As of 06-30-2018

Market Overview

The Federal Reserve (Fed) raised overnight lending rates in June. This marked the eighth increase since the Fed began normalizing interest rates in December 2015. The labor statistics continued to point to a strong and robust employment market. The unemployment rate finished the quarter at 3.8%. For all intents and purposes, the Fed reached its mandate of full employment as inflation reached the Fed’s 2% target during the quarter. Given that inflation undershot its target for nine years, the Fed indicated a desire to let it run above target without dramatically increasing rates to combat rising prices. The path forward on inflation is highly uncertain. Oil traded higher due to supply restrictions from OPEC and increased global demand. However, wage gains were tepid in response to the tight labor market. Inflation expectations were stable around 2.1% since the first quarter. The Treasury yield curve flattened during the quarter as shorter-maturity notes rose more in yield than longer-maturity bonds. The Fed communicated its desire to increase rates in a deliberate and methodical pace.

The administration announced new tariffs on certain goods and countries with which it deemed to have an unfair trading relationship. Its goal is for fair and reciprocal trade. This escalation of trade tensions with major trading partners, both geopolitical allies and adversaries, created a lot of commentary regarding future growth and inflation prospects. So far, the market has taken these tensions in stride. Other events that caused market gyrations during the quarter were the strength of the dollar hurting the performance of emerging market securities of Turkey, Argentina and Brazil. Given these events, financial market volatility remained contained during the quarter. The strength of the economy continued to dominate trade and geopolitical headlines in determining financial market returns.

For the quarter, 2-year Treasury rates rose 26 basis points and 5-year rates rose 18 basis points. Inflation expectations widened by 3 to 7 basis points, and Treasury Inflation-Protected Securities (TIPS) modestly outperformed.

Fund Performance

For the three months ended June 30, 2018, Federated Real Return Bond Fund (Institutional Shares) returned 1.00% versus 0.77% for the Bloomberg Barclays U.S. TIPS Index. The Institutional Shares’ net asset value (NAV) on June 30, 2018, was $10.39.

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.

Click the Performance tab for standard fund performance.

Positioning and Strategy

The fund’s strategy is to maintain less interest-rate risk (primarily by selling U.S. Treasury note futures contracts) than the index in an attempt to reduce the negative impact on shareholder NAV in a rising interest-rate environment. The rationale is that the fund’s benchmark has duration in excess of five years and therefore a significant amount of interest-rate risk. When interest rates increase, whether due to rising inflation or other causes, they have a negative impact on the fund’s total return. That being said, with the aggressive increase in yields, the fund added duration during the quarter by buying back some shorts in the long end and buying futures in the front end as a hedge against more risk asset volatility.

Tactical credit-sector exposure is an integral part of the fund’s strategy in that the incremental yield from credit provides additional income to shareholders and can help to smooth the highly variable inflation accruals on TIPS. The fund still has exposure to high-yield corporates, but exited its derivative exposure to investment-grade credit.