Federated Capital Income Fund (F) CAPFX
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|A B C IS R||Mutual Fund||Balanced/Hybrid||Conservative Allocation|
Key U.S. stock indices reached all-time market highs during the fourth-quarter, despite a 16-day government shutdown and a decision by the Federal Reserve (Fed) to begin tapering its quantitative-easing program of $85 billion in monthly asset purchases.
The quarter began with the government shutdown as both sides of the legislative aisle struggled to make a budget deal and avoid a debt-ceiling breach. Cooler heads prevailed late in the quarter, as House Republicans and Senate Democrats struck a bipartisan agreement that laid the foundation for a future deal to fund the government over the next two years. Investors applauded the move as it provided a much-welcomed level of fiscal certainty into the New Year.
As was the case for much of the year, the market was intently focused on the Fed the final three months of the year. After months of speculation, central bank policymakers initiated a modest $10 billion reduction in the monthly asset purchases after determining economic growth was sufficient enough to support such tapering. The expectation for an improving market was further reinforced by an increase in the real third-quarter GDP, which came at 4.1%, well above expectations. Overall, the fourth quarter capped a strong year for U.S. equities that saw both the S&P 500 and the Dow Jones indexes reach record highs and the Nasdaq advance to its highest point since 2000.
The global economy ended 2013 on a high note, as well. Since pulling out of recession in 2013’s third quarter, the eurozone’s growth prospects continued to improve at a better-than-expected pace. Elsewhere, emerging-market economies as a whole remained mixed, while in China, the economy appeared to be rebounding slightly, though its growth remains tepid relative to past years as it transitions from an export- and investment-driven economy to one that relies more on domestic consumption.
Looking to 2014, we remain optimistic for improving U.S. economic growth. We expect the U.S. housing market should continue to accelerate despite higher mortgage rates and that auto sales will continue to trend positively. We also expect capital expenditure by companies to increase, supporting overall economic growth prospects. We expect corporate America’s earnings in the fourth quarter to be mostly positive, albeit with managements continuing to express cautious outlooks. Also, we anticipate further dividend increases and share buyback announcements due to strong balance sheets and free cash flows. Globally, we believe Europe will continue to improve and slowly work through its growth challenges, while China and the emerging markets’ longer-term growth story will remain positive.
In fixed income, interest rates were on the rise during the fourth quarter, with intermediate-term interest rates up 15 to 45 basis points and long-term rates up 30 to 40 basis points. The 5-year Treasury yield rose 36 basis points to 1.74%, still very low by historical standards. Driven by some very encouraging economic statistics, fixed income investors were leaving Treasury bonds for the attractive opportunities in the equity markets. Lower credit quality bonds (both high-yield and emerging-market bonds) performed well during the quarter, showing positive total returns, while Treasuries had negative total returns.
During the quarter, the S&P returned 10.50%, the Nasdaq Composite Index returned 11.14% and the Dow Jones Select Dividend Index returned 8.46%. Value stocks underperformed growth stocks, with the Russell 1000 Value Index returning 10.01% while the Russell 1000 Growth Index returned 10.44%.
For the fourth quarter of 2013, the Barclays High Yield Index returned 3.58%, the Barclays Emerging Markets Index returned 1.17%, and the Barclays Mortgage Index returned -0.43%.
For the fourth quarter, Federated Capital Income Fund (Class A Shares at NAV) returned 4.70%, outperforming the 4.21% return of the fund’s benchmark comprising of 40% Dow Jones Select Dividend Index, 20% Barclays High Yield 2% Issuer Capped Index, 20% Barclays Emerging Market Bond Index and 20% Barclays Mortgage-Backed Securities 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.
Within the fund’s equity holdings, stock selection slightly detracted from performance while sector allocation added to the fund’s performance. Relative to the benchmark, the fund’s three best contributing sectors were Utilities, Information Technology and Energy. The three sectors that most negatively contributed to fund performance were Financials, Industrials, and Consumer Staples.
On an absolute basis, the five securities contributing most to performance were Seagate Technology, Unisys, Hewlett Packard, Astrazenaca, and Valero Energy. The five positions detracting most from performance were Baytex Energy, Hospitality Properties Trust, Whirlpool (Put-Option), Northland Power, and Best Buy (Put-Option).
The fixed-income holdings of the portfolio continued to generate substantial income and for the fourth quarter outperformed the benchmark by a wide margin. The fund’s outperformance was due to an overweight to high yield bonds and emerging market bonds relative to the benchmark.
Click on the Portfolio Characteristics tab for the fund’s top 10 holdings.
Positioning and Strategy
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 benchmark include Energy, Information Technology and Health Care. The fund’s largest underweight positions include Utilities, Consumer Staples and Industrials.
Within the fixed-income portfolio, we held portfolio duration steady during the quarter at around 91% of the benchmark as it appeared interest rates may be trending higher going forward. The portfolio had an effective duration of 4.24 years versus the benchmark at 4.63 years. We moved our yield-curve stance to bulleted on the expectation that in a rising rate environment, long-term rates would rise the most, resulting in a significant steepening in the yield curve.
We adjusted our allocations a tad during the fourth quarter. High yield was reduced to 48.5% of the fixed-income portfolio from 50%, Emerging rose to 41.9% from 37.9%, MBS rose to 2.8% from 1.7%, and CMBS fell to 2.4% from 3.8%.