As of 09-30-2018

Market Overview

U.S. equity markets rallied on strong economic and corporate profit growth in the third quarter of 2018, while bonds continued to sell off in response to further Federal Reserve (Fed) rate hikes. International markets had more mixed results as they had to contend with trade tensions, uncertainty around Brexit and Italian fiscal policy, a strong dollar, higher U.S. interest rates and currency instability in certain emerging markets (EM).

For the quarter, the MSCI All Country World Index returned 4.39%. The U.S. once again led the way, with large caps as measured by the Russell 1000 index up 7.42% and small caps as measured by the Russell 2000 index up 3.57%. Returns among international developed markets were positive, but more muted, as the MSCI World ex USA Index was up 1.38%. Meanwhile, EM continued to lag, with the MSCI Emerging Market Index down 1% for the quarter.

Within fixed income, resurgent economic growth coupled with the gradual Fed tightening contributed to significant outperformance of risk assets during the quarter. The Bloomberg Barclays US High Yield Index spread tightened over 48 basis points while the Bloomberg Barclays US Treasury Index lost 59 basis point as interest rates jumped more than 20 basis points higher across the yield curve.

This risk-asset outperformance was even more impressive when considering all the headwinds weighing on the financial market: escalating trade tensions with China, economic stress in some vulnerable EM economies, Italy’s fiscal issues, the risk of a “no-deal” Brexit and higher oil prices, among them. However, investors for the most remained focused on the positives: a strong U.S. economy with the lowest unemployment rate since 1970, surging business and consumer confidence, record-level corporate profits and core PCE inflation that finally hit the Fed’s 2% target.

Fund Performance

Federated Global Allocation Fund A Shares returned 2.81% at net asset value during the third quarter of 2018, while the fund’s blended benchmark, which consists of 60% of the return from the MSCI All Country World Index and 40% of the return of the Barclays Global Aggregate Bond Index, returned 2.18%.

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.

During the quarter, equity security selection was, once again, a positive driver. The international developed and EM security selection strategies led the way, while the domestic large-cap strategy also modestly outperformed. Only the domestic small-cap strategy underperformed during the quarter. The results on the fixed-income side also were positive, with both the domestic and international strategies outperforming. During the quarter, the fund benefitted from the following fixed-income positions: interest-rate exposure that ranged 90-95% of the index during a period in which interest rates rose significantly; an overweight to high yield (HY) and investment-grade (IG) corporates, which outperformed similar-duration Treasuries; and an overweight to trade finance and bank loans, which performed strongly in the quarter due to the short duration of floating-rate securities and the risk-on macro environment in general.

From an allocation perspective, an overweight to stocks relative to bonds was beneficial given strong equity market returns relative to bonds.

Tactical overlay strategies also contributed to performance. The global currency strategy led the way, benefitting from a net long position in the U.S. dollar. The global fixed-income strategy was also positive, while the global equity strategy was the sole detractor.

Positioning and Strategy

The fund continues to have an overweight allocation to stocks vs. bonds, as we remain bullish into year-end given strong economic fundamentals, continued corporate earnings growth and still benign levels of inflation and interest rates. We also continue to have a net long in the dollar.

From a fixed income perspective, we begin the fourth quarter with 97.5% of the interest-rate sensitivity (duration) of the index. While we expect interest rates to move higher, we have reduced the short from 95% to 97.5% to lock in profits and reduce risk ahead of the U.S. midterm elections. At the same time, the fund entered a flattening trade for the yield curve strategy. While there is certainly less to play for at this stage of the cycle, the long-term trend suggests further flattening that could take the 2-year to 10-year Treasury yield curve closer to zero, at which point the Fed may pause to prevent a curve inversion and to avoid repeating their past mistakes of over-tightening and pushing the economy into recession.

The fund remains a small overweight to HY and is neutral on IG corporate bonds. We continue to anticipate tighter spread in HY given the supply dynamics and the robust economy. However, as the Fed's quantitative tightening is gradually kicking in and expectations for foreign monetary policy accommodation are reduced slowly, we expect declining demand for IG corporate bonds over time, deteriorating technicals, increasing volatility and eventually a spread widening environment. The fund is neutral in government mortgages, where despite improved valuations on recent underperformance, the market is still in search of new equilibrium spread level. Even though interest-rate volatility has declined meaningfully, the Fed continues to reduce its MBS purchases and REITS are in the capital preservation mode as the yield curve flattens.