As of 03-31-2018

Market Overview

The Federal Reserve (Fed) raised overnight lending rates in March and forecast an additional two hikes later this year. The Fed has spoken for years about a gradual normalization of overnight interest rates and has hiked five times in the last three years. The labor statistics continued to point to a strong and robust employment situation and satisfied the Fed’s mandate of full employment. Inflation, its other mandate, has not reached the Fed’s 2% target in many years. However, during the quarter, inflation prints surprised to the upside. The weak dollar and strong commodities (oil) sowed the seeds for inflation to increase over time. Also supportive of future inflation was the administration’s announcement of tariffs on imported steel and aluminum. Fiscal policy again provided market-moving developments as legislative leaders agreed to a budget outline that increased federal outlays by $390 billion. This action, coupled with the tax reform package, increased the fiscal budget deficit and the amount of supply needed to be auctioned by the Treasury Department. The vast majority of this increased supply was in the bill sector and forced shorter maturity Treasury rates higher. Another noteworthy event in the quarter was the return of volatility to risk assets. The VIX Index, which measures volatility in the equity market, jumped to more than 35, startling investors. This index had been trading under 20 since the last quarter of 2016. Risk assets were sold initially but finished the quarter with a small loss.

For the quarter, 2-year Treasury rates rose 38 basis points and 5-year rates rose 36 basis points. Inflation expectations widened by 10 to 15 basis points, and Treasury Inflation-Protected Securities (TIPS) modestly outperformed.

Fund Performance

For the three months ended March 31, 2018, Federated Real Return Bond Fund (Institutional Shares) returned -0.03% versus -0.79% for the Bloomberg Barclays U.S. TIPS Index. The Institutional Shares’ net asset value (NAV) on March 31, 2018, was $10.37.

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 significantly 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.

Federated’s Sector Pod recommended an overweight position to investment-grade corporates, along with its continued recommended exposure to high-yield credit. 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 and investment-grade corporates.