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|Share Classes||Product Type||Asset Class||Category|
|A B C F R||Mutual Fund||Balanced/Hybrid||Conservative Allocation|
Despite heightened volatility, U.S. equities closed the first quarter of 2015 at roughly the same place they began the year. Much of the volatility in the year’s first three months could be attributed to central bank actions domestically and abroad, inclement winter weather, continued U.S. dollar strength and uncertainty in the energy markets.
On the domestic front, the Federal Reserve (Fed) finally removed “patient” from its policy language, signaled continued data dependency with its decision-making process and began to discuss the possibility of moving rates off zero. Combined with the West Coast port strikes, a tough winter throughout the country and the previously mentioned dollar strengthening and energy-market volatility, the environment created headwinds for the markets, company earnings and investor sentiment. On the positive side, auto sales continued to show strength, gasoline prices remained relatively low and consumer friendly, employment continued on a recovery albeit somewhat slower path, and inflation—at least for the short term—still looks benign.
Looking abroad, the European Central Bank (ECB) finally unveiled quantitative easing (QE), with an asset buyback program totaling more than 1 trillion euro through late 2016 to jump-start European economic growth. The program, along with cheaper energy prices, a lower euro, prospects of near-term geopolitical stability in Ukraine and continued economic discussions with Greece, helped European markets trend higher during the quarter. China continued to manage its economic slowdown, though some contradicting economic measures are causing the markets to second guess the pace of slowdown. And emerging markets (EM) felt the impact of currency volatility, with countries that are energy importers and have deeper ties to stronger developed economies generally outperforming countries that are energy producing and/or have larger current account deficits.
We expect additional volatility as 2015 continues and remain optimistic about the U.S. economy, though first-half growth is likely to be slower due to the headwinds noted above, followed by a stronger second half. The Fed will continue to dominate the headlines with an anticipated rate hike sometime during the second half, with the debate over the timing likely to be overshadowed from the market’s perspective by a magnitude and pace that at this point appears will be favorable. We remain firm in our belief that the dollar will continue to strengthen, though not at the pace it has over the prior six months, and expect further mergers and acquisitions, dividend increases and share buybacks due to both strong balance sheets and free cash flows from our companies and the persistent low interest rate environment. Globally, we believe Europe will continue to benefit from QE as well as a reduced likelihood of a Greek exit from the common currency. We expect Chinese growth to remain muted but we not a hard landing, with this slower growth influencing the rest of Asia, along with energy prices and currency volatility. We remain vigilant for opportunities globally and adhere to our true and tested investment process to guide us through this year’s volatile waters.
On the fixed-income front, U.S interest rates continued their downward momentum during the quarter, with the decline in U.S Treasury yields driven primarily by four factors: 1) the ECB’s QE announcement, which drove already low European government yields even lower; 2) the Fed’s downwardly revised growth and rate projections in March; 3) a stronger dollar that is lowering U.S. inflation and growth expectations, and 4) investors’ risk aversion created by the Greek sovereign-debt/euro morass. The ECB’s QE program in particular has made U.S. Treasury rates look more appealing on a relative value basis, with the Fed’s more dovish cast — it lowered its median expected year-end 2015 fed funds target rate from 1.125% to 0.625% — further dampening upward moves. The decline in U.S. Treasury yields was most pronounced in the 3- to 10-year portion of the Treasury curve, where rates declined anywhere from 22 to 26 basis points. The first quarter total return of the U.S Treasury index underperformed the total return of the risk based fixed income asset classes of high yield, EM, investment-grade corporate and commercial mortgage-backed securities.
In the first quarter, the Barclays Treasury Index returned 1.64%, the Barclays High Yield Index returned 2.52%, the Barclays Emerging Markets USD Aggregate Index returned 2.30% and the Barclays Mortgage Index returned 1.06%. In addition, the S&P 500 Index returned 0.95%, the Dow Jones Select Dividend Index returned -0.96% and the Barclays Aggregate Index returned 1.61%.
The fund met its primary goal of current income and long-term growth of income during the first quarter of 2015, with the fund’s 12-month distribution yield for Class A Shares at NAV at 5.44% net at quarter-end versus. a 30-Day SEC yield of 4.45%. The fund’s yield is well above the S&P 500 yield at 2.00%; Dow Jones Select Dividend Index at 3.72%; 10 year Treasury yield at 1.92% and Morningstar Conservative Allocation at approximately 2.04%. The fund received more than 5 dividend increases during the first quarter lead by Valero, Kinder Morgan, and Lorillard.
For the first quarter, Federated Capital Income Fund Class A Shares at NAV returned 0.71%, underperforming the 0.79% return of the fund’s benchmark comprising of 40% Dow Jones Select Dividend Index, 20% BHY2%ICI, 20% BMB and 20% BEMB Index.
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 Performance tab. Performance does not reflect the maximum 5.5% sales charge for Class A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
The fund’s first-quarter performance within its class was impacted primarily by two factors 1) value significantly underperformed growth within equities and 2) asset allocation overweight to equities relative to the fund’s neutral position.
During the quarter, within equities growth stocks significantly outperformed value stocks. For the quarter, the Russell 1000 Growth Index returned 3.84% while the Russell 1000 Value Index returned -0.72%. The fund’s equity portfolio is diversified across income-producing securities that tend to have a more value orientation and hence our style was impacted by this relative performance differential. In terms of asset allocation, the S&P 500 index underperformed the broader Barclays Aggregate Index and the Barclays Treasury Index. The fund is overweight equities at 50% of its asset allocation relative to its neutral 40% equity index exposure and class. The equity relative overweight, which has helped performance since 2010, was a relative negative contributor during the quarter also.
In the equity portfolio, stock selection added to and sector weight detracted from the fund’s overall performance. Relative to the fund’s Dow Jones Select Dividend Index, the two best performing sectors were Utilities and Energy. The two sectors that most negatively contributed to fund performance were Materials and Consumer Discretionary.
On an absolute basis the five securities contributing most fund performance were Pfizer, Valero, Apple (ELN), GlaxoSmithKline, and RR Donnelley. The five positions detracting most from performance were Corus Entertainment, CenturyLink, Bank of Montreal, Micron Technology (ELN), and Consolidated Communications.
The fixed-income portfolio underperformed its blended benchmark by 6 basis points during the quarter but outperformed the Barclays U.S. Treasury and U.S Aggregate indices. The fund’s underperformance versus the blended benchmark was due primarily to the fund’s duration positioning, which was approximately 95% of its benchmark, and negative security selection in the EM portfolio. These negatives factors were partially offset by the positive contributions from the fund’s overweight position in the high-yield sector and positive security selection in both the high-yield and high-quality portions of the fixed-income portfolio. The high-yield security selection was particularly strong in the Packaging, Energy, Midstream, Gaming, Industrial Other and Retail sectors. The fund’s yield curve positioning had no material impact on the first-quarter results.
Click on the Portfolio Characteristics tab for the fund’s top 10 holdings.
The Fund continues to strive to achieve its primary goal of current income and long-term growth of income with capital appreciation as a secondary objective.
Given some of the macro issues discussed above, we remain broadly diversified within equity market sectors, with a prudent approach to balancing income, risk and long term total return.
The fund’s equity holdings are positioned within a diversified portfolio of income-producing securities and dividend-growing stocks with favorable valuations, strong balance sheets and improving business fundamentals. The portfolio continues to aim for high yield and consistent dividend growth.
Sector overweight positions relative to the fund’s Dow Jones Select Dividend Index benchmark include Information Technology, Health Care, and Telecom Services. The fund’s largest underweight positions include Utilities, Consumer Staples and Consumer Discretionary.
Similarly, within the fixed-income portfolio, we believe the best opportunities currently are to remain overweight high yield, market-weight EM and underweight the higher-quality markets relative to the fixed-income portfolio’s blended benchmark. The portfolio had an average effective duration of 4.2 years versus the benchmark at 4.4 years, and maintained its yield curve flattening bias.
The 12-month Distribution Yield is calculated by summing the income distributions over the trailing 12 months and dividend that by the sum of the last month’s ending NAV plus any capital gains distributed over the 12-month period.