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|A B C R IS||Mutual Fund||Balanced/Hybrid||Conservative Allocation|
The first quarter of 2016 began on a turbulent note, with U.S. equities suffering their worst start to a year on record. By mid-February, however, the broader market began to recover and, by quarter end, was able to deliver a positive gain for the period.
On the domestic front, a new year brought softer U.S economic data, another leg down in energy markets and potential for four U.S Federal Reserve (Fed) rate hikes in 2016. This created considerable uncertainty, which when mixed with weaker overseas data, fear of further Chinese currency devaluation and Japanese rate cuts, created considerable investor angst. However, as the quarter progressed, stabilization in the energy market and improvement in the economic data (led by the ISM manufacturing gauge, employment and retail sales) helped the markets recover. It helped that the Fed, citing concern about global economies and market volatility, took a March rate hike off the table and signaled a slower path the rest of the year, easing investor worries about potentially more aggressive tightening.
Looking abroad, investors were encouraged as the quarter progressed by various central bank actions. The Bank of Japan backed off taking rates deeper into negative territory, a relief to markets increasingly concerned about the impact of negative rates on the banking sector. In China, talk of currency devaluation abated and economic data came in better than feared. And in Europe, European Central Bank Chair Mario Draghi pledged to use his quantitative-easing capital to buy corporate bonds, putting a bid under risk assets in Europe and helping lift fixed-income and equity assets for the quarter.
As we look to the second quarter of 2016 and beyond, we expect market volatility to continue, though we believe the near term economic threats have receded. In the U.S., the consumer remains in good shape with the job market and wages continuing to improve and the energy dividend kicking in with stable, lower gas prices helping the roughly 70% of GDP driven by consumers. In addition, U.S. corporate balance sheets remain strong in general. We do not believe all is clear, though we are encouraged by signs that the energy, industrial and manufacturing sectors may be bottoming. Fed decisions and their impact on the U.S. dollar continue to cast a long shadow and will drive a large portion of market volatility throughout the year. Another potential wildcard is the U.S. presidential election. As that continues to come into focus and the nominations occur, the potential exists to have heightened volatility surrounding election rhetoric and proposals, especially in certain sectors such as financials and health care.
Globally, we continue to believe China will not have a hard landing but are watching incoming data carefully. As with any economic transition, the road will not always be smooth as China transitions to a consumer economy. Also on watch are various potential central bank actions, especially in Japan, China and European Union. Further signs of currency devaluation or potentially deeper negative rates likely will destabilize global financial markets once again. The crisis du jour in Europe is the impending referendum in the U.K. on leaving the European Union. Expect volatile markets around this key vote as the second quarter draws to a close. Through all the troubled waters, we continue to focus on companies with strong balance sheets, free cash flow and shareholder friendly management that exhibit growth, quality and valuation factors that we look for in our fundamental investment process.
From a fixed-income perspective, similar to the equity markets, the first quarter was a tale of two halves for similar reasons. But it does appear the second week of February turned out to be an inflection point, with fixed-income risk assets rallying through the remainder of the quarter. As a result, the credit-sensitive investment-grade corporate, high-yield and emerging-market (EM) sectors all outperformed the U.S. Treasury market on a total return and a duration-adjusted total return basis. U.S. Treasury rates declined for all maturities of six months or longer, with the largest declines in the 5-year to 10-year part of the curve.
For the first quarter of 2016, the Barclays Treasury Index returned 3.20%, the Barclays Mortgage Index returned 1.98%, the Barclays Commercial Mortgage Index returned 3.61%, the Barclays Credit Index returned 3.92%, the Barclays High Yield 2% Issuer Capped Index returned 3.35% and the Barclays Emerging Markets USD Aggregate Index returned 4.52%. In addition, the S&P 500 Index returned 1.35%, the Dow Jones Select Dividend Index returned 9.63% and the Barclays Aggregate Index returned 3.03%.
The fund met its primary goal of current income and long-term growth of income during the first quarter. The fund’s 12-month yield for Class A Shares at net asset value (NAV) was 5.28% net at quarter-end, with an SEC yield of 3.77%. The fund’s yield is well above the S&P 500 yield at 2.11%, Dow Jones Select Dividend Index at 3.80%, 10 year Treasury yield at 1.77% and Morningstar Conservative Allocation at approximately 2.19%. The fund received 10 dividend increases during the first quarter including Kimberly Clark, TJX, and Best Buy.
For the first quarter, Federated Capital Income Fund Class A Shares returned 2.12% at NAV, underperforming the 5.82% return of the fund’s benchmark comprising of 40% Dow Jones Select Dividend Index, 20% BHY2%ICI, 20% BMB and 20% BEMB 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 Class A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
The fund’s first-quarter performance within its class was impacted primarily dividend stocks outperforming growth stocks.
During the quarter, within the equity markets, dividend stocks outperformed growth stocks. For the quarter, the Dow Jones Select Dividend returned 9.63% while the Russell 1000 Growth Index returned 0.74%. In terms of asset allocation, the Dow Jones Select Dividend Index outperformed the broader Barclays Aggregate Index and the Barclays Treasury Index. The fund is overweight equities at 45% of its asset allocation relative to its neutral 40% equity index exposure and class. The equity relative overweight, which has helped performance since 2010, was a positive contributor during the quarter.
In the equity portfolio, both stock selection and sector weight detracted from the fund’s overall performance. Relative to the fund’s Dow Jones Select Dividend Index, the two best-performing sectors were Telecom Services and Consumer Staples. The two sectors that most negatively contributed to fund performance were Utilities and Financials.
On an absolute basis the five securities contributing most to fund performance were CenturyLink, Excelon (Conv. Pfd.), Verizon, Tyson Foods (Conv, Pfd.) and BCE. The five positions detracting most from performance were Allergan (Conv. Pfd.), Teva Pharmaceutical (Conv, Pfd.), Bank of New York Mellon, Bank of America and JPMorgan.
Click on the Portfolio Characteristics tab for the fund’s top ten holdings.
The fixed-income portfolio underperformed its blended benchmark by 42 basis points in the first quarter and performed roughly in line with the U.S. Aggregate Index while underperforming the Barclays U.S. Treasury. Sector selection was the largest negative contributor to performance due primarily to an underweight to investment grade sector and a bias to lower quality during the quarter. The impact of interest rates on the portfolio was negative due to the fund’s duration position, which was approximately 95% of the fixed-income blended benchmark’s duration. The underperformance from duration was slightly reduced due to the fund’s yield-curve flattening position. Security selection had the positive contribution to performance due to strong security selection in the High Yield and investment grade corporate credit portfolio.
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 Dow Jones Select Dividend Index benchmark include Information Technology, Health Care and Financials. The fund’s largest underweight positions include Utilities, Consumer Discretionary, and Materials.
The fixed-income portfolio remains slightly overweight the high-yield and EM sectors and underweight the higher-quality corporate and mortgage markets relative to the fixed-income portfolio’s blended benchmark. The portfolio had an average effective duration of 4.03 years versus the benchmark at 4.33 years. The fixed-income portfolio is positioned neutral relative to the yield curve.