As of 06-30-2018

Highlights

  • The first-quarter’s synchronized global growth took a divergent path during the second quarter, abetted by growing trade disputes
  • Much more of a risk-on environment prevailed in the U.S. as lower-quality credit outperformed higher-quality credit and small-cap equities outperformed large caps.
  • The situation was reverse globally, with corporate credit dramatically underperforming sovereign bonds in Europe, government bonds of peripheral countries underperforming the European core, and emerging-market (EM) sovereign and corporate bonds generally weak
  • The yield curve continued to flatten, with yields at the front end up significantly while the long end was relatively subdued
  • The U.S. dollar appreciated aggressively against most currencies

Looking Back

The positive economic trends present in the U.S. for some time continued, and corporate profitability significantly improved, aided by December’s tax cuts. Despite this good news, market volatility has reemerged to challenge risk assets, in part because of geopolitical events and the move by central banks to gradually withdraw stimulus. We don’t think the start of a bear market, but simply a recognition that there are challenges.

Domestic equity returns were still largely positive, albeit with low- to mid-single-digit returns. Treasury yields have gradually increased, with domestic sub-investment-grade debt continuing to outperform investment-grade (IG). While the dollar’s appreciation was somewhat of a surprise, we feel the negative knock-on effects in emerging debt and equity markets have been somewhat overdone. We believe much of the sell-off in global financial assets, in EM and developed countries, is attributable to the surge in protectionist trade actions and rhetoric.

For the U.S. Treasury market, the most notable change was the continuing flattening of the yield curve. June’s decision by Federal Reserve (Fed) policymakers to raise the target rate an additional quarter point prompted the front end of the curve as represented by 2- and 3-year Treasuries to also rise about 25 basis points. On the longer end, 10-year Treasury yields increased only 12 basis points and 30-year yields a mere 1.5 basis points during the quarter.

As measured by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index, high yield (HY) bonds returned a positive 0.69% for the quarter. Lower-rated B and CCC bonds outperformed higher-quality BB bonds while IG corporates underperformed, largely due to exceptionally high issuance as large corporations sought to fund previously announced mergers and acquisitions.

Finally, EM debt as measured by the Bloomberg Barclays EM USD Aggregate Index returned -2.40% as dollar strength and rising U.S. rates fed concerns that countries with large amounts of dollar-denominated debt could encounter repayment difficulties. Argentina, Venezuela and Brazil were notable underperformers and also were in the midst of elections, adding to their volatility.

Agency mortgage-backed securities (MBS) slightly outperformed U.S. Treasuries with a nominal return of 0.24% and an excess return of 0.15%.

Fund Performance

Federated Strategic Income Fund Institutional Shares had a total return at net asset value (NAV) of -0.43%, slightly underperforming its blended benchmark with a return of -0.11% during the quarter. The fund’s return also underperformed the Bloomberg Barclays Aggregate Bond Index, a commonly used barometer of performance for the broad high-quality bond market, which returned -0.16% during the quarter.

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

  • Portfolio maintained shorter-than-benchmark duration
  • Overweight in domestic HY bonds and equity
  • Good security selection within the domestic HY bond holdings

Performance Detractors

  • Overweight allocation in EM and IG corporate bonds, which underperformed Treasuries. Also an underweight position in MBS which outperformed
  • Negative from security and currency selection within the EM holdings.
  • Slight negative from yield-curve positioning

How We Are Positioned

We expect elevated market volatility will persist, and continue to focus on the strong fundamentals of a growing global economy, increasing corporate profits and a strengthening consumer. From a market perspective, investor demand for corporate issuance continues to be strong as new deals were largely oversubscribed and pricing remained attractive for issuers.

We remain comfortable with our overweight to EM debt, domestic HY and IG corporate bonds and our technical allocation to equity. With interest rates likely to keep rising at a gradual pace, our duration is shorter than the benchmark. We also feel Treasury Inflation-Protected Securities (TIPS) presents an attractive hedge against an unexpected surge of inflation expectations.

The U.S. dollar likely will continue to be volatile as global trade rhetoric keeps making news. We do not expect recent dollar strength to turn into a long-term trend that could threaten future economic growth. In the end, we think new trade agreements will be reached and the actual financial impact will be much more benign than recent reactions to political rhetoric would suggest.