As of 06-30-2018

Highlights

  • Less interest rate sensitivity (duration) than the benchmark was the main positive contributor
  • An overweight to investment-grade (IG) corporates and a 4% position in emerging-market (EM) bonds were the main detractors
  • The fund is positioned for interest rates to rise and the credit sectors (including loans) to outperform both Treasuries and government mortgage-backed securities (MBS)

Looking Back

During the quarter, the bond market was trapped in a tug of war between accelerating domestic growth and increasing geopolitical risks. On the home front, second-quarter gross domestic product (GDP) growth was expected to double the first-quarter’s 2% pace, the unemployment rate fell to its lowest level since 1970 with more jobs available than people looking for work, business and consumer confidence surged, corporate profits exploded and core PCE inflation finally hit the Federal Reserve’s (Fed) 2% target. While domestic strength argued for higher interest rates and outperformance by the bond market’s riskier, credit-oriented sectors, geopolitical storms pointed to lower rates and risk-asset underperformance. Topping the list of international worries: escalating trade tensions with China and Italy’s potential break with the European Union.

This tug of war kept 10-year Treasury rates trapped in a range between 2.74% and 3.11% during the quarter. Uncertainty is rarely good for risk assets, and the second quarter was no exception. The worst performing sector by far was EM bonds, which are most at risk from trade wars and a strengthening dollar. For a second straight quarter, IG corporates significantly underperformed lower-rated high-yield bonds—unusual during “risk-off” periods. The relative underperformance primarily can be attributed to weaker demand as opposed to deteriorating credit quality. Additionally, supply running 23% below last year’s pace helped support the high-yield sector.

The bond market’s securitized sectors generally outperformed duration-equivalent Treasuries. Trade-finance loans posted the best relative returns, followed by asset-backed securities, government MBS and commercial MBS.

Performance

Federated Total Return Bond Fund Institutional Shares posted a total return net of fees of -0.27% for the quarter. This compared with a return of -0.16% for the Bloomberg Barclays U.S. Aggregate Bond (BBAB) Index. The fund’s total return also reflected actual cash flows, transaction costs and other expenses 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.

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

Performance Contributors

  • Duration management: rates increased during a quarter in which the fund’s duration (interest-rate sensitivity) averaged 90% of index duration

Performance Detractors

  • Yield-curve positioning: A bias for short-term rates to outperform long-term rates in May detracted slightly from returns
  • Sector allocation: Gains from a 5% position in bank and trade-finance loans and a 6% position in high-yield bonds were negated by losses on an overweight to IG corporates and a 4% allocation to EM bonds
  • Security selection: suboptimal security selection in EM, in particular Argentina, detracted from returns

How We Are Positioned

The fund ended the second quarter with 95% of the interest-rate sensitivity (duration) of the index on expectations interest rates will move higher due primarily to inflation and supply. Inflation is likely to creep up for three main reasons: a tightening labor market that puts upward pressure on wages; enactment of tariffs that by definition boost prices; and a Fed that has indicated it will tolerate a modest overshoot without accelerating the removal of policy accommodation. As for supply, Treasury issuance is increasing dramatically in response to tax cuts and increased spending in the most recent federal budget bill, both of which are increasing the federal deficit.

The fund is laddered across the yield curve, with no bias for either steepening or flattening. In terms of sector allocation, the fund has approximately 6% in high-yield bonds, increased its EM exposure from 3.5% to just over 4% and reduced its allocation to IG corporates to 37% but remains overweight. Elsewhere, it has a neutral weighting in government mortgages, 7% in loans (2% in bank loans and 5% in trade finance), 19% in Treasuries primarily as a hedge against a major unforeseen risk-off event, little non-dollar currency exposure, a reduced allocation to Treasury Inflation-Protected Securities and increased exposure (from 2% to 2.5%) in CMBS.