Federated Short-Intermediate Duration Municipal Trust (IS) FSHIX

Share Classes Product Type Asset Class Category
Mutual Fund Fixed Income Muni National
As of 09-30-2017

Market Environment

Treasury yields rose modestly during the third quarter of 2017 amid indications of improving U.S. and global growth, heightened prospects for stimulative U.S. tax policy and the beginning of gradual balance-sheet reduction by the Federal Reserve (Fed). Continued low inflation and bouts of risk aversion related to potential conflict between the U.S. and North Korea offered countervailing downward pressure on market yields during the quarter. Two-year Treasury yields increased by 10 basis points, while 10-year and 30-year Treasury yields both increased by 3 basis points. Municipal bond yields followed a similar pattern, with steady inflows into municipal bond funds and modest new issuance supporting some outperformance for short- and intermediate-term municipal bonds relative to Treasuries. Municipal Market Data (MMD) 2-year AAA tax-exempt yields decreased 6 basis points, while the 10-year and 30-year AAA tax-exempt yields increased by 1 basis point and 5 basis points, respectively.

The S&P Municipal Bond Index posted a return of 0.99%. The 3-year component of the index returned 0.61%, the 10-year component returned 1.18% and the portion of the index maturing in 22 years and longer returned 0.86%. The AAA/Aaa component of the index returned 0.72%, the A-rated component returned 1.46% and the BBB-rated component returned 2.08%. The S&P 1-5 Year National AMT-Free Municipal Bond Index (SP15MBI), the fund’s prospectus benchmark, posted a return of 0.55%.

While geopolitical, social and environmental turbulence dominated U.S. headlines in the third quarter, economic data largely avoided volatility and moderately improved. The progress was enough for the Fed in September to begin the long process of shrinking its massive balance sheet built up over years of quantitative easing. While the tapering that gets underway in October is modest, it symbolizes the end of a decade of extraordinary accommodation following the financial crisis. However, policymakers did not raise interest rates in the reporting period.

The third quarter was beset with vigorous debate in the U.S. over the removal of Confederate statues, the future of the Affordable Care Act, belligerent rhetoric by North Korea and the federal budget. But these were overshadowed by the ferociousness of enormous hurricanes that slammed Texas, Florida and the Caribbean in late August and September. Nonetheless, the U.S. economy continued to expand as business confidence rose, manufacturing accelerated, consumer sentiment improved and the labor market posted solid gains. Retail and auto sales disappointed and housing softened, but the overall narrative looking forward was positive.

In the equity markets, the major indexes repeatedly set new highs, bolstered by growth and expectations for tax reform. The corporate credit markets also performed well, while the Treasury yield curve flattened slightly. Subdued inflation remained an issue. Although various price gauges rose slightly in September, they remained below the Fed’s 2% target, in part due to wages not rising as much as has historically been the case in response to a tightening labor market.

During the three months ended Sept. 30, the 1-month London interbank offered rate (Libor) did not move materially, ending at 1.23%, while 3-month Libor rose from 1.30% to 1.33%. The 1-year MIG1 note yield rose from 0.95% to 0.99%. The 7-day SIFMA Municipal Swap Index began the third quarter at 0.91%, dipped to 0.77% in mid-August and then rose to 0.94% to end the quarter. The short end of the U.S. Treasury curve rose over the quarter, with 1-month and 3-month Treasury yields rising from 0.89% to 0.97% and 1.00% to 1.05%, respectively.

Performance

During the third quarter of 2017, the fund had total returns of 0.66% for the Institutional Shares (IS), 0.59% for the Service Shares (SS) and 0.43% for the Class A Shares at net asset value (NAV). The fund’s AMT-free, tax-exempt income was enhanced by 3 cents of NAV appreciation for both IS and SS share classes and 2 cents of appreciation for the Class A shares. The SP15MBI, the fund’s prospectus benchmark, returned 0.55% during the quarter.

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. To view performance current to the most recent month-end and for after tax returns, click on the Performance tab. Performance does not reflect the maximum 1% sales charge for Class A Shares. If included, it would reduce the performance quoted.

Click the Performance tab for standard fund performance.

Strategy

Over the quarter, the fund’s duration decreased only slightly from 1.74 years to 1.71 years , as part of a tactical decision to take advantage of attractive issuance, as well as to keep the portfolio’s interest-rate sensitivity low relative to the SP15MBI benchmark (2.38 years at quarter-end) and slightly short of fund peer average. Management believed short-term municipal interest rates were likely to slowly rise over the next 6 to 12 months as the Fed indicated a high probability of another 25 basis-point tightening in interest rates in 2017 with plans for several more in 2018. The Fed also is preparing for normalization of its massive balance sheet which could put some pressure on interest rates on the short and intermediate portions of the yield curve.

During the third quarter, yields for 2-year AAA-rated short-term municipal bonds moved downward before rising sharply in mid-September to close slightly higher on news that the Fed is on track to normalize interest rates. The 2-year Treasury yield followed a similar pattern over the quarter. Two-year AAA-rated municipal yields started the quarter at a high of 1.06% and moved steadily downward in July and August to a low of 0.84% before rising sharply in September to end the quarter at 1.00%. As a result, 2-year municipal-to-Treasury yield ratios, a measure of relative value, moved from 72% at the start of the quarter (fair value) to 62% (very rich) to 68% (slightly rich) at quarter-end. A lack of supply and strong demand for short-maturity municipal bonds resulted in the municipal outperformance relative to comparable maturity Treasury notes. At quarter-end, the municipal yield curve from one to five years remained relatively flat, offering little incremental income per unit of risk (approximately 10 basis points per year) to extend duration, especially amid a Fed tightening cycle.

Over the quarter, the fund’s gross returns significantly exceeded the SP15MBI and essentially matched on a net basis after expenses. The fund’s excess return over benchmark was positively impacted by credit-quality positioning, as the fund’s holdings in A and BBB rated issues outperformed. Security selection was also a positive factor, while sector positioning negatively impacted fund performance relative to SP15MBI. The fund’s excess return was not impacted by its defensive duration positioning. The fund’s duration was about 75% of the SP15MBI over the quarter.

From a security-selection perspective, we continued to emphasize investments in floating-rate notes (FRNs) at 25% of the portfolio, variable-rate demand notes (VRDNs) for core income and liquidity, 30-60 day rolls of commercial paper, general obligation bond and note opportunities in the 1-year range combined with attractive revenue bond offerings from two to seven years in maturity. These decisions enabled the fund to keep its portfolio duration short relative to benchmark in expectation of rising short-term interest rates in 2017 and 2018.

In addition, FRNs that the fund holds generally outperformed in income relative to currently offered comparable-maturity fixed-coupon bonds during the quarter, and many experienced incremental price improvement due to increasing demand. FRNs have coupons tied to either the 7-day municipal weekly reset SIFMA index plus a spread or a percentage of the 30-day Libor rate plus a spread. FRNs and VRDNs benefit when the Fed is in a tightening cycle because their coupons increase as the base Libor and SIFMA indexes react to the Fed’s moves.

The fund’s overweight in credit, namely A and BBB securities, relative to the SP15MBI benefited performance over the quarter, as bonds rated A and BBB outperformed their higher-quality brethren. Also, the fund’s holdings in Illinois and New Jersey (appropriation) experienced credit-spread tightening on improving budget fundamentals, which positively impacted performance. The fund had little exposure to noninvestment grade debt and did not use derivative instruments for hedging purposes. It did not have any exposure to Puerto Rico or any of its public corporations within the Commonwealth.

Click on the Portfolio Characteristics tab for information on quality ratings.