As of 12-31-2017

Market Overview

U.S. equity markets continued to soar the final three months of 2017 as the S&P 500 finished higher for a ninth consecutive quarter even as volatility remained extremely restrained—the S&P never experienced a pullback greater than 3% the entire year. Congressional passage of U.S. corporate tax reform was the primary impetus for equities in the fourth quarter, though continued solid economic and earnings data domestically and abroad aided as well.

On the domestic front, the much-anticipated corporate tax cut was finally passed by Congress in December, cutting the statutory corporate rate from 36.5% to 21% effective January 2018 and including several other measures to incentivize corporate investments. This led equity investors to shift their focus toward sectors such as Consumer Discretionary, Industrials and Financials that should benefit from the lower tax rate. U.S. stocks also rallied on solid third-quarter earnings that seemed to shrug off the effects of a destructive hurricane season; strong macroeconomic data; and robust holiday retail sales. Real GDP was revised to 3.2% for the third quarter, marking the first back-to-back 3%+ quarters of annualized GDP growth since 2014. The U.S. Federal Reserve also continued to pull back stimulus, raising its target funds rate a quarter point for a third time in 2017 to a range of 1.25-1.50% and initiating balance-sheet reduction. Looking abroad, countries in Europe and Asia also enjoyed improving economies despite several geopolitical conflicts, including continued Brexit discussions, the Catalonian vote for independence from Spain and North Korea’s ongoing provocations.

On the fixed-income front, U.S. Treasury rates remained near historic lows due to low sovereign interest rates in other developed markets around the world, continued easy monetary policies by central banks in Europe and Japan, and the lack of domestic and global inflation. As a result, the U.S. credit markets remain attractive to global investors seeking more yield, resulting in tighter credit spreads and solid total returns for the spread sectors—notably investment-grade, high-yield and emerging-market (EM) bonds—compared to U.S. Treasuries. In the quarter, the U.S. yield curve flattened with interest rates increasing the most for shorter maturities, reflecting the impact of the Fed rate increase.

With the calendar set to turn to 2018, there were signs 2017’s momentum should continue. A number of U.S. companies announced pay increases, bonuses and capital investments on the back of the announced tax reform, and earnings estimates were trending higher as the fourth quarter wound down. Tame inflation and a still accommodative Fed also were being viewed as supportive for the risk markets. Among the clouds that could dim this bullish scenario are the potential for a surprise breakout in inflation, midterm elections in Washington as well as critical elections overseas. Infrastructure investment and possibly entitlement reform are among issues likely to garner domestic focus in coming months, while pending Italian elections and German Chancellor Angela Merkel’s struggles to form a cohesive governing coalition bear watching. Given relative market valuations, which are cheaper thanks to the tax cut but not inexpensive, we think a balanced portfolio of cyclical and defensive companies that have strong cash flow, balance sheet strength and improving fundamentals could help navigate the current investment landscape.

For the fourth quarter of 2017, the Bloomberg Barclays Aggregate Index returned 0.39%, the Bloomberg Barclays Mortgage Index returned 0.15%, the Bloomberg Barclays HY 2% Issuer Cap Index returned 0.47%, and the Bloomberg Barclays Emerging Markets USD Aggregate Index returned 0.62%. In addition, the S&P 500 Index returned 6.64% and the Russell 1000 Value Index return 5.33%.

Fund Performance

The fund met its primary goal of current income and long-term growth of income during the fourth quarter of 2017. The fund’s 12-month yield for A Shares at net asset value (NAV) at end of quarter was 3.91%, with an SEC yield of 3.09%. The fund’s yield was well above the S&P 500 dividend yield at 1.88%; Russell 1000 Value Index at 2.35%; 10-year Treasury yield at 2.40% and Morningstar Conservative Allocation average at approximately 2.33%. The fund received about 10 dividend increases during the fourth quarter including Aflac, Simon Property Group and Waste Management.

For the fourth quarter, Federated Capital Income Fund A Shares returned 2.93% at NAV, outperforming the 2.36% return of the fund’s benchmark comprising of 40% Russell 1000 Value Index, 20% BBHY2%ICI, 20% BBMB and 20% BBEMB 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 A Shares. If included, it would reduce the performance quoted.

Click on the Portfolio Characteristics tab for the fund’s top ten holdings.

Click the Performance tab for standard fund performance.

Within the equity markets, growth stocks outperformed value stocks during the quarter, with the Russell 1000 Growth Index returning 7.86% while the Russell 1000 Value Index returned 5.33%. In terms of asset allocation, the Russell 1000 Value Index outperformed the broader Bloomberg Barclays Aggregate Index as well as the Bloomberg Barclays Treasury Index. At 49%, the fund is overweight equities relative to its neutral 40% equity exposure. The equity relative overweight, which has helped performance since 2010, was a positive contributor during the quarter.

In the equity portfolio, stock selection and sector weight both added to overall performance. Relative to the fund’s Russell 1000 Value Index benchmark, the three best-performing sectors were Industrials, Consumer Staples and Consumer Discretionary. The three sectors that most negatively contributed to fund performance were Health Care, Information Technology and Financials.

On an absolute basis the five securities contributing most fund performance were Wal-Mart, Texas Instruments, Caterpillar, Bank of America and Honda. The five positions detracting most from performance were Allergan PLC Conv. Pfd., GlaxoSmithKline PLC, Time Warner, Merck and Xerox.

The fixed-income portfolio returned 0.32% for the year’s final three months. That compares with the fund’s fixed-income blended benchmark (50% Bloomberg Barclays MBS / 25% Bloomberg Barclays HY2CAP / 25% Bloomberg Barclays EM US Agg) return of 0.35%. Positive security selection in the EM, investment-grade corporate and MBS portions of the portfolio contributed to the performance of the fund during the quarter. The fund’s duration, which was less than the fixed-income’s benchmark, was a slight positive in the quarter as well. The fixed-income portfolio’s yield-curve positioning, which was a steepener, was the largest detractor from performance in the quarter. Negative security selection in the high-yield portfolio partially offset positive security selection in the other fixed-income sectors.

Positioning and Strategy

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.

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 Russell 1000 Value Index benchmark include Information Technology, Industrials and Consumer Discretionary. The fund’s largest underweight positions include Financials, Energy and Utilities.

Domestic and global macroeconomic fundamentals remain solid, global interest rates remain low, and inflation remains in check. In addition, the new U.S. tax plan will likely provide incremental domestic economic growth. This type of environment remains favorable for the fixed-income spread markets, as we continue to remain overweight high yield, EM and investment-grade corporates. In terms of interest rates, 2018 may finally be the year in which the strong labor market leads to increased wage pressures and ultimately higher inflation expectations, while at the same time central banks around the globe reduce their accommodative monetary policies. The combination of these factors should lead to higher interest rates, and support the fixed-income’s portfolio duration position, which is less than the duration of the benchmark.