shares at NAV). The return for the inverse of the USD Index was -0.08% for the same period. Fund performance benefited from U.S. dollar weakness versus most currencies, as well as from gains in gold stocks.
The fund’s gold positions somewhat underperformed the 10.9% first quarter gain in the NYSE Arca Gold Bugs (“HUI”) Index. The fund’s overall gold allocation ended the quarter at 5.0% of fund assets.
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 4.5% sales charge for Class A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
Fund performance benefited from gains in the Japanese yen, Australian dollar, New Zealand dollar, Norwegian krone, Singapore dollar, Swiss franc and euro. Fund performance was hurt by declines in the Canadian dollar and Swedish krona.
The fund’s performance relative to the USD Index benefited during the first quarter of 2014 from above-index allocations to the Australian dollar, New Zealand dollar, Swiss franc, Norwegian krona and gold stocks. Performance versus the USD Index was hurt by above-benchmark allocation to the Swedish krona, along with below-index allocations to the euro and yen.
Positioning and Strategy
The fund remained somewhat defensively positioned throughout the first quarter. The allocation to U.S. dollars began the quarter at 16.4% of fund assets. The fund managers increased U.S. dollar exposure 200 basis points during the quarter to end the reporting period at 18.4% of fund assets. During March the fund managers liquidated the fund’s remaining holdings in Hong Kong dollars, a currency pegged to the U.S. dollar. With Chinese officials seemingly ending their strong yuan policy, the fund managers viewed the risk versus reward calculus for holding Hong Kong dollars as less attractive.
During the quarter, the fund managers adjusted allocations to both European and “commodity” currencies. Allocations were increased 180 basis points to the euro and 170 basis points to the Swiss franc, while the Swedish krona was reduced 250 basis points and the British pound was reduced 270 basis points. The Canadian dollar position was reduced 390 basis points. The Australian dollar was increased 240 basis points and the New Zealand dollar was boosted 140 basis points, as the managers moved to participate in the general “risk-on” backdrop. The allocation to the Japanese yen was increased 310 basis points.
The fund’s allocation to gold stocks increased 110 basis points during the reporting period. Bullion and gold-related equities were notably volatile throughout the quarter. Gold stocks performed strongly for much of the reporting period before reversing course into quarter-end. The managers were encouraged that gold appeared to be regaining haven status.
The fund managers anticipate no imminent resolution to extraordinary global financial and economic uncertainties. The liquidity backdrop remained generally constructive for “risk on” through the end of the reporting period. But the managers fear global markets have become dangerously addicted to extreme central bank monetary stimulus. The managers see myriad potential risks that could derail “risk on” and push global markets toward “risk off.” In particular, the fund managers will continue to closely monitor developments in China and the soundness of the U.S. equities market. They will remain on guard for market instability associated with the hedge fund community being caught on the wrong side of rapidly shifting markets. And especially with the Fed on course to conclude QE later in the year, the fund managers will be intensively monitoring the general liquidity backdrop.
The fund managers continue working diligently to navigate through a very challenging environment. With a disciplined approach to risk management, a sound analytical framework, and a keen focus on market dynamics, the managers believe the fund is prepared for ongoing market challenges and opportunities. And with a well-diversified global portfolio of highly-rated short-term government debt instruments, the fund managers believe the fund is well-positioned for unstable global markets.