As of 09-30-2017

Market Overview

The U.S. economic expansion continued in the third quarter of 2017, aided by improving growth overseas and a generally more positive global economic outlook. The S&P 500 rose during the quarter and risk assets outperformed on a continued high level of optimism. The unemployment rate and the labor force participation rate both held steady as payroll growth remained positive and average hourly earnings continued to grow. Before the distortions from hurricanes Harvey and Irma, new jobless claims remained low. Concern about the state of the U.S. economy and the ability of the current expansion to sustain momentum continued to abate as markets priced in higher growth due to expectations of lower taxes, less regulation and increased federal spending. Core Consumer Price Index (CPI) stabilized and headline CPI moved up somewhat, but inflation remained somewhat below the Federal Reserve’s (Fed) 2% target. Fed Chair Janet Yellen pointed to transitory factors holding down reported CPI that she expects to pass in the coming quarters. The Federal Open Market Committee (FOMC) held the federal funds target rate constant within a range of 1% to 1.25%, and interest rates largely remained rangebound, with small increases across the yield curve. During its September meeting, the FOMC announced plans to reduce the size of the Fed’s balance sheet gradually by allowing a portion of its Treasury and mortgage-backed security holdings to roll off without reinvestment over a period of years, subject to certain caps on the pace of decline in holdings. The September announcement was in line with the earlier projections released by the Fed and was not a surprise to the market.

Outside the U.S. the outlook improved. Growth in Europe continued at a moderate pace and the growth trajectory also improved in emerging markets such as China, Russia and Brazil. The fiscal position of the U.S. government continued to be troublesome. Previous budget deals stabilized domestic discretionary spending growth, but the long-term burden of rapidly growing entitlement spending had not been addressed. Total U.S. Treasury debt outstanding is over $20 trillion, more than the entire gross domestic product (GDP) of the U.S.

Treasury rates rose slightly during the period across the yield curve. Mortgage securities outperformed similar-duration Treasuries. Within the coupon stack, 3% coupons outperformed 3.5% and 4% coupons.

As of Sept. 30, 2017, the federal funds target range was 1% to 1.25%. The yield on 2-year Treasury securities rose 10 basis points to end the quarter at 1.48%, and the yield on 10-year Treasury securities rose 3 basis points to end at 2.33%.

Fund Performance

For the three months ended Sept. 30, 2017, Federated Mortgage Fund (Institutional Shares) returned 0.80% versus 0.96% for the unmanaged Bloomberg Barclays U.S. Mortgage Backed Securities Index. The Institutional Shares’ net asset value (NAV) on Sept. 30, 2017, was $9.59.

Performance data 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 the Performance tab.

Click the Performance tab for standard fund performance.

Duration management did not contribute significantly to the fund’s performance as the fund maintained a below-neutral duration stance and yields changed only slightly during the period. The fund’s sector allocation also did not make a material contribution to fund performance during the quarter as the fund has reduced its out-of-index sector allocations.

Positioning and Strategy

We continue to keep a low allocation to non-government sectors as spreads have become very tight, and we see less opportunity for outperformance. These sectors include non-agency-guaranteed mortgage-backed securities (MBS), non-agency-guaranteed commercial mortgage securities and asset-backed securities. Within the government sector, we maintained a balanced allocation between Ginnie Mae, Fannie Mae and Freddie Mac mortgage securities. The fund ended the third quarter with a below-neutral duration stance.