Market Overview
The stock markets in the second quarter were all down with the S&P down 11.8%, the Dow down 9.9% and the Nasdaq down 12.0%. During the quarter world markets were hit with some extraordinary events. In the U.S. this included the April “Flash Crash,” the Deepwater Horizon rig explosion and resulting and continuing oil spill, the U.S. financial regulation legislation on banks and credit cards, and the scrutiny of investment banks as exemplified by the SEC suit against Goldman. Reports of lower-than-forecast home sales, and lack of manufacturing and private sector job growth added to the negative sentiment. In Europe the Greek contagion continued with Greece, Spain and Portugal sovereign credit downgrades leading to a sharp drop in the euro. Germany initiated a naked short selling ban. In Asia, escalating tensions between North and South Korea, indications of China’s economy slowing led by its property market and rising inflation in China dominated concerns. Consumer confidence which had been on the rise for three months declined sharply in June. In addition to these events, as the quarter ended there was much debate among economists as to whether the economy was entering a double dip recession.

Despite this high level of bearishness, there was some good news to report. Retail sales improved throughout the quarter. U.S. mortgage rates were at all-time historic lows. Brazil has had its best growth since 1996. The U.S. dollar has rallied during April and May and at the end of June earnings estimates are being revised upwards at the fastest level in six years. As of June 30 the S&P was at 1030 and consensus estimates were 81.63 creating a 12x earnings, a historically low valuation.

The stock market as a whole posted negative returns during the second quarter. Mid cap companies underperformed small cap companies while outperforming large cap companies on a relative basis. The S&P 500 Index declined 11.8% vs. the Russell Midcap Index declining 10.4%, vs. the Russell 2000 Index (small caps) declining 7.61%. In terms of investment style, value stocks in the Russell 2000 Index underperformed growth stocks by 1.4% during the quarter. The best-performing small cap growth (Russell 2000 Growth Index) sectors were Consumer Staples (down 6.0%), Industrials (down 6.4%), and Utilities (down 6.7%). Laggard sectors during the quarter were Energy (down 14.5%), Consumer Discretionary (down 11.3%), and Healthcare (down 10.5%).

Fund Performance
Federated Kaufmann Small Cap Fund (Class A shares at NAV) declined 9.72% while its benchmark, the Russell 2000 Growth Index, declined 9.22%. Good performers included Owens Corning, Jetblue Airways, Dynavax Technologies, IESI-BFC Ltd. and Rural Electrification. Laggard companies included Central European Media, Thompson Creek Metals, Auxilium Pharmaceuticals, Orient-Express Hotel and Piaggio.

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 of 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 Performance to the left.

Also click Performance on the left for standard fund performance.

Positioning and Strategy
Our mission at Federated Kaufmann remains the same: To achieve superior long term performance by uncovering promising growth companies trading at attractive valuations through proprietary fundamental research.

Approximately 79% of the portfolio as of June 30 is currently invested in four large sectors; Industrials, Healthcare, Consumer Discretionary, and Information Technology. These sectors have historically provided good opportunities for bottom-up growth investors. The 1.7% cash holdings in the fund are down a little from the first quarter. We continue to find attractive small and mid cap investment opportunities—companies that are dominant competitors and that have strengthening fundamentals delivering both near-term and long-term growth in sales and earnings. We believe such strong growth companies, if purchased at attractive prices, will provide investors with the opportunity for superior returns over the long term.