As of 09-30-2018

Highlights

  • The fund’s IS shares returned 0.58% vs. 0.02% for the Bloomberg Barclays U.S. Aggregate Bond (BBAB) Index in the third quarter of 2018
  • Main reasons for the fund’s outperformance were overweights to the credit sectors of the bond market (high-yield and high-grade corporates, emerging markets, commercial mortgage-backed securities and loans); as well as less interest-rate sensitivity than the index
  • The fund is positioned for interest rates to rise with longer-term yields increasing less than shorter-term yields, and for the credit sectors to continue outperforming both Treasuries and government mortgage-backed securities (MBS)

Looking Back

After struggling during the year’s first half mainly on concerns trade wars would hamper global growth, the “risk-on” trade resumed in the third quarter with credit-sensitive sectors leading the bond market higher. Trade deals with Mexico and Canada, as well as progress toward deals with Korea and Europe, helped corporate bonds outperform government bonds during the quarter. The best-performing sectors of the bond market, in order of excess return over Treasuries, were high-yield corporates, emerging market (EM) bonds, investment-grade (IG) corporates, bank loans, commercial MBS (CMBS), trade finance loans, asset-backed securities and MBS. While the trade dispute with China became more entrenched, easing of trade tensions in the rest of the world also helped industrials outperform utilities and financials within the corporate bond market.

While tighter spreads in these sectors supported bond prices, rising interest rates dragged prices back down. Yields on 2-year Treasuries rose from 2.53% to 2.82%, while yields on 30-year Treasuries rose from 2.99% to 3.21%. Interest rates rose due to increasing Treasury supply to fund tax cuts, gradually increasing wages and inflation, diminished fears of a global trade war, continued rate hikes and balance-sheet reduction by the Federal Reserve (Fed), and expectations the European Central Bank will end bond purchases late this year (pushing up interest rates in Europe).

Performance

Federated Total Return Bond Fund Institutional Shares posted a total return net of fees of 0.58% for the quarter. The fund’s performance compares to a return of 0.02% for the BBAB Index. The fund’s total return for the period also reflected actual cash flows, transaction costs and other expenses that were not reflected in the total return of the BBAB Index.

Performance data 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.

Click the Performance tab for standard fund performance.

Performance Contributors

  • Duration Management: Rates increased during a quarter in which the fund’s duration (interest-rate sensitivity) averaged 92% of index duration
  • Sector Allocation: Overweights to high yield and IG corporates, EM bonds and CMBS added returns as spreads to Treasuries tightened
  • Currency and security selection: A short position in the U.S. dollar relative to a basket of European, Asian and Latin American currencies generated a small profit, while gains from Treasury Inflation-Protected Securities (TIPS) and an overweight to BBB-rated corporates more than offset sub-optimal security selection in EM bonds

Click on the Portfolio Characteristics tab for information on quality ratings.

How We Are Positioned

The fund ended the third quarter with 95% of the interest-rate sensitivity (duration) of the index, up from an average of 92% in the third quarter. While Federated’s Duration Pod expects interest rates to continue to grind higher, uncertainty regarding the outcome of the midterm elections and the unresolved trade conflict with China warranted a less aggressive duration stance. At the end of the period, the fund moved from a neutral to flattener position on the yield curve, anticipating short rates will increase more than long rates.

In terms of sector allocation, the fund maintains a 6% position in high-yield bonds and a 4% position in EM bonds. High yield has been supported by a rising stock market and subdued issuance, and EM volatility thus far has been constrained to specific locales (namely Argentina, South Africa and Turkey). The fund reduced its allocation to IG corporates from 37% to 34% due to rich valuations; maintains a neutral weighting in government mortgages (23% of the fund) as less supply and reduced prepayment risk are offset by less buying of MBS by the Fed; and has a small overweight to CMBS vs. the index (3% of the fund). The fund has 7% in loans: 2% in bank loans and 5% in trade-finance loans, two asset classes that offer attractive yields with little interest-rate risk. The fund increased its position in Treasuries from 19% to 22% on a decrease in IG corporate holdings. Treasuries primarily are held to hedge against unforeseen risk-off events.

The fund has small positions in Australian and New Zealand dollars that cheapened due to the decline in commodity prices as Chinese economic growth slowed. In terms of major security selection themes, the fund increased its TIPS allocation from 5% to 7%, consistent with the belief the market is underpricing the potential for an uptick in inflation, and reduced its overweight to BBB-rated corporates. The bulk of the fund’s MBS exposure is in government mortgages as non-agency MBS have richened significantly. Within IG corporates, the largest sector holding, the fund is overweight utilities, aerospace/defense, apartment REITs, food and beverage, life insurers, media/entertainment, wireless carriers, and integrated and midstream energy producers. It’s underweight banking, chemicals, health care, independent energy producers, pharmaceuticals, railroads, restaurants, tobacco and supranationals.

The fund employed derivatives to help implement the duration, yield curve, currency and sector allocation strategies. Investors should be aware government regulations have reduced the ability of dealers to warehouse bonds, resulting in potentially less liquid and more volatile bond markets that could impact performance during volatile market periods.