As of 12-31-2017

Market Overview

The Federal Reserve (Fed) raised overnight lending rates in December for the third time in 2017. After having forecasted multiple rate increases in previous years but actually only hiking once per each of them, 2017 finally saw the Fed deliver on a year-ahead forecast. In the fourth quarter, the Fed also started shrinking its balance sheet in a plan, announced the preceding quarter, of purchasing $6 billion fewer Treasuries per month from its maturing Treasury positions accumulated during its asset purchase program and $4 billion fewer government mortgage-backed securities (MBS). Saber rattling between North Korea and the U.S., which caused a sharp but brief flight-to-quality bid in Treasuries in the third quarter, quieted down this quarter. After the failure to repeal and replace the Affordable Care Act, expectations of U.S. fiscal policy reform were quite low compared to post-election exuberance. However, the Republican-held Congress was able to coalesce around a tax bill that lowered corporate and individual tax rates. Supportive tax policy, business-friendly regulatory changes and improved overseas economic growth kept risk assets rising. The real U.S. economy was on solid footing in the fourth quarter, and business and consumer confidence remained at high levels. The labor market continued to be strong and steady, with the Fed admitting it had probably met its mandate for full employment. Inflation continued to lag behind its goal of 2% growth, but fears of deflation receded.

For the quarter, 2-year Treasury rates rose 40 basis points and 5-year rates rose 27 basis points. Inflation expectations widened by 10 basis points, and Treasury Inflation-Protected Securities (TIPS) modestly outperformed.

Fund Performance

For the three months ended Dec. 31, 2017, Federated Real Return Bond Fund (Institutional Shares) returned 1.54% versus 1.26% for the Bloomberg Barclays U.S. TIPS Index. The Institutional Shares’ net asset value (NAV) on Dec. 31, 2017, was $10.41.

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 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.

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.