As of 09-30-2017

Market Overview

The Federal Reserve (Fed) did not increase short-term interest rate targets during the third quarter, but showed an inclination to continue its tightening bias at the upcoming December meeting, if a reading of the September Federal Open Market Committee (FOMC) meeting minutes provides any indication. An outline for the reduction of the Fed’s balance sheet was offered with a start date of October 2017, which will itself be a form of monetary tightening. Yet the minutes showed that the Fed was still optimistic about the U.S. growth and employment situation and that the recent weather disruption is unlikely to alter the economy’s course in the medium term. Furthermore, the Fed remained “confident that inflation will return back to the 2% target.” All in all, the tone of the release appeared to indicate a preference on the part of the Fed for an additional federal funds target rate hike in December.

The effect of this event on the bond market was an increase in rates from where they had been prior to the Fed meeting, with short-term yields increasing more than longer-term ones, a common reaction when the Fed is believed to be in a tightening mode. The yield on the 2-year Treasury note ended up increasing modestly, rising from 1.38% at June 30, 2017, to 1.49% at Sept. 30, 2017. The 5-year point of the Treasury curve increased less, from 1.89% to 1.94%, and the 10-year point increased only slightly, from 2.30% to 2.32%, over the reporting period.

With regard to credit metrics, spreads further out the maturity spectrum continued their tightening trend in the third quarter, with the Bloomberg Barclays Credit Index tightening from an option-adjusted spread of 103 basis points to 96 during the quarter (the level was 154 at Dec. 31, 2016). As has been the case all throughout 2017, shorter-dated credit performed better than longer credit (at least in terms of the amount of basis-point tightening), with the spread (option-adjusted) on the Bloomberg Barclays 1-3 year Credit Index tightening from 0.52% at June 30, 2017, to 0.44% at Sept. 30, 2017. The spread on the Bloomberg Barclays ABS Index, which at 2.28 years in duration represents a reasonable proxy for short-term spreads in securitized product, also tightened, from 0.46% at June 30, 2017, to 0.44% at Sept. 30, 2017. At this point, short-credit levels are either very close to or through their post-crisis tights (0.45% in May 2014 and 0.41% in December 2011 for the 1-3 Credit and ABS indices, respectively), though management continues to maintain a credit overweight in the portfolio. There is still room for spreads to tighten, however, as long as the economy continues to perform reasonably and foreign demand for yield continues, with the prospect of a tax-cut induced extension of the current economic cycle providing another potential (though not absolutely essential) catalyst.

Fund Performance

Federated Ultrashort Bond Fund’s return on Institutional Shares at net asset value (NAV) for the quarter was 0.45%, compared with a return on the Lipper Ultrashort Obligations Funds Average of 0.35%, and a return on the Bank of America Merrill Lynch 1-Year Treasury Bill Index of 0.25%. The fund’s fairly short duration and income capture from spread securities over the course of the quarter helped performance relative to both its benchmarks and peers despite higher interest rates. The fund’s floating-rate exposure during the quarter was 59% at 9/30/17 from 58% at 6/30/17, with these securities benefitting from London interbank offered rates (Libor) which have increased over the past six months in response to changes in Federal Reserve policy. Management believes further Fed rate increases will continue to benefit the portfolio in terms of both yield and total return, while the presence of more floating-rate paper should help to maintain capital stability.

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.

Also click the Performance tab for standard fund performance.

Strategy

Fund duration was maintained in the 0.5–0.6 year range during the quarter. In terms of sector allocation, the asset-backed security (ABS) allocation remained constant at 47% of the portfolio during the quarter. Corporate exposure (including noninvestment grade holdings) decreased from 44% to 42%, including a 4% position in both corporate and financial commercial paper and certificates of deposit (down from 5% last quarter). The noninvestment grade component of the portfolio was unchanged at 5%. Both residential and commercial mortgage-backed securities (MBS) exposure were unchanged at 4% and 2%, respectively, during the quarter. Government exposure (excluding agency MBS) remained at zero. Cash equivalents increased from 2% of the portfolio at June 30, 2017, to 4% at Sept. 30, 2017.

With regard to fund quality, cash and AAA-rated security exposure increased marginally from 46% to 48% of the portfolio at Sept. 30, 2017. AA-rated exposure increased from 9% to 10%, A-rated exposure decreased from 20% to 18%, BBB-rated exposure remained constant at 19% and noninvestment grade exposure rounded down to 5% from 6% last quarter (all figures are rounded and long-term ratings of commercial paper/certificates of deposit issuers are used).

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


Key Investment Team