Federated Short-Intermediate Duration Municipal Trust (IS) FSHIX

Share Classes Product Type Asset Class Category
Mutual Fund Fixed Income Muni National
As of 12-31-2017

Market Environment

Yields on short- and intermediate-term Treasury securities increased, while yields on long-term Treasury securities declined during the fourth quarter of 2017 amid ongoing moderate U.S. economic expansion, incremental tightening of monetary policy by the U.S. Federal Reserve (Fed), continued modest inflation and enactment of federal tax reform in December. Two-year and 10-year Treasury yields increased by 40 basis points and 7 basis points, respectively, while the 30-year Treasury yield decreased by 12 basis points. Municipal bond yields followed a similar pattern over the quarter, after some bouts of volatility related to a record surge in municipal issuance late in the year ahead of the effective date for tax policy changes. The surge in supply was met with strong demand, thus allowing yields on intermediate- and long-term municipal bonds to decline more than was observed in the Treasury market. Municipal Market Data (MMD) 2-year AAA tax-exempt yields increased 56 basis points, while the 10-year and 30-year AAA tax-exempt yields decreased by 2 basis points and 30 basis points, respectively.

The S&P Municipal Bond Index posted a return of 0.64%. The 3-year component of the index returned -0.92%, while the 10-year component returned 0.60% and the portion of the index maturing in 22 years and longer returned 2.14%. The AAA/Aaa-rated component of the index returned 0.40%, the A-rated component returned 0.87% and the BBB-rated component returned 1.55%. The S&P 1-5 Year National AMT-Free Municipal Bond Index (SP15MBI), the fund’s prospectus benchmark, posted a loss of -0.73%.

While uncertainties about a major tax overhaul and a flattening yield curve were in the forefront during the fourth quarter of 2017, the U.S. economy and its central bank provided a positive underpinning for the markets. Temporary distortion of data due to major hurricanes that hit various parts of the U.S. in late summer gave way to data showing many aspects of the economy on an upward trend. Gross domestic product appeared to hover around the strong 3% growth track experienced in the second and third quarters, a significant acceleration over the year-ago pace. The labor market continued to tighten, with unemployment falling and wages beginning to inch upward. Consumer spending was solid, with the combination of rising employment and robust confidence pushing holiday retail sales to 3-year highs. Business sentiment and manufacturing activity also improved, while the housing market shed its summer lull with a boost of late-year activity.

Although the news was welcome, the policy actions announced by the Federal Reserve (Fed) in the quarter were long in the making: the shrinking of its massive balance sheet of government and agency securities and another hike in interest rates. The reduction of its holdings began modestly, with $30 billion allowed to roll off its books in the quarter, but will increase in size over the coming quarters. December’s increase of rates, the third move in the year, raised the target range to 1.25% to 1.50% and was accompanied by an optimistic outlook for the economy in 2018 and a projection for three additional hikes in 2018. But policymakers remained troubled by the lack of inflation and the flattening of the yield curve, the latter occurring as the difference in rates between the short and long end of the Treasury curve decreased over the quarter. The reporting period ended in a flurry of activity in the U.S. municipal bond market as issuers and investors reacted to various GOP tax-reform proposals that could impact local and state governments as well as muni bond investors. President Trump signed the final bill into law in late December.

During the three months ended Dec. 31, 2017, the 1-month London interbank offered rate (Libor) rose from 1.23% to 1.56% and 3-month Libor rose from 1.33% to 1.69%. The short end of the U.S. Treasury curve also increased over the quarter, with 1- and 3-month Treasury yields rising from 0.97% to 1.25% and 1.00% to 1.45%, respectively.

The 7-day SIFMA Municipal Swap Index began the fourth quarter at 0.94% and held that level until jumping in December to end the quarter at 1.71% on year-end excess supply of variable-rate demand notes (VRDNs) and Fed tightening. The 1-year MIG-1 yield leapt from 0.99% to 1.46% due to higher rates and continued flattening with the market building in a case for three Fed hikes in 2018.

Performance

During the fourth quarter of 2017, the fund had total returns of -0.11% for the Institutional Shares (IS), -0.17% for the Service Shares (SS) and -0.24% for the Class (A) Shares at net asset value (NAV). The fund’s AMT-free, tax-exempt income was offset by 5 cents of NAV depreciation as the NAV ended the quarter at $10.24 per share. The SP15MBI, the fund’s prospectus benchmark, returned -0.73% during the quarter. For calendar year 2017, the fund had total returns of 2.16% (IS), 1.91% (SS) and 1.65% (A shares at NAV). The SP15MBI returned 1.49% for calendar year 2017.

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 increased slightly from 1.71 years to 1.77 years as part of a tactical decision to take advantage of an attractive municipal supply surge in December, 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 rise over the next six to 12 months as the Fed tightened again in December, with several more planned for 2018. The Fed also is in the early stages of 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 fourth quarter, yields for 2-year AAA-rated short-term municipal bonds trended upward before rising sharply in mid-November and into December as the effects of the tax reform legislation spurred municipal issuers to rush to market before various issuance provisions were eliminated by year-end. Fourth quarter 2017 issuance was a record $145 billion, which created buying opportunities and relative cheapness versus taxable counterparts. During the quarter, the 2-year and 5-year AAA-rated municipal yields rose 54 basis points and 34 basis points, respectively, while 2-year and 5-year Treasury notes moved up 40 basis points and 27 basis points, respectively. During the quarter 2-year municipal-to-Treasury yield ratios moved from a low of 66% (rich) in mid-October to a high of 86% (very cheap) in late November before ending the year at 81% (cheap). At quarter-end, the municipal yield curve from one to five years remained relatively flat, offering little incremental income per unit of risk (approximately 4 basis points per year) to extend duration, especially during a Fed tightening cycle.

Over the quarter, the fund’s gross returns and net returns exceeded the SP15MBI. The fund’s excess return over SP15MBI was positively impacted by duration positioning (75% of SP15MBI with interest rates rising) and credit-quality positioning, as the fund’s holdings in A and BBB rated issues outperformed, with fund being overweight relative to the SP15MBI. Sector selection and security selection also were positive factors, relative to SP15MBI.

From a security selection perspective, we continued to emphasize investments in floating-rate notes (FRNs) at 28% of the portfolio, VRDNs for core income and liquidity, general obligation 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 2018.

In addition, the FRNs the fund held generally outperformed in income relative to currently offered comparable maturity fixed-coupon bonds during the quarter, and some experienced incremental price improvement due to increasing demand in a rising interest rate environment. 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 had nominal exposure to noninvestment-grade debt and did not use derivative instruments for hedging purposes. It also 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.