Federated Prudent DollarBear Fund (IS) FPGIX
|Share Classes||Product Type||Asset Class||Category|
|A C||Mutual Fund||Alternative and Objective-Based||World Bond|
The third quarter of 2014 provided a continuation of extraordinary global policymaking, economic and market backdrops. Throughout much of the reporting period, a “risk-on” speculative dynamic generally held sway over global risk markets, supported by ongoing ultra-loose policies from all the world’s major central banks. Yet instability and major divergences began to emerge across global markets, especially late in the reporting period.
Treading in U.S. Treasuries was unsettled. Market sentiment was generally supported by the forces of global disinflation and safe-haven appeal but also at times pressured by U.S. growth dynamics and a less accommodative Federal Reserve (the Fed). The historic collapse in European periphery yields ran unabated. The quarter saw 10-year sovereign yields drop 51 basis points in Italy, 52 basis points in Spain and 49 basis points in Portugal. Other markets faired much less favorably. Greece’s 10-year yields jumped 68 basis points. Key emerging- market (EM) bond markets experienced abrupt reversals. Ten-year local currency yields jumped 101 basis points in Russia, 101 basis points in Turkey and 14 basis points in Brazil.
As troubles mounted, Argentine and Venezuelan bonds fell under heavy selling pressure. There was general weakness and notable declines in EM currencies. The Russian ruble fell 14.19%, the Ukrainian hryvnia dropped 9.27%, the Polish zloty declined 8.24% and the Hungarian forint fell 8.07%. The Turkish lira declined 7.01%. In Latin America, the Brazilian real sank 9.51%, the Chilean peso dropped 7.58%, the Colombian peso fell 7.28% and the Mexican peso fell 3.43%. Notable moves in Asia included a 4.11% decline in the South Korean won and a 2.57% decline in the Indonesian rupiah.
Throughout the reporting period, the managers noted important deterioration in global fundamentals. Growth slowed in China, Europe, Japan and in many developing economies. In spite of loose financial conditions and buoyant markets, major economies including France, Italy and Brazil were in recession. The geopolitical backdrop also worsened. The Ukrainian conflict came to the brink of a full-scale war with Russia. Tit-for-tat sanctions between the West and Russia began to have a real economic impact in an already fragile Europe. The Middle East appeared to be sliding into the abyss. Western African countries were stunned by an Ebola outbreak.
From the managers’ perspective, the divergence between a deteriorating fundamental backdrop and inflating global securities market bubbles became more extreme. In the face of economic vulnerability, EM stocks and bonds rallied strongly throughout much of the quarter. The Standard & Poor’s 500 Index posted its seventh consecutive quarter of positive returns, trading to a record high in late-September. Ongoing market exuberance was stoked by the view that global central bankers were willing to do even more to counter heightened economic and deflation risks. Bullish pundits believed the Fed would hold at zero for longer, the Bank of Japan would stay the course with aggressive quantitative easing (QE) and the Draghi European Central Bank would move aggressively to implement a trillion euro QE program.
In spite of ongoing extreme global monetary stimulus, disinflationary forces gained powerful momentum. During the period, the S&P GSCI commodities index sank 12.80%, trading to the lowest level since 2012. Many commodity prices traded to multi-year lows. The reporting period saw soybeans sink 34.8%, wheat drop 15.4% and corn fall 24.4%. Cotton lost 21.8%. Silver sank 18.8%, platinum dropped 12.5% and Brent crude fell 15.7% during the quarter. Developed and developing economies with large commodities exposure saw their currencies severely punished.
Overall, the managers believed an increasingly destabilizing “king dollar” dynamic was taking hold. Especially as September unfolded, sinking commodities prices, faltering EM currencies and a self-reinforcing dollar rally began fostering unsettled markets more generally. EM companies and countries that have accumulated large amounts of external debt were at heightened risk. In the markets, speculators employing leverage confronted challenging market instability. Indicators the managers monitor closely pointed to an incipient de-risking/de-leveraging dynamic. The quarter was notable for weakness in broader U.S. equities indices, widening U.S. corporate credit spreads, junk bond underperformance, and outflows from high-yield bond and loan funds.
Developed country currency markets turned highly unsettled, with most currencies suffering major losses versus the U.S. dollar. For the third quarter of 2014, the U.S. Dollar Index (USD Index) increased 7.72%. European currencies were under heavy selling pressure. The euro declined 7.75% during the period. The Swedish krona declined 7.35%, the Swiss franc declined 7.15%, the British pound declined 5.22% and the Norwegian krone fell 4.56%. The commodities currencies were hammered. For the period, the New Zealand dollar sank 10.85%, the Australian dollar fell 7.27%, and the Canadian dollar declined 4.71% against the U.S. currency. The Japanese yen sank 7.59% and the Singapore dollar declined 2.29%.
The third quarter 2014 return for Federated Prudent DollarBear Fund was -5.79% (Class A Shares at NAV). The return for the inverse of the USD Index was -7.72% for the same period. Fund performance was hurt by U.S. dollar strength versus all of the fund’s currency holdings, as well as from losses in gold stocks.
The fund’s gold positions somewhat outperformed about in line with the 18.67% third quarter decline in the NYSE Arca Gold Bugs (“HUI”) Index. Gold bullion sank $119 during the reporting period, or 9.0%. The fund’s overall gold allocation ended the quarter at 5.8% 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.
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The fund’s performance relative to the USD Index benefitted during the third quarter of 2014 by a significantly below USD Index weighting in the euro and a corresponding allocation to dollar-denominated instruments.
Positioning and Strategy
The fund remained defensively positioned throughout the third quarter. The allocation to U.S. dollars began the quarter at 20.7% of fund assets. The fund managers increased U.S. dollar exposure 1,180 basis points during the quarter to end the reporting period at 32.5% of fund assets. The significant allocation to the U.S. dollar was primarily in response to unstable currency markets and the resulting broad-based weakness in global currencies versus the dollar.
During the quarter, the fund managers adjusted holdings throughout the portfolio. Allocations were reduced 510 basis points to the euro, 220 basis points to the British pound, 160 basis points to the Swedish krona and 80 basis points to the Swiss franc. Allocations were reduced 190 basis points to the Canadian dollar and 110 basis points to the Japanese yen.
With worsening European fundamentals and the Draghi ECB prepared to aggressively expand its balance sheet, the managers eliminated the fund’s remaining exposure to the euro. From the managers’ perspective, weak fundamentals and zealous central banking in Europe and Japan, along with a rapidly deteriorating EM backdrop, spurred general currency market instability. The resulting “king dollar” dynamic saw the U.S. dollar surge versus virtually all currencies and commodities. While the managers view dollar strength as based more on market dislocation and less on sound U.S. fundamentals, they moved aggressively to reduce fund exposure to faltering currencies.
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.