Federated Equity Advantage Fund (IS) FEKIX

Share Classes Product Type Asset Class Category
Mutual Fund Equity Small Cap
As of 09-30-2017

Market Overview

For the three months ended September 30, 2017, leveraged company stocks outperformed large- and mid-cap stocks but underperformed small-cap stocks. For example, leveraged company stocks returned approximately 4.60% in the quarter versus the 4.48% return of the Russell 1000 Index, the 3.47% return of the Russell Mid Cap Index and the 5.67% return of the Russell 2000 Index. Leveraged company stocks also underperformed the 5.11% return of the Russell 2000 Value Index, which is the fund’s primary index.

Leveraged company stocks continued to deliver attractive returns during the third quarter. It appears that a global synchronized economic expansion has taken hold with the U.S., Europe and China all showing positive economic performance.  While not robust, the slow and steady pace of economic activity was very soothing to markets. In this environment, corporate credit quality remained strong as default rates moved lower, balance sheet leverage remained at acceptable levels, interest coverage remained high and cash flow generation remained robust. Recognizing these factors, equity markets moved to new highs and high-yield bond spreads continued to tighten. While the quarter was not without its challenges–hurricanes Harvey and Irma, inflamed rhetoric relating to the Korean peninsula and political policy uncertainty-solid economic conditions seemed to carry the day.  

Within the small-cap value segment of the stock market, the strongest-performing sectors relative to the Russell 2000 Value Index were: Health Care, Industrials and Materials. The worst-performing sectors relative to the Russell 2000 Value Index were:  Telecommunication Services, Real Estate and Consumer Discretionary. 

Fund Performance

The fund primarily invests in stocks of companies with leveraged balance sheets. Market capitalizations ranging from micro to mid are targeted, but the fund does not focus on a particular investment style (growth or value). Given the fund’s “go anywhere” approach, it does not fit neatly into a size/style basket. The fund’s primary benchmark is the Russell 2000 Value Index, based on the fund’s long-term composite, which has been historically biased toward small-cap stocks with value characteristics. However, more recently, the fund has been biased toward mid-cap stocks and has had meaningful exposure to growth stocks, making current benchmark comparisons difficult. The fund’s secondary benchmark is the Credit Suisse Leveraged Equity Index, which tracks the public stocks of high-yield bond issuers. This index is weighted toward the mid-cap range of the market.

The fund outperformed both the Russell 2000 Value Index and the leveraged company segment of the stock market in the quarter. Relative to the Russell 2000 Value Index, the fund was positively impacted by strong security selection in the Industrials, Consumer Discretionary and Information Technology sectors. The fund was negatively impacted by weak security selection in the Health Care and Materials sectors, along with a significant overweight to the Consumer Discretionary sector.

Specific stocks held by the portfolio that substantially outperformed the index included: Avis Budget Group, Inc., Eldorado Resorts and Tower Semiconductor Ltd. Specific stocks held by the portfolio that substantially underperformed the index included:  Urban One, Party City Holdco, Inc. and CommScope Holding Co., Inc.

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 either benchmark.

Past performance is no guarantee of future results.

Click on the Performance tab for standard fund performance.

Click on the Portfolio Characteristics tab for the fund’s top 10 holdings.

Outlook

For now, economic momentum appears solid and it is difficult to find much not to like with the slow, steady U.S. economic expansion. Looking forward, we expect an expanding economy coupled with pro-growth policies, including the potential for tax reform or tax cuts, to lead to higher corporate earnings and equity multiple expansion. We also expect high-yield credit spreads to continue to tighten, which has historically been positively correlated with the outperformance of leveraged company stocks versus the broad equity indices. Geopolitical unrest, central bank policy and unusual dynamics on the political front will need to be monitored closely for signs that they will steer investor sentiment away from the current positive corporate and economic environment that is currently supporting valuations.