As of 12-31-2017

Highlights

  • Continued economic and earnings growth supportive of spread product performance
  • Cautious duration posture remains warranted into 2018
  • Fund has high floating rate exposure (60% at 12/31/17)

Looking Back

The Federal Reserve (Fed) continued its normalization of interest-rate policy in the fourth quarter of 2017 by raising the federal funds target rate range by 25 basis points, the fifth such move in the past two years. The range now stands at 1.25-1.50%, and most market participants believe it will be increased further in 2018. The program to reduce the size of the Fed’s balance sheet began in October, and represents an additional form of monetary tightening. Fund duration was maintained in the 0.5-0.6 year range during the quarter, at the shorter-end of the fund’s normal 0.4-1.0 year duration range.

Short-term yields increased more than longer-term yields during the quarter, a common reaction when the Fed is believed to be in a tightening mode. The yield on the 2-year Treasury note increased by 40 basis points over the course of the fourth quarter, from 1.49% at 9/30/17 to 1.89% at 12/29/17. The 5-year point of the Treasury curve increased by 27 basis points, from 1.94% to 2.21%. However, the 10-year point increased by only 9 basis points, from 2.32% to 2.41%. With regard to credit metrics, the spread (option-adjusted) on the Bloomberg Barclays 1-3 Year Credit Index tightened from 0.44% at 9/30/17 to 0.40% at 12/29/17. The spread on the Bloomberg Barclays ABS Index, which at 2.16 years in duration represents a reasonable proxy for short-term spreads in securitized product, tightened significantly, from 0.44% at 9/30/17 to 0.34% at 12/29/17.

Fund Performance

Federated Ultrashort Bond Fund’s return on Institutional Shares at net asset value (NAV) for the quarter was 0.35%, compared with a return on the Lipper Ultrashort Obligations Funds Average of 0.35%, a return on the ICE Bank of America Merrill Lynch 1-Year Treasury Bill Index of 0.06%, and a return on the Bloomberg Barclays Short-Term Government/Credit Index of 0.23%

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.

Performance Contributors

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 averaged around 60%, the same level that stood at 12/29/17. Floating rate securities benefitted from LIBOR rates, which have increased over the past year in response to changes in Federal Reserve policy. Management believes further Fed rate increases should 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 Detractors

None.

How We Are Positioned

Continued growth in the U.S. economy and labor force conditions consistent with “full employment” are expected to keep the Fed “in play” with regard to higher interest rates in the coming year, despite a current absence of observable inflation. At this point, short credit levels are now through their previous post-crisis tights (0.45% in May 2014 and 0.41% in December 2011 for the 1-3 Credit and ABS indexes, respectively), though management continues to maintain a credit overweight in the portfolio. There is still room for spreads to tighten, as long as the economy continues to perform reasonably and foreign demand for yield continues, with the tailwind of a tax-cut induced extension of the current economic cycle providing another potential (though not absolutely essential) catalyst.