3 Questions: Federated Ultrashort Bond Fund
“3 Questions” explores investment approaches used by Federated Investors strategists. This installment features Portfolio Manager Randall Bauer.
Q: Could you briefly explain the Federated Ultrashort Bond Fund strategy?
The fund offers investors access to a strategy with a multi-pronged approach, focusing on credit risk, interest-rate risk and liquidity. It is built for investors seeking to reduce their interest-rate exposure—the fund maintains an effective duration of a year or less—while potentially gaining better yields than similar maturity government securities, i.e., they are willing to take some credit risk, but not much. The fund is invested predominantly in investment-grade securities.
Q: What is the appeal of ultrashort bonds now that the Federal Reserve is contemplating a rate cut?
As interest rates fall, a bond fund will tend to hold a higher income stream longer than a money market fund. This is because the higher-coupon securities held in a bond fund purchased prior to any decline in rates will take longer to mature than money market securities, so the higher yield will tend to be maintained for a longer period of time. When securities mature in any mutual fund portfolio, the proceeds need to be redeployed in new securities, which will have lower yields in the event interest rates are falling. If rates don’t decline, there is generally a yield advantage to an ultrashort fund relative to a money fund. Since the majority of an ultrashort’s total return is generated by the yield on the securities in the portfolio, this generally means that an ultrashort fund may generate a higher total return as well.
We believe the fund's conservative profile merits a place in just about every portfolio as a vehicle to help weather uptics in market volatility brought on by either concerns over slowing economic growth or uncertainly over Fed policy.
Q: What is the outlook and positioning for fund over the next 3 to 6 months?
With developments in the marketplace indicating the Fed is more likely to reduce interest rates in the short to intermediate term, the effective duration of the portfolio (i.e., its sensitivity to changes in interest rates) has been increased in order to take advantage of any further decline in market yields. If the Fed does, in fact, lower short-term rates, we expect that the fund will be able to generate some modest amount of capital appreciation in addition to the coupon yield earned on the portfolio.