Federated Prudent DollarBear Fund (C) FPGCX

The first quarter of 2013 provided a continuation of extraordinary global policymaking, economic and market backdrops. The Federal Reserve (the Fed) moved full-speed ahead with its first major quantitative easing (QE) program in a non-crisis environment. A new central bank chief in Japan committed to do whatever it takes to generate some inflation. And in Europe, the post-“Draghi Plan” collapse in periphery bond yields ran unabated during much of the quarter, as increasingly speculative global risk markets benefitted from the perception of endless monetary stimulus.

Extraordinarily loose financial conditions and booming asset markets in the U.S. helped the marketplace look past U.S. fiscal worries. Throughout the quarter, global currency markets vacillated as analysts and traders shifted their focus between aggressive monetary measures and murky global fundamentals. As the quarter progressed, the U.S. dollar benefitted from strong U.S. securities markets and the reemergence of global stress causing safe haven investment in the U.S. markets.

For the quarter, the USD Index advanced 4.02%. After recovering from January weakness, the U.S. dollar posted strong gains against most currencies. Versus the U.S. dollar, the euro declined 2.83%, the Norwegian krone fell 4.83%, the Swiss franc dropped 3.56%, and the Swedish krona declined 0.38%. The British pound also declined 6.50% versus the dollar. Commodity currencies mostly outperformed against the U.S. dollar. The New Zealand dollar gained 1.01% and the Australian dollar increased 0.23% against the U.S. dollar. The Canadian dollar dropped 2.49% against the U.S. dollar and the Singapore dollar declined 1.49%

The first quarter 2013 return for Federated Prudent DollarBear Fund was -3.19% (Class A Shares at net asset value). The return for the inverse of the USD Index was -4.02% for the same period. Fund performance suffered from broad-based weakness in most currencies versus the U.S. dollar, in addition to losses in the fund’s gold equities holdings. With gold bullion down almost $70, the NYSE Arca Gold Bugs (“HUI”) Index suffered a first quarter decline of 19.6%. Helping to mitigate fund losses, the fund’s gold holdings continued to outperform the HUI during the quarter, while the overall gold allocation remained at the low-end of its typical range.

Fund performance benefitted from gains in the New Zealand dollar and Australian dollar. The fund’s performance relative to the USD Index benefitted from a significantly below benchmark weighting in the euro and a corresponding allocation to dollar-denominated instruments, largely U.S. Treasury securities. Allocations to the Hong Kong dollar and Singapore dollar also helped performance relative to the USD index.

The fund remained defensively positioned throughout the first quarter of 2013. The allocation to U.S. dollars began the quarter at 18.3% of fund assets. Dollar exposure was reduced somewhat during January, as the fund managers viewed a global “risk on” market backdrop coupled with the Fed’s $85 billion monthly QE as generally favorable for non-dollar currencies. However, the fund managers had reversed course by mid-quarter. The Italian election, initial Chinese tightening measures and booming U.S. equities altered the managers’ view of near-term prospects for various currencies, including the U.S. dollar.

U.S. dollar holdings ended the reporting period at 22.0%. After beginning the period at 4.20%, the fund ended the quarter with no euro holdings. During the quarter, fund allocations were reduced 460 basis points to the British pound, 160 basis points to the Norwegian krone and 100 basis points to the Canadian dollar. Allocations were increased 250 basis points to the Swedish krona, 240 basis points to the Australian dollar, 160 basis points to the Singapore dollar and 140 basis points to the Hong Kong dollar. The fund’s allocation to gold equities was reduced 80 basis points to end the quarter at 4.60%. Overall, the fund’s allocations to the U.S. dollar and Asian currencies were increased, while European exposures were meaningfully reduced during the quarter.

The fund managers anticipate no imminent resolution to extraordinary global financial and economic uncertainties. Indeed, they believe currency markets have likely entered a period of heightened uncertainty and instability. The fund managers believe that financial and economic systems around the globe suffer deep scars from years of historic excess and imbalances. In fund management’s opinion, policy measures in response to inevitable fragilities have been unprecedented.

Political instability in Italy, the Cyprus fiasco and a troubling economic backdrop may cause the markets to question investment in Europe. Meanwhile, China’s new government confronts serious issues, including corruption, an environmental crisis, a runaway housing bubble and a boom in “shadow banking.” At the Fed, fund management has seen no inclination to remove the punchbowl despite overheated asset markets and bubble risk. The Bank of Japan has aggressively followed the Fed’s lead in experimental monetary stimulus. At the same time, “developing” economies and markets have shown signs of heightened strains after years of rapid credit expansion. From the fund managers’ perspective, global risk markets confront a volatile mix of issues.

The fund managers continue working diligently to navigate through an extremely challenging environment. With a disciplined approach to risk management, a sound analytical framework, and a keen focus on market dynamics, the fund 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 potentially tumultuous global markets.