As of 06-30-2018

Highlights

  • Economic and earnings growth still reasonable, but looming trade war threatens continued expansion
  • Federal Reserve appears to confirm fund management’s decision to maintain a cautious duration posture
  • Spread product performance generally flat in second quarter; management taking a more cautious view on credit

Looking Back

The Federal Reserve (Fed) continued normalizing interest-rate policy in the second quarter of 2018 by raising the federal funds target rate range by 25 basis points—the seventh such move since December of 2015. The range now stands at 1.75-2%, and most market participants believe there will be two more hikes in 2018, effectively confirmed in the minutes of the June Federal Open Market Committee meeting following the most recent hike. The program to reduce the size of the Fed’s balance sheet represents an ancillary form of monetary tightening, and accordingly, fund duration was maintained in the 0.45-0.50 year range during the quarter, at the shorter-end of the fund’s typical 0.4-1.0 year range.

While interest rates increased in general over the course of the quarter, short-term yields increased more than longer-term ones, a common reaction when the Fed is in a tightening mode. The yield on the 2-year Treasury note increased 26 basis points, from 2.27% on March 31 to 2.53% on June 30. The 5-year point of the Treasury curve rose 18 basis points, from 2.56% to 2.74%, while the 10-year point increased by only 12 basis points, from 2.74% to 2.86%. With regard to credit metrics, the spread (option-adjusted) on the Bloomberg Barclays 1-3 Year Credit Index was essentially unchanged, from 0.56% on March 31 to 0.55% on June 30. The spread on the Bloomberg Barclays ABS Index, which at 2.11 years in duration represents a reasonable proxy for short-term spreads in securitized product, moved by a single basis point, from 0.48% to 0.47%.

Fund Performance

Federated Ultrashort Bond Fund’s return on Institutional Shares at net asset value (NAV) for the quarter was 0.58%, compared with returns on the Lipper Ultrashort Obligations Funds Average of 0.56%, a return on the ICE Bank of America Merrill Lynch 1-Year Treasury Bill Index of 0.39%, and a return on the Bloomberg Barclays Short- Term Government/Credit Index (BBSTGCI) of 0.50%.

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.

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

Performance Contributors

The fund’s fairly short duration and income capture from spread securities over the course of the quarter placed it ahead of its benchmarks and peer group for the quarter despite higher interest rates. The fund’s floating-rate exposure at quarter-end stood at 68%, 3 percentage points higher than the same metric at the end of the first quarter. Floating-rate securities benefitted from London interbank offered rates (Libor), which increased over the past year in response to changes in Fed policy. Management believes further hikes would continue to benefit the portfolio in terms of both yield and total return, and that the presence of more floating-rate paper should help to maintain capital stability.

Performance Detractors

Some weakness in credit spreads on lower-rated investment-grade and non-investment grade securities detracted at the margin from fund performance. On average, however, credit-spread performance was flat in the quarter, so there was no material performance impact from credit. Higher rates also had some effect, though the fund maintained a very low duration profile.

How We Are Positioned

The Fed has made clear to the marketplace that a deliberate, yet measured pace of monetary tightening will remain in place for the foreseeable future. While the Fed’s policy actions likely will remain data dependent or driven by an unforeseen exogenous events, fund management is positioning the portfolio in anticipation of the expected rate outcome. Moving into the third quarter of 2018, short credit levels exhibit more value than they did at the beginning of 2018, yet management is watching its modest portfolio credit overweight carefully. There is room for spreads to tighten, but more caution may be warranted if the current protectionist tilt out of Washington proves a material drag on economic activity.