As of 03-31-2018

Market Overview

The U.S. economic expansion continued in the first quarter of 2018, aided by improving growth overseas and a generally more positive global economic outlook. The unemployment rate held steady at a low 4.1% even with robust job growth as a strong job market encouraged more people to seek jobs, driving an increase in the labor force participation rate. Companies continued to hold tightly to existing employees as new jobless claims fell to a more than 40-year low during the quarter. The recently enacted tax cuts, federal spending increases and lighter regulatory environment continued to drive a high level of confidence in the economic expansion from both corporations and consumers. The Federal Reserve’s (Fed) favored measure of inflation, Core Personal Consumption Expenditure (PCE), remained somewhat below the target of 2%. However, the newly confirmed Fed Chair, Jerome Powell, stated that the members of the Federal Open Market Committee (FOMC) expect inflation to slowly rise in coming quarters toward the longer-term target. The FOMC raised the federal funds target rate to a range of 1.50-1.75% during its March meeting. The FOMC continued to reduce the size of the Fed’s balance sheet by gradually 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.

Interest rates rose across the curve, with larger increases at the short end and a smaller increase at the 10-year point. The S&P 500 fell during the quarter and risk assets underperformed as concerns related to tariffs and trade restrictions weighed on market sentiment. Outside the U.S., the outlook continued to improve. Growth in Europe, Japan and emerging markets continued in a synchronized advance with the U.S. 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 $21 trillion, more than the entire gross domestic product (GDP) of the U.S.

Treasury rates rose during the period across the yield curve as the markets priced in more interest rate increases by the Fed. Mortgage securities underperformed similar-duration Treasuries. Within the coupon stack, 4.5% and higher coupons outperformed lower coupons.

As of March 31, 2018, the federal funds target rate range was 1.50-1.75%. The yield on 2-year Treasury securities rose 38 basis points to end the quarter at 2.27%, and the yield on 10-year Treasury securities rose 33 basis points to end the quarter at 2.74%.

Fund Performance

For the three months ended March 31, 2018, Federated Mortgage Fund (Institutional Shares) returned -1.04% versus -1.19% for the unmanaged Bloomberg Barclays U.S. Mortgage Backed Securities Index. The Institutional Shares’ net asset value (NAV) on March 31, 2018, was $9.38.

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 made a positive contribution to the fund’s performance as the fund maintained a below-neutral duration stance and yields rose during the period. The fund’s overweight to higher-coupon mortgages, relative to 3% and 3.5% mortgages, contributed to fund performance as the lower-coupon mortgages underperformed during the quarter. The fund’s sector allocation 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

The fund continues 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, 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 first quarter with a below-neutral duration stance.