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 fourth quarter of 2014, equity markets once again reached all-time highs despite increased volatility. While softening economies in Europe and Asia had a material impact on the markets, falling oil prices drove market volatility and headlined equity news throughout the quarter.
On the domestic front, the S&P 500 rallied from six-month lows in mid-October before reaching all-time highs in late December on the heels of strong economic data—third-quarter GDP was revised up from 3.9% to 5.0%—and a better-than-expected earnings season. Continued U.S. economic strength coupled with a patient Federal Reserve (the Fed) helped the equity markets withstand oil’s relentless decline. Employment continued to be a bright spot in the U.S., as it has been all year. November posted the largest one-month increase in nonfarm payrolls in almost three years and the unemployment rate continued its downward march. Auto and broader retail spending remained strong, helped by lower gasoline prices, which essentially work as a tax cut to consumers. Overall, the U.S. continued to show strength domestically amid growing signs of global stress.
In Japan, where the economy fell back into recession, the Bank of Japan in October said it would commence with a large round of quantitative-easing (QE), adding to market volatility. The market expects European policymakers may soon follow suit, given a softening eurozone economy and a new bout of deflation fears. In addition to slowing Japanese and European economies, rising geopolitical tensions over Russia’s intentions, talk of a potential Greek exodus from the European Union (EU) and a slowing China also shook the markets in the quarter. Russia in particular experienced large currency depreciation and drastically raised its benchmark interest rate as the collapse in oil prices severely challenged its economy.
Indeed, oil’s decline dominated the headlines in the 2014’s final few months, creating considerable volatility in both domestic and global markets. West Texas Intermediate, a crude oil benchmark, began the quarter above $89 a barrel and ended close to $50, continuing its slide from high of $100 a barrel in June. Much of the volatility surrounding oil can be attributed to softening of global growth led by Europe, China and emerging-market (EM) economies. These concerns led to market speculation about a potential global oversupply of oil, a view exacerbated by OPEC’s decision at its November meeting to forego an expected cut in production. The decision further roiled the markets, pressuring energy markets lower and pushing volatility higher. Uncertainty over why OPEC chose not to bring supply more in line with demand has kept the market volatile and unpredictable.
2015 will surely be another volatile year. We remain optimistic that the U.S. economy will continue to improve, but are cognizant of the potential impacts of both a global slowdown on corporate growth rates and a possible upward shift in the Fed’s interest-rate policies. We expect further mergers and acquisitions, dividend increases and share buybacks due to strong balance sheets and free cash flows from our portfolio companies. Globally, Europe’s struggle with lack of growth and deflationary issues persist, balanced by potential QE from the European Central Bank to reignite its lackluster economies. Pending Greek elections have raised the possibility that one or more countries may exit the EU, while on the other side of the globe, China continues to exhibit a managed slowdown that is impacting regional and EM growth rates though, as in previous years, we do not believe China is in a hard-landing scenario. Ongoing tensions in the Middle East, Russia and South America also continue to stress global growth rates, as do uncertainties within energy. We remain vigilant for opportunities as we adhere to a tested investment process to guide us through rough waters.
In fixed income, U.S Treasury yields still declined and the U.S. Treasury curve also flattened despite solid U.S. economic data releases during the quarter. U.S. Treasury yields decreased for all maturities of three years or greater, with the largest declines in securities with maturities of seven years or higher. The decline in U.S Treasury yields was due primarily to four factors: 1) the dramatic decline in oil prices, feeding risk aversion by investors; 2) global growth concerns; 3) the lack of inflation in the U.S. and globally; and 4) the attractiveness of U.S Treasury yields relative to the sovereign debt yields of other countries.
During the quarter, the Fed continued down the path of monetary policy normalization with the termination of its asset purchase program in October and the elimination of the “considerable time” policy language regarding potential fed fund rate increases in its December statement. As a result of the overall decline in U.S. Treasury rates, the fourth quarter total return for U.S Treasuries outperformed the risk-based fixed-income high-yield, emerging-market, commercial mortgage-backed securities and investment-grade corporate asset classes. High yield in particular was severely and negatively impacted by the -10.6% return in from the asset class’s Energy sector, which accounts for approximately 13% of the Barclays High Yield Index. The selloff in oil prices also materially negatively impacted the returns of the oil-dependent EM countries, including Venezuela and Russia, which were down -29% and -14%, respectively.
Federated Capital Income Fund (Class A Shares at NAV) returned -1.81% in the fourth quarter, underperforming the 3.15% 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 Markets USD Aggregate Index and 20% Barclays Mortgage-Backed Securities Index. However, the fund met its primary goal of current income and long-term growth of income during 2014. The fund’s 30-Day yield for Class A Shares at the end of fourth quarter was 4.79% at NAV and 4.52% at Maximum Offering Price. The fund’s yield is well above the S&P 500 yield at 1.95%; Dow Jones Select Dividend Index at 3.45%; 10-year Treasury yield at 2.17% and Morningstar Conservative Allocation at approximately 2.12%. The fund received greater than 10 dividend increases during the fourth quarter lead by Pfizer, AbbVie and Six Flags Entertainment. For the full year 2014, the fund has received greater than 35 dividend increases.
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 fourth quarter performance, which impacted the full year results, was driven by two factors 1) our overweight sector allocation to credit sensitive bonds underperformed Treasuries and 2) Energy sector underperformance within equities.
In fixed income, the fund’s underperformance was due primarily to relative sector overweight allocations to the High Yield and Emerging Market sectors, which underperformed Treasuries but at yields better aligned with our income objective.
Security selection was a significant positive contributor to fund performance, especially in the High Yield portion of the portfolio, which was underweight the Energy sector. Security selection in the EM portfolio had a negative impact on the fund’s performance due to negative security selection primarily in Russia and Brazil. Security selection in the fund’s higher quality bucket had a slight positive contribution to performance in the quarter. The fund’s duration position, which was less than the benchmark, also negatively impacted the fund’s performance in the quarter and more than offset the slight positive benefit from the fund’s yield-curve flattening position.
In equities, energy positions negatively impacted performance during the fourth quarter. Energy prices ended the year down more than 50% from their peak, in a very volatile and steep fashion that hurt some of our largest holdings. The two sectors that underperformed during the quarter was our overweight in Energy and Underweight in Utilities. The five positions detracting most from performance were primarily all energy related: Baytex, Bonavista, Crescent Point, Total, and LyondellBasell. On the positive side, two best contributing sectors were our overweight in Information Technology and Telecom Services. On absolute basis five securities contributing most to performance Staples (Equity Linked Note, or ELN), Hospitality Properties Trust, Six Flags Entertainment, Regal Entertainment, and Delta Airlines (ELN).
Click on the Portfolio Characteristics tab for the fund’s top 10 holdings.
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.
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.
As we look to 2015, we see more global economic and monetary uncertainties, which have lead us to move the equity portfolio to be more sector neutral. We have reduced our cyclical tilt by reducing our energy position from 10% of the Fund as of September 30, 2014 to 4.75% as of December 31, 2014, with the sale proceeds redistributed back into other market sectors.
Sector overweight positions relative to the fund’s Dow Jones Select Dividend Index benchmark include Information Technology, Energy, and Health Care. The fund’s largest underweight positions include Utilities, Consumer Staples, and Industrials.
Within the fixed-income portfolio, the sector allocation has remained consistent throughout the quarter with a significant over-weight to High Yield and slight overweight to EM. The portfolio had an average effective duration of 4.1 years vs. the benchmark at 4.5 years. The fund maintained its yield-curve flattening bias.