Federated Capital Income Fund (F) CAPFX
|Share Classes||Product Type||Asset Class||Category|
|A B C IS R||Mutual Fund||Balanced/Hybrid||Conservative Allocation|
In the third quarter of 2014, equity markets in the United States once again hit new highs despite added volatility. Geopolitical events—including tension between Russia and Ukraine, the ongoing conflict in the Middle East and the Scottish vote for independence—dominated the headlines and drove market volatility.
On the domestic front, the momentum in U.S. equity markets was driven primarily by stronger domestic economic data. Robust retail and auto sales and an upward revised to second-quarter GDP from 3.9% to 4.6% more than offset softer housing figures and lifted investor sentiment. Employment growth also continued to show improvement. June and July saw robust employment growth while August, traditionally negatively affected by summer seasonality, saw some slowing but was revised up once and was expected to be revised higher a second time.
Looking abroad, conflict in the Middle East and Ukraine was again a source of market uneasiness. Additionally, although unsuccessful, the vote for Scottish independence also impacted global equities, especially in United Kingdom. Softening economies in Europe and several emerging-market (EM) countries, including China, also kept investors at bay during the July-September quarter as the U.S. dollar strengthened.
As we look to the remainder of 2014, we are optimistic that U.S. economic growth will continue to show positive improvement. We believe retail and auto sales trends will remain positive while the housing market, although slower, should continue its moderate growth. We also expect capital expenditures by companies to increase, further supporting longer-term economic growth prospects. Corporate earnings from U.S.-focused end markets should improve, offset by a potentially negative foreign exchange impact and slower ex-U.S. growth. We expect further mergers & acquisitions, dividend increases and share buybacks due to strong balance sheets and free cash flows from our companies. Globally, we believe Europe still needs to work through its growth challenges, while China and the EM’s longer-term growth story should remain positive.
In fixed income, the U.S. Treasury yield curve flattened during the quarter. Yields on 2-year to 7-year maturities all increased, while yields on maturities of 15 years and greater declined. The 10-year U.S. Treasury yield was volatile, starting the quarter slightly above 2.60%, rallying to a low of 2.34% at the end of August before finishing the quarter just shy of 2.50%. Much of the rate volatility centered on Federal Reserve (Fed) meetings, and the release of those meetings’ minutes, and increased geopolitical risk in the Middle East and Ukraine. At the September meeting, the Fed continued the reduction of its asset-purchase program known as quantitative easing (QE), which is expected to be completed in October. The Fed also maintained its “considerable time” forward guidance policy language on the federal funds target rate. However, the policymakers’ economic projections that accompanied the statement’s release showed an increase in the projected median funds rate from 1.125% to 1.375% in 2015, and a 38 basis points increase to 2.875% in 2016. This change implies rates could increase faster than the committee’s previous projections.
Against this backdrop of rates uncertainty and volatility, the third quarter total return for U.S Treasuries outperformed the risk-based fixed-income asset classes of high yield, emerging markets, commercial mortgage-backed securities (CMBS), MBS and investment-grade corporate bonds. For the remainder of 2014, we expect the economy to continue to improve and the unemployment rate and inflation to move closer to the Fed’s targets, which should result in higher U.S. Treasury rates.
During the quarter, the S&P 500 Index returned 1.13%, the Nasdaq Composite Index returned 2.24% and the Dow Jones Select Dividend Index returned -3.20%. Growth stocks outperformed value stocks with the Russell 1000 Growth Index returning 1.49% while the Russell 1000 Value Index returned -0.19%.
For the third quarter of 2014, the Barclays High Yield Index returned -1.86%, the Barclays Emerging Markets Index returned -0.78% and the Barclays Mortgage Index returned 0.18%.
For the third quarter, Federated Capital Income Fund Class A Shares at NAV returned -2.67%, underperforming the -1.75% return of the fund’s benchmark comprising of 40% Dow Jones Select Dividend Index, 20% Barclays U.S. Corporate 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, sector allocation added to the fund’s performance while stock selection detracted from the fund’s performance. Relative to the benchmark, the fund’s three best contributing sectors were Utilities, Consumer Discretionary, and Information Technology. The three sectors that most negatively contributed to fund performance were Energy, Industrials, and Consumer Staples.
On an absolute basis, the five securities contributing most to performance Gilead Sciences (ELN), Staples (ELN), Frontier Communications, Alexion Pharmaceuticals (ELN), and LyondellBasell Industries. The five positions detracting most from performance were Post, Crescent Point, Bonavista, Baytex, and Total SA.
The fixed-income holdings of the portfolio continued to generate substantial income, but for the third quarter underperformed the benchmark. The fund’s underperformance was due primarily to overweight allocations to the high yield and EM sectors, which more than offset the positive contributions from security selection and a duration position less than 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 sheet 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, Health Care, and Information Technology. The fund’s largest underweight positions include Utilities, Consumer Staples and Industrials.
Within the fixed-income portfolio, the fund’s duration position was slightly higher than last quarter at approximately 89%, and we still believe that interest rates may be trending higher over the remainder of the year. The portfolio had an average effective duration of 4.08 years vs. the benchmark at 4.56 years. The fund maintained its yield curve flattening bias.
We adjusted our allocations slightly during the quarter. The high-yield allocation was increased to 47% of the fixed-income portfolio from 46%, EM was reduced from 37% to 36% and the high quality allocation was unchanged at 17%.