As of 03-31-2018

Market Overview

The year started off strong, with the S&P 500 surging 2.8% in the first week, marking a new record high each day, and representing the best start to a year since 2006. The strong start was the result of fiscal stimulus and surging earnings estimates, but the rally peaked in late January, when an inflation scare and systematic selling led to the first 10% correction since early 2016. During this time, the yield on the benchmark 10-year Treasury hit a 5-year high of 2.95%.

More benign inflation readings began to calm market fears, which allowed markets to recover, but volatility again picked up in late February, as escalating trade tensions between the U.S. and China led to competing tariff proposals, and Facebook’s troublesome data-sharing policies and President Trump’s attacks on Amazon staunched the momentum of the previously untouchable FAANG stocks (Facebook, Amazon, Apple, Netflix and Google, aka Alphabet).

For the quarter, the MSCI All Country World Index finished down -0.85%. Performance held up a bit better in the U.S., with large caps as measured by the Russell 1000 index down -0.69% and small caps as measured by the Russell 2000 index down just -0.08%. Internationally, emerging markets (EM) once again led the pack, with the MSCI EM Index up 1.24%. International Developed stocks as measured by the MSCI World ex USA Index were the laggards, down -1.38%.

On the fixed-income side, concerns about heavier Treasury issuance and an overheating economy raised fears of much higher bond yields, which in turn started the global equity correction in early February. As mentioned, the U.S. 10-year Treasury yield peaked at 2.95%, about 55 basis points above its year-end level. After stabilizing into the quarter end, U.S. yields were still much higher for the quarter. As a result, most fixed-income assets delivered negative returns for quarter. Based on Bloomberg Barclays data, the U.S. Treasury index returned -1.18% in the quarter. Investment-grade (IG) corporates with high interest-rate sensitivity fared even worse, with the IG Corporate Index down -2.32% for the there-month period. On the other hand, high yield (HY) bonds lost just 0.86%, slightly underperforming duration-equivalent Treasuries.

Fund Performance

Federated Global Allocation Fund A Shares returned -0.66% at net asset value during the first quarter, 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 Bloomberg Barclays Global Aggregate Bond Index, returned -0.02%.

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, the fund saw outperformance from the core security selection strategies. On the equity side, the domestic large-cap, international stock and domestic small-cap strategies all outperformed on the strength of security selection. On the bond side, the domestic fixed-income strategy was essentially in line with its benchmark, while the international fixed-income strategy underperformed. On the positive side of the ledger, interest-rate exposure ranged from 90-92.5% of the index during a period in which interest rates rose, resulting in less price depreciation relative to the index. Additionally, an underweight to agency mortgage-backed securities (MBS), which underperformed similar duration Treasuries due primarily to higher levels of interest-rate volatility and less Federal Reserve buying, and an overweight to Treasury Inflation-Protected Securities (TIPS), which outperformed nominal Treasuries despite little movement in core inflation, contributed to performance. On the other hand, a bias for longer-maturity bonds to outperform shorter-maturity bonds in February (a yield curve flattener), and overweights to HY and IG corporate bonds during a period of credit spread widening detracted from performance.

An overweight to stocks relative to bonds was a modest detractor during the quarter, as equity markets were volatile but finished the quarter only modestly lower.

The tactical overlay strategies also detracted from performance during the quarter. The global equity, bond and currency strategies all produced either flat or negative total returns during the quarter, as did the US vs. EM allocation and the VIX strategy.

Current Strategy

The fund continues to employ a meaningful overweight allocation to stocks vs. bonds, having added to stocks on the 10% correction in early February. While volatility has certainly picked up and risks remain around trade and tech, the three pillars of our bullish thesis—robust earnings growth, a slow grind higher in inflation and interest rates, and a measured Fed—remain intact.

From a fixed income perspective, the fund begins the second quarter of 2018 with 92.5% of the interest-rate sensitivity (duration) of the index, as we expect interest rates to move higher as central banks globally gradually reduce monetary stimulus, global economic growth accelerates (aided in the U.S. by tax reform, higher spending budget and reduced regulatory burden on businesses), the Fed continues to gradually hike the federal funds target rate, and the combination of a weaker dollar and tighter labor markets begins to push inflation higher. In terms of the yield curve, the fund exited a flattening trade and moved to a tactical neutral positioning, anticipating a short-term reversal of the large flattening move.

The fund remains overweight HY and IG corporate bonds. After a significant rally in January, the credit market has given back its prior gains and more. The recent spread widening has improved valuations and we still anticipate credit outperformance going forward. The risk of recession is minimal, central bank removal of accommodation is progressing at a very slow pace, defaults remain low, bank lending standards have loosened, and corporate tax cuts should boost profitability and potentially reduce supply. The fund is still underweighting government mortgages as the Fed will buy progressively fewer MBS in 2018, valuations are very rich and it seems we have exited a period of abnormally low interest-rate volatility in the past 12- 18 months.