Certified Annual Shareholder Report by a Management Investment Company — Form N-CSR Filing Table of Contents
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N-CSR — Certified Annual Shareholder Report by a Management Investment Company Document Table of Contents
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes Management's Discussion of Fund Performance, a complete listing of your fund's holdings,
performance information and financial statements along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Management's Discussion
of Fund Performance (unaudited)
The total return of
Federated Managed Tail Risk Fund II (the “Fund”), based on net asset value for the 12-month reporting period ended December 31, 2017, was 10.95% for the Primary Shares and 10.67% for the Service Shares.
The total return of the S&P 500 Index (S&P 500),1 the Fund's broad-based securities market index, was 21.83% for the same period. The total returns of the MSCI All Country
World Index2 (MSCI ACWI) and the Bloomberg Barclays U.S. Universal Index2 (BBUSUI) were 23.97% and 4.09%, respectively. Weighting these benchmarks (60% MSCI ACWI and 40% BBUSUI),2 the total return of the blended benchmark (“Blended Index”) was 15.65%.The Fund's total returns reflected actual
cash flows, transaction costs and other expenses, which were not reflected in the total return of the Blended Index.
During the reporting period, the Fund's performance was affected by: (a) the Fund's targeted neutral asset allocation; (b) tactical allocation relative to these neutral points; (c) the security selection of the
underlying funds; and (d) the Fund's risk management overlay. The risk management overlay was the most significant factor affecting the Fund's performance relative to the Blended Index.
The
following discussion will focus on the performance of the Fund's Primary Shares.
MARKET OVERVIEW
During the reporting
period, equity markets reached all-time highs amid record low volatility,3 supported by a strong global economy and hopes of domestic tax reform. Tax reform was passed at the end of the year to help
propel equity markets to their year-end levels. The march to these levels was relatively smooth, with only a few bouts of volatility that saw the Chicago Board Options Exchange (CBOE) Volatility Index (VIX),4 a measure of implied forward volatility of the S&P 500, close above 15, which would ordinarily be a typical value rather
than a maximum. The most notable of these occurred in May when Deputy Attorney General Rod Rosenstein appointed Robert Mueller as a special prosecutor for the investigation of Russian interference in the 2016
election. This led some to speculate about the potential of an impeachment of President Donald Trump; however, those fears quickly faded, and volatility returned to low levels. During this reporting period, the U.S.
Federal Reserve (the Fed) continued to increase the federal funds target rate by hiking the rate by 25 basis points three times during the year. Furthermore, they initiated a process to unwind the Fed's balance sheet
in a process dubbed “normalization” in the fall. This process will see several trillion dollars of assets expire from the Fed's balance sheet over the coming years, in a slow, managed process, which could
affect the valuation of similar bonds.
The
market, as measured by the S&P 500, ended the year up 21.83%, and domestic small-caps, as measured by the Russell 2000® Index,5 were up 14.65%. U.S. equities underperformed the rest of the world with the S&P 500 underperforming the MSCI ACWI, which
returned 23.97%. Equities continued to outpace the 3.54% return of the Bloomberg Barclays U.S. Aggregate Bond Index.6 The commodity market continued to strengthen on improving economic conditions, as indicated by the strong 6.16% return of
the DBIQ Optimum Yield Diversified Commodity Index.7 High-yield bond spreads declined substantially, and high-yield bonds, as measured by the BofA Merrill Lynch U.S. High Yield
Index,8 returned 7.48%. Renewed inflation expectations following the election led to solid performance of the Treasury
Inflation-Protected Securities (TIPS) asset class, as the total return of U.S. TIPS, as measured by the Bloomberg Barclays U.S. TIPS Index,9 was 1.90%.
Market volatility decreased slightly from a moderate level of 14 to a low level of 11 during the reporting period, as measured by the VIX. It only increased a few times during the year peaking at 15.96, 15.59 and
16.04 in April, May and August, respectively. All of these volatility increases were short-lived and receded quickly.
NEUTRAL ASSET ALLOCATION
The diversified10 neutral allocation, which was intended to provide resilience in down markets, was tilted toward Value Equities relative to
the Blended Index. Also, the fixed-income portion of the Fund held TIPS, commodities and floating-rate notes for inflation protection. The diversified mix contributed negatively to Fund performance over the reporting
period.
TACTICAL ALLOCATION
The Fund began the
reporting period overweight in equities and maintained the overweight for the entire year. This tactical move positively impacted Fund performance.
SECURITY SELECTION
Security selection
positively impacted Fund performance in the reporting period, with several underlying funds outperforming their respective benchmarks.
The Fund uses an S&P
500 futures11 overlay to reduce the Fund's risk in markets with unusually high volatility. None of the aforementioned volatility spikes
were to a high enough level to require the use of the risk management overlay. As such, this had no impact on Fund performance. At the end of the reporting period, the Fund had no overlay position.
1
Please see the footnotes to the line graphs under “Fund Performance and Growth of a $10,000 Investment” below for the definition of, and more information about, the S&
P 500.
2
Please see the footnotes to the line graphs under “Fund Performance and Growth of a $10,000 Investment” below for the definition of, and more information about, the
Blended Index (60% MSCI ACWI and 40% BBUSUI). The Blended Index is being used for comparison purposes because, although it is not the Fund's broad-based securities market index, the Fund's Adviser believes it more
closely reflects the market sectors in which the Fund invests.
3
Volatility is a statistical measurement of the frequency and level of changes in the value of an asset, index or instrument without regard to the direction of those changes.
Volatility may result from rapid and dramatic price swings.
4
The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.*
5
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The index is a subset of the
Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000
of the smallest securities based on a combination of their market cap and current index membership. The R2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted
annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.*
6
The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and
corporate securities, mortgage-backed securities (agency fixed-rate and hybrid ARM pass-throughs), asset-backed securities and commercial mortgage-backed securities.*
7
The DBIQ Optimum Yield Diversified Commodity Index is based on 14 commodities drawn from the Energy, Precious Metals, Industrial Metals and Agriculture sectors.*
8
The BofA Merrill Lynch U.S. High Yield Index tracks the performance of U.S. dollar-denominated below investment-grade corporate debt publicly issued in the U.S. domestic market.*
9
The Bloomberg Barclays U.S. TIPS Index is a market value-weighted index that tracks inflation-protected securities issued by the U.S. Treasury.*
10
Diversification does not assure a profit nor protect against loss.
11
The Fund's use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional
instruments.
*
The index is unmanaged, and it is not possible to invest directly in an index.
FUND PERFORMANCE AND GROWTH OF A
$10,000 INVESTMENT
The graph below
illustrates the hypothetical investment of $10,0001 in the Federated Managed Tail Risk Fund II from December 31, 2007 to December 31, 2017, compared to the Standard &
Poor's 500 Index (S&P 500),2 the Fund's broad-based securities market index, and a blended index comprised of 60% of the MSCI All Country World Index
(MSCI ACWI) and 40% of the Bloomberg Barclays U.S. Universal Index (BBUSUI) (the “Blended Index”).3 The Average Annual Total Return table below shows returns for each class averaged over the stated periods.
The Fund offers multiple
share classes whose performance may be greater than or less than its other share class(es) due to differences in sales charges and expenses.
Average Annual Total Returnsfor the Period Ended 12/31/2017
1 Year
5 Years
10 Years
Primary Shares
10.95%
2.81%
0.83%
Service Shares
10.67%
2.53%
0.59%
S&P 500
21.83%
15.79%
8.50%
Blended Index
15.65%
7.53%
4.86%
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. Performance of a variable investment option changes over time and current performance may be lower or higher than what is stated. For current to the most recent month end performance, contact your insurance
company. The performance information presented does not include the charges and expenses imposed by the insurance company under the variable insurance product contract. The inclusion of such charges would lower
performance. Please refer to the variable insurance product prospectus for a complete listing of these expenses. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable
life insurance policies and variable annuity contracts. Variable investment options are not obligations of or guaranteed by any bank and are not federally insured.
1
The Fund's performance assumes the reinvestment of all dividends and distributions. The S&P 500, the MSCI ACWI and the BBUSUI have been adjusted to reflect reinvestment of
dividends on securities in the index.
2
The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500
stocks representing all major industries. The index is not adjusted to reflect sales loads, expenses or other fees that the Securities and Exchange Commission (SEC) requires to be reflected in the Fund's performance.
The index is unmanaged and, unlike the Fund, is not affected by cash flows. It is not possible to invest directly in an index.
3
The MSCI ACWI captures large- and mid-cap representation across 23 developed markets and 23 emerging markets countries. The index covers approximately 85% of the
global investable equity opportunity set. The BBUSUI covers USD-denominated taxable bonds that are rated either investment-grade or high-yield. The indexes are not adjusted to reflect sales loads, expenses or other
fees that the SEC requires to be reflected in the Fund's performance. The indexes are unmanaged and, unlike the Fund, are not affected by cash flows. It is not possible to invest directly in an index.
See the Fund's Prospectus for a description of the principal types of securities in which the Fund invests. As of the date specified above, the Fund owned shares of one or more affiliated investment companies. For
purposes of this table, the affiliated investment company (other than an affiliated money market mutual fund) is not treated as a single portfolio security, but rather the Fund is treated as owning a pro rata portion
of each security and each other asset and liability owned by the affiliated investment company. Accordingly, the percentages of total net assets shown in the table will differ from those presented on the Portfolio of
Investments.
2
Represents the notional value of S&P 500 futures contracts held by the Federated Prudent Bear Fund and Federated Absolute Return Fund.
3
Based upon net unrealized appreciation (depreciation) or value of the derivative contracts as applicable. Derivative contracts may consist of futures, forwards, options and swaps. The impact of a derivative contract
on the Fund's performance may be larger than its unrealized appreciation (depreciation) or value may indicate. In many cases, the notional value or amount of a derivative contract may provide a better indication of
the contract's significance to the portfolio. More complete information regarding the Fund's direct investments in derivative contracts, including unrealized appreciation (depreciation), value, and notional values or
amounts of such contracts, can be found in the table at the end of the Portfolio of Investments included in this Report.
4
Represents less than 0.1%.
5
Other Security Types consist of exchange-traded funds.
6
Cash Equivalents include any investments in money market mutual funds and/or overnight repurchase agreements.
7
Assets, other than investments in securities and derivative contracts, less liabilities. See Statement of Assets and Liabilities.
U.S. Treasury Inflation-Protected Note, 0.125%, 4/15/2020
$460,357
353,858
U.S. Treasury Inflation-Protected Note, 0.125%, 4/15/2021
352,300
190,722
U.S. Treasury Inflation-Protected Note, 0.125%, 1/15/2022
189,888
740,424
U.S. Treasury Inflation-Protected Note, 0.125%, 4/15/2022
735,066
3,116
U.S. Treasury Inflation-Protected Note, 0.125%, 7/15/2024
3,078
49,989
U.S. Treasury Inflation-Protected Note, 0.250%, 1/15/2025
49,515
104,016
U.S. Treasury Inflation-Protected Note, 0.375%, 7/15/2025
104,123
229,759
U.S. Treasury Inflation-Protected Note, 0.375%, 1/15/2027
228,021
55,461
U.S. Treasury Inflation-Protected Note, 0.375%, 7/15/2027
55,149
1,026,502
U.S. Treasury Inflation-Protected Note, 0.625%, 1/15/2024
1,043,681
67,478
U.S. Treasury Inflation-Protected Note, 0.625%, 1/15/2026
68,515
1,710,163
U.S. Treasury Inflation-Protected Note, 1.250%, 7/15/2020
1,765,335
55,000
United States Treasury Bond, 2.750%, 8/15/2047
55,069
1,000
United States Treasury Bond, 3.000%, 11/15/2044
1,051
25,000
United States Treasury Bond, 3.000%, 5/15/2047
26,287
90,000
United States Treasury Note, 2.000%, 11/30/2022
89,191
15,000
United States Treasury Note, 2.250%, 8/15/2027
14,798
TOTAL U.S. TREASURY
(IDENTIFIED COST $12,291,578)
12,244,705
REPURCHASE AGREEMENT—4.8%
9,246,000
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887.
(IDENTIFIED COST $9,246,000)
9,246,000
TOTAL INVESTMENT IN SECURITIES—100.0%
(IDENTIFIED COST $199,697,730)4
Affiliated fund holdings are
investment companies which are managed by Federated Global Investment Management Corp., Federated Investment Management Company and Federated Equity Management Company of Pennsylvania (collectively, the
“Co-Advisers”) or an affiliate of the Co-Advisers. Transactions with affiliated fund holdings during the year ended December 31, 2017, were as follows:
Federated Clover Small Value Fund, Institutional Shares
730,265
184,407
(97,126)
817,546
21,256,199
(1,237,090)
438,749
159,370
3,025,002
Federated Equity Income Fund, Inc., Institutional Shares
833,185
114,586
(121,320)
826,451
20,909,216
1,739,827
233,600
475,082
677,436
Federated Intermediate Corporate Bond Fund, Institutional Shares
798,016
28,513
(122,316)
704,213
6,464,674
37,400
(30,934)
207,481
73,164
Federated International Leaders Fund, Class R6 Shares
349,652
127,110
(75,583)
401,179
14,992,066
2,842,187
22,891
98,675
—
Federated International Strategic Value Dividend Fund, Institutional Shares
2,977,505
1,321,549
(482,761)
3,816,293
14,387,424
1,044,943
(45,606)
495,249
—
Federated Kaufmann Large Cap Fund, Class R6 Shares
744,525
8,568
(150,140)
602,953
14,507,040
2,562,418
385,224
—
202,456
Federated Mortgage Core Portfolio
494,493
10,345
(188,042)
316,796
3,104,599
25,757
(26,708)
101,666
—
Federated Project and Trade Finance Core Fund
1,182,345
49,975
—
1,232,320
11,189,468
(252,606)
—
458,066
—
Federated Prudent Bear Fund, Institutional Shares
417,944
83,700
(12,770)
488,874
7,797,536
(1,290,203)
(1,405)
—
—
Federated Strategic Value Dividend Fund, Institutional Shares
3,245,193
499,370
(350,076)
3,394,487
20,876,093
591,936
225,805
752,745
1,316,516
Federated U.S. Gov't Securities Fund: 2-5 Years, Institutional Shares
980
12
—
992
10,672
(108)
—
138
—
High Yield Bond Portfolio
232,162
19,800
(51,381)
200,581
1,283,721
30,236
(13,274)
77,096
—
Affiliated issuers no longer in the portfolio at period end
545,762
—
(545,762)
—
—
2,501,233
—
—
—
TOTAL OF AFFILIATED TRANSACTIONS
14,340,285
2,491,725
(2,324,789)
14,507,221
$153,807,166
$9,413,192
$1,182,963
$2,991,137
$5,295,408
2
Floating/variable note with current rate and current maturity or next reset date shown.
3
Non-income-producing security.
4
The cost of investments for federal tax purposes amounts to $199,987,119.
5
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
The inputs or methodology used for
valuing securities are not an indication of the risk associated with investing in those securities.
The following is a summary of the
inputs used, as of December 31, 2017, in valuing the Fund's assets carried at fair value:
Valuation Inputs
Level 1—
Quoted
Prices
Level 2—
Other
Significant
Observable
Inputs
Level 3—
Significant
Unobservable
Inputs
Total
Investment Companies1
$136,781,456
$—
$—
$153,807,166
Debt Securities:
Corporate Bonds
—
2,459,571
—
2,459,571
Asset-Backed Securities
—
282,580
—
282,580
Commercial Mortgage-Backed Securities
—
561,486
—
561,486
Collateralized Mortgage Obligations
—
87,104
—
87,104
U.S. Treasury
—
12,244,705
—
12,244,705
Exchange-Traded Funds
15,701,242
—
—
15,701,242
Repurchase Agreement
—
9,246,000
—
9,246,000
TOTAL SECURITIES
$152,482,698
$24,881,446
$—
$194,389,854
Other Financial Instruments2
Assets
$14,354
$—
$—
$14,354
Liabilities
(2,278)
—
—
(2,278)
TOTAL OTHER FINANCIAL INSTRUMENTS
$12,076
$—
$—
$12,076
1
As permitted by U.S. generally accepted accounting principles (GAAP), Investment Companies valued at $17,025,710 are measured at fair value using the net asset value (NAV) per share practical expedient and have not
been categorized in the chart above but are included in the Total column. The amount included herein is intended to permit reconciliation of the fair value classifications to the amounts presented on the Statement of
Assets and Liabilities. The price of shares redeemed in Emerging Markets Core Fund, Federated Bank Loan Core Fund, Federated Mortgage Core Portfolio and High Yield Bond Portfolio is the next determined NAV after
receipt of a shareholder redemption request. The price of shares redeemed of Federated Project and Trade Finance Core Fund may be determined as of the closing NAV of the fund up to twenty-four days after receipt of a
shareholder redemption request.
2
Other Financial Instruments are futures contracts.
The following acronyms are used
throughout this portfolio:
LIBOR
—London Interbank Offered Rate
MTN
—Medium Term Note
See Notes which are an integral part
of the Financial Statements
Net realized and unrealized gain (loss) on investments, futures contracts, written options and foreign currency
transactions
0.44
(0.29)
(0.42)
(0.13)
0.91
TOTAL FROM INVESTMENT OPERATIONS
0.52
(0.21)
(0.34)
(0.05)
1.02
Less Distributions:
Distributions from net investment income
(0.08)
(0.09)
(0.09)
(0.12)
(0.07)
Distributions from net realized gain on investments, futures contracts, written options and foreign currency transactions
—
—
(0.01)
(1.34)
(0.14)
TOTAL DISTRIBUTIONS
(0.08)
(0.09)
(0.10)
(1.46)
(0.21)
Net Asset Value, End of Period
$5.25
$4.81
$5.11
$5.55
$7.06
Total Return2
10.95%
(4.20)%
(6.29)%
(0.97)%
16.45%
Ratios to Average Net Assets:
Net expenses
0.30%
0.28%
0.28%
0.30%
0.50%
Net investment income
1.65%
1.57%
1.54%
1.41%
1.62%
Expense waiver/reimbursement3
0.67%
0.69%
0.67%
0.61%
0.53%
Supplemental Data:
Net assets, end of period (000 omitted)
$137,245
$133,556
$141,823
$153,165
$169,658
Portfolio turnover
18%
21%
49%
39%
137%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Net realized and unrealized gain (loss) on investments, futures contracts, written options and foreign currency
transactions
0.44
(0.29)
(0.42)
(0.16)
0.86
TOTAL FROM INVESTMENT OPERATIONS
0.51
(0.23)
(0.35)
(0.08)
1.00
Less Distributions:
Distributions from net investment income
(0.07)
(0.07)
(0.08)
(0.11)
(0.05)
Distributions from net realized gain on investments, futures contracts, written options and foreign currency transactions
—
—
(0.01)
(1.34)
(0.14)
TOTAL DISTRIBUTIONS
(0.07)
(0.07)
(0.09)
(1.45)
(0.19)
Net Asset Value, End of Period
$5.24
$4.80
$5.10
$5.54
$7.07
Total Return2
10.67%
(4.48)%
(6.43)%
(1.33)%
16.11%
Ratios to Average Net Assets:
Net expenses
0.54%
0.53%
0.53%
0.54%
0.75%
Net investment income
1.36%
1.32%
1.29%
1.46%
2.01%
Expense waiver/reimbursement3
0.67%
0.69%
0.67%
0.63%
0.54%
Supplemental Data:
Net assets, end of period (000 omitted)
$57,094
$63,317
$69,876
$67,434
$10,101
Portfolio turnover
18%
21%
49%
39%
137%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Realized gain distributions from affiliated investment company shares
5,295,408
Net change in unrealized depreciation of investments (including net change in unrealized depreciation of $9,413,192 on
investments in affiliated holdings)
10,601,729
Net change in unrealized depreciation of futures contracts
16,245
Net realized and unrealized gain on investments and futures contracts
17,139,650
Change in net assets resulting from operations
$20,175,122
See Notes which are an integral part
of the Financial Statements
Net realized gain (loss) on investments including allocation from affiliated partnership, futures contracts, written
options and foreign currency transactions
6,521,676
(17,484,676)
Net change in unrealized appreciation of investments, futures contracts and translation of assets and liabilities in
foreign currency
10,617,974
5,118,358
CHANGE IN NET ASSETS RESULTING FROM OPERATIONS
20,175,122
(9,371,516)
Distributions to Shareholders:
Distributions from net investment income
Primary Shares
(2,206,940)
(2,372,125)
Service Shares
(825,106)
(959,350)
CHANGE IN NET ASSETS RESULTING FROM DISTRIBUTIONS TO SHAREHOLDERS
(3,032,046)
(3,331,475)
Share Transactions:
Proceeds from sale of shares
9,582,389
25,650,999
Net asset value of shares issued to shareholders in payment of distributions declared
3,032,046
3,331,475
Cost of shares redeemed
(32,291,581)
(31,104,930)
CHANGE IN NET ASSETS RESULTING FROM SHARE TRANSACTIONS
(19,677,146)
(2,122,456)
Change in net assets
(2,534,070)
(14,825,447)
Net Assets:
Beginning of period
196,873,035
211,698,482
End of period (including undistributed net investment income of $4,529,620 and $3,069,391, respectively)
$194,338,965
$196,873,035
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated Managed Tail Risk Fund II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented separately. The assets
of each portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. The Fund offers two classes of shares: Primary Shares and
Service Shares. All shares of the Fund have equal rights with respect to voting, except on class-specific matters. Fund shares are available exclusively as a funding vehicle for life insurance companies writing
variable life insurance policies and variable annuity contracts. The investment objective of the Fund is capital appreciation.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with GAAP.
Investment Valuation
In calculating its NAV, the Fund generally values
investments as follows:
■
Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs.
■
Equity securities listed on an exchange or traded through a regulated market system are valued at their last reported sale price or official closing price in their principal exchange or market.
■
Fixed-income securities are fair valued using price evaluations provided by a pricing service approved by the Fund's Board of Trustees (the “Trustees”).
■
Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations.
■
Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered such as: the last
traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer's financial statements or other available documents, fundamental analytical data, the nature
and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable issuers,
movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions.
If any price, quotation, price
evaluation or other pricing source is not readily available when the NAV is calculated, if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a
reasonable period of time as set forth in the Fund's valuation policies and procedures, or if information furnished by a pricing service, in the opinion of the valuation committee (“Valuation Committee”),
is deemed not representative of the fair value of such security, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund
could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share.
Fair Valuation and Significant
Events Procedures
The Trustees have ultimate responsibility for
determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a Valuation Committee comprised of officers of the Fund, the Co-Advisers and certain of the
Co-Adviser's affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of pricing services recommended by the Valuation Committee
to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various methods for reviewing third-party pricing-service evaluations
including periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs, methods, models and assumptions), transactional back-testing, comparisons of evaluations of
different pricing services, and review of price challenges by the Co-Advisers based on recent market activity. In the event that market quotations and price evaluations are not available for an investment, the
Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review and approve the fair valuations made by the Valuation Committee
and any changes made to the procedures.
Factors considered
by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions,
indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a “bid” evaluation).
Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a “mid” evaluation). The Fund normally uses bid
evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC
derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the
Trustees.
The Trustees also
have adopted procedures requiring an investment to be priced at its fair value whenever the Co-Advisers determine that a significant event affecting the value of the investment has occurred between the time as of
which the price of the investment would otherwise be determined and the time as of which the NAV is computed. An event is considered significant if there is both an affirmative expectation that the investment's value
will change in response to the event and a reasonable basis for quantifying the resulting change in value. Examples of significant events that may occur after the close of the principal market on which a security is
traded, or after the time of a price evaluation provided by a pricing service or a dealer, include:
■
With respect to securities traded principally in foreign markets, significant trends in U.S. equity markets or in the trading of foreign securities index futures contracts;
■
Political or other developments affecting the economy or markets in which an issuer conducts its operations or its securities are traded;
■
Announcements concerning matters such as acquisitions, recapitalizations, litigation developments, or a natural disaster affecting the issuer's operations or regulatory changes or
market developments affecting the issuer's industry.
The Trustees have adopted procedures
whereby the Valuation Committee uses a pricing service to determine the fair value of equity securities traded principally in foreign markets when the Co-Advisers determine that there has been a significant trend in
the U.S. equity markets or in index futures trading. For other significant events, the Fund may seek to obtain more current quotations or price evaluations from alternative pricing sources. If a reliable alternative
pricing source is not available, the Fund will determine the fair value of the investment in accordance with the fair valuation procedures approved by the Trustees. The Trustees have ultimate responsibility for any
fair valuations made in response to a significant event.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the
transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be
transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's
Co-Advisers and their affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its
share of proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements (MNA) which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a
single payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash
or securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Foreign dividends are recorded on the ex-dividend date or when the Fund is informed of the ex-dividend date. Positive or negative inflation adjustments on Treasury Inflation-Protected
Securities (TIPS) are included in interest income. Distributions of net investment income, if any, are declared and paid annually. Non-cash dividends included in dividend income, if any, are recorded at fair value.
Amortization/accretion of premium and discount is included in investment income. Gains and losses realized on principal payment of mortgage-backed securities (paydown gains and losses) are classified as part of
investment income. The Fund had invested in Emerging Markets Fixed Income Core Fund (EMCORE), a portfolio of Federated Core Trust II, L.P., which was a limited partnership established under the laws of the state of
Delaware. The Fund recorded daily its proportionate share of income, expenses, realized and unrealized gains and losses from EMCORE. Investment income, realized and unrealized gains and losses, and certain fund-level
expenses are allocated to each class based on relative average daily net assets, except that Primary Shares and Service Shares may bear distribution services fees unique to those classes. The detail of the total fund
expense waiver and reimbursement of $1,295,516 is disclosed in various locations in Note 5.
Dividends are
declared separately for each class. No class has preferential dividend rights; differences in per share dividend rates are generally due to differences in separate class expenses.
Restricted Securities
The Fund may purchase securities which are
considered restricted. Restricted securities are securities that either: (a) cannot be offered for public sale without first being registered, or being able to take advantage of an exemption from registration under
the 1933 Act; or (b) are subject to contractual restrictions on public sales. In some cases, when a security cannot be offered for public sale without first being registered, the issuer of the restricted security has
agreed to register such securities for resale, at the issuer's expense, either upon demand by the Fund or in connection with another registered offering of the securities. Many such restricted securities may be resold
in the secondary market in transactions exempt from registration. Restricted securities may be determined to be liquid under criteria established by the Trustees. The Fund will not incur any registration costs upon
such resales. The Fund's restricted securities, like other securities, are priced in accordance with procedures established by and under the general supervision of the Trustees.
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code (the “Code”) and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary.
As of and during the year ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax
expense in the Statement of Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the
Commonwealth of Massachusetts.
When-Issued and Delayed-Delivery
Transactions
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
The Fund purchases and sells financial futures
contracts to manage duration, market and yield curve risks. Upon entering into a financial futures contract with a broker, the Fund is required to deposit in a segregated account, either U.S. government securities or
a specified amount of Restricted cash, which is shown in the Statement of Assets and Liabilities. Futures contracts are valued daily and unrealized gains or losses are recorded in a “variation margin”
account. Daily, the Fund receives from or pays to the broker a specified amount of cash based upon changes in the variation margin account. When a contract is closed, the Fund recognizes a realized gain or loss.
Futures contracts have market risks, including the risk that the change in the value of the contract may not correlate with the changes in the value of the underlying securities. There is minimal counterparty risk to
the Fund since futures contracts are exchange traded and the exchange's clearing house, as counterparty to all exchange traded futures contracts, guarantees the futures contracts against default.
Futures contracts
outstanding at period end are listed after the Fund's Portfolio of Investments.
The average
notional value of long and short futures contracts held by the Fund throughout the period was $6,685,875 and $3,464,670, respectively. This is based on amounts held as of each month-end throughout the fiscal
period.
The Fund buys or sells put and call options to seek
to increase return and to manage market risk. The seller (“writer”) of an option receives a payment or premium, from the buyer, which the writer keeps regardless of whether the buyer exercises the option.
When the Fund writes a put or call option, an amount equal to the premium received is recorded as a liability and subsequently marked to market to reflect the current value of the option written. Premiums received
from writing options which expire are treated as realized gains. The Fund, as a writer of an option, bears the market risk of an unfavorable change in the price of the underlying reference instrument. When the Fund
purchases a put or call option, an amount equal to the premium paid is recorded as an increase to the cost of the investment and subsequently marked to market to reflect the current value of the option purchased.
Premiums paid for purchasing options which expire are treated as realized losses. Premiums received/paid for writing/purchasing options which are exercised or closed are added to the proceeds or offset against amounts
paid on the underlying reference instrument to determine the realized gain or loss. The risk associated with purchasing put and call options is limited to the premium paid. Options can trade on securities or
commodities exchanges. In this case, the exchange sets all the terms of the contract except for the price. Most exchanges require investors to maintain margin accounts through their brokers to cover their potential
obligations to the exchange. This protects investors against potential defaults by the counterparty.
At December 31,2017, and during the year then ended, the Fund had no outstanding written option contracts.
Foreign Currency Translation
The accounting records of the Fund are maintained
in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rates of exchange of such currencies against U.S. dollars on the date of valuation. Purchases
and sales of securities, income and expenses are translated at the rate of exchange quoted on the respective date that such transactions are recorded. The Fund does not isolate that portion of the results of
operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included with the net realized and
unrealized gain or loss from investments. Reported net realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on
securities transactions, the difference between the amounts of dividends, interest and foreign withholding taxes recorded on the Fund's books, and the U.S. dollar equivalent of the amounts actually received or paid.
Net unrealized foreign exchange gains and losses arise from changes in the value of assets and liabilities other than investments in securities at fiscal year end, resulting from changes in the exchange rate.
Receivable for daily
variation margin
on futures contracts
$12,076*
*
Includes cumulative net appreciation of futures contracts as reported in the footnotes to the Portfolio of Investments. Only the current day's variation margin is reported within the
Statement of Assets and Liabilities.
The Effect of Derivative
Instruments on the Statement of Operations for the Year Ended December 31, 2017
Amount of Realized Gain or (Loss) on Derivatives Recognized in Income
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
3. SHARES OF BENEFICIAL
INTEREST
The following tables summarize share
activity:
Year Ended December 31
2017
2016
Primary Shares:
Shares
Amount
Shares
Amount
Shares sold
1,260,101
$6,261,034
2,955,103
$14,301,919
Shares issued to shareholders in payment of distributions declared
452,242
2,206,940
492,142
2,372,125
Shares redeemed
(3,354,022)
(16,735,488)
(3,387,677)
(16,394,502)
NET CHANGE RESULTING FROM PRIMARY SHARE TRANSACTIONS
(1,641,679)
$(8,267,514)
59,568
$279,542
Year Ended December 31
2017
2016
Service Shares:
Shares
Amount
Shares
Amount
Shares sold
666,337
$3,321,355
2,349,268
$11,349,080
Shares issued to shareholders in payment of distributions declared
169,079
825,106
199,035
959,350
Shares redeemed
(3,140,069)
(15,556,093)
(3,041,516)
(14,710,428)
NET CHANGE RESULTING FROM SERVICE SHARE TRANSACTIONS
(2,304,653)
$(11,409,632)
(493,213)
$(2,401,998)
NET CHANGE RESULTING FROM TOTAL FUND SHARE TRANSACTIONS
The timing and character of income
and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are due to differing treatments for the expiration of capital loss carryforwards,
short-term capital gain distributions from registered investment companies, recognition of passive losses, and discount accretion/premium amortization on debt securities.
For the year
ended December 31, 2017, permanent differences identified and reclassified among the components of net assets were as follows:
Increase (Decrease)
Paid-In Capital
Undistributed
Net Investment
Income (Loss)
Accumulated
Net Realized
Gain (Loss)
$(2,259,665)
$1,456,803
$802,862
Net investment income (loss), net
realized gains (losses), and net assets were not affected by this reclassification.
The tax character
of distributions as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Ordinary income
$3,032,046
$3,331,475
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Undistributed ordinary income
$4,529,905
Net unrealized depreciation
$(5,597,265)
Capital loss carryforwards
$(15,395,861)
The difference between book-basis
and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for the deferral of losses on wash sales, mark-to-market of futures contracts, discount accretion/premium amortization on
debt securities, partnership basis adjustments and TIPS deflation deferrals.
At December 31,2017, the cost of investments for federal tax purposes was $199,987,119. The net unrealized depreciation of investments for federal tax purposes was $5,597,265. This consists of net unrealized appreciation from
investments for those securities having an excess of value over cost of $6,917,864 and net unrealized depreciation from investments for those securities having an excess of cost over value of $12,515,129. The amounts
presented are inclusive of derivative contracts.
At December 31,2017, the Fund had a capital loss carryforward of $15,395,861 which will reduce the Fund's taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code, thereby
reducing the amount of distributions to shareholders which would otherwise be necessary to relieve the Fund of any liability for federal income tax. Pursuant to the Code, a net capital loss incurred in taxable years
beginning after December 22, 2010, retains its character as either short-term or long-term and does not expire. All of the Fund's capital loss carryforwards were incurred in taxable years beginning after December 22,2010.
The following
schedule summarizes the Fund's capital loss carryforwards:
Short-Term
Long-Term
Total
$14,315,581
$1,080,280
$15,395,861
Capital loss carryforwards of
$2,259,665 expired during the year ended December 31, 2017.
The Fund used
capital loss carryforwards of $5,041,316 to offset capital gains realized during the year ended December 31, 2017.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The co-advisory agreement between the Fund and the
Co-Advisers, provides for an annual fee equal to 0.75% of the Fund's average daily net assets. Subject to the terms described in the Expense Limitation note, the Co-Advisers may voluntarily choose to waive any portion
of their fee. For the year ended December 31, 2017, the Co-Advisers voluntarily waived $370,245 of their fee. The Co-Advisers have agreed to reimburse the Fund for certain investment adviser fees as a result of
transactions in other affiliated investment companies. For the year ended December 31, 2017, the Co-Advisers reimbursed $925,271.
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
Subject to the terms described in
the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, the annualized fee paid to FAS was 0.079% of average daily net assets of the Fund.
Prior to
September 1, 2017, the breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
Distribution Services Fee
The Fund has adopted a Distribution Plan (the
“Plan”) pursuant to Rule 12b-1 under the Act. Under the terms of the Plan, the Fund will compensate Federated Securities Corp. (FSC), the principal distributor, from the daily net assets of the Fund's
Primary Shares and Service Shares to finance activities intended to result in the sale of these shares. The Plan provides that the Fund may incur distribution expenses at the following percentages of average daily net
assets annually, to compensate FSC:
Share Class Name
Percentage of Average
Daily Net Assets of Class
Primary Shares
0.25%
Service Shares
0.25%
Subject to the terms described in
the Expense Limitation note, FSC may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, distribution services fees for the Fund were as follows:
Distribution Services
Fees Incurred
Service Shares
$146,314
When FSC receives fees, it may pay
some or all of them to financial intermediaries whose customers purchase shares. For the year ended December 31, 2017, FSC retained $63 of fees paid by the Fund. For the year ended December 31, 2017, the Fund's
Primary Shares did not incur a distribution services fee; however, it may begin to incur this fee upon approval of the Trustees.
Expense Limitation
The Co-Advisers and certain of their affiliates
(which may include FSC and FAS) on their own initiative have agreed to waive certain amounts of their respective fees and/or reimburse expenses. Effective May 1, 2017, total annual fund operating expenses (as shown in
the financial highlights, excluding interest expenses, extraordinary expenses, line of credit expenses and proxy-related expenses paid by the Fund, if any) paid by the Fund's Primary Shares and Service Shares (after
the voluntary waivers and/or reimbursements) will not exceed 0.30% and 0.55% (the “Fee Limit”), respectively, up to but not including the later of (the “Termination Date”): (a) May 1, 2018; or
(b) the date of the Fund's next effective Prospectus. While the Co-Advisers and their applicable affiliates currently do not anticipate terminating or increasing these arrangements prior to the Termination Date, these
arrangements may only be terminated or the Fee Limit increased prior to the Termination Date with the agreement of the Trustees.
Directors'/Trustees' and
Miscellaneous Fees
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Co-Advisers which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
Purchases and sales of investments,
excluding long-term U.S. government securities and short-term obligations, for the year ended December 31, 2017, were as follows:
Purchases
$29,871,767
Sales
$37,950,234
7. LINE OF CREDIT
The Fund participates with certain
other Federated Funds, on a several basis, in an up to $500,000,000 unsecured, 364-day, committed, revolving line of credit (LOC) agreement. The LOC was made available to finance temporarily the repurchase or
redemption of shares of the Fund, failed trades, payment of dividends, settlement of trades and for other short-term, temporary or emergency general business purposes. The Fund cannot borrow under the LOC if an
inter-fund loan is outstanding. The Fund's ability to borrow under the LOC also is subject to the limitations of the Act and various conditions precedent that must be satisfied before the Fund can borrow. Loans under
the LOC are charged interest at a fluctuating rate per annum equal to the highest, on any day, of (a) (i) the federal funds effective rate, (ii) the one month London Interbank Offered Rate (LIBOR), and (iii) 0.0%,
plus (b) a margin. The LOC also requires the Fund to pay, quarterly in arrears and at maturity, its pro rata share of a commitment fee based on the amount of the lenders' commitment that has not been utilized. As of
December 31, 2017, the Fund had no outstanding loans. During the year ended December 31, 2017, the Fund did not utilize the LOC.
8. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission, the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
9. Subsequent Event
On February 2, 2018, the Fund filed
a supplement to its current Prospectus notifying shareholders that the Trustees have approved a proposed Agreement and Plan of Reorganization (Reorganization) pursuant to which Federated Managed Volatility Fund II,
another fund of the Trust, would acquire all or substantially all of the assets of the Fund in complete liquidation and termination of the Fund. Pending submission of proxy materials to shareholders, a special meeting of the shareholders is proposed to be held in the third quarter of 2018 to approve or disapprove the proposed
Reorganization.
10. FEDERAL TAX INFORMATION
(UNAUDITED)
Of the ordinary income distributions
made by the Fund during the year ended December 31, 2017, 32.98% qualify for the dividend received deduction available to corporate shareholders.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF The
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED MANAGED TAIL RISK FUND II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated Managed Tail Risk Fund II (the “Fund”), a portfolio of Federated Insurance Series, as of December31, 2017, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively, the
“financial statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all
material respects the financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities
laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors' - investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other funds used as variable investment options. It is based on an investment of $1,000
invested at the beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of the table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual:
Primary Shares
$1,000
$1056.30
$1.55
Service Shares
$1,000
$1054.30
$2.85
Hypothetical (assuming a 5% return before expenses):
Primary Shares
$1,000
$1,023.70
$1.53
Service Shares
$1,000
$1,022.40
$2.80
1
Expenses are equal to the Fund's annualized net expense ratios, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The expenses shown in the table
do not include the charges and expenses imposed by the insurance company under the variable insurance product contract. Please refer to the variable insurance product prospectus for a complete listing of these
expenses. The annualized net expense ratios are as follows:
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
Vice President
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
President
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated Managed Tail Risk Fund
II (the “Fund”)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory contract,
under which Federated Investment Management Company, Federated Equity Management Company of Pennsylvania and Federated Global Investment Management Corp. will serve as co-advisers to the Fund
(“Co-Advisers”) for an additional one-year term at its May 2017 meetings. The Board's decision regarding the contract reflects the exercise of its business judgment after considering all of the information
received on whether to continue the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory contract.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory contract generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to institutional and other
clients of each Co-Adviser and their advisory affiliates for what might be viewed as like services. The Board was aware of these factors and was guided by them in its review of the Fund's investment advisory contract
to the extent it considered them to be appropriate and relevant, as discussed further below. Also, in weighing these factors, the Board considered the aggregate advisory fee paid by the Fund for the services of all
Co-Advisers in addition to considering the allocation of that aggregate fee among the Co-Advisers and the rationale for that allocation.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings, at which the Board's formal approval of the investment advisory contract occurred. At the May meetings, in addition to meeting in
separate sessions of the independent trustees without management present, senior management of the Co-Advisers also met with the independent trustees and their counsel to discuss the materials presented and any other
matters thought relevant by the Co-Advisers or the trustees. Between regularly scheduled meetings, the Board also received information on particular matters as the need arose. The Board's consideration of the
investment advisory contract included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Co-Advisers' investment philosophy, revenue, profitability,
personnel and processes; investment and operating strategies; the Fund's short- and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well as in terms relative to its particular
investment program and certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's investment objectives; the Fund's expenses,
including the advisory fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for contractual or voluntary expense limitations; the
use and allocation of brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other services provided to the Fund by the Co-Advisers
and their affiliates. The Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Co-Advisers in sponsoring the Fund; the continuing state of
competition in the mutual fund industry
and market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's relationship to the Federated funds which include a comprehensive array of funds with different investment
objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales charges; compliance and audit reports concerning the Federated funds and the Federated
companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and relevant developments in the mutual fund industry and how the
Federated funds and/or Federated are responding to them. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on relevant criteria change in recognition of changing
circumstances in the mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses, therefore, appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
investment advisory contract between the Fund and the Co-Advisers provides for payment of a single advisory fee by the Fund for all services provided by the Co-Advisers. The investment advisory contract permits the
Co-Advisers to allocate the advisory fee in a manner commensurate with the services they provide to the Fund. Throughout the year, as well as in connection with its May meetings, the Board considered the fee
allocation and analyzed whether the allocation of fees among the Co-Advisers continued to be a reasonable proxy for and measurement of the level of resources and services provided by each Co-Adviser toward the
management of the Fund.
The
Board reviewed the contractual advisory fee rate, net advisory fee rate where partially waived and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses
relative to its peers. In this regard, the Board noted that the contractual advisory fee rate was above the median of the relevant peer group, but the Board noted the applicable waivers and reimbursements, and that
the overall expense structure of the Fund remained competitive in the context of other factors considered by the Board.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory contract.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Co-Advisers and the resources of the Co-Advisers and their affiliates dedicated to the Fund. In particular, the Board
considered the services provided by the Co-Advisers in the aggregate, to the extent that the Co-Advisers collaborate in the implementation of the Fund's strategy, as well as separately, to the extent to which specific
services provided by a Co-Adviser are distinguishable and subject to meaningful assessment. In this regard, the Board evaluated, among other things, the Co-Advisers' personnel, experience, track record, overall
reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications, backgrounds and responsibilities of the portfolio management team
primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of, and the compliance-related resources provided to, the Fund by the Co-Advisers. The Fund's ability to deliver
competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Co-Advisers are executing the Fund's investment program. The Co-Advisers' ability to
execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent, and quality of the Co-Advisers' investment management services warrant the continuation of the investment
advisory contract.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by
independent fund ranking organizations,
regarding the performance of, and fees charged by, other mutual funds, noting his view that comparisons to fund peer groups may be helpful, though not conclusive, in judging the reasonableness of the proposed fees.
The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and unique differences in their objectives and management techniques when compared to other funds
within an industry peer group.
The
Fund's performance fell below the median of the relevant peer group for the one-year, three-year and five-year periods covered by the Senior Officer's Evaluation. The Board discussed the Fund's performance with the
Co-Advisers and recognized the efforts being taken by the Co-Advisers in the context of the other factors considered relevant by the Board.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the investment advisory contract.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers.
The
Board considered Federated's previous reductions in contractual management fees to certain funds in response to the Senior Officer's recommendations.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Co-Advisers have made significant
and long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions,
as well as systems technology (including technology relating to cybersecurity) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family
as a whole. The Board noted that the Co-Advisers' investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses
and that this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information
relative to revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints or to apply
breakpoints, at higher levels. It should not be viewed to determine the appropriateness of advisory fees because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any
applicable regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to
structuring fund advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee for the Fund was reasonable. Under these circumstances, no changes were recommended to, and no objection was raised to the continuation of, the Fund's
investment advisory contract.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Co-Advisers' industry
standing and reputation and with the expectation that the Co-Advisers will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the
investment advisory contract reflected
the fact that it is the shareholders who have effectively selected the Co-Advisers by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature,
quality and scope of the services provided to the Fund by the Co-Advisers and their affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory contract on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of the factors and
considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's decision to approve
the continuation of the contract reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangements.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes Management's Discussion of Fund Performance, a complete listing of your fund's holdings,
performance information and financial statements along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Management's Discussion
of Fund Performance (unaudited)
The total return of
Federated Managed Volatility Fund II (the “Fund”), based on net asset value for the 12-month reporting period ended December 31, 2017, was 18.11%. The 18.11% total return for the reporting period consisted
of 13.44% in price appreciation and 4.67% in reinvested dividends. For the same period, the Russell 1000® Value Index (R1000V) returned 13.66%, the Bloomberg Barclays High Yield 2% Issuer Capped Index (BBHY2%ICI) returned
7.50%, the Bloomberg Barclays Mortgage Backed Securities Index (BBMB) returned 2.47% and the Bloomberg Barclays Emerging Markets USD Aggregate Index (BBEMAI) returned 8.17%. Weighting these benchmarks (40% R1000V, 20%
BBHY2%ICI, 20% BBMB and 20% BBEMAI), the blended index (“Blended Index”)1 return for the period was 9.06%. The Fund's total return for the most recently completed fiscal year reflected actual cash
flows, transaction costs and other expenses, which are not reflected in the total return of the Blended Index.
The
Fund's investment strategy focused on income-earning investments, specifically high-quality, dividend-paying stocks and fixed-income securities with high current yield through: (1) portfolio allocation; (2) sector and
security selection for equities; and (3) sector and security selection for bonds to achieve the Fund's objectives of high current income and moderate capital appreciation.2
MARKET OVERVIEW
During the reporting
period, equity markets reached all-time highs amid record low volatility,3 supported by a strong global economy and hopes of domestic tax reform. Tax reform was passed at the end of the year to help
propel equity markets to their year-end levels. The march to these levels was relatively smooth, with only a few bouts of volatility that saw the Chicago Board Options Exchange (CBOE) Volatility Index (VIX),4 a measure of implied forward volatility of the S&P 500 Index (S&P 500),5 close above 15, which would ordinarily be a typical value rather than a maximum. The most notable of these occurred in May
when Deputy Attorney General Rod Rosenstein appointed Robert Mueller as a special prosecutor for the investigation of Russian interference in the 2016 election. This led some to speculate about the potential of an
impeachment of President Donald Trump; however, those fears quickly faded, and volatility returned to low levels. During this reporting period, the U.S. Federal Reserve (the Fed) continued to increase the federal
funds target rate by hiking the rate by 25 basis points three times during the year. Furthermore, they initiated a process to unwind the Fed's balance sheet in a process dubbed “normalization” in the fall.
This process will see several trillion dollars of assets expire from the Fed's balance sheet over the coming years, in a slow, managed process, which could affect the valuation of similar bonds.
The
S&P 500 returned 21.83% during the reporting period. In general, value stocks underperformed growth stocks, with cyclical sectors outperforming defensive sectors. The S&P 500's weak performance in the Energy
and Telecommunications sectors was overshadowed by stronger performance in the Information Technology, Materials and Consumer Discretionary sectors.
On
the fixed-income side, changes to U.S. Treasury rates during the reporting period were driven primarily by actions of the Fed. The raising of the federal funds target rate three times in 2017 led to a “Bear
Flattening” of the U.S. Treasury curve. Specifically, interest rates for maturities of 1-month to 2-years increased by at least 70 basis points, while rates at the longer end were essentially unchanged for the
10-year maturity and down 32 basis points for the 30-year maturity. Low levels of domestic and global inflation and low sovereign yields in other developed markets combined to put downward pressure on the long end of
the treasury curve. As a result of this low interest rate environment, global investor demand for yield drove U.S. credit spreads tighter. The credit-sensitive U.S. fixed-income markets such as high yield,6 investment-grade corporates7 and commercial mortgage-backed securities8 all outperformed the U.S. Treasury market on a total return and duration-adjusted basis.9 The Bloomberg Barclays U.S. Treasury Index10 total return was 2.31% during the reporting period, compared to the BBHY2%ICI total return of 7.5%, the BBEMAI total return
of 8.2% and the BBMB total return of 2.5%. The fixed-income portfolio's blended benchmark's total return for the reporting period was 5.1%.
PORTFOLIO ALLOCATION
During the reporting
period, the Fund's portfolio was allocated between stocks and fixed-income securities in a manner reflecting the Fund's primary investment objective of income and its secondary objective of capital appreciation.
Factors used in making this allocation were: (1) the Fund's ability to pay and maintain an attractive level of dividends; and (2) the expected relative total return of fixed-income securities and stocks. The
allocation at the end of the reporting period was 54% fixed-income securities, 40% stocks and 6% cash equivalents and other assets/liabilities.
Relative to the Blended Index, the Fund's allocation had a moderate negative effect on Fund performance because of an allocation to cash for futures margin.
The equity component of
the Fund contributed to the Fund's current income objective; additionally, it outperformed the R1000V benchmark during the reporting period. Fund management focused on realization of the Fund's income and total return
objectives by purchasing and holding income-producing equity securities with favorable valuation levels. Relative to the equity component of the Blended Index, stock selection and sector allocation both contributed
positively to the Fund's equity performance. Stock selection in the Industrials sector contributed positively to the Fund's equity performance. This was partially offset by negative stock selection in the Energy and
Consumer Staples sectors. Sector selection in Energy and Information Technology helped the Fund's performance relative to the R1000V but was partially offset by negative sector selection in Utilities.
During the reporting period, the Fund invested in S&P 500 futures contracts for volatility risk management purposes.11 There were only limited volatility spikes throughout the year causing the Fund to not trade away from its maximum allocation to futures, ending the year at about
+58%. The long futures exposure in the year was the major positive contributor to Fund performance for the reporting period. However, due to the maximum 60% futures exposure limitation and the record low market
volatility, the realized, annualized daily volatility of the Fund during the reporting period was 6.1%, short of the 8%-12% target range.
SECTOR AND SECURITY
SELECTION–BONDS12
Sector was the largest
positive contributor to the Fund's fixed-income performance during the reporting period. The overweight to the high-yield sector and the resulting underweight to the mortgage-backed securities market (MBS) were the
primary drivers of the positive sector contribution. As discussed above, the return of the high-yield market outperformed the total return of the fixed-income portion of the Blended Index, while the return of the MBS
market underperformed the total return of the fixed-income portion of the Blended Index. Security selection in the emerging-market,13 MBS and investment-grade corporate sectors also positively contributed to the fixed-income portfolio's performance during
the reporting period. The largest negative contributor to performance was the fixed-income portfolio's yield curve steepener positioning, which resulted in an overweight of shorter maturities and an underweight to
longer maturities. The negative contribution from the yield curve position was partially offset by the fixed-income duration position, which averaged 95% of the fixed-income benchmark during the reporting period.
However, interest rates overall had a negative impact on the fixed-income portfolio's performance.
1
Please see the footnotes to the line graphs under “Fund Performance and Growth of a $10,000 Investment” below for the definition of, and more information about, the
Blended Index.
2
There are no guarantees that dividend-paying stocks will continue to pay dividends. In addition, dividend-paying stocks may not experience the same capital appreciation potential as
non-dividend-paying stocks.
3
Volatility is a statistical measurement of the frequency and level of changes in the value of an asset, index or instrument without regard to the direction of those changes.
Volatility may result from rapid and dramatic price swings.
4
The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.*
5
Please see the footnotes to the line graphs under “Fund Performance and Growth of a $10,000 Investment” below for the definition of, and more information about, the S&
P 500.
6
High-yield, lower-rated securities generally entail greater market, credit and liquidity risks than investment-grade securities and may include higher volatility and a higher risk of
default.
7
Investment-grade securities are securities that are rated at least “BBB- (minus)” or unrated securities of a comparable quality. Noninvestment-grade securities are
securities that are not rated at least “BBB- (minus)” or unrated securities of a comparable quality. Credit ratings are an indication of the risk that a security will default. They do not protect a
security from credit risk. Lower-rated bonds typically offer higher yields to help compensate investors for the increased risk associated with them. Among these risks are lower credit-worthiness, greater price
volatility, more risk to principal and income than with higher-rated securities and increased possibilities of default.
8
The value of some mortgage-backed securities may be particularly sensitive to changes in the prevailing interest rates, and although the securities are generally supported by some
form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations.
9
Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities
of shorter durations.
10
The Bloomberg Barclays U.S. Treasury Index measures U.S dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury.*
11
The Fund's use of derivative instruments involves risks different from, and possibly greater than, the risks associated with investing directly in securities or other traditional
instruments.
12
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
13
International investing involves special risks including currency risk, increased volatility, political risks and differences in auditing and other financial standards. Prices of
emerging-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.
*
The index is unmanaged, and it is not possible to invest directly in an index.
FUND PERFORMANCE AND GROWTH OF A
$10,000 INVESTMENT
The graph below
illustrates the hypothetical investment of $10,0001 in the Federated Managed Volatility Fund II from December 31, 2007 to December 31, 2017, compared to the Standard &
Poor's 500 Index (S&P 500),2,3 the Russell 1000® Value Index (R1000V),3,4 both broad-based securities market indexes, and a blend of indexes comprised of 40% R1000V/20% Bloomberg Barclays Emerging
Markets USD Aggregate Index (BBEMAI)/20% Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index (BBHY2%ICI)/20% Bloomberg Barclays Mortgage Backed Securities Index (BBMB) (“Blended
Index”).3,4 The Average Annual Total Return table below shows returns averaged over the stated periods.
Average Annual Total Returnsfor the Period Ended 12/31/2017
1 Year
5 Years
10 Years
Fund
18.11%
8.26%
7.31%
S&P 500
21.83%
15.79%
8.50%
R1000V
13.66%
14.04%
7.10%
Blended Index
9.06%
7.96%
6.92%
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. Performance of a variable investment option changes over time and current performance may be lower or higher than what is stated. For current to the most recent month end performance, contact your insurance
company. The performance information presented does not include the charges and expenses imposed by the insurance company under the variable insurance product contract. The inclusion of such charges would lower
performance. Please refer to the variable insurance product prospectus for a complete listing of these expenses. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable
life insurance policies and variable annuity contracts. Variable investment options are not obligations of or guaranteed by any bank and are not federally insured.
The Fund's performance assumes the reinvestment of all dividends and distributions. The S&P 500, R1000V and the Blended Index have been adjusted to reflect reinvestment of
dividends on securities in the indexes.
2
The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500
stocks representing all major industries.
3
The S&P 500, R1000V and the Blended Index are not adjusted to reflect sales charges, expenses or other fees that the Securities and Exchange Commission (SEC) requires to be
reflected in the Fund's performance. The indexes are unmanaged and, unlike the Fund, are not affected by cash flows. It is not possible to invest directly in an index.
4
The Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those
Russell 1000® Index companies with lower price-to-book ratios and lower expected growth values. The R1000V is constructed to provide
a comprehensive and unbiased barometer for the large-cap value segment. The R1000V is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to
reflect value characteristics. The BBEMAI tracks total returns for external-currency-denominated debt instruments of the emerging markets. The BBHY2%ICI is an issuer-constrained version of the Bloomberg Barclays U.S.
Corporate High-Yield Index that measures the market of USD-denominated, noninvestment-grade, fixed-rate, taxable corporate bonds. The index follows the same rules as the uncapped index but limits the exposure of each
issuer to 2% of the total market value and redistributes any excess market value index-wide on a pro-rata basis. The BBMB covers agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) issued
by Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC).
At December 31, 2017, the
Fund's sector composition6 for its equity securities was as follows:
Sector Composition of Equity Holdings
Percentage of
Equity Securities
Financials
26.7%
Health Care
13.4%
Energy
10.9%
Consumer Staples
8.6%
Industrials
8.5%
Information Technology
8.4%
Consumer Discretionary
6.8%
Utilities
6.0%
Real Estate
4.8%
Telecommunication Services
3.0%
Materials
2.9%
TOTAL
100.0%
1
See the Fund's Prospectus and Statement of Additional Information for a description of the types of securities in which the Fund invests. As of the date specified above, the Fund owned shares of one or more
affiliated investment companies. For purposes of this table, the affiliated investment company (other than an affiliated money market mutual fund) is not treated as a single portfolio security, but rather the Fund is
treated as owning a pro rata portion of each security and each other asset and liability owned by the affiliated investment company. Accordingly, the percentages of total net assets shown in the table will differ from
those presented on the Portfolio of Investments.
2
Based upon net unrealized appreciation (depreciation) or value of the derivative contracts as applicable. Derivative contracts may consist of futures, forwards, options and swaps. The impact of a derivative contract
on the Fund's performance may be larger than its unrealized appreciation (depreciation) or value may indicate. In many cases, the notional value or amount of a derivative contract may provide a better indication of
the contract's significance to the portfolio. More complete information regarding the Fund's direct investments in derivative contracts, including unrealized appreciation (depreciation), value and notional values or
amounts of such contracts, can be found in the table at the end of the Portfolio of Investments included in this Report.
3
Other Security Types consist of purchased options.
4
Cash Equivalents include any investments in money market mutual funds and/or overnight repurchase agreements.
5
Assets, other than investments in securities and derivative contracts, less liabilities. See Statement of Assets and Liabilities.
6
Sector classifications are based upon, and individual portfolio securities are assigned to, the classifications of the Global Industry Classification Standard (GICS) except that the
Adviser assigns a classification to securities not classified by the GICS and to securities for which the Adviser does not have access to the classification made by the GICS.
TOTAL PURCHASED PUT OPTIONS
(IDENTIFIED COST $2,153,900)
1,137,525
U.S. TREASURY—0.9%
$5,500,000
United States Treasury Note, 0.750%, 02/28/2018
(IDENTIFIED COST $5,491,578)
5,494,844
INVESTMENT COMPANY—14.8%
13,497,668
3
Federated High Income Bond Fund II, Class P
(IDENTIFIED COST $87,653,943)
92,054,094
REPURCHASE AGREEMENT—3.5%
21,652,000
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887.
(IDENTIFIED COST $21,652,000)
21,652,000
TOTAL INVESTMENT IN SECURITIES—98.1%
(IDENTIFIED COST $575,651,207)4
Net Unrealized Appreciation
(Depreciation) on Futures Contracts, and the value of Swap Contracts and Written Option Contracts is included in “Other Assets and Liabilities—Net.”
1
Non-income-producing security.
2
Floating/adjustable note with current rate and current maturity or next reset date shown. Adjustable rate mortgage security coupons are based on the weighted average note rates of the underlying mortgages less the
guarantee and servicing fees. These securities do not indicate an index and spread in their description above.
3
Affiliated holding.
Affiliated fund holdings are
investment companies which are managed by Federated Global Investment Management Corp., Federated Investment Management Company and Federated Equity Management Company of Pennsylvania (collectively, the
“Co-Advisers”) or an affiliate of the Co-Advisers. Transactions with affiliated fund holdings during the year ended December 31, 2017, were as follows:
Federated High Income
Bond Fund II
Balance of Shares Held 12/31/2016
13,177,127
Purchases/Additions
1,755,042
Sales/Reductions
(1,434,501)
Balance of Shares Held 12/31/2017
13,497,668
Value
$92,054,094
Change in Unrealized Appreciation/Depreciation
$48,352
Net Realized Gain/(Loss)
$(81,093)
Dividend Income
$6,155,289
4
The cost of investments for federal tax purposes amounts to $577,732,838.
5
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
6
Implied credit spreads, represented in absolute terms, utilized in determining the market value of credit default swap agreements serve as an indicator of the current status of the
payment/performance risk and represent the likelihood or risk of default for the credit derivative. The implied credit spread of a particular referenced entity reflects the cost of buying/selling protection and may
include upfront payments required to be made to enter into the agreement. Wider credit spreads represent a deterioration of the referenced entity's credit soundness and a greater likelihood or risk of default or other
credit event occurring as defined under the terms of the agreement. A credit spread identified as “Defaulted” indicates a credit event has occurred for the referenced entity or obligation.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
The inputs or methodology used for
valuing securities are not an indication of the risk associated with investing in those securities.
Net realized and unrealized gain (loss) on investments, futures contracts, written options, swap contracts and foreign
currency transactions
1.39
0.34
(1.20)
(0.12)
1.54
TOTAL FROM INVESTMENT OPERATIONS
1.68
0.68
(0.76)
0.42
2.04
Less Distributions:
Distributions from net investment income
(0.40)
(0.45)
(0.44)
(0.38)
(0.30)
Distributions from net realized gain on investments, futures contracts, written options, swap contracts and foreign
currency transactions
—
—
(0.05)
(0.80)
—
TOTAL DISTRIBUTIONS
(0.40)
(0.45)
(0.49)
(1.18)
(0.30)
Net Asset Value, End of Period
$10.80
$9.52
$9.29
$10.54
$11.30
Total Return2
18.11%
7.69%
(7.64)%
4.01%
21.74%
Ratios to Average Net Assets:
Net expenses
0.83%
0.79%3
0.75%3
0.76%
0.82%
Net investment income
2.91%
3.72%
4.38%
4.99%
4.80%
Expense waiver/reimbursement4
0.09%
0.14%
0.16%
0.15%
0.16%
Supplemental Data:
Net assets, end of period (000 omitted)
$621,804
$563,745
$631,701
$652,011
$451,067
Portfolio turnover
71%
90%
97%
54%
52%
Portfolio turnover (excluding purchases and sales from dollar-roll transactions)
71%
90%
97%
54%
52%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
The net expense ratio is calculated without reduction for expense offset arrangements. The net expense ratios are 0.79% and 0.75% for the years ended December 31, 2016 and 2015, respectively, after taking into
account these expense reductions.
4
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Net unrealized appreciation of investments, futures contracts, written options, swap contracts and translation of assets
and liabilities in foreign currency
37,905,585
Accumulated net realized loss on investments, futures contracts, written options, swap contracts and foreign currency
transactions
(11,073,824)
Undistributed net investment income
17,449,297
TOTAL NET ASSETS
$621,804,194
Net Asset Value, Offering Price and Redemption Proceeds Per Share:
$621,804,194 ÷ 57,585,175 shares outstanding, no par value, unlimited shares authorized
$10.80
See Notes which are an integral part
of the Financial Statements
Dividends (including $6,155,289 received from an affiliated holding, see footnotes to Portfolio of Investments and net of
foreign taxes withheld of $20,526)
$12,646,740
Interest
9,340,282
TOTAL INCOME
21,987,022
Expenses:
Investment adviser fee (Note 5)
$4,410,235
Administrative fee (Note 5)
590,598
Custodian fees
58,045
Transfer agent fee
44,266
Directors'/Trustees' fees (Note 5)
6,148
Auditing fees
33,399
Legal fees
10,393
Portfolio accounting fees
180,401
Printing and postage
86,241
Miscellaneous (Note 5)
35,396
TOTAL EXPENSES
5,455,122
Reimbursements:
Reimbursement of investment adviser fee (Note 5)
$(551,807)
Reimbursement of other operating expenses (Note 2)
(5,952)
TOTAL REIMBURSEMENTS
(557,759)
Net expenses
4,897,363
Net investment income
17,089,659
Realized and Unrealized Gain (Loss) on Investments, Futures Contracts, Written Options, Swap Contracts and Foreign Currency
Transactions:
Net realized gain on investments (including net realized gain (loss) of $(81,093) on sales of investments in an affiliated
holding)
3,729,443
Net realized gain on foreign currency transactions
Net change in unrealized appreciation of investments (including net change in unrealized appreciation of $48,352 on
investments in an affiliated holding)
11,538,823
Net change in unrealized appreciation/depreciation of translation of assets and liabilities in foreign currency
2,877
Net change in unrealized appreciation of futures contracts
2,544,065
Net change in unrealized appreciation of written options
384,781
Net change in unrealized appreciation of swap contracts
(145,563)
Net realized and unrealized gain on investments, futures contracts, written options, swap contracts and foreign currency
transactions
80,824,253
Change in net assets resulting from operations
$97,913,912
See Notes which are an integral part
of the Financial Statements
Net realized gain (loss) on investments, futures contracts, written options, swap contracts, foreign exchange contracts and
foreign currency transactions
66,499,270
(19,131,364)
Net change in unrealized appreciation/depreciation of investments, futures contracts, written options, swap contracts,
foreign exchange contracts and translation of assets and liabilities in foreign currency
14,324,983
39,613,681
CHANGE IN NET ASSETS RESULTING FROM OPERATIONS
97,913,912
42,615,482
Distributions to Shareholders:
Distributions from net investment income
(22,796,040)
(29,859,782)
Share Transactions:
Proceeds from sale of shares
61,126,884
65,300,190
Net asset value of shares issued to shareholders in payment of distributions declared
22,796,040
29,859,782
Cost of shares redeemed
(100,981,610)
(175,871,264)
CHANGE IN NET ASSETS RESULTING FROM SHARE TRANSACTIONS
(17,058,686)
(80,711,292)
Change in net assets
58,059,186
(67,955,592)
Net Assets:
Beginning of period
563,745,008
631,700,600
End of period (including undistributed net investment income of $17,449,297 and $22,776,038, respectively)
$621,804,194
$563,745,008
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated Managed Volatility Fund II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented separately. The
assets of each portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. Fund shares are available exclusively as a funding
vehicle for life insurance companies writing variable life insurance policies and variable annuity contracts. The investment objective of the Fund is to achieve high current income and moderate capital appreciation.
The Co-Advisers each are registered as a “commodity pool operator” with respect to operation of the Fund.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP).
Investment Valuation
In calculating its net asset value (NAV), the Fund
generally values investments as follows:
■
Equity securities listed on an exchange or traded through a regulated market system are valued at their last reported sale price or official closing price in their principal exchange or market.
■
Fixed-income securities are fair valued using price evaluations provided by a pricing service approved by the Fund's Board of Trustees (the “Trustees”).
■
Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs.
■
Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations.
■
Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered such as: the last
traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer's financial statements or other available documents, fundamental analytical data, the nature
and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable issuers,
movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions.
If any price, quotation, price
evaluation or other pricing source is not readily available when the NAV is calculated, if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a
reasonable period of time as set forth in the Fund's valuation policies and procedures, or if information furnished by a pricing service, in the opinion of the valuation committee (“Valuation Committee”),
is deemed not representative of the fair value of such security, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund
could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share.
Fair Valuation and Significant
Events Procedures
The Trustees have ultimate responsibility for
determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a Valuation Committee comprised of officers of the Fund, the Co-Advisers and certain of the
Co-Advisers' affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of pricing services recommended by the Valuation Committee
to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various methods for reviewing third-party pricing-service evaluations
including periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs, methods, models and assumptions), transactional back-testing, comparisons of evaluations of
different pricing services, and review of price challenges by the Co-Advisers based on recent market activity. In the event that market quotations and price evaluations are not available for an investment, the
Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review and approve the fair valuations made by the Valuation Committee
and any changes made to the procedures.
Factors considered
by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions,
indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a “bid” evaluation).
Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a “mid” evaluation). The Fund normally uses bid
evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC
derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the
Trustees.
The Trustees also
have adopted procedures requiring an investment to be priced at its fair value whenever the Co-Advisers determine that a significant event affecting the value of the investment has occurred between the time as of
which the price of the investment would otherwise be determined and the time as of which the NAV is computed. An event is considered significant if there is both an affirmative expectation that the investment's value
will change in response to the event and a reasonable basis for quantifying the resulting change in value. Examples of significant events that may occur after the close of the principal market on which a security is
traded, or after the time of a price evaluation provided by a pricing service or a dealer, include:
■
With respect to securities traded principally in foreign markets, significant trends in U.S. equity markets or in the trading of foreign securities index futures contracts;
■
Political or other developments affecting the economy or markets in which an issuer conducts its operations or its securities are traded;
■
Announcements concerning matters such as acquisitions, recapitalizations, litigation developments, or a natural disaster affecting the issuer's operations or regulatory changes or
market developments affecting the issuer's industry.
The Trustees have adopted procedures
whereby the Valuation Committee uses a pricing service to determine the fair value of equity securities traded principally in foreign markets when the Co-Advisers determine that there has been a significant trend in
the U.S. equity markets or in index futures trading. For other significant events, the Fund may seek to obtain more current quotations or price evaluations from alternative pricing sources. If a reliable alternative
pricing source is not available, the Fund will determine the fair value of the investment in accordance with the fair valuation procedures approved by the Trustees. The Trustees have ultimate responsibility for any
fair valuations made in response to a significant event.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the
transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be
transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's
Co-Advisers and their affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its
share of proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements (MNA) which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a
single payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash
or securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Foreign dividends are recorded on the ex-dividend date or when the Fund is informed of the ex-dividend date. Positive or negative inflation adjustments on Treasury Inflation-Protected
Securities (TIPS) are included in interest income. Distributions of net investment income, if any, are declared and paid annually. Non-cash dividends included in dividend income, if any, are recorded at fair value.
Amortization/accretion of premium and discount is included in investment income. Gains and losses realized on principal payment of mortgage-backed securities (paydown gains and losses) are classified as part of
investment income. The detail of the total fund expense reimbursements of $557,759 is disclosed in various locations in this Note 2 and Note 5. For the year ended December 31, 2017, the portfolio accountant reimbursed
$5,952 of their fees.
Federal Taxes
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code (the “Code”) and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary.
As of and during the year ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax
expense in the Statement of Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the
Commonwealth of Massachusetts.
The Fund may be
subject to taxes imposed by governments of countries in which it invests. Such taxes are generally based on either income or gains earned or repatriated. The Fund accrues and applies such taxes to net investment
income, net realized gains and net unrealized gains as income and/or gains are earned.
When-Issued and Delayed-Delivery
Transactions
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
The Fund may
transact in To Be Announced Securities (TBAs). As with other delayed-delivery transactions, a seller agrees to issue TBAs at a future date. However, the seller does not specify the particular securities to be
delivered. Instead, the Fund agrees to accept any security that meets specified terms such as issuer, interest rate and terms of underlying mortgages. The Fund records TBAs on the trade date utilizing information
associated with the specified terms of the transaction as opposed to the specific mortgages. TBAs are marked to market daily and begin earning interest on the settlement date. Losses may occur due to the fact that the
actual underlying mortgages received may be less favorable than those anticipated by the Fund.
Dollar-Roll Transactions
The Fund engages in dollar-roll transactions in
which the Fund sells mortgage-backed securities with a commitment to buy similar (same type, coupon and maturity), but not identical mortgage-backed securities on a future date. Both securities involved are TBA
mortgage-backed securities. The Fund treats dollar-roll transactions as purchases and sales. Dollar-rolls are subject to interest rate risks and credit risks.
Swap contracts involve two parties that agree to
exchange the returns (or the differential in rates of return) earned or realized on particular predetermined investments, instruments, indices or other measures. The gross returns to be exchanged or
“swapped” between parties are generally calculated with respect to a “notional amount” for a predetermined period of time. The Fund may enter into interest rate, total return, credit default,
currency and other swap agreements. Risks may arise upon entering into swap agreements from the potential inability of the counterparties to meet the terms of their contract from unanticipated changes in the value of
the swap agreement.
The Fund uses
credit default swaps to seek to increase income and to manage country, currency, duration, individual security, market, sector/asset class and yield curve risks. The “buyer” in a credit default swap is
obligated to pay the “seller” a periodic stream of payments over the term of the contract provided that no event of default on an underlying reference obligation has occurred. If an event of default
occurs, the seller must pay the buyer the full notional value, or the “par value”, of the reference obligation in exchange for the reference obligation. In connection with these agreements, securities may
be identified as collateral in accordance with the terms of the respective swap agreements to provide assets of value and recourse in the event of default or bankruptcy/insolvency. Recovery values are assumed by
market makers considering either industry standard recovery rates or entity specific factors and considerations until a credit event occurs. If a credit event has occurred, the recovery value is typically determined
by a facilitated auction whereby a minimum number of allowable broker bids, together with a specific valuation method, are used to calculate the settlement value. The maximum amount of the payment that may occur, as a
result of a credit event payable by the protection seller, is equal to the notional amount of the underlying index or security. The Fund's maximum exposure to loss of the notional value of credit default swaps
outstanding at December 31, 2017, is $400,000. The Fund's maximum risk of loss from counterparty credit risk, either as the protection buyer or as the protection seller, is the fair value of the contract. This risk is
mitigated by having a master netting arrangement between the Fund and the counterparty and by the posting of collateral by the counterparty to the Fund to cover the Fund's exposure to the counterparty.
Upfront payments
received or paid by the Fund will be reflected as an asset or liability on the Statement of Assets and Liabilities. Changes in the value of swap contracts are included in Swaps, at value on the Statement of Assets and
Liabilities, and periodic payments are reported as “Net realized gain (loss) on swap contracts” in the Statement of Operations.
Certain swap
contracts are subject to MNA. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. The cash or securities deposited in a segregated
account, offsets the amount due to the broker reducing the net settlement amount to zero.
Certain swap
contracts may be centrally cleared (“centrally cleared swaps”), whereby all payments made or received by the Fund pursuant to the contract are with a central clearing party (CCP) rather than the
counterparty. The CCP guarantees the performance of the parties to the contract. Upon entering into centrally cleared swaps, the Fund is required to deposit with the CCP, either in cash or securities, an amount of
initial margin determined by the CCP, which is subject to adjustment. For centrally cleared swaps, the daily change in valuation is recorded as a receivable or payable for variation margin and settled in cash with the
CCP daily. In the case of centrally cleared swaps, counterparty risk is minimal due to protections provided by the CCP.
Swap, at value at
period end, including net unrealized appreciation/depreciation, are listed after the Fund's Portfolio of Investments.
The average
notional amount of swap contracts held by the Fund throughout the period was $5,273,462. This is based on amounts held as of each month-end throughout the fiscal period.
The Fund purchases and sells financial futures
contracts to manage duration, market and yield curve risks. Upon entering into a financial futures contract with a broker, the Fund is required to deposit in a segregated account, either U.S. government securities or
a specified amount of Restricted cash, which is shown in the Statement of Assets and Liabilities. Futures contracts are valued daily and unrealized gains or losses are recorded in a “variation margin”
account. Daily, the Fund receives from or pays to the broker a specified amount of cash based upon changes in the variation margin account. When a contract is closed, the Fund recognizes a realized gain or loss.
Futures contracts have market risks, including the risk that the change in the value of the contract may not correlate with the changes in the value of the underlying securities. There is minimal counterparty risk to
the Fund since futures contracts are exchange traded and the exchange's clearing house, as counterparty to all exchange traded futures contracts, guarantees the futures contracts against default.
Futures contracts
outstanding at period end are listed after the Fund's Portfolio of Investments.
The average
notional value of long and short futures contracts held by the Fund throughout the period was $365,907,759 and $31,466,474, respectively. This is based on amounts held as of each month-end throughout the fiscal
period.
The Fund enters into foreign exchange contracts to
manage currency risk. Purchased contracts are used to acquire exposure to foreign currencies, whereas, contracts to sell are used to hedge the Fund's securities against currency fluctuations. Risks may arise upon
entering into these transactions from the potential inability of counterparties to meet the terms of their commitments and from unanticipated movements in security prices or foreign exchange rates. The foreign
exchange contracts are adjusted by the daily exchange rate of the underlying currency and any gains or losses are recorded for financial statement purposes as unrealized until the settlement date.
The accounting records of the Fund are maintained
in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rates of exchange of such currencies against U.S. dollars on the date of valuation. Purchases
and sales of securities, income and expenses are translated at the rate of exchange quoted on the respective date that such transactions are recorded. The Fund does not isolate that portion of the results of
operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included with the net realized and
unrealized gain or loss from investments.
Reported net
realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions, the difference between the amounts
of dividends, interest and foreign withholding taxes recorded on the Fund's books, and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from
changes in the value of assets and liabilities other than investments in securities at fiscal year end, resulting from changes in the exchange rate.
The Fund buys or sells put and call options to
manage market risk. The seller (“writer”) of an option receives a payment or premium, from the buyer, which the writer keeps regardless of whether the buyer exercises the option. When the Fund writes a put
or call option, an amount equal to the premium received is recorded as a liability and subsequently marked to market to reflect the current value of the option written. Premiums received from writing options which
expire are treated as realized gains. The Fund, as a writer of an option, bears the market risk of an unfavorable change in the price of the underlying reference instrument. When the Fund purchases a put or call
option, an amount equal to the premium paid is recorded as an increase to the cost of the investment and subsequently marked to market to reflect the current value of the option purchased. Premiums paid for purchasing
options which expire are treated as realized losses. Premiums received/paid for writing/purchasing options which are exercised or closed are added to the proceeds or offset against amounts paid on the underlying
reference instrument to determine the realized gain or loss. The risk associated with purchasing put and call options is limited to the premium paid. Options can trade on securities or commodities exchanges. In this
case, the exchange sets all the terms of the contract except for the price. Most exchanges require investors to maintain margin accounts through their brokers to cover their potential obligations to the exchange. This
protects investors against potential defaults by the counterparty.
Purchased option
contracts outstanding at period-end are listed in the Fund's Portfolio of Investments and written option contracts outstanding at period end are listed after the Fund's Portfolio of Investments.
The average market
value of purchased call and put options held by the Fund throughout the period was $246,356 and $1,835,175, respectively. This is based on amounts held as of each month-end throughout the fiscal period.
The average market
value of written call and put options held by the Fund throughout the period was $75,865 and $734,331, respectively. This is based on amounts held as of each month-end throughout the fiscal period.
Restricted Securities
The Fund may purchase securities which are
considered restricted. Restricted securities are securities that either: (a) cannot be offered for public sale without first being registered, or being able to take advantage of an exemption from registration, under
the Securities Act of 1933; or (b) are subject to contractual restrictions on public sales. In some cases, when a security cannot be offered for public sale without first being registered, the issuer of the restricted
security has agreed to register such securities for resale, at the issuer's expense, either upon demand by the Fund or in connection with another registered offering of the securities. Many such restricted securities
may be resold in the secondary market in transactions exempt from registration. Restricted securities may be determined to be liquid under criteria established by the Trustees. The Fund will not incur any registration
costs upon such resales. The Fund's restricted securities, like other securities, are priced in accordance with procedures established by and under the general supervision of the Trustees.
Total derivatives not accounted for as hedging
instruments under ASC Topic 815
$1,530,345
$(2,876,831)
*
Includes cumulative appreciation/depreciation of futures contracts as reported in the footnotes to the Portfolio of Investments. Only the current day's variation margin is reported
within the Statement of Assets and Liabilities.
The Effect of Derivative
Instruments on the Statement of Operations for the Year Ended December 31, 2017
Amount of Realized Gain or (Loss) on Derivatives Recognized in Income
The net realized gain (loss) on Purchased Option Contracts is found within the Net realized gain on investments on the Statement of Operations.
2
The net change in unrealized appreciation/depreciation of Purchased Option Contracts is found within the Net change in unrealized appreciation of investments on
the Statement of Operations.
Other
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
Shares issued to shareholders in payment of distributions declared
2,357,398
3,404,764
Shares redeemed
(10,085,603)
(19,435,105)
NET CHANGE RESULTING FROM FUND SHARE TRANSACTIONS
(1,634,297)
(8,771,833)
4. FEDERAL TAX INFORMATION
The timing and character of income
and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are primarily due to differing treatments for defaulted securities, discount
accretion/premium amortization on debt securities, partnership income, return of capital adjustments, expiration of capital loss carryforwards and credit default swap contracts.
For the year
ended December 31, 2017, permanent differences identified and reclassified among the components of net assets were as follows:
Increase (Decrease)
Paid-In
Capital
Undistributed
Net Investment
Income (Loss)
Accumulated
Net Realized
Gain (Loss)
$(1,181,382)
$379,640
$801,742
Net investment income (loss), net
realized gains (losses), and net assets were not affected by this reclassification.
The tax character
of distributions as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Ordinary income
$22,796,040
$29,859,782
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Undistributed ordinary income
$17,241,037
Capital loss carryforwards
$(5,604,437)
Net unrealized appreciation
$32,644,458
The difference between book-basis
and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for defaulted securities, deferral of losses on wash sales, discount accretion/premium amortization on debt securities,
non-taxable dividends, straddle loss deferrals, mark to market of derivative instruments and partnership basis adjustments.
At December 31,2017, the cost of investments for federal tax purposes was $577,732,838. The net unrealized appreciation of investments for federal tax purposes was $32,642,839. This consists of net unrealized appreciation from
investments for those securities having an excess of value over cost of $40,277,764 and net unrealized depreciation from investments for those securities having an excess of cost over value of $7,634,925. The amounts
presented are inclusive of derivative contracts.
At December 31,2017, the Fund had a capital loss carryforward of $5,604,437 which will reduce the Fund's taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code, thereby
reducing the amount of distributions to shareholders which would otherwise be necessary to relieve the Fund of any liability for federal income tax. Pursuant to the Code, a net capital loss incurred in taxable years
beginning after December 22, 2010, retains its character as either short-term or long-term and does not expire. All of the Fund's capital loss carryforwards were incurred in taxable years beginning after December 22,2010.
The following
schedule summarizes the Fund's capital loss carryforwards:
Short-Term
Long-Term
Total
$5,604,437
$—
$5,604,437
Capital loss carryforwards of
$1,181,382 expired during the year ended December 31, 2017.
The Fund used
capital loss carryforwards of $68,250,299 to offset capital gains realized during the year ended December 31, 2017.
At December 31,2017, for federal income tax purposes, the Fund had $2,180 in straddle loss deferrals.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The co-advisory agreement between the Fund and the
Co-Advisers provides for an annual fee equal to 0.75% of the Fund's average daily net assets. Subject to the terms described in the Expense Limitation note, the Co-Advisers may voluntarily choose to waive any portion
of their fee. The Co-Advisers have agreed to reimburse the Fund for certain investment adviser fees as a result of transactions in other affiliated investment companies. For the year ended December 31, 2017, the
Co-Advisers reimbursed $551,807.
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
In addition to the fees described
above, the Fund agrees to pay FAS an annual Administrative Service Charge of $125,000 for administrative and compliance services related to Commodities Futures Trading Commission Rule 4.5. Subject to the terms
described in the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, the annualized fee paid to FAS was 0.100% of average daily net assets of the
Fund.
Prior to
September 1, 2017, the breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
Expense Limitation
The Co-Advisers and certain of their affiliates
(which may include FAS) on their own initiative have agreed to waive certain amounts of their respective fees and/or reimburse expenses. Effective May 1, 2017, total annual fund operating expenses (as shown in the
financial highlights, excluding interest expense, extraordinary expenses, line of credit expenses and proxy related expenses paid by the Fund, if any) paid by the Fund (after the voluntary waivers and/or
reimbursements) will not exceed 0.89% (the “Fee Limit”) up to but not including the later of (the “Termination Date”): (a) May 1, 2018; or (b) the date of the Fund's next effective Prospectus.
While the Co-Advisers and their applicable affiliates currently do not anticipate terminating or increasing these arrangements prior to the Termination Date, these arrangements may only be terminated or the Fee Limit
increased prior to the Termination Date with the agreement of the Trustees.
Interfund Transactions
During the year ended December 31, 2017, the Fund
engaged in purchase and sale transactions with funds that have a common investment adviser (or affiliated investment advisers), common Directors/Trustees and/or common Officers. These purchase and sale transactions
complied with Rule 17a-7 under the Act and amounted to $2,550,188 and $719,222, respectively.
Directors'/Trustees' and
Miscellaneous Fees
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Co-Advisers which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
6. INVESTMENT TRANSACTIONS
Purchases and sales of investments,
excluding long-term U.S. government securities and short-term obligations, for the year ended December 31, 2017, were as follows:
Purchases
$391,345,347
Sales
$363,787,711
7. CONCENTRATION OF RISK
The Fund invests in securities of
non-U.S. issuers. Political or economic developments may have an effect on the liquidity and volatility of portfolio securities and currency holdings.
At December 31,2017, the diversification of countries was as follows:
Country
Percentage of
Net Assets
United States
81.6%
Mexico
1.4%
China
1.3%
Other1
13.8%
1
Countries representing less than 1.0% have been aggregated under the designation “Other.”
8. LINE OF CREDIT
The Fund participates with certain
other Federated Funds, on a several basis, in an up to $500,000,000 unsecured, 364-day, committed, revolving line of credit (LOC) agreement. The LOC was made available to finance temporarily the repurchase or
redemption of shares of the Fund, failed trades, payment of dividends, settlement of trades and for other short-term, temporary or emergency general business purposes. The Fund cannot borrow under the LOC if an
inter-fund loan is outstanding. The Fund's ability to borrow under the LOC also is subject to the limitations of the Act and various conditions precedent that must be satisfied before the Fund can borrow. Loans under
the LOC are charged interest at a fluctuating rate per annum equal to the highest, on any day, of (a) (i) the federal funds effective rate, (ii) the one month London Interbank Offered Rate (LIBOR), and (iii) 0.0%,
plus (b) a margin. The LOC also requires the Fund to pay, quarterly in arrears and at maturity, its pro rata share of a commitment fee based on the amount of the lenders' commitment that has not been utilized. As of
December 31, 2017, the Fund had no outstanding loans. During the year ended December 31, 2017, the Fund did not utilize the LOC.
9. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission, the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
10. subsequent events
The Trustees have approved a
proposed Agreement and Plan of Reorganization (Reorganization) pursuant to which the Fund will acquire all or substantially all of the assets of Federated Managed Tail Risk Fund II, another fund of the Trust, in
complete liquidation and termination of Federated Managed Tail Risk Fund II. Pending submission of proxy materials to shareholders of Federated Managed Tail Risk Fund II, a special meeting of the shareholders is
proposed to be held in the third quarter of 2018 to approve or disapprove the proposed Reorganization.
In addition, in
order to facilitate the Reorganization, the Trustees have approved the designation of the existing shares of the Fund as Primary Shares and the addition of a new share class of Service Shares, to be effective the
second quarter of 2018.
11. FEDERAL TAX INFORMATION
(UNAUDITED)
Of the ordinary income distributions
made by the Fund during the year ended December 31, 2017, 23.87% qualify for the dividend received deduction available to corporate shareholders.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF The
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED MANAGED VOLATILITY FUND II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated Managed Volatility Fund II (the “Fund”), a portfolio of Federated Insurance Series, as of December31, 2017, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively, the
“financial statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all
material respects the financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities
laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors'- investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other funds used as variable investment options. It is based on an investment of $1,000
invested at the beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of the table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual
$1,000
$1,092.00
$4.38
Hypothetical (assuming a 5% return before expenses)
$1,000
$1,021.00
$4.23
1
Expenses are equal to the Fund's annualized net expense ratio of 0.83%, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The expenses shown in the
table do not include the charges and expenses imposed by the insurance company under the variable insurance product contract. Please refer to the variable insurance product prospectus for a complete listing of these
expenses.
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
Vice President
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
President
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated Managed Volatility Fund
II (the “Fund”)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory contract,
under which Federated Global Investment Management Corp., Federated Equity Management Company of Pennsylvania and Federated Investment Management Company will serve as co-advisers to the Fund
(“Co-Advisers”) for an additional one-year term at its May 2017 meetings. The Board's decision regarding the contract reflects the exercise of its business judgment after considering all of the information
received on whether to continue the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory contract.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory contract generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to institutional and other
clients of each Co-Adviser and their advisory affiliates for what might be viewed as like services. The Board was aware of these factors and was guided by them in its review of the Fund's investment advisory contract
to the extent it considered them to be appropriate and relevant, as discussed further below. Also, in weighing these factors, the Board considered the aggregate advisory fee paid by the Fund for the services of all
Co-Advisers in addition to considering the allocation of that aggregate fee among the Co-Advisers and the rationale for that allocation.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings, at which the Board's formal approval of the investment advisory contract occurred. At the May meetings, in addition to meeting in
separate sessions of the independent trustees without management present, senior management of the Co-Advisers also met with the independent trustees and their counsel to discuss the materials presented and any other
matters thought relevant by the Co-Advisers or the trustees. Between regularly scheduled meetings, the Board also received information on particular matters as the need arose. The Board's consideration of the
investment advisory contract included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Co-Advisers' investment philosophy, revenue, profitability,
personnel and processes; investment and operating strategies; the Fund's short- and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well as in terms relative to its particular
investment program and certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's investment objectives; the Fund's expenses,
including the advisory fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for contractual or voluntary expense limitations; the
use and allocation of brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other services provided to the Fund by the Co-Advisers
and their affiliates. The Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Co-Advisers in sponsoring the Fund; the continuing state of
competition in the mutual fund industry
and market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's relationship to the Federated funds which include a comprehensive array of funds with different investment
objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales charges; compliance and audit reports concerning the Federated funds and the Federated
companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and relevant developments in the mutual fund industry and how the
Federated funds and/or Federated are responding to them. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on relevant criteria change in recognition of changing
circumstances in the mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses, therefore, appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
investment advisory contract between the Fund and the Co-Advisers provides for payment of a single advisory fee by the Fund for all services provided by the Co-Advisers. The investment advisory contract permits the
Co-Advisers to allocate the advisory fee in a manner commensurate with the services they provide to the Fund. Throughout the year, as well as in connection with its May meetings, the Board considered the fee
allocation and analyzed whether the allocation of fees among the Co-Advisers continued to be a reasonable proxy for and measurement of the level of resources and services provided by each Co-Adviser toward the
management of the Fund.
The
Board reviewed the contractual advisory fee rate, net advisory fee rate where partially waived and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses
relative to its peers. In this regard, the Board noted that the contractual advisory fee rate was below the median of the relevant peer group and the Board was satisfied with that the overall expense structure of the
Fund remained competitive.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory contract.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Co-Advisers and the resources of the Co-Advisers and their affiliates dedicated to the Fund. In particular, the Board
considered the services provided by the Co-Advisers in the aggregate, to the extent that the Co-Advisers collaborate in the implementation of the Fund's strategy, as well as separately, to the extent to which specific
services provided by a Co-Adviser are distinguishable and subject to meaningful assessment. In this regard, the Board evaluated, among other things, the Co-Advisers' personnel, experience, track record, overall
reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications, backgrounds and responsibilities of the portfolio management team
primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of, and the compliance-related resources provided to, the Fund by the Co-Advisers. The Fund's ability to deliver
competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Co-Advisers are executing the Fund's investment program. The Co-Advisers' ability to
execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent, and quality of the Co-Advisers' investment management services warrant the continuation of the investment
advisory contract.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by independent fund ranking organizations, regarding the performance of, and fees charged by, other mutual funds, noting his
view that comparisons to fund peer
groups may be helpful, though not conclusive, in judging the reasonableness of the proposed fees. The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and
unique differences in their objectives and management techniques when compared to other funds within an industry peer group.
For
the periods covered by the Senior Officer's Evaluation, the Fund's performance for the one-year and five-year periods was above the median of the relevant peer group, and the Fund's performance fell below the median
of the relevant peer group for the three-year period. The Board discussed the Fund's performance with the Co-Advisers and recognized the efforts being taken by the Co-Advisers in the context of the other factors
considered relevant by the Board.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the investment advisory contract.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers.
The
Board considered Federated's previous reductions in contractual management fees to certain funds in response to the Senior Officer's recommendations.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Co-Advisers have made significant
and long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions,
as well as systems technology (including technology relating to cybersecurity) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family
as a whole. The Board noted that the Co-Advisers' investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses
and that this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information
relative to revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints or to apply
breakpoints, at higher levels. It should not be viewed to determine the appropriateness of advisory fees because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any
applicable regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to
structuring fund advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee for the Fund was reasonable. Under these circumstances, no changes were recommended to, and no objection was raised to the continuation of, the Fund's
investment advisory contract.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Co-Advisers' industry
standing and reputation and with the expectation that the Co-Advisers will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the
investment advisory contract reflected
the fact that it is the shareholders who have effectively selected the Co-Advisers by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature,
quality and scope of the services provided to the Fund by the Co-Advisers and their affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory contract on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of the factors and
considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's decision to approve
the continuation of the contract reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangements.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes Management's Discussion of Fund Performance, a complete listing of your fund's holdings,
performance information and financial statements along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Management's Discussion
of Fund Performance (unaudited)
The total return of
Federated High Income Bond Fund II (the “Fund”), based on net asset value for the 12-month reporting period ended December 31, 2017, was 6.94% for the Primary Shares and 6.56% for the Service Shares. The
total return of the Fund's Primary Shares consisted of 7.23% current income and -0.29% of depreciation in the net asset value of the Fund's shares. The total return of the Bloomberg Barclays U.S. Corporate High Yield
2% Issuer Capped Index (BBHY2%ICI),1 a broad-based securities market index, was 7.50% during the same period. The total return of the Lipper Variable Underlying
High Yield Funds Average (LVHYFA),2 a peer group for the Fund, was 6.49% during the same period. The Fund's and LVHYFA's total returns for the most recently
completed fiscal year reflected actual cash flows, transaction costs and other expenses which were not reflected in the total return of the BBHY2%ICI.
During the reporting period, the most significant factors affecting the Fund's performance relative to the BBHY2%ICI were: (1) the allocation among industry sectors and (2) the selection of individual securities.
The following discussion will focus on the performance of the Fund's Primary Shares.
MARKET OVERVIEW
The total return for the
high-yield3 market for the reporting period was attractive on both an absolute as well as a relative basis. For example, the BBHY2%ICI,
which returned 7.50% for the period, substantially outperformed the Bloomberg Barclays U.S. Aggregate Bond Index,4 a measure of high-quality bond5 performance, which returned 3.54% for the period. The high-yield market benefited from a global, synchronized economic
expansion that appeared to be strengthening as 2017 came to a close. This was driven by a business-friendly administration in Washington, accommodative central bank policy outside the U.S., high levels of employment
as well as strong levels of business and consumer confidence. These factors led to strong corporate earnings, high levels of cash generation by high-yield companies and declining default rates which supported
high-yield bonds. These positive drivers also led to surging equity markets increasing the overall enterprise value for corporations. From a macro standpoint, the December 2017 passage of tax reform legislation would
seem to be another factor to add to the long list of items positively impacting U.S. economic growth and corporate earnings. The impact of these factors can be seen in the spread between high-yield bonds and U.S.
Treasury securities with comparable maturities which, according to the Credit Suisse High Yield Bond Index,6 began the reporting period at 472 basis points and ended the reporting period at 394 basis points.
Within the high-yield market, major industry sectors that substantially outperformed the overall BBHY2%ICI during the reporting period included: Pharmaceuticals, Transportation Services, Banking, Electric Utilities
and Diversified Manufacturing. Major industry sectors that substantially underperformed the overall BBHY2%ICI during the reporting period included: Wireline Telecommunications, Retail, Consumer Products, Wireless
Telecommunications and Media & Entertainment. From a credit quality perspective, the “CCC”-rated sector returned 10.38% while the “BB”-rated and “B”-rated sectors returned 7.32%
and 6.48%, respectively during the reporting period.
Sector Allocation
The Fund was positively
affected by its sector allocation during the reporting period. This was mainly a result of its substantial underweight position in the poor-performing Wireline Telecommunications industry sector. This was partially
offset by the Fund's cash holdings and its underweight position in the strong-performing Banking sector. An overweight position in the strong-performing Pharmaceutical sector and an underweight position in the
poor-performing Retail sector helped to offset some of the poor security selection in these two sectors during the reporting period.
Security Selection
The Fund was negatively
affected by its security selection during the period. This was especially true in the Retail, Consumer Products, Pharmaceutical, Midstream and Chemicals industry sectors. Specific high-yield issuers held by the Fund
that negatively impacted performance relative to the BBHY2%ICI included: FGI Operating Co., PetSmart, Mallinckrodt, Team Health and Jaguar Holdings.
The
Fund was positively impacted by security selection in the Healthcare, Cable & Satellite, Automotive, Wireless Telecommunications, Packaging, Metals and the Media & Entertainment industry sectors during the
reporting period. Specific high-yield issuers held by the Fund that positively impacted performance relative to the BBHY2%ICI included: Intelsat, Ortho-Clinical Diagnostics, Valeant Pharmaceutical, Tenet Healthcare
and Freeport-McMoRan.
1
Please see the footnotes to the line graphs below for definitions of, and further information about, the BBHY2%ICI.
2
Please see the footnotes to the line graphs below for definitions of, and further information about, the LVHYFA.
3
High-yield, lower-rated securities generally entail greater market, credit and liquidity risks than investment-grade securities and may include higher volatility and a higher risk of
default.
4
The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based index that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market.*
5
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
6
Credit Suisse High Yield Bond Index serves as a benchmark to evaluate the performance of low-quality bonds. Low-quality is defined as those bonds in the range from “BB” to
“CCC” and defaults.*
*
The index is unmanaged, and it is not possible to invest directly in an index.
FUND PERFORMANCE AND GROWTH OF A
$10,000 INVESTMENT
The graph below
illustrates the hypothetical investment of $10,0001 in the Federated High Income Bond Fund II from December 31, 2007 to December 31, 2017, compared to the Bloomberg Barclays
U.S. Corporate High Yield 2% Issuer Capped Index (BBHY2%ICI)2 and the Lipper Variable Underlying High Yield Funds Average (LVHYFA).3 The Average Annual Total Return table below shows returns for each class averaged over the stated periods.
Average Annual Total Returnsfor the Period Ended 12/31/2017
1 Year
5 Years
10 Years
Primary Shares
6.94%
5.62%
7.48%
Service Shares
6.56%
5.35%
7.21%
BBHY2%ICI
7.50%
5.78%
8.09%
LVHYFA
6.49%
4.74%
6.46%
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. Performance of a variable investment option changes over time and current performance may be lower or higher than what is stated. For current to the most recent month end performance, contact your insurance
company. The performance information presented does not include the charges and expenses imposed by the insurance company under the variable insurance product contract. The inclusion of such charges would lower
performance. Please refer to the variable insurance product prospectus for a complete listing of these expenses. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable
life insurance policies and variable annuity contracts. Variable investment options are not obligations of or guaranteed by any bank and are not federally insured.
1
The Fund's performance assumes the reinvestment of all dividends and distributions. The BBHY2%ICI and the LVHYFA have been adjusted to reflect reinvestment of dividends on securities
in the index and average.
2
The BBHY2%ICI is an issuer-constrained version of the Bloomberg Barclays U.S. Corporate High Yield Index that measures the market of USD-denominated, noninvestment-grade, fixed-rate,
taxable corporate bonds. The index follows the same rules as the uncapped index but limits the exposure of each issuer to 2% of the total market value and redistributes any excess market value index-wide on a pro-rata
basis. The BBHY2%ICI is not adjusted to reflect sales charges, expenses or other fees that the Securities and Exchange Commission (SEC) requires to be reflected in the Fund's performance. The index is unmanaged and
unlike the Fund, is not affected by cash flows. It is not possible to invest directly in an index.
3
Lipper figures represent the average of the total returns reported by all funds designated by Lipper, Inc., as falling into the respective category and is not
adjusted to reflect any sales charges. The Lipper figures in the Growth of $10,000 line graph are based on historical return information published by Lipper and reflect the return of the funds comprising the category
in the year of publication. Because the funds designated by Lipper as falling into the category can change over time, the Lipper figures in the line graph may not match the Lipper figures in the Average Annual Total
Returns table, which reflect the return of the funds that currently comprise the category.
Portfolio of Investments
Summary Table (unaudited)
At December 31, 2017, the
Fund's index classification1 was as follows:
Index Classification
Percentage of
Total Net Assets
Health Care
10.5%
Technology
9.5%
Cable Satellite
7.8%
Packaging
6.3%
Independent Energy
5.8%
Midstream
5.7%
Media Entertainment
5.6%
Wireless Communications
4.2%
Gaming
4.1%
Pharmaceuticals
3.9%
Other2
32.2%
Cash Equivalents3
2.9%
Other Assets and Liabilities—Net4
1.5%
TOTAL
100.0%
1
Index classifications are based upon, and individual portfolio securities are assigned to, the classifications and sub-classifications of the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index
(BBHY2%ICI). Individual portfolio securities that are not included in the BBHY2%ICI are assigned to an index classification by the Fund's Adviser.
2
For purposes of this table, index classifications which constitute less than 3.5% of the Fund's total net assets have been aggregated under the designation “Other.”
3
Cash Equivalents include any investments in money market mutual funds and/or overnight repurchase agreements.
4
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
T-Mobile USA, Inc., Sr. Unsecd. Note, 6.00%, 3/1/2023
288,612
225,000
T-Mobile USA, Inc., Sr. Unsecd. Note, 6.375%, 3/1/2025
241,313
375,000
T-Mobile USA, Inc., Sr. Unsecd. Note, 6.50%, 1/15/2024
398,437
325,000
T-Mobile USA, Inc., Sr. Unsecd. Note, 6.50%, 1/15/2026
355,469
TOTAL
10,281,901
TOTAL CORPORATE BONDS
(IDENTIFIED COST $228,349,278)
231,858,514
REPURCHASE AGREEMENT—2.9%
Finance - Banking—2.9%
7,045,000
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887.
(IDENTIFIED COST $7,045,000)
7,045,000
TOTAL INVESTMENT IN SECURITIES—98.5%
(IDENTIFIED COST $235,394,278)1
238,903,514
OTHER ASSETS AND LIABILITIES - NET—1.5%2
3,574,932
TOTAL NET ASSETS—100%
$242,478,446
1
The cost of investments for federal tax purposes amounts to $235,607,473.
2
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
The inputs or methodology used for
valuing securities are not an indication of the risk associated with investing in those securities.
As of December 31, 2017, all
investments of the Fund utilized Level 2 inputs in valuing the Fund's assets carried at fair value.
The following acronym is used
throughout this portfolio:
MTN
—Medium Term Note
See Notes which are an integral part
of the Financial Statements
Net realized and unrealized gain (loss) on investments
0.09
0.53
(0.53)
(0.20)
0.04
TOTAL FROM INVESTMENT OPERATIONS
0.45
0.90
(0.16)
0.19
0.48
Less Distributions:
Distributions from net investment income
(0.47)
(0.42)
(0.39)
(0.43)
(0.50)
Net Asset Value, End of Period
$6.82
$6.84
$6.36
$6.91
$7.15
Total Return2
6.94%
14.82%
(2.57)%
2.69%
6.99%
Ratios to Average Net Assets:
Net expenses
0.78%
0.72%
0.77%
0.77%
0.79%
Net investment income
5.26%
5.74%
5.55%
5.60%
6.21%
Expense waiver/reimbursement3
0.00%4
0.06%
—%
—%
—%
Supplemental Data:
Net assets, end of period (000 omitted)
$192,194
$190,070
$267,448
$287,649
$246,994
Portfolio turnover
32%
26%
33%
33%
32%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
4
Represents less than 0.01%.
See Notes which are an integral part
of the Financial Statements
Net realized and unrealized gain (loss) on investments
0.09
0.53
(0.52)
(0.21)
0.04
TOTAL FROM INVESTMENT OPERATIONS
0.43
0.88
(0.17)
0.17
0.46
Less Distributions:
Distributions from net investment income
(0.46)
(0.40)
(0.37)
(0.41)
(0.48)
Net Asset Value, End of Period
$6.78
$6.81
$6.33
$6.87
$7.11
Total Return2
6.56%
14.53%
(2.72)%
2.42%
6.73%
Ratios to Average Net Assets:
Net expenses
1.03%
0.96%
1.01%
1.02%
1.04%
Net investment income
5.01%
5.48%
5.29%
5.35%
5.97%
Expense waiver/reimbursement3
0.00%4
0.08%
—%
—%
—%
Supplemental Data:
Net assets, end of period (000 omitted)
$50,284
$49,183
$44,179
$57,999
$64,085
Portfolio turnover
32%
26%
33%
33%
32%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
4
Represents less than 0.01%.
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated High Income Bond Fund II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented separately. The assets
of each portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. The Fund offers two classes of shares: Primary Shares and
Service Shares. All shares of the Fund have equal rights with respect to voting, except on class-specific matters. Fund shares are available exclusively as a funding vehicle for life insurance companies writing
variable life insurance policies and variable annuity contracts. The investment objective of the Fund is to seek high current income.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP).
Investment Valuation
In calculating its net asset value (NAV), the Fund
generally values investments as follows:
■
Fixed-income securities are fair valued using price evaluations provided by a pricing service approved by the Fund's Board of Trustees (the “Trustees”).
■
Equity securities listed on an exchange or traded through a regulated market system are valued at their last reported sale price or official closing price in their principal exchange or market.
■
Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs.
■
Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations.
■
Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered, such as: the
last traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer's financial statements or other available documents, fundamental analytical data, the
nature and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable
issuers, movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions.
If any price, quotation, price
evaluation or other pricing source is not readily available when the NAV is calculated, if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a
reasonable period of time as set forth in the Fund's valuation policies and procedures, or if information furnished by a pricing service, in the opinion of the valuation committee (“Valuation Committee”),
is deemed not representative of the fair value of such security, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund
could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share.
Fair Valuation and Significant
Events Procedures
The Trustees have ultimate responsibility for
determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a Valuation Committee comprised of officers of the Fund, Federated Investment Management
Company (“Adviser”) and certain of the Adviser's affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of pricing
services recommended by the Valuation Committee to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various methods for
reviewing third-party pricing-service evaluations including periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs, methods, models and assumptions),
transactional back-testing, comparisons of evaluations of different pricing services, and review of price challenges by the Adviser based on recent market activity. In the event that market quotations and price
evaluations are not available for an investment, the Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review and approve
the fair valuations made by the Valuation Committee and any changes made to the procedures.
Factors considered
by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions,
indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a “bid” evaluation).
Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a “mid” evaluation). The Fund normally uses bid
evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC
derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the
Trustees.
The Trustees also
have adopted procedures requiring an investment to be priced at its fair value whenever the Adviser determines that a significant event affecting the value of the investment has occurred between the time as of which
the price of the investment would otherwise be determined and the time as of which the NAV is computed. An event is considered significant if there is both an affirmative expectation that the investment's value will
change in response to the event and a reasonable basis for quantifying the resulting change in value. Examples of significant events that may occur after the close of the principal market on which a security is
traded, or after the time of a price evaluation provided by a pricing service or a dealer, include:
■
With respect to securities traded principally in foreign markets, significant trends in U.S. equity markets or in the trading of foreign securities index futures contracts;
■
Political or other developments affecting the economy or markets in which an issuer conducts its operations or its securities are traded;
■
Announcements concerning matters such as acquisitions, recapitalizations, litigation developments, or a natural disaster affecting the issuer's operations or regulatory changes or
market developments affecting the issuer's industry.
The Trustees have adopted procedures
whereby the Valuation Committee uses a pricing service to determine the fair value of equity securities traded principally in foreign markets when the Adviser determines that there has been a significant trend in the
U.S. equity markets or in index futures trading. For other significant events, the Fund may seek to obtain more current quotations or price evaluations from alternative pricing sources. If a reliable alternative
pricing source is not available, the Fund will determine the fair value of the investment in accordance with the fair valuation procedures approved by the Trustees. The Trustees have ultimate responsibility for any
fair valuations made in response to a significant event.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the
transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be
transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's Adviser
and its affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its share of
proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements (MNA) which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a
single payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash
or securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Foreign dividends are recorded on the ex-dividend date or when the Fund is informed of the ex-dividend date. Distributions of net investment income, if any, are declared and paid
annually. Non-cash dividends included in dividend income, if any, are recorded at fair value. Amortization/accretion of premium and discount is included in investment income. Investment income, realized and unrealized
gains and losses, and certain fund-level expenses are allocated to each class based on relative average daily net assets, except that Service Shares may bear distribution services fees unique to that class. The detail
of the total fund expense reimbursement of $8,594 is disclosed in this Note 2.
For the year
ended December 31, 2017, the portfolio accountant reimbursed $8,594 of their fees.
Dividends are
declared separately for each class. No class has preferential dividend rights; differences in per share dividend rates are generally due to differences in separate class expenses.
Federal Taxes
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code (the “Code”) and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary.
As of and during the year ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax
expense in the Statement of Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the
Commonwealth of Massachusetts.
When-Issued and Delayed-Delivery
Transactions
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
The Fund may purchase securities which are
considered restricted. Restricted securities are securities that either: (a) cannot be offered for public sale without first being registered, or being able to take advantage of an exemption from registration, under
the Securities Act of 1933; or (b) are subject to contractual restrictions on public sales. In some cases, when a security cannot be offered for public sale without first being registered, the issuer of the restricted
security has agreed to register such securities for resale, at the issuer's expense, either upon demand by the Fund or in connection with another registered offering of the securities. Many such restricted securities
may be resold in the secondary market in transactions exempt from registration. Restricted securities may be determined to be liquid under criteria established by the Trustees. The Fund will not incur any registration
costs upon such resales. The Fund's restricted securities, like other securities, are priced in accordance with procedures established by and under the general supervision of the Trustees.
Other
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
3. SHARES OF BENEFICIAL
INTEREST
The following tables summarize share
activity:
Year Ended December 31
2017
2016
Primary Shares:
Shares
Amount
Shares
Amount
Shares sold
6,176,728
$41,996,711
5,623,772
$36,762,619
Shares issued to shareholders in payment of distributions declared
1,958,739
12,712,214
2,770,120
17,147,041
Shares redeemed
(7,715,309)
(52,592,213)
(22,695,504)
(146,842,193)
NET CHANGE RESULTING FROM PRIMARY SHARE TRANSACTIONS
420,158
$2,116,712
(14,301,612)
$(92,932,533)
Year Ended December 31
2017
2016
Service Shares:
Shares
Amount
Shares
Amount
Shares sold
1,313,486
$8,855,556
2,046,961
$13,233,268
Shares issued to shareholders in payment of distributions declared
516,238
3,340,060
435,026
2,684,113
Shares redeemed
(1,636,129)
(11,044,856)
(2,247,018)
(14,431,346)
NET CHANGE RESULTING FROM SERVICE SHARE TRANSACTIONS
193,595
$1,150,760
234,969
$1,486,035
NET CHANGE RESULTING FROM TOTAL FUND SHARE TRANSACTIONS
613,753
$3,267,472
(14,066,643)
$(91,446,498)
4. FEDERAL TAX INFORMATION
The timing and character of income
and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are due to differing treatments for expiration of capital loss carryforwards,
regulatory settlement proceeds and discount accretion/premium amortization on debt securities.
For the year
ended December 31, 2017, permanent differences identified and reclassified among the components of net assets were as follows:
Increase (Decrease)
Paid-In Capital
Undistributed Net
Investment Income (Loss)
Accumulated Net
Realized Gain (Loss)
$(9,764,712)
$180,519
$9,584,193
Net investment income (loss), net
realized gains (losses), and net assets were not affected by this reclassification.
The tax character
of distributions as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Ordinary income
$16,052,281
$19,831,154
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Undistributed ordinary income
$12,952,328
Net unrealized appreciation
$3,296,041
Capital loss carryforwards
$(21,105,015)
The difference between book-basis
and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for discount accretion/premium amortization on debt securities.
At December 31,2017, the cost of investments for federal tax purposes was $235,607,473. The net unrealized appreciation of investments for federal tax purposes was $3,296,041. This consists of net unrealized appreciation from
investments for those securities having an excess of value over cost of $7,692,459 and net unrealized depreciation from investments for those securities having an excess of cost over value of $4,396,418.
At December 31,2017, the Fund had a capital loss carryforward of $21,105,015 which will reduce the Fund's taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code, thereby
reducing the amount of distributions to shareholders which would otherwise be necessary to relieve the Fund of any liability for federal income tax. Pursuant to the Code, a net capital loss incurred in taxable years
beginning on or before December 22, 2010, is characterized as short-term and may be carried forward for a maximum of eight tax years (“Carryforward Limit”), whereas a net capital loss incurred in taxable
years beginning after December 22, 2010, retains its character as either short-term or long-term, does not expire and is required to be utilized prior to the losses which have a Carryforward Limit.
The following
schedule summarizes the Fund's capital loss carryforwards and expiration years:
Expiration Year
Short-Term
Long-Term
Total
No Expiration
$—
$12,171,611
$12,171,611
2018
$8,933,404
NA
$8,933,404
The Fund used capital loss
carryforwards of $79,472 to offset capital gains realized during the year ended December 31, 2017.
Capital loss
carryforwards of $9,764,569 expired during the year ended December 31, 2017.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The advisory agreement between the Fund and the
Adviser provides for an annual fee equal to 0.60% of the Fund's average daily net assets.
Administrative Fee
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
For the year ended December 31,2017, the annualized fee paid to FAS was 0.079% of average daily net assets of the Fund.
Prior to September 1, 2017, the
breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
Distribution Services Fee
The Fund has adopted a Distribution Plan (the
“Plan”) pursuant to Rule 12b-1 under the Act. Under the terms of the Plan, the Fund will compensate Federated Securities Corp. (FSC), the principal distributor, from the daily net assets of the Fund's
Service Shares to finance activities intended to result in the sale of these shares. The Plan provides that the Fund may incur distribution expenses at 0.25% of average daily net assets, annually, to compensate FSC.
For the year ended December 31, 2017, distribution services fees for the Fund were as follows:
Distribution Services
Fees Incurred
Service Shares
$130,729
When FSC receives fees, it may pay
some or all of them to financial intermediaries whose customers purchase shares. For the year ended December 31, 2017, FSC retained $250 of fees paid by the Fund.
Interfund Transactions
During the year ended December 31, 2017, the Fund
engaged in purchase and sale transactions with funds that have a common investment adviser (or affiliated investment advisers), common Directors/Trustees and/or common Officers. These purchase and sale transactions
complied with Rule 17a-7 under the Act and amounted to $479,891 and $223,109, respectively.
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Adviser which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
Affiliated Shares of Beneficial
Interest
As of December 31, 2017, 38% of the shares of
beneficial interest outstanding are owned by other affiliated investment companies.
6. INVESTMENT TRANSACTIONS
Purchases and sales of investments,
excluding long-term U.S. government securities and short-term obligations, for the year ended December 31, 2017, were as follows:
Purchases
$74,837,843
Sales
$77,253,882
7. LINE OF CREDIT
The Fund participates with certain
other Federated Funds, on a several basis, in an up to $500,000,000 unsecured, 364-day, committed, revolving line of credit (LOC) agreement. The LOC was made available to finance temporarily the repurchase or
redemption of shares of the Fund, failed trades, payment of dividends, settlement of trades and for other short-term, temporary or emergency general business purposes. The Fund cannot borrow under the LOC if an
inter-fund loan is outstanding. The Fund's ability to borrow under the LOC also is subject to the limitations of the Act and various conditions precedent that must be satisfied before the Fund can borrow. Loans under
the LOC are charged interest at a fluctuating rate per annum equal to the highest, on any day, of (a) (i) the federal funds effective rate, (ii) the one month London Interbank Offered Rate (LIBOR), and (iii) 0.0%,
plus (b) a margin. The LOC also requires the Fund to pay, quarterly in arrears and at maturity, its pro rata share of a commitment fee based on the amount of the lenders' commitment that has not been utilized. As of
December 31, 2017, the Fund had no outstanding loans. During the year ended December 31, 2017, the Fund did not utilize the LOC.
8. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission, the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF The
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED HIGH INCOME BOND FUND II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated High Income Bond Fund II (the “Fund”), a portfolio of Federated Insurance Series, as of December31, 2017, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively, the
“financial statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all
material respects the financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Fund in accordance with the U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors'- investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other variable investment options. It is based on an investment of $1,000 invested at the
beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of the table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual:
Primary Shares
$1,000
$1,017.90
$3.87
Service Shares
$1,000
$1,016.50
$5.13
Hypothetical (assuming a 5% return before expenses):
Primary Shares
$1,000
$1,021.40
$3.87
Service Shares
$1,000
$1,020.10
$5.14
1
Expenses are equal to the Fund's annualized net expense ratios, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The expenses shown in the table
do not include the charges and expenses imposed by the insurance company under the variable insurance product contract. Please refer to the variable insurance product prospectus for a complete listing of these
expenses. The annualized net expense ratios are as follows:
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
VICE PRESIDENT
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
PRESIDENT
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated High Income Bond Fund
II (the “Fund”)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory contract for
an additional one-year term at its May 2017 meetings. The Board's decision regarding the contract reflects the exercise of its business judgment after considering all of the information received on whether to continue
the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory contract.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory contract generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to institutional and other
clients of Federated Investment Management Company (the “Adviser”) and its advisory affiliates for what might be viewed as like services. The Board was aware of these factors and was guided by them in its
review of the Fund's investment advisory contract to the extent it considered them to be appropriate and relevant, as discussed further below.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings at which the Board's formal approval of the investment advisory contract occurred. At the May meetings in addition to meeting in separate
sessions of the independent trustees without management present, senior management of the Adviser also met with the independent trustees and their counsel to discuss the materials presented and any other matters
thought relevant by the Adviser or the trustees. Between regularly scheduled meetings, the Board also received information on particular matters as the need arose. The Board's consideration of the investment advisory
contract included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Adviser's investment philosophy, revenue, profitability, personnel and processes;
investment and operating strategies; the Fund's short-term and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well as in terms relative to its particular investment program and
certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's investment objectives; the Fund's expenses, including the advisory
fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for contractual or voluntary expense limitations; the use and allocation of
brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other services provided to the Fund by the Adviser and its affiliates. The
Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Adviser in sponsoring the Fund; the continuing state of competition in the mutual fund industry and
market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's relationship to the Federated funds which include a comprehensive array of funds with different investment
objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales
charges; compliance and audit reports
concerning the Federated funds and the Federated companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and relevant
developments in the mutual fund industry and how the Federated funds and/or Federated are responding to them. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on relevant
criteria change in recognition of changing circumstances in the mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses, therefore, appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
Board reviewed the contractual advisory fee rate, and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses relative to its peers. In this regard, the Board
noted that the contractual advisory fee rate was below the median of the relevant peer group and the Board was satisfied that the overall expense structure of the Fund remained competitive.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees.
The
Senior Officer noted that the services, administrative responsibilities and risks associated with such relationships are quite different than serving as a primary adviser to a fund.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory contract.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Adviser and the resources of the Adviser and its affiliates dedicated to the Fund. In this regard, the Board evaluated, among
other things, the Adviser's personnel, experience, track record, overall reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications,
backgrounds and responsibilities of the portfolio management team primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of, and the compliance-related resources
provided to, the Fund by the Adviser. The Fund's ability to deliver competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Adviser is
executing the Fund's investment program. The Adviser's ability to execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent and quality of the Adviser's investment
management services warrant the continuation of the investment advisory contract.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by independent fund ranking organizations, regarding the performance of, and fees charged by, other mutual funds, noting his view that comparisons to fund peer groups may be helpful,
though not conclusive, in judging the reasonableness of the proposed fees. The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and unique differences in
their objectives and management techniques when compared to other funds within an industry peer group.
For
the one-year, three-year and five-year periods covered by the Senior Officer's Evaluation, the Fund's performance was above the median of the relevant peer group.
Following such evaluation, and full deliberations, the Board concluded that the performance of the Fund supported renewal of the Fund's investment advisory contract.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers. The Board considered Federated's previous reductions in contractual management fees to certain funds in response to the Senior Officer's recommendations.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Adviser has made significant and
long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions, as
well as systems technology (including technology relating to cybersecurity) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family as
a whole. The Board noted that the Adviser's investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses and that
this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information relative to
revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints, or to apply breakpoints at
higher levels. It should not be viewed to determine the appropriateness of advisory fees because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any applicable
regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to structuring fund
advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee for the Fund was reasonable. Under these circumstances, no changes were recommended to, and no objection was raised to the continuation of the Fund's investment
advisory contract.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Adviser's industry standing
and reputation and with the expectation that the Adviser will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the investment advisory contract reflected the fact that
it is the shareholders who have effectively selected the Adviser by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature, quality and scope of
the services provided to the Fund by the Adviser and its affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory contract on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of the factors and
considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's decision to approve
the continuation of the contract reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangement.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes Management's Discussion of Fund Performance, a complete listing of your fund's holdings,
performance information and financial statements along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Management's Discussion
of Fund Performance (unaudited)
The total return of
Federated Kaufmann Fund II (the “Fund”), based on net asset value for the 12-month reporting period ended December 31, 2017, was 28.33% for the Primary Shares and 27.97% for the Service Shares. The Fund's
benchmark, the Russell Midcap® Growth Index (the RMCGI),1 a broad-based securities market index, had a total return of 25.27% for the period. The total return of the Morningstar
Insurance Mid-Cap Growth Funds Average (MIMCGFA)2 peer group average for the Fund, was 25.81%. The Fund's and MIMCGFA's total returns for the most recently completed fiscal
year reflected actual cash flows, transaction costs and other expenses, which were not reflected in the total return of the RMCGI.
During the reporting period, the Fund's investment strategy focused on stock selection, sector exposure and country allocation. These were the most significant factors affecting the Fund's performance relative to
the RMCGI.
The
following discussion will focus on the Fund's Primary Shares.
MARKET OVERVIEW
As the U.S. economy
enters 2018, the positive momentum in output has accelerated from its tepid pace in the previous few years as global growth has picked up, U.S. business confidence reached new highs and the U.S. passage of historic
corporate tax reform all may help sustain the recent GDP acceleration in 2017. Earnings growth drove 2017's equity market rally helped by stable global growth and a weaker dollar as well as accommodative central bank
policies around the world. Global markets have looked past most of the political discourse as the focus returned to company earnings and investment growth in the coming years.
Large-cap companies significantly outperformed both mid- and small-cap companies during the reporting period. The U.S. equity markets were led by the S&P 500 Index3 which was up 21.83%. Large-cap stocks, as measured by the Russell 1000® Index,4 returned 21.69%. The Russell Midcap® Index,5 representing mid-cap, returned 18.52%, and the Russell 2000® Index,6 representing small-cap stocks, returned 14.65%. Mid-cap growth stocks, as measured by the RMCGI (25.27%), also outperformed
mid-cap value stocks, as measured by the Russell Midcap® Value Index7 (13.34%), throughout the reporting period.
The
best-performing RMCGI sectors were: Utilities (64.17%), Information Technology (37.49%) and Financials (33.03%). The weakest-performing sectors during the quarter were: Energy (-5.63%), Consumer Staples (7.49%) and
Consumer Discretionary (15.29%).
STOCK SELECTION
The five stocks that
contributed the most to the Fund's performance versus the RMCGI were: Corcept Therapeutics, arGEN-X, ServiceNow, Veeva Systems and Mobileye.
The
five stocks that most negatively affected Fund performance were: NVIDIA, Minerva Neurosciences, Progenics Pharmaceuticals, Illumina and U.S. Silica Holdings.
SECTOR EXPOSURE
At the end of the
reporting period, approximately 72% of the portfolio was invested in four large sectors: Health Care, Information Technology, Industrials and Consumer Discretionary. These sectors have historically provided good
opportunities for bottom-up growth investors. In 2017, stock selection in Health Care and Information Technology had a positive impact on performance. The Fund maintained higher-than-benchmark exposure to cash which
hurt Fund performance. The cash position of the Fund was approximately 14.02% on average throughout the reporting period.
COUNTRY ALLOCATION
The reporting period
ended with approximately 17% of the Fund invested in non-U.S. holdings. During the reporting period, stock selection in foreign companies8 was a positive contributor to Fund performance. However, the allocation outside the U.S. hurt Fund performance relative to
the RMCGI.
1
Please see the footnotes to the line graphs below for definitions of, and further information about, the RMCGI.
2
Please see the footnotes to the line graphs below for definitions of, and further information about, the MIMCGFA.
3
The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500
stocks representing all major industries.*
4
The Russell 1000® Index measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 1000 of
the smallest securities based on a combination of their market cap and current index membership.*
5
The Russell Midcap® Index measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap® Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current
index membership.*
6
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2000 of
the smallest securities based on a combination of their market cap and current index membership.*
7
The Russell Midcap® Value Index measures the performance of the mid-cap value segment of the U.S. equity universe. It includes those
Russell Midcap Index companies with lower price-to-book ratios and lower forecasted growth values.*
8
International investing involves special risks including currency risk, increased volatility, political risks and differences in auditing and other financial standards.
*
The index is unmanaged, and it is not possible to invest directly in an index.
FUND PERFORMANCE AND GROWTH OF A
$10,000 INVESTMENT
The graph below
illustrates the hypothetical investment of $10,0001 in the Federated Kaufmann Fund II from December 31, 2007 to December 31, 2017, compared to the Russell Midcap® Growth Index (RMCGI)2 and the Morningstar Insurance Mid-Cap Growth Funds Average (MIMCGFA).3 The Average Annual Total Return table below shows returns for each class averaged over the stated periods.
The Fund offers multiple
share classes whose performance may be greater or less than its other share class(es) due to differences in sales charges and expenses.
Average Annual Total Returnsfor the Period Ended 12/31/2017
1 Year
5 Years
10 Years
Primary Shares
28.33%
16.82%
7.00%
Service Shares
27.97%
16.51%
6.74%
RMCGI
25.27%
15.30%
9.10%
MIMCGFA
25.81%
13.89%
7.46%
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. Performance of a variable investment option changes over time and current performance may be lower or higher than what is stated. For current to the most recent month-end performance, contact your insurance
company. The performance information presented does not include the charges and expenses imposed by the insurance company under the variable insurance product contract. The inclusion of such charges would lower
performance. Please refer to the variable insurance product prospectus for a complete listing of these expenses. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable
life insurance policies and variable annuity contracts. Variable investment options are not obligations of or guaranteed by any bank and are not federally insured.
1
The Fund's performance assumes the reinvestment of all dividends and distributions. The RMCGI and MIMCGFA have been adjusted to reflect reinvestment of dividends on securities in the
index and average.
2
The RMCGI measures the performance of the mid-cap growth segment of the U.S. equity universe. It includes those Russell Midcap® Index companies with higher price-to-book ratios and higher forecasted growth values. The RMCGI is constructed to
provide a comprehensive and unbiased barometer of the mid-cap growth market. The RMCGI is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true
mid-cap growth market. The RMCGI is not adjusted to reflect sales charges, expenses or other fees that the Securities and Exchange Commission requires to be reflected in the Fund's performance. The index is unmanaged
and unlike the Fund, is not affected by cash flows. It is not possible to invest directly in an index.
3
Morningstar figures represent the average of the total returns reported by all the funds designated by Morningstar as falling into the respective category
indicated. They do not reflect sales charges. The Morningstar figures in the Growth of $10,000 line graph are based on historical return information published by Morningstar and reflect the return of the funds
comprising the category in the year of publication. Because the funds designated by Morningstar as falling into the category can change over time, the Morningstar figures in the line graph may not match the
Morningstar figures in the Average Annual Total Returns table, which reflect the return of the funds that currently comprise the category.
Except for Securities Lending Collateral, Cash Equivalents and Other Assets and Liabilities, sector classifications are based upon, and individual portfolio securities are assigned to, the classifications of the
Global Industry Classification Standard (GICS), except that the Adviser assigns a classification to securities not classified by the GICS and to securities for which the Adviser does not have access to the
classification made by the GICS.
2
Represents less than 0.1%.
3
Based upon net unrealized appreciation (depreciation) or value of the derivative contracts as applicable. Derivative contracts may consist of futures, forwards, options and swaps. The impact of a derivative contract
on the Fund's performance may be larger than its unrealized appreciation (depreciation) or value may indicate. In many cases, the notional value or amount of a derivative contract may provide a better indication of
the contract's significance to the portfolio. More complete information regarding the Fund's direct investments in derivative contracts, including unrealized appreciation (depreciation), value and notional values or
amounts of such contracts, can be found in the table at the end of the Portfolio of Investments included in this Report.
4
Cash collateral received from lending portfolio securities which is invested in short-term investments such as repurchase agreements or money market mutual funds.
5
Cash Equivalents include any investments in money market mutual funds and/or overnight repurchase agreements other than those representing securities lending collateral.
6
Assets, other than investments in securities and derivative contracts, less liabilities. See Statement of Assets and Liabilities.
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887.
18,584,000
2,377,411
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887. (purchased with proceeds from securities lending collateral).
2,377,411
TOTAL REPURCHASE AGREEMENTS
(AT COST)
20,961,411
TOTAL INVESTMENT IN SECURITIES—101.6%
(IDENTIFIED COST $95,127,047)6
An affiliated company is a company
in which the Fund has ownership of at least 5% of the voting shares. Transactions with affiliated companies during the year ended December 31, 2017, were as follows:
Balance of
Shares
Held
12/31/2016
Purchases/
Additions
Sales/
Reductions
Balance of
Shares
Held
12/31/2017
Value
Change in
Unrealized
Appreciation/
Depreciation
Net
Realized
Gain/(Loss)
Dividend
Income
arGEN-x
34,394
10,629
(—)
45,023
$2,833,434
$2,081,400
$—
$—
ContraFect Corp.
42,500
87,500
(—)
130,000
$131,300
$(51,575)
$—
$—
ContraFect Corp., Warrants
42,500
—
(—)
42,500
$14,684
$(24,306)
$—
$—
ContraFect Corp., Warrants
—
87,500
(—)
87,500
$24,649
$23,774
$—
$—
Corcept Therapeutics, Inc.
303,000
54,082
(60,345)
296,737
$5,359,070
$2,817,885
$412,089
$—
Dyax Corp.
220,470
—
(—)
220,470
$531,333
$286,611
$—
$—
*Dynavax Technologies Corp.
56,654
—
(9,254)
47,400
$886,380
$913,005
$(143,514)
$—
Hamilton Lane, Inc.
—
21,900
(—)
21,900
$775,041
$372,223
$—
$11,167
Minerva Neurosciences, Inc.
122,882
32,405
(—)
155,287
$939,486
$(753,227)
$—
$—
Progenics Pharmaceuticals, Inc.
275,600
10,567
(38,505)
247,662
$1,473,589
$(657,787)
$(35,471)
$—
*Protalix Biotherapeutics, Inc.
38,203
—
(34,882)
3,321
$2,196
$11,218
$(4,046)
$—
SCYNEXIS, Inc.
66,360
17,040
(—)
83,400
$193,488
$(48,084)
$—
$—
SCYNEXIS, Inc. Warrants
21,060
—
(—)
21,060
$23,922
$(14,805)
$—
$—
SteadyMed Ltd.
28,534
—
(—)
28,534
$105,576
$29,961
$—
$—
SteadyMed Ltd.
2,945
—
(—)
2,945
$9,218
$6,967
$—
$—
SteadyMed Ltd.
27,200
32,206
(—)
59,406
$221,481
$29,164
$—
$—
*Zogenix, Inc.
31,400
7,133
(7,600)
30,933
$1,238,867
$711,474
$(59,189)
$—
Affiliated issuers no longer in the portfolio at period end
316,184
—
(316,184)
—
$—
$49,535
$(836,521)
$—
TOTAL OF AFFILIATED TRANSACTIONS
1,629,886
360,962
(466,770)
1,524,078
$14,763,714
$5,783,433
$(666,652)
$11,167
*
At December 31, 2017, the Fund no longer has ownership of at least 5% of the voting shares.
4
Market quotations and price evaluations are not available. Fair value determined using significant unobservable inputs in accordance with procedures established by and under the general supervision of the Fund's
Board of Trustees (the “Trustees”).
5
Denotes a restricted security that either: (a) cannot be offered for public sale without first being registered, or availing of an exemption from registration, under the Securities Act of 1933; or (b) is subject to
a contractual restriction on public sales. At December 31, 2017, these restricted securities amounted to $114,794, which represented 0.1% of total net assets.
6
The cost of investments for federal tax purposes amounts to $95,470,944.
7
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
The inputs or methodology used for
valuing securities are not an indication of the risk associated with investing in those securities.
Net realized and unrealized gain on investments, futures contracts and foreign currency transactions
4.54
0.56
1.44
1.91
5.76
TOTAL FROM INVESTMENT OPERATIONS
4.40
0.45
1.29
1.76
5.64
Less Distributions:
Distributions from net realized gain on investments, futures contracts and foreign currency transactions
(1.94)
(1.17)
(2.79)
(2.06)
(1.48)
Net Asset Value, End of Period
$19.16
$16.70
$17.42
$18.92
$19.22
Total Return2
28.33%
3.66%
6.37%
9.71%
40.12%
Ratios to Average Net Assets:
Net expenses
1.54%
1.54%3
1.53%3
1.53%3
1.53%3
Net investment income (loss)
(0.77)%
(0.67)%
(0.84)%
(0.83)%
(0.75)%
Expense waiver/reimbursement4
—%
0.03%
0.00%5
0.09%
0.25%
Supplemental Data:
Net assets, end of period (000 omitted)
$47,985
$42,122
$46,450
$49,425
$53,392
Portfolio turnover
44%
59%
60%
51%
71%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
The net expense ratio is calculated without reduction for expense offset arrangements. The net expense ratios are 1.54%, 1.53%, 1.53% and 1.53% for the years ended December 31, 2016, 2015, 2014 and 2013,
respectively, after taking into account these expense reductions.
4
This expense decrease is reflected in both the net expense and the net investment income (loss) ratios shown above.
5
Represents less than 0.01%.
See Notes which are an integral part
of the Financial Statements
Net realized and unrealized gain on investments, futures contracts and foreign currency transactions
4.33
0.53
1.41
1.86
5.63
TOTAL FROM INVESTMENT OPERATIONS
4.16
0.39
1.22
1.67
5.47
Less Distributions:
Distributions from net realized gain on investments, futures contracts and foreign currency transactions
(1.94)
(1.17)
(2.79)
(2.06)
(1.48)
Net Asset Value, End of Period
$18.26
$16.04
$16.82
$18.39
$18.78
Total Return2
27.97%
3.42%
6.15%
9.43%
39.67%
Ratios to Average Net Assets:
Net expenses
1.79%
1.79%3
1.78%3
1.78%3
1.78%3
Net investment income (loss)
(1.02)%
(0.92)%
(1.07)%
(1.08)%
(1.00)%
Expense waiver/reimbursement4
—%
0.03%
0.00%5
0.09%
0.25%
Supplemental Data:
Net assets, end of period (000 omitted)
$96,037
$78,870
$91,458
$69,369
$70,159
Portfolio turnover
44%
59%
60%
51%
71%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
The net expense ratio is calculated without reduction for expense offset arrangements. The net expense ratios are 1.79%, 1.78%, 1.78% and 1.78% for the years ended December 31, 2016, 2015, 2014 and 2013,
respectively, after taking into account these expense reductions.
4
This expense decrease is reflected in both the net expense and the net investment income (loss) ratios shown above.
5
Represents less than 0.01%.
See Notes which are an integral part
of the Financial Statements
Investment in securities, at value including $2,267,520 of securities loaned (Note 2) and including $12,636,271 of
investment in affiliated companies (identified cost $95,127,047)
$146,380,301
Cash
595
Restricted cash (Note 2)
72,000
Income receivable
63,000
Receivable for investments sold
4,199
Receivable for shares sold
300,227
TOTAL ASSETS
146,820,322
Liabilities:
Payable for investments purchased
99,980
Payable for shares redeemed
175,342
Payable for daily variation margin on futures contracts
28,953
Payable for collateral due to broker for securities lending
2,377,411
Payable to adviser (Note 5)
15,454
Payable for administrative fees (Note 5)
953
Payable for distribution services fee (Note 5)
20,083
Accrued expenses (Note 5)
80,093
TOTAL LIABILITIES
2,798,269
Net assets for 7,764,138 shares outstanding
$144,022,053
Net Assets Consist of:
Paid-in capital
$81,756,415
Net unrealized appreciation of investments, futures contracts and translation of assets and liabilities in foreign currency
51,238,375
Accumulated net realized gain on investments, futures contracts and foreign currency transactions
11,228,009
Accumulated net investment income (loss)
(200,746)
TOTAL NET ASSETS
$144,022,053
Net Asset Value, Offering Price and Redemption Proceeds Per Share
Primary Shares:
Net asset value per share ($47,984,567 ÷ 2,504,671 shares outstanding), no par value, unlimited shares authorized
$19.16
Service Shares:
Net asset value per share ($96,037,486 ÷ 5,259,467 shares outstanding), no par value, unlimited shares authorized
$18.26
See Notes which are an integral part
of the Financial Statements
Dividends (including $11,167 received from affiliated companies, see footnotes to Portfolio of Investments and net of
foreign taxes withheld of $15,376)
$802,671
Interest
168,288
Net income on securities loaned
52,110
TOTAL INCOME
1,023,069
Expenses:
Investment adviser fee (Note 5)
$1,730,320
Administrative fee (Note 5)
105,404
Custodian fees
27,199
Transfer agent fee
14,050
Directors'/Trustees' fees (Note 5)
2,244
Auditing fees
33,400
Legal fees
5,630
Portfolio accounting fees
65,958
Distribution services fee (Note 5)
219,414
Printing and postage
37,325
Miscellaneous (Note 5)
29,108
TOTAL EXPENSES
2,270,052
Net investment income (loss)
(1,246,983)
Realized and Unrealized Gain (Loss) on Investments, Futures Contracts and Foreign Currency Transactions:
Net realized gain on investments (including net realized loss of $666,652 on sales of investments in affiliated companies)
12,563,097
Net realized gain on foreign currency transactions
Net change in unrealized appreciation of investments (including net change in unrealized appreciation of $5,783,433 on
investments in affiliated companies)
21,581,778
Net change in unrealized appreciation/depreciation of translation of assets and liabilities in foreign currency
(274)
Net change in unrealized appreciation of futures contracts
(21,823)
Net realized and unrealized gain on investments, futures contracts and foreign currency transactions
33,973,703
Change in net assets resulting from operations
$32,726,720
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated Kaufmann Fund II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented separately. The assets of each
portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. The Fund offers two classes of shares: Primary Shares and Service
Shares. All shares of the Fund have equal rights with respect to voting, except on class-specific matters. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable life
insurance policies and variable annuity contracts. The investment objective of the Fund is capital appreciation.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP).
Investment Valuation
In calculating its net asset value (NAV), the Fund
generally values investments as follows:
■
Equity securities listed on an exchange or traded through a regulated market system are valued at their last reported sale price or official closing price in their principal exchange or market.
■
Fixed-income securities are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs.
■
Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations.
■
Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered such as: the last
traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer's financial statements or other available documents, fundamental analytical data, the nature
and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable issuers,
movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions.
If any price, quotation, price
evaluation or other pricing source is not readily available when the NAV is calculated, if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a
reasonable period of time as set forth in the Fund's valuation policies and procedures, or if information furnished by a pricing service, in the opinion of the valuation committee (“Valuation Committee”),
is deemed not representative of the fair value of such security, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund
could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share.
Fair Valuation and Significant
Events Procedures
The Trustees have ultimate responsibility for
determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a Valuation Committee comprised of officers of the Fund, Federated Equity Management Company
of Pennsylvania (“Adviser”) and certain of the Adviser's affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of
pricing services recommended by the Valuation Committee to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various
methods for reviewing third-party pricing-service evaluations including periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs, methods, models and
assumptions), transactional back-testing, comparisons of evaluations of different pricing services, and review of price challenges by the Adviser based on recent market activity. In the event that market quotations
and price evaluations are not available for an investment, the Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review
and approve the fair valuations made by the Valuation Committee and any changes made to the procedures.
Factors considered
by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions,
indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a “bid” evaluation).
Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a “mid” evaluation). The Fund normally uses bid
evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC
derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the
Trustees.
The Trustees also
have adopted procedures requiring an investment to be priced at its fair value whenever the Adviser determines that a significant event affecting the value of the investment has occurred between the time as of which
the price of the investment would otherwise be determined and the time as of which the NAV is computed. An event is considered significant if there is both an affirmative expectation that the investment's value will
change in response to the event and a reasonable basis for quantifying the resulting change in value. Examples of significant events that may occur after the close of the principal market on which a security is
traded, or after the time of a price evaluation provided by a pricing service or a dealer, include:
■
With respect to securities traded principally in foreign markets, significant trends in U.S. equity markets or in the trading of foreign securities index futures contracts;
■
Political or other developments affecting the economy or markets in which an issuer conducts its operations or its securities are traded;
■
Announcements concerning matters such as acquisitions, recapitalizations, litigation developments, or a natural disaster affecting the issuer's operations or regulatory changes or
market developments affecting the issuer's industry.
The Trustees have adopted procedures
whereby the Valuation Committee uses a pricing service to determine the fair value of equity securities traded principally in foreign markets when the Adviser determines that there has been a significant trend in the
U.S. equity markets or in index futures trading. For other significant events, the Fund may seek to obtain more current quotations or price evaluations from alternative pricing sources. If a reliable alternative
pricing source is not available, the Fund will determine the fair value of the investment in accordance with the fair valuation procedures approved by the Trustees. The Trustees have ultimate responsibility for any
fair valuations made in response to a significant event.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the
transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be
transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's Adviser
and its affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its share of
proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements (MNA) which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a
single payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash
or securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Foreign dividends are recorded on the ex-dividend date or when the Fund is informed of the ex-dividend date. Amortization/accretion of premium and discount is included in investment
income. Distributions of net investment income, if any, are declared and paid annually. Non-cash dividends included in dividend income, if any, are recorded at fair value. Investment income, realized and unrealized
gains and losses, and certain fund-level expenses are allocated to each class based on relative average daily net assets, except that Primary Shares and Service Shares may bear distribution services fees unique to
those classes.
Dividends are
declared separately for each class. No class has preferential dividend rights; differences in per share dividend rates are generally due to differences in separate class expenses.
Federal Taxes
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary. As of and during the year
ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax expense in the Statement of
Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the Commonwealth of
Massachusetts.
The Fund may be
subject to taxes imposed by governments of countries in which it invests. Such taxes are generally based on either income or gains earned or repatriated. The Fund accrues and applies such taxes to net investment
income, net realized gains and net unrealized gains as income and/or gains are earned.
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
The Fund purchases and sells financial futures
contracts to manage currency risk and market risks. Upon entering into a financial futures contract with a broker, the Fund is required to deposit in a segregated account, either U.S. government securities or a
specified amount of Restricted cash, which is shown in the Statement of Assets and Liabilities. Futures contracts are valued daily and unrealized gains or losses are recorded in a “variation margin”
account. Daily, the Fund receives from or pays to the broker a specified amount of cash based upon changes in the variation margin account. When a contract is closed, the Fund recognizes a realized gain or loss.
Futures contracts have market risks, including the risk that the change in the value of the contract may not correlate with the changes in the value of the underlying securities. There is minimal counterparty risk to
the Fund since futures contracts are exchange traded and the exchange's clearing house, as counterparty to all exchange traded futures contracts, guarantees the futures contracts against default.
Futures contracts
outstanding at period end are listed after the Fund's Portfolio of Investments.
The average
notional value of short futures contracts held by the Fund throughout the period was $1,043,475. This is based on amounts held as of each month-end throughout the fiscal period.
The Fund enters into foreign exchange contracts for
the delayed-delivery of securities or foreign currency exchange transactions. The Fund enters into foreign exchange contracts to protect assets against adverse changes in foreign currency exchange rates or exchange
control regulations. Purchased contracts are used to acquire exposure to foreign currencies, whereas, contracts to sell are used to hedge the Fund's securities against currency fluctuations. Risks may arise upon
entering into these transactions from the potential inability of counterparties to meet the terms of their commitments and from unanticipated movements in security prices or foreign exchange rates. The foreign
exchange contracts are adjusted by the daily exchange rate of the underlying currency and any gains or losses are recorded for financial statement purposes as unrealized until the settlement date.
The accounting records of the Fund are maintained
in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rates of exchange of such currencies against U.S. dollars on the date of valuation. Purchases
and sales of securities, income and expenses are translated at the rate of exchange quoted on the respective date that such transactions are recorded. The Fund does not isolate that portion of the results of
operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included with the net realized and
unrealized gain or loss from investments.
Reported net
realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions, the difference between the amounts
of dividends, interest and foreign withholding taxes recorded on the Fund's books, and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from
changes in the value of assets and liabilities other than investments in securities at fiscal year end, resulting from changes in the exchange rate.
Securities Lending
The Fund participates in a securities lending
program providing for the lending of equity securities to qualified brokers. The Fund normally receives cash collateral for securities loaned that is invested in an affiliated money market fund or in short-term
securities including repurchase agreements. Collateral is maintained at a minimum level of 100% of the market value of investments loaned, plus interest, if applicable. In accordance with the Fund's securities lending
agreement, the market value of securities on loan is determined each day at the close of business and any additional collateral required to cover the value of securities on loan is delivered to the Fund on the next
business day. Earnings on collateral are allocated between the borrower of the security, the securities lending agent, as a fee for its services under the program and the Fund, according to agreed-upon rates.
Securities lending
transactions are subject to MNA which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a single payment, in the event
of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amount but gross. As indicated below, the cash collateral received by the
Fund exceeds the market value of the securities loaned reducing the net settlement amount to zero. The chart below identifies the amount of collateral received as well as the market value of securities on loan.
Additionally, the securities lending agreement executed by the Fund includes an indemnification clause. This clause stipulates that the borrower will reimburse the Fund for any losses as a result of any failure of the
borrower to return equivalent securities to the Fund.
As of December31, 2017, securities subject to this type of arrangement and related collateral were as follows:
The Fund may purchase securities which are
considered restricted. Restricted securities are securities that either: (a) cannot be offered for public sale without first being registered, or being able to take advantage of an exemption from registration, under
the Securities Act of 1933; or (b) are subject to contractual restrictions on public sales. In some cases, when a security cannot be offered for public sale without first being registered, the issuer of the restricted
security has agreed to register such securities for resale, at the issuer's expense, either upon demand by the Fund or in connection with another registered offering of the securities. Many such restricted securities
may be resold in the secondary market in transactions exempt from registration. Restricted securities may be determined to be liquid under criteria established by the Trustees. The Fund will not incur any registration
costs upon such resales. The Fund's restricted securities, like other securities, are priced in accordance with procedures established by and under the general supervision of the Trustees.
Additional
information on restricted securities, excluding securities purchased under Rule 144A that have been deemed liquid by the Trustees, if applicable, held at December 31, 2017, is as follows:
Security
Acquisition
Date
Cost
Market
Value
SteadyMed Ltd.
7/29/2016
$89,311
$105,576
SteadyMed Ltd.
1/26/2015
$17,008
$9,218
Additional Disclosure Related to
Derivative Instruments
Fair Value of Derivative Instruments
Liability
Statement of
Assets and
Liabilities
Location
Fair
Value
Derivatives not accounted for as hedging instruments under ASC Topic 815
Payable for daily variation
margin on futures contracts
$14,872*
*
Includes cumulative depreciation of futures contracts as reported in the footnotes to the Portfolio of Investments. Only the current day's variation margin is reported within the
Statement of Assets and Liabilities.
The Effect of Derivative
Instruments on the Statement of Operations for the Year Ended December 31, 2017
Amount of Realized Gain or (Loss) on Derivatives Recognized in Income
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
3. SHARES OF BENEFICIAL
INTEREST
The following tables summarize share
activity:
Year Ended December 31
2017
2016
Primary Shares:
Shares
Amount
Shares
Amount
Shares sold
195,640
$3,425,347
172,747
$2,727,161
Shares issued to shareholders in payment of distributions declared
289,029
4,734,294
209,164
3,022,416
Shares redeemed
(502,213)
(8,803,914)
(526,403)
(8,309,116)
NET CHANGE RESULTING FROM PRIMARY SHARE TRANSACTIONS
Shares issued to shareholders in payment of distributions declared
593,980
9,289,851
453,229
6,304,411
Shares redeemed
(1,142,552)
(19,265,145)
(1,868,028)
(28,466,407)
NET CHANGE RESULTING FROM SERVICE SHARE TRANSACTIONS
341,509
$4,971,826
(520,151)
$(8,512,220)
NET CHANGE RESULTING FROM TOTAL FUND SHARE TRANSACTIONS
323,965
$4,327,553
(664,643)
$(11,071,759)
4. FEDERAL TAX INFORMATION
The timing and character of income
and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are due to differing treatments for foreign currency reclassifications, net
operating loss utilized to offset short-term capital gains, net operating losses, passive foreign investment company gains and losses and discount accretion/premium amortization on debt securities.
For the year
ended December 31, 2017, permanent differences identified and reclassified among the components of net assets were as follows:
Increase (Decrease)
Paid-In
Capital
Undistributed
Net Investment
Income (Loss)
Accumulated
Net Realized
Gain (Loss)
$(302,141)
$1,238,338
$(936,197)
Net investment income (loss), net
realized gains (losses), and net assets were not affected by this reclassification.
The tax character
of distributions as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Long-term capital gains
$14,024,159
$9,326,827
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Net unrealized appreciation
$50,909,350
Undistributed long-term capital gains
$11,356,288
The difference between book-basis
and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for deferral of losses on wash sales, mark to market of futures contracts and passive foreign investment company
adjustments.
At December 31,2017, the cost of investments for federal tax purposes was $95,470,944. The net unrealized appreciation of investments for federal tax purposes was $50,909,357. This consists of net unrealized appreciation from
investments for those securities having an excess of value over cost of $52,187,458 and net unrealized depreciation from investments for those securities having an excess of cost over value of $1,278,101. The amounts
presented are inclusive of derivative contracts.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The advisory agreement between the Fund and the
Adviser provides for an annual fee equal to 1.30% of the Fund's average daily net assets. Subject to the terms described in the Expense Limitation note, the Adviser may voluntarily choose to waive any portion of its
fee.
Certain of the
Fund's assets are managed by Federated Global Investment Management Corp. (the “Sub-Adviser”). Under the terms of a sub-advisory agreement between the Adviser and the Sub-Adviser, the Sub-Adviser receives
an allocable portion of the Fund's adviser fee. The fee is paid by the Adviser out of its resources and is not an incremental Fund expense. For the year ended December 31, 2017, the Sub-Adviser earned a fee of
$1,418,862.
Administrative Fee
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
Subject to the terms described in
the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, the annualized fee paid to FAS was 0.079% of average daily net assets of the Fund.
Prior to
September 1, 2017, the breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
Distribution Services Fee
The Fund has adopted a Distribution Plan (the
“Plan”) pursuant to Rule 12b-1 under the Act. Under the terms of the Plan, the Fund will compensate Federated Securities Corp. (FSC), the principal distributor, from the daily net assets of the Fund's
Primary Shares and Service Shares to finance activities intended to result in the sale of these shares. The Plan provides that the Fund may incur distribution expenses at the following percentages of average daily net
assets annually, to compensate FSC:
Share Class Name
Percentage of Average
Daily Net Assets of Class
Primary Shares
0.25%
Service Shares
0.25%
Subject to the terms described in
the Expense Limitation note, FSC may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, distribution services fees for the Fund were as follows:
Distribution Services
Fees Incurred
Service Shares
$219,414
When FSC receives fees, it may pay
some or all of them to financial intermediaries whose customers purchase shares. For the year ended December 31, 2017, FSC did not retain any fees paid by the Fund. For the year ended December 31, 2017, the Fund's
Primary Shares did not incur a distribution services fee; however, it may begin to incur this fee upon approval of the Trustees.
Expense Limitation
The Adviser and certain of its affiliates (which
may include FSC and FAS) on their own initiative have agreed to waive certain amounts of their respective fees and/or reimburse expenses. Total annual fund operating expenses (as shown in the financial highlights,
excluding interest expense, extraordinary expenses, line of credit expenses and proxy-related expenses paid by the Fund, if any) paid by the Fund's Primary Shares and Service Shares (after the voluntary waivers and/or
reimbursements) will not exceed 1.53% and 1.78% (the “Fee Limit”), respectively, up to but not including the later of (the “Termination Date”): (a) May 1, 2018; or (b) the date of the Fund's
next effective Prospectus. While the Adviser and its applicable affiliates currently do not anticipate terminating or increasing these arrangements prior to the Termination Date, these arrangements may only be
terminated or the Fee Limit increased prior to the Termination Date with the agreement of the Trustees.
Interfund Transactions
During the year ended December 31, 2017, the Fund
engaged in purchase and sale transactions with funds that have a common investment adviser (or affiliated investment advisers), common Directors/Trustees and/or common Officers. These purchase and sale transactions
complied with Rule 17a-7 under the Act and amounted to $245,028 and $113,595, respectively.
Directors'/Trustees' and
Miscellaneous Fees
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Adviser which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
6. INVESTMENT TRANSACTIONS
Purchases and sales of investments,
excluding long-term U.S. government securities and short-term obligations, for the year ended December 31, 2017, were as follows:
The Fund invests in securities of
non-U.S. issuers. Political or economic developments may have an effect on the liquidity and volatility of portfolio securities and currency holdings. At December 31, 2017, the diversification of countries was as
follows:
Country
Percentage of
Net Assets
United States
82.5%
China
3.0%
Netherland
2.7%
Italy
2.3%
Belgium
2.2%
Denmark
1.2%
Singapore
1.1%
Other1
6.6%
1
Countries representing less than 1.0% have been aggregated under the designation “Other.”
8. LINE OF CREDIT
The Fund participates with certain
other Federated Funds, on a several basis, in an up to $500,000,000 unsecured, 364-day, committed, revolving line of credit (LOC) agreement. The LOC was made available to finance temporarily the repurchase or
redemption of shares of the Fund, failed trades, payment of dividends, settlement of trades and for other short-term, temporary or emergency general business purposes. The Fund cannot borrow under the LOC if an
inter-fund loan is outstanding. The Fund's ability to borrow under the LOC also is subject to the limitations of the Act and various conditions precedent that must be satisfied before the Fund can borrow. Loans under
the LOC are charged interest at a fluctuating rate per annum equal to the highest, on any day, of (a) (i) the federal funds effective rate, (ii) the one month London Interbank Offered Rate (LIBOR), and (iii) 0.0%,
plus (b) a margin. The LOC also requires the Fund to pay, quarterly in arrears and at maturity, its pro rata share of a commitment fee based on the amount of the lenders' commitment that has not been utilized. As of
December 31, 2017, the Fund had no outstanding loans. During the year ended December 31, 2017, the Fund did not utilize the LOC.
9. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission (SEC), the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
10. FEDERAL TAX INFORMATION
(UNAUDITED)
For the year ended December 31,2017, the amount of long-term capital gains designated by the Fund was $14,024,159.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF the
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED KAUFMANN FUND II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated Kaufmann Fund II (the “Fund”), a portfolio of Federated Insurance Series, as of December 31, 2017,
the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively, the “financial
statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all material respects the
financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then ended, and the financial
highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities
laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors' - investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other funds used as variable investment options. It is based on an investment of $1,000
invested at the beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of the table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual:
Primary Shares
$1,000
$1,117.90
$8.22
Service Shares
$1,000
$1,116.10
$9.55
Hypothetical (assuming a 5% return before expenses):
Primary Shares
$1,000
$1,017.40
$7.83
Service Shares
$1,000
$1,016.20
$9.10
1
Expenses are equal to the Fund's annualized net expense ratios, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The annualized net expense ratios
are as follows:
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
VICE PRESIDENT
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
PRESIDENT
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated Kaufmann Fund II (the
“Fund”)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory and
subadvisory contracts for an additional one-year term at its May 2017 meetings. The Board's decision regarding these contracts reflects the exercise of its business judgment after considering all of the information
received on whether to continue the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory and subadvisory contracts.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory and subadvisory contracts generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to
institutional and other clients of Federated Equity Management Company of Pennsylvania (the “Adviser”) and any subadviser and their advisory affiliates, for what might be viewed as like services. The Board
was aware of these factors and was guided by them in its review of the Fund's investment advisory and subadvisory contracts to the extent it considered them to be appropriate and relevant, as discussed further
below.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings at which the Board's formal approval of the investment advisory and subadvisory contracts occurred. At the May meetings, in addition to
meeting in separate sessions of the independent trustees without management present, senior management of the Adviser also met with the independent trustees and their counsel to discuss the materials presented and any
other matters thought relevant by the Adviser or the trustees. Between regularly scheduled meetings, the Board also received information on particular matters as the need arose. The Board's consideration of the
investment advisory and subadvisory contracts included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Adviser's and subadviser's investment
philosophy, revenue, profitability, personnel and processes; investment and operating strategies; the Fund's short-term and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well
as in terms relative to its particular investment program and certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's
investment objectives; the Fund's expenses, including the advisory fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for
contractual or voluntary expense limitations; the use and allocation of brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other
services provided to the Fund by the Adviser and its affiliates. The Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Adviser in sponsoring the Fund;
the continuing state of competition in the mutual fund industry and market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's relationship to the Federated funds which
include a comprehensive array of
funds with different investment
objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales charges; compliance and audit reports concerning the Federated funds and the Federated
companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and relevant developments in the mutual fund industry and how the
Federated funds and/or Federated are responding to them. The Board also considered that the longevity and experience of the Fund's portfolio management team and their unique approach to investing may limit the utility
of comparisons to other equity mutual funds. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on relevant criteria change in recognition of changing circumstances in the
mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses, therefore, appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
Board reviewed the contractual advisory fee rate, net advisory fee rate where partially waived and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses
relative to its peers. In this regard, the Board noted that the contractual advisory fee rate was above the median of the relevant peer group, but the Board noted the applicable waivers and reimbursements, and that
the overall expense structure of the Fund remained competitive in the context of other factors considered by the Board.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory and subadvisory contracts.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Adviser and the resources of the Adviser and its affiliates dedicated to the Fund. In this regard, the Board evaluated, among
other things, the Adviser's personnel, experience, track record, overall reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications,
backgrounds and responsibilities of the portfolio management team primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of and the compliance-related resources
provided to the Fund by the Adviser. The Fund's ability to deliver competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Adviser is
executing the Fund's investment program. The Adviser's ability to execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent, and quality of the Adviser's investment
management services warrant the continuation of the investment advisory and subadvisory contracts.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by independent fund ranking organizations, regarding the performance of, and fees charged by, other mutual funds, noting his view that comparisons to fund peer groups may be helpful,
though not conclusive, in judging the reasonableness of the proposed fees. The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and unique differences in
their objectives and management techniques when compared to other funds within an industry peer group.
For
the periods covered by the Senior Officer's Evaluation, the Fund's performance for the three-year and five-year period was above the median of the relevant peer group, and the Fund's performance fell below the median
of the relevant peer group for the one-year period. The Board discussed the Fund's performance with the Adviser and recognized the efforts being taken by the Adviser in the context of other factors considered relevant
by the Board.
Following such evaluation and full deliberations, the Board concluded that the performance of the Fund supported renewal of the Fund's investment advisory and subadvisory contracts.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers. The Board considered Federated's previous reductions in contractual management fees to certain funds in response to the Senior Officer's recommendations.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Adviser has made significant and
long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions, as
well as systems technology (including technology relating to cybersecurity,) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family
as a whole. The Board noted that the Adviser's investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses and
that this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information
relative to revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints or to apply
breakpoints at higher levels. It should not be viewed to determine the appropriateness of advisory fees, because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any
applicable regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to
structuring fund advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee the Fund was reasonable. Under these circumstances, no changes were recommended to, and no objection was raised to, the continuation of the Fund's investment
advisory and subadvisory contracts.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Adviser's industry standing
and reputation and with the expectation that the Adviser will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the advisory and subadvisory contracts reflected the fact
that it is the shareholders who have effectively selected the Adviser by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature, quality and
scope of the services provided to the Fund by the Adviser and its affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory and subadvisory contracts on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of
the factors and considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's
decision to approve the continuation of the contracts reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangements.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes a complete listing of your fund's holdings, performance information and financial statements
along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Portfolio of Investments
Summary Tables (unaudited)
At December 31, 2017, the
Fund's portfolio composition1 was follows:
Security Type
Percentage of
Total Net Assets
U.S. Government Agency Securities
42.7%
U.S. Treasury Securities
0.3%
Repurchase Agreements
55.5%
Other Assets and Liabilities—Net2
1.5%
TOTAL
100.0%
At December 31, 2017, the
Fund's effective maturity schedule3 was follows:
Securities With an Effective Maturity of:
Percentage of
Total Net Assets
1-7 Days
60.0%
8-30 Days
20.1%
31-90 Days
8.6%
91-180 Days
2.9%
181 Days or more
6.9%
Other Assets and Liabilities—Net2
1.5%
TOTAL
100.0%
1
See the Fund's Prospectus and Statement of Additional Information for a description of the types of securities in which the Fund invests.
2
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
3
Effective maturity is determined in accordance with the requirements of Rule 2a-7 under the Investment Company Act of 1940, which regulates money market mutual funds.
Interest in $250,000,000 joint repurchase agreement 1.41%, dated 12/29/2017 under which ABN Amro Bank N.V., Netherlands
will repurchase securities provided as collateral for $250,039,167 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency and
U.S. Treasury securities with various maturities to 7/1/2047 and the market value of those underlying securities was $255,535,791.
20,000,000
10,000,000
Interest in $750,000,000 joint repurchase agreement 1.40%, dated 12/29/2017 under which BNP Paribas S.A. will repurchase
securities provided as collateral for $750,116,667 on 1/2/2018. The securities provided as collateral at the end of the period were U.S. Treasury securities with various maturities to 4/15/2018 and the market value of
those underlying securities was $764,535,793.
10,000,000
2,000,000
Interest in $4,000,000,000 joint repurchase agreement 1.36%, dated 12/29/2017 under which Barclays Bank PLC will repurchase
securities provided as collateral for $4,000,604,444 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Treasury securities with various
maturities to 8/15/2047 and the market value of those underlying securities was $4,080,616,607.
2,000,000
20,000,000
Interest in $450,000,000 joint repurchase agreement 1.44%, dated 12/29/2017 under which J.P. Morgan Securities LLC will
repurchase securities provided as collateral for $450,072,000 on 1/2/2018. The securities provided as collateral at the end of the period held with JPMorgan Chase as tri-party agent, were U.S. Government Agency
securities with various maturities to 1/15/2054 and the market value of those underlying securities was $463,500,419.
20,000,000
TOTAL REPURCHASE AGREEMENTS
52,000,000
TOTAL INVESTMENT IN SECURITIES—98.5%
(AT AMORTIZED COST)3
92,300,347
OTHER ASSETS AND LIABILITIES - NET—1.5%4
1,418,719
TOTAL NET ASSETS—100%
$93,719,066
1
Discount rate(s) at time of purchase.
2
Floating/variable note with current rate and current maturity or next reset date shown.
3
Also represents cost for federal tax purposes.
4
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
The inputs or methodology used for
valuing securities are not an indication of the risk associated with investing in those securities.
In valuing the Fund's assets as of
December 31, 2017, all investments of the Fund are valued using amortized cost, which is a methodology utilizing Level 2 inputs.
The following acronym is used
throughout this portfolio:
LIBOR
—London Interbank Offered Rate
See Notes which are an integral part
of the Financial Statements
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
4
Computed on an annualized basis.
5
Represents less than $1,000.
See Notes which are an integral part
of the Financial Statements
Distributions from net realized gain on investments
—
—
(0.000)1
—
—
TOTAL DISTRIBUTIONS
(0.003)
(0.000)1
(0.000)1
—
—
Net Asset Value, End of Period
$1.00
$1.00
$1.00
$1.00
$1.00
Total Return2
0.31%
0.00%
0.00%
0.00%
0.00%
Ratios to Average Net Assets:
Net expenses
0.63%
0.49%
0.34%
0.26%
0.27%
Net investment income
0.30%
0.00%3
0.00%
0.00%
0.00%
Expense waiver/reimbursement4
0.07%
0.19%
0.40%
0.42%
0.41%
Supplemental Data:
Net assets, end of period (000 omitted)
$93,719
$112,214
$139,170
$132,678
$154,973
1
Represents less than $0.001.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract. Total returns for periods of less than one year are not annualized.
3
Represents less than 0.01%.
4
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated Government Money Fund II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented separately. The assets
of each portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. The Fund offers two classes of shares: Primary Shares and
Service Shares. All shares of the Fund have equal rights with respect to voting, except on class-specific matters. Fund shares are available exclusively as a funding vehicle for life insurance companies writing
variable life insurance policies and variable annuity contracts. The investment objective of the Fund is to provide current income consistent with stability of principal and liquidity.
The Fund operates
as a government money market fund. As a government money market fund, the Fund: (1) invests at least 99.5% of its total assets in: (i) cash; (ii) securities issued or guaranteed by the United States or certain U.S.
government agencies or instrumentalities; and/or (iii) repurchase agreements that are collateralized fully; (2) generally continues to use amortized cost to value its portfolio securities and transact at a stable
$1.00 net asset value (NAV); and (3) has elected not to be subject to the liquidity fees and gates requirement at this time as permitted by Rule 2a-7 under the Act.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP).
Investment Valuation
Securities are valued at amortized cost. Under the
amortized cost valuation method, an investment is valued initially at its cost as determined in accordance with GAAP. The Fund then adjusts the amount of interest income accrued each day over the term of the
investment to account for any difference between the initial cost of the investment and the amount payable at its maturity. If amortized cost is determined not to approximate fair value, the value of the portfolio
securities will be determined in accordance with the procedures described below. There can be no assurance that the Fund could obtain the fair value assigned to an investment if it sold the investment at approximately
the time at which the Fund determines its NAV per share.
The Fund's Board
of Trustees (the “Trustees”) have ultimate responsibility for determining the fair value of investments. The Trustees have appointed a valuation committee (“Valuation Committee”) comprised of
officers of the Fund, Federated Investment Management Company (“Adviser”) and certain of the Adviser's affiliated companies to assist in determining fair value of securities and in overseeing the
comparison of amortized cost to market-based value. The Trustees have also authorized the use of pricing services recommended by the Valuation Committee to provide fair value evaluations of the current value of
certain investments for purposes of monitoring the relationship of market-based value and amortized cost. The Valuation Committee employs various methods for reviewing third-party pricing-service evaluations including
periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs and assumptions), and review of price challenges by the Adviser based on recent market activity. In
the event that market quotations and price evaluations are not available for an investment, the Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees.
The Trustees periodically review and approve the fair valuations made by the Valuation Committee and any changes made to the procedures.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the
transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be
transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's Adviser
and its affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its share of
proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a single
payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash or
securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Distributions to shareholders are recorded on the
ex-dividend date. Distributions of net investment income are declared daily and paid monthly. Amortization/accretion of premium and discount is included in investment income. Investment income, realized and unrealized
gains and losses, and certain fund-level expenses are allocated to each class based on relative average daily net assets, except that Primary Shares and Service Shares may bear distribution services fees and other
service fees unique to those classes. The detail of the total fund expense waiver and reimbursement of $74,352 is disclosed in various locations in this Note 2 and Note 5.
Dividends are
declared separately for each class. No class has preferential dividend rights; differences in per share dividend rates are generally due to differences in separate class expenses.
Other Service Fees
The Fund may pay other service fees up to 0.25% of
the average daily net assets of the Fund's Primary Shares and Service Shares to unaffiliated financial intermediaries for providing services to shareholders and maintaining shareholder accounts. Subject to the terms
described in the Expense Limitation note, the Adviser may voluntarily reimburse the Fund for other service fees. In addition, unaffiliated third-party financial intermediaries may waive other service fees. This waiver
can be modified or terminated at any time.
For the year
ended December 31, 2017, other service fees for the Fund were as follows:
Other Service
Fees Incurred
Other Service
Fees Reimbursed
Service Shares
$246,524
$(144)
For the year ended December 31,2017, the Fund's Primary Shares did not incur other service fees.
Federal Taxes
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary. As of and during the year
ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax expense in the Statement of
Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the Commonwealth of
Massachusetts.
When-Issued and Delayed-Delivery
Transactions
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
Other
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
3. SHARES OF BENEFICIAL
INTEREST
The following tables summarize share
activity:
Year Ended
12/31/2017
Period Ended
12/31/20161
Primary Shares:
Shares
Amount
Shares
Amount
Shares sold
—
$—
100
$100
NET CHANGE RESULTING FROM PRIMARY SHARE TRANSACTIONS
—
$—
100
$100
Year Ended December 31
2017
2016
Service Shares:2
Shares
Amount
Shares
Amount
Shares sold
40,826,268
$40,826,268
65,231,601
$65,231,601
Shares issued to shareholders in payment of distributions declared
302,806
302,806
96
96
Shares redeemed
(59,624,139)
(59,624,139)
(92,186,339)
(92,186,339)
NET CHANGE RESULTING FROM SERVICE SHARE TRANSACTIONS
(18,495,065)
$(18,495,065)
(26,954,642)
$(26,954,642)
NET CHANGE RESULTING FROM TOTAL FUND SHARE TRANSACTIONS
The tax character of distributions
as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Ordinary income
$302,806
$96
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Undistributed ordinary income
$27
Capital loss carryforwards
$(942)
At December 31, 2017, the Fund had a
capital loss carryforward of $942 which will reduce the Fund's taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code, thereby reducing the amount of
distributions to shareholders which would otherwise be necessary to relieve the Fund of any liability for federal income tax. Pursuant to the Code, a net capital loss incurred in taxable years beginning after December22, 2010, retains its character as either short-term or long-term and does not expire. All of the Fund's capital loss carryforwards were incurred in taxable years after December 22, 2010.
The following
schedule summarizes the Fund's capital loss carryforwards:
Short-Term
Long-Term
Total
$444
$498
$942
The Fund used capital loss
carryforwards of $7 to offset capital gains realized during the year ended December 31, 2017.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The advisory agreement between the Fund and the
Adviser provides for an annual fee equal to 0.20% of the Fund's average daily net assets. Subject to the terms described in the Expense Limitation note, the Adviser may voluntarily choose to waive any portion of its
fee. For the year ended December 31, 2017, the Adviser voluntarily waived $74,208 of its fee.
Administrative Fee
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
Subject to the terms described in
the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, the annualized fee paid to FAS was 0.079% of average daily net assets of the Fund.
Prior to
September 1, 2017, the breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
The Fund has adopted a Distribution Plan (the
“Plan”) pursuant to Rule 12b-1 under the Act. Under the terms of the Plan, the Fund will compensate Federated Securities Corp. (FSC), the principal distributor, from the daily net assets of the Fund's
Primary Shares to finance activities intended to result in the sale of these shares. The Plan provides that the Fund may incur distribution expenses at the following percentages of average daily net assets annually,
to compensate FSC:
Share Class Name
Percentage of Average
Daily Net Assets of Class
Primary Shares
0.25%
Subject to the terms described in
the Expense Limitation note, FSC may voluntarily choose to waive any portion of its fee.
When FSC receives
fees, it may pay some or all of them to financial intermediaries whose customers purchase shares. For the year ended December 31, 2017, the Fund's Primary Shares did not incur a distribution services fee; however, it
may begin to incur this fee upon approval of the Trustees.
Other Service Fees
For the year ended December 31, 2017, the Adviser
reimbursed $144 of the other service fees disclosed in Note 2.
Expense Limitation
Due to the possibility of changes in market
conditions and other factors, there can be no assurance that the level of waivers/reimbursement/reduction of Fund expenses reflected in the financial highlights will be maintained in the future. However, the Adviser
and certain of its affiliates (which may include FAS and FSC) on their own initiative have agreed to waive certain amounts of their respective fees and/or reimburse expenses. Total annual fund operating expenses (as
shown in the financial highlights, excluding interest expense, extraordinary expenses and proxy-related expenses paid by the Fund, if any) paid by the Fund's Primary Shares and Service Shares (after the voluntary
waivers and/or reimbursements) will not exceed 0.38% and 0.63% (the “Fee Limit”), respectively, up to but not including the later of (the “Termination Date”): (a) May 1, 2018; or (b) the date
of the Fund's next effective Prospectus. While the Adviser and its applicable affiliates currently do not anticipate terminating or increasing these arrangements prior to the Termination Date, these arrangements may
only be terminated or the Fee Limit increased prior to the Termination Date with the agreement of the Trustees.
Directors'/Trustees' and
Miscellaneous Fees
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Adviser which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
6. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission, the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF the
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED Government MONEY FUND II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated Government Money Fund II (the “Fund”), a portfolio of Federated Insurance Series, as of December31, 2017, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively, the
“financial statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all
material respects the financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Fund in accordance with the U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors'- investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other variable investment options. It is based on an investment of $1,000 invested at the
beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of each table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual:
Primary Shares
$1,000
$1,003.70
$1.92
Service Shares
$1,000
$1,002.40
$3.18
Hypothetical (assuming a 5% return before expenses):
Primary Shares
$1,000
$1,023.30
$1.94
Service Shares
$1,000
$1,022.00
$3.21
1
Expenses are equal to the Fund's annualized net expense ratios, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The expenses shown in the table
do not include the charges and expenses imposed by the insurance company under the variable insurance product contract. Please refer to the variable insurance product prospectus for a complete listing of these
expenses. The annualized net expense ratios are as follows:
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
VICE PRESIDENT
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
PRESIDENT
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated Government Money Fund
II (the “Fund”)
(formerly, Federated Prime Money
Fund II)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory contract for
an additional one-year term at its May 2017 meetings. The Board's decision regarding the contract reflects the exercise of its business judgment after considering all of the information received on whether to continue
the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory contract.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory contract generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to institutional and other
clients of Federated Investment Management Company (the “Adviser”) and its advisory affiliates for what might be viewed as like services. The Board was aware of these factors and was guided by them in its
review of the Fund's investment advisory contract to the extent it considered them to be appropriate and relevant, as discussed further below.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings, at which the Board's formal approval of the investment advisory contract occurred. At the May meetings, in addition to meeting in
separate sessions of the independent trustees without management present, senior management of the Adviser also met with the independent trustees and their counsel to discuss the materials presented and any other
matters thought relevant by the Adviser or the trustees. Between regularly scheduled meetings, the Board also received information on matters as the need arose. The Board's consideration of the investment advisory
contract included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Adviser's investment philosophy, revenue, profitability, personnel and processes;
investment and operating strategies; the Fund's short-term and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well as in terms relative to its particular investment program and
certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's investment objectives; the Fund's expenses, including the advisory
fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for contractual or voluntary expense limitations; the use and allocation of
brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other services provided to the Fund by the Adviser and its affiliates. The
Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Adviser in sponsoring the Fund; the continuing state of competition in the mutual fund industry and
market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's
relationship to the Federated funds
which include a comprehensive array of funds with different investment objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales charges; compliance and
audit reports concerning the Federated funds and the Federated companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and
relevant developments in the mutual fund industry and how the Federated funds and/or Federated are responding to them. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on
relevant criteria change in recognition of changing circumstances in the mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses therefore appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
Board reviewed the contractual advisory fee rate, net advisory fee rate where partially waived and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses
relative to its peers. In this regard, the Board noted that the contractual advisory fee rate was below the median of the relevant peer group and the Board was satisfied that the overall expense structure of the Fund
remained competitive.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees. The Senior Officer noted that the services, administrative responsibilities and risks associated with such relationships are quite different than serving as a primary adviser to a fund.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory contract.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Adviser and the resources of the Adviser and its affiliates dedicated to the Fund. In this regard, the Board evaluated, among
other things, the Adviser's personnel, experience, track record, overall reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications,
backgrounds and responsibilities of the portfolio management team primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of, and the compliance-related resources
provided to, the Fund by the Adviser. The Fund's ability to deliver competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Adviser is
executing the Fund's investment program. The Adviser's ability to execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent, and quality of the Adviser's investment
management services warrant the continuation of the investment advisory contract.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by independent fund ranking organizations, regarding the performance of, and fees charged by, other mutual funds, noting his view that comparisons to fund peer groups may be helpful,
though not conclusive, in judging the reasonableness of the proposed fees. The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and unique differences in
their objectives and management techniques when compared to other funds within an industry peer group.
The
Fund's performance was above the median of the relevant peer group for the one-year period covered by the Senior Officer's Evaluation. The Board also considered the relatively tight dispersion of performance data with
respect to the Fund and its peers.
Following such evaluation, and full deliberations, the Board concluded that the performance of the Fund supported renewal of the Fund's investment advisory contract.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Adviser has made significant and
long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions, as
well as systems technology (including technology relating to cybersecurity,) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family
as a whole. The Board noted that the Adviser's investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses and
that this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information
relative to revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints, or to apply
breakpoints at higher levels. It should not be viewed to determine the appropriateness of advisory fees because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any
applicable regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to
structuring fund advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee for the Fund was reasonable. Under these circumstances, no objection was raised to the continuation of, the Fund's investment advisory contract.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Adviser's industry standing
and reputation and with the expectation that the Adviser will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the investment advisory contract reflected the fact that
it is the shareholders who have effectively selected the Adviser by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature, quality and scope of
the services provided to the Fund by the Adviser and its affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory contract on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of the factors and
considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's decision to approve
the continuation of the contract reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangement.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
You could lose money by
investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the Fund is not insured or guaranteed by the Federal
Deposit Insurance Corporation or any other government agency. The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial
support to the Fund at any time.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes Management's Discussion of Fund Performance, a complete listing of your fund's holdings,
performance information and financial statements along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Management's Discussion
of Fund Performance (unaudited)
The total return of
Federated Quality Bond Fund II (the “Fund”), based on net asset value for the 12-month reporting period ended December 31, 2017, was 4.04% for the Primary Shares and 3.75% for the Service Shares. The total
return of the Fund's broad-based benchmark, the Bloomberg Barclays U.S. Intermediate Credit Index (“BBICI”),1 was 3.67% during the same period. The 4.04% total return of the Fund's Primary Shares consisted of 3.40% of taxable income
and 0.64% of appreciation in the net asset value of shares. The Fund's total return for the most recently completed fiscal year reflected actual cash flows, transaction costs and other expenses, which were not
reflected in the total return of the BBICI.
During the reporting period, the most significant factors affecting the Fund's performance relative to the BBICI were: (a) individual security selection; (b) the selection of various industries and sectors of the
corporate bond market; and interest rate sensitivity of the portfolio, as measured by the effective duration2 of the Fund.
The
following discussion will focus on the performance of the Fund's Primary Shares.
market overview
The reporting period
continued the strong risk-on rally that began after the surprise election of Donald Trump as U.S. president and a Republican sweep of both houses of Congress. Markets were focused on the pro-growth aspects of the
incoming administration's agenda which included tax reform, regulatory relief and fiscal stimulus, prompting a broad run-up in equities and interest rates. But as the new administration settled in, expectations fueled
by campaign promises gave way to the realities of governing in Washington, D.C. Efforts to repeal and replace the Affordable Care Act repeatedly failed, a Justice Department investigation into potential Russian
meddling in the 2016 elections cast a cloud over the White House, and escalating North Korean missile launches led a list of increasing geopolitical tensions. As optimism faded, longer rates began to fall back again,
with the 10-year Treasury yield threatening to break below 2% in late summer amid the unsettled situation in the nation's capital and concerns about the impact of devastating hurricanes in Texas and Florida. All the
while, global economic growth appeared to remain on a steady, if not accelerating trajectory. The yield on the 10-year Treasury started the period at 2.45% and ended it at 2.41%, with rate volatility interspersed
throughout the period, reaching a peak of 2.63% and trough of 2.04%. Despite the volatility on longer rates, the Federal Reserve (the “Fed”) continued on its path to normalize short-term rates, raising the
federal funds target rate three times during the reporting period and signaling it expects additional increases in the subsequent months. The reporting period ended with the federal funds target range at 1.25% to
1.50% and the 10-year U.S. Treasury yield at 2.41%.
Corporate credit spreads continued to grind tighter, with the option-adjusted spread on the BBICI starting the period at 97 basis points and ending at 67 basis points. Credit spreads were in a gradual tightening
environment throughout the period despite the volatility3 in rates with peak spreads occurring at the beginning of the period and the trough (67 basis points) occurring near the
end.
SECURITY selection
For the reporting period,
individual security selection was the largest driver of Fund performance relative to the BBICI. Security selection was particularly strong in the Capital Goods, Consumer Non-Cyclical, Energy and Insurance sectors.
Specific credits that contributed the most to performance included: Textron, Valero, Nationwide Mutual, Bruce Mansfield and Electricite de France. Conversely, credits that detracted the most included: Teva, M&T
Bank, Reckitt Benckiser, Petroleos Mexicanos and General Electric.
SECTOR/INDUSTRY selection
The decision to hold
overweight or underweight positions in specific corporate sectors and/or ratings qualities was the secondary driver of Fund performance relative to the BBICI. Broadly, the Fund held overweight positions in
lower-quality investment-grade4 securities (i.e., those in the “BBB” rated category), which benefited Fund performance for the reporting period.
The Fund was helped by overweight positions in such sectors as Basic Industries and Brokers/Asset Managers as well as from underweight positions in underperforming sectors such as Supranationals and Local Authority.
An underweight position in the Sovereign sector, which outperformed the benchmark, as well as an overweight position in the underperforming Electric Utilities sector, hurt performance during the reporting period.
Duration had a positive
impact on the performance of the Fund as the Fund was less interest rate sensitive5 than the BBICI throughout the year (97%). The entire duration performance contribution came in the latter half of the
reporting period as interest rates rose from the year-to-date lows to close out the year at 2.41%. Derivatives, which were U.S. Treasury futures6 that were used to adjust duration targets, had a negative impact on Fund performance during the reporting period.
1
Please see the footnotes to the line graphs under “Fund Performance and Growth of a $10,000 Investment” below for the definition of, and more information about, the BBICI.
2
Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities
of shorter durations.
3
Volatility is a statistical measurement of the frequency and level of changes in the value of an asset, index or instrument without regard to the direction of those changes.
Volatility may result from rapid and dramatic price swings.
4
Investment-grade securities are securities that are rated at least “BBB- (minus)” or unrated securities of a comparable quality. Noninvestment-grade securities are
securities that are not rated at least “BBB- (minus)” or unrated securities of a comparable quality. Credit ratings are an indication of the risk that a security will default. They do not protect a
security from credit risk. Lower-rated bonds typically offer higher yields to help compensate investors for the increased risk associated with them. Among these risks are lower credit-worthiness, greater price
volatility, more risk to principal and income than with higher-rated securities and increased possibilities of default.
5
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
6
The Fund's use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and
other traditional instruments.
FUND PERFORMANCE AND GROWTH OF A
$10,000 INVESTMENT
The graph below
illustrates the hypothetical investment of $10,0001 in the Federated Quality Bond Fund II from December 31, 2007 to December 31, 2017, compared to the Bloomberg Barclays U.S.
Intermediate Credit Index (BBICI).2 The Average Annual Total Return table below shows returns for each class averaged over the stated periods.
Average Annual Total Returnsfor the Period Ended 12/31/2017
1 Year
5 Years
10 Years
Primary Shares
4.04%
2.47%
4.39%
Service Shares
3.75%
2.21%
4.12%
BBICI
3.67%
2.43%
4.55%
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. Performance of a variable investment option changes over time and current performance may be lower or higher than what is stated. For current to the most recent month end performance, contact your insurance
company. The performance information presented does not include the charges and expenses imposed by the insurance company under the variable insurance product contract. The inclusion of such charges would lower
performance. Please refer to the variable insurance product prospectus for a complete listing of these expenses. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable
life insurance policies and variable annuity contracts. Variable investment options are not obligations of or guaranteed by any bank and are not federally insured.
1
The Fund's performance assumes the reinvestment of all dividends and distributions. The BBICI has been adjusted to reflect reinvestment of dividends on securities in the index.
2
The BBICI measures the investment-grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related bond markets. The index only includes
securities with maturity between one and ten years. It is composed of the Bloomberg Barclays U.S. Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local
authorities. The index is not adjusted to reflect sales loads, expenses or other fees that the Securities and Exchange Commission requires to be reflected in the Fund's performance. The index is unmanaged and, unlike
the Fund, is not affected by cash flows. It is not possible to invest directly in an index.
See the Fund's Prospectus and Statement of Additional Information for a description of these security types.
2
For purposes of this table, Mortgage-Backed Securities include mortgage-backed securities guaranteed by Government-Sponsored Enterprises.
3
Represents less than 0.1%.
4
Based upon net unrealized appreciation (depreciation) or value of the derivative contracts as applicable. Derivative contracts may consist of futures, forwards, options and swaps. The impact of a derivative contract
on the Fund's performance may be larger than its unrealized appreciation (depreciation) or value may indicate. In many cases, the notional value or amount of a derivative contract may provide a better indication of
the contract's significance to the portfolio. More complete information regarding the Fund's direct investments in derivative contracts, including unrealized appreciation (depreciation), value and notional values or
amounts of such contracts, can be found in the table at the end of the Portfolio of Investments included in this Report.
5
Cash Equivalents include any investments in money market mutual funds and/or overnight repurchase agreements.
6
Assets, other than investments in securities and derivative contracts, less liabilities. See Statement of Assets and Liabilities.
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887.
(IDENTIFIED COST $2,803,000)
$2,803,000
TOTAL INVESTMENT IN SECURITIES—99.0%
(IDENTIFIED COST $201,701,283)3
Net Unrealized Appreciation
(Depreciation) on Futures Contracts is included in “Other Assets and Liabilities—Net.”
1
Floating/variable note with current rate and current maturity or next reset date shown. Certain variable rate securities are not based on a published reference rate and spread but are determined by the issuer or
agent and are based on current market conditions. These securities do not indicate a reference rate and spread in their description above.
2
Market quotations and price evaluations are not available. Fair value determined using significant unobservable inputs in accordance with procedures established by and under the general supervision of the Fund's
Board of Trustees (the “Trustees”).
3
The cost of investments for federal tax purposes amounts to $201,701,431.
4
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
5
Non-income-producing security.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
The inputs or methodology used for
valuing securities are not an indication of the risk associated with investing in those securities.
Net realized and unrealized gain (loss) on investments and futures contracts
0.12
0.07
(0.39)
0.03
(0.29)
TOTAL FROM INVESTMENT OPERATIONS
0.43
0.41
(0.02)
0.43
0.12
Less Distributions:
Distributions from net investment income
(0.36)
(0.40)
(0.43)
(0.44)
(0.49)
Net Asset Value, End of Period
$11.05
$10.98
$10.97
$11.42
$11.43
Total Return2
4.04%
3.82%
(0.24)%
3.79%
1.04%
Ratios to Average Net Assets:
Net expenses
0.74%
0.73%
0.73%
0.73%
0.73%
Net investment income
2.81%
3.10%
3.30%
3.53%
3.55%
Expense waiver/reimbursement3
0.06%
0.07%
0.05%
0.04%
0.06%
Supplemental Data:
Net assets, end of period (000 omitted)
$185,026
$188,831
$198,990
$220,355
$230,647
Portfolio turnover
27%
26%
17%
18%
23%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Net realized and unrealized gain (loss) on investments and futures contracts
0.12
0.07
(0.38)
0.01
(0.29)
TOTAL FROM INVESTMENT OPERATIONS
0.40
0.38
(0.04)
0.39
0.09
Less Distributions:
Distributions from net investment income
(0.33)
(0.37)
(0.40)
(0.40)
(0.46)
Net Asset Value, End of Period
$11.01
$10.94
$10.93
$11.37
$11.38
Total Return2
3.75%
3.53%
(0.44)%
3.51%
0.75%
Ratios to Average Net Assets:
Net expenses
0.99%
0.98%
0.98%
0.98%
0.98%
Net investment income
2.56%
2.86%
3.04%
3.29%
3.29%
Expense waiver/reimbursement3
0.06%
0.07%
0.05%
0.04%
0.06%
Supplemental Data:
Net assets, end of period (000 omitted)
$22,596
$23,920
$27,977
$33,857
$38,536
Portfolio turnover
27%
26%
17%
18%
23%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated Quality Bond Fund II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented separately. The assets of
each portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. The Fund offers two classes of shares: Primary Shares and Service
Shares. All shares of the Fund have equal rights with respect to voting, except on class-specific matters. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable life
insurance policies and variable annuity contracts. The investment objective of the Fund is to provide current income.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP).
Investment Valuation
In calculating its net asset value (NAV), the Fund
generally values investments as follows:
■
Fixed-income securities are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations.
■
Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs.
■
For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered, such as: the
last traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer's financial statements or other available documents, fundamental analytical data, the
nature and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable
issuers, movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions.
If any price, quotation, price
evaluation or other pricing source is not readily available when the NAV is calculated, if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a
reasonable period of time as set forth in the Fund's valuation policies and procedures, or if information furnished by a pricing service, in the opinion of the valuation committee (“Valuation Committee”),
is deemed not representative of the fair value of such security, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund
could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share.
Fair Valuation and Significant
Events Procedures
The Trustees have ultimate responsibility for
determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a Valuation Committee comprised of officers of the Fund, Federated Investment Management
Company (the “Adviser”) and certain of the Adviser's affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of
pricing services recommended by the Valuation Committee to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various
methods for reviewing third-party pricing-service evaluations including periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs, methods, models and
assumptions), transactional back-testing, comparisons of evaluations of different pricing services, and review of price challenges by the Adviser based on recent market activity. In the event that market quotations
and price evaluations are not available for an investment, the Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review
and approve the fair valuations made by the Valuation Committee and any changes made to the procedures.
Factors considered
by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions,
indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a “bid” evaluation).
Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a “mid” evaluation). The Fund normally uses bid
evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC
derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the
Trustees.
The Trustees also
have adopted procedures requiring an investment to be priced at its fair value whenever the Adviser determines that a significant event affecting the value of the investment has occurred between the time as of which
the price of the investment would otherwise be determined and the time as of which the NAV is computed. An event is considered significant if there is both an affirmative expectation that the investment's value will
change in response to the event and a reasonable basis for quantifying the resulting change in value. Examples of significant events that may occur after the close of the principal market on which a security is
traded, or after the time of a price evaluation provided by a pricing service or a dealer, include:
■
With respect to securities traded principally in foreign markets, significant trends in U.S. equity markets or in the trading of foreign securities index futures contracts;
Political or other developments affecting the economy or markets in which an issuer conducts its operations or its securities are traded;
■
Announcements concerning matters such as acquisitions, recapitalizations, litigation developments, or a natural disaster affecting the issuer's operations or regulatory changes or
market developments affecting the issuer's industry.
The Trustees have adopted procedures
whereby the Valuation Committee uses a pricing service to determine the fair value of equity securities traded principally in foreign markets when the Adviser determines that there has been a significant trend in the
U.S. equity markets or in index futures trading. For other significant events, the Fund may seek to obtain more current quotations or price evaluations from alternative pricing sources. If a reliable alternative
pricing source is not available, the Fund will determine the fair value of the investment in accordance with the fair valuation procedures approved by the Trustees. The Trustees have ultimate responsibility for any
fair valuations made in response to a significant event.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the
transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be
transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's Adviser
and its affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its share of
proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a single
payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash or
securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Foreign dividends are recorded on the ex-dividend date or when the Fund is informed of the ex-dividend date. Distributions of net investment income, if any, are declared and paid
annually. Non-cash dividends included in dividend income, if any, are recorded at fair value. Amortization/accretion of premium and discount is included in investment income. Gains and losses realized on principal
payment of mortgage-backed securities (paydown gains and losses) are classified as part of investment income. Investment income, realized and unrealized gains and losses, and certain fund-level expenses are allocated
to each class based on relative average daily net assets, except that Primary Shares and Service Shares may bear distribution services fees unique to those classes. The detail of the total fund expense waiver of
$119,617 is disclosed in Note 5.
Dividends are
declared separately for each class. No class has preferential dividend rights; differences in per share dividend rates are generally due to differences in separate class expenses.
Federal Taxes
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code (the “Code”) and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary.
As of and during the year ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax
expense in the Statement of Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the
Commonwealth of Massachusetts.
When-Issued and Delayed-Delivery
Transactions
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
The Fund purchases and sells financial futures
contracts to manage duration risk and yield curve risk. Upon entering into a financial futures contract with a broker, the Fund is required to deposit in a segregated account, either U.S. government securities or a
specified amount of Restricted cash, which is shown in the Statement of Assets and Liabilities. Futures contracts are valued daily and unrealized gains or losses are recorded in a “variation margin”
account. Daily, the Fund receives from or pays to the broker a specified amount of cash based upon changes in
the variation margin account. When a contract is
closed, the Fund recognizes a realized gain or loss. Futures contracts have market risks, including the risk that the change in the value of the contract may not correlate with the changes in the value of the
underlying securities. There is minimal counterparty risk to the Fund since futures contracts are exchange traded and the exchange's clearing house, as counterparty to all exchange traded futures contracts, guarantees
the futures contracts against default.
Futures contracts
outstanding at period end are listed after the Fund's Portfolio of Investments.
The average
notional value of long and short futures contracts held by the Fund throughout the period was $15,560,289 and $19,043,260, respectively. This is based on amounts held as of each month-end throughout the fiscal
period.
Restricted Securities
The Fund may purchase securities which are
considered restricted. Restricted securities are securities that either: (a) cannot be offered for public sale without first being registered, or being able to take advantage of an exemption from registration, under
the Securities Act of 1933; or (b) are subject to contractual restrictions on public sales. In some cases, when a security cannot be offered for public sale without first being registered, the issuer of the restricted
security has agreed to register such securities for resale, at the issuer's expense, either upon demand by the Fund or in connection with another registered offering of the securities. Many such restricted securities
may be resold in the secondary market in transactions exempt from registration. Restricted securities may be determined to be liquid under criteria established by the Trustees. The Fund will not incur any registration
costs upon such resales. The Fund's restricted securities, like other securities, are priced in accordance with procedures established by and under the general supervision of the Trustees.
Additional Disclosure Related to
Derivative Instruments
Asset
Statement of
Assets and
Liabilities
Location
Fair
Value
Derivatives not accounted for as hedging instruments under ASC Topic 815
Receivable for daily
variation margin on
futures contracts
$(66,723)*
*
Includes cumulative depreciation of futures contracts as reported in the footnotes to the Portfolio of Investments. Only the current day's variation margin is reported within the
Statement of Assets and Liabilities.
The Effect of Derivative
Instruments on the Statement of Operations for the Year Ended December 31, 2017
Amount of Realized Gain or (Loss) on Derivatives Recognized in Income
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
3. SHARES OF BENEFICIAL
INTEREST
The following tables summarize share
activity:
Year Ended December 31
2017
2016
Primary Shares:
Shares
Amount
Shares
Amount
Shares sold
1,108,844
$12,178,568
1,301,003
$14,280,877
Shares issued to shareholders in payment of distributions declared
572,662
6,150,393
656,233
7,034,809
Shares redeemed
(2,130,443)
(23,413,689)
(2,901,973)
(31,983,988)
NET CHANGE RESULTING FROM PRIMARY SHARE TRANSACTIONS
Shares issued to shareholders in payment of distributions declared
65,623
704,140
84,892
909,198
Shares redeemed
(450,145)
(4,942,162)
(538,703)
(5,929,121)
NET CHANGE RESULTING FROM SERVICE SHARE TRANSACTIONS
(134,116)
$(1,505,197)
(374,215)
$(4,144,169)
NET CHANGE RESULTING FROM TOTAL FUND SHARE TRANSACTIONS
(583,053)
$(6,589,925)
(1,318,952)
$(14,812,471)
4. FEDERAL TAX INFORMATION
The timing and character of income
and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are due to differing treatments for expiration of capital loss carryforwards.
For the year
ended December 31, 2017, permanent differences identified and reclassified among the components of net assets were as follows:
Increase (Decrease)
Paid-In Capital
Accumulated
Net Realized
Gain (Loss)
$(371,956)
$371,956
Net investment income (loss), net
realized gains (losses), and net assets were not affected by this reclassification.
The tax character
of distributions as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Ordinary income
$6,854,536
$7,944,007
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Undistributed ordinary income
$5,882,594
Net unrealized appreciation
$3,810,095
The difference between book-basis
and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for deferral of losses on wash sales and mark-to-market of futures contracts.
At December 31,2017, the cost of investments for federal tax purposes was $201,701,431. The net unrealized appreciation of investments for federal tax purposes was $3,810,095. This consists of net unrealized appreciation from
investments for those securities having an excess of value over cost of $5,427,531 and net unrealized depreciation from investments for those securities having an excess of cost over value of $1,617,436. The amounts
presented are inclusive of derivative contracts.
The Fund used
capital loss carryforwards of $915,735 to offset capital gains realized during the year ended December 31, 2017.
Capital loss
carryforwards of $371,956 expired during the year ended December 31, 2017.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The advisory agreement between the Fund and the
Adviser provides for an annual fee equal to 0.60% of the Fund's average daily net assets. Subject to the terms described in the Expense Limitation note, the Adviser may voluntarily choose to waive any portion of its
fee. For the year ended December 31, 2017, the Adviser voluntarily waived $119,617 of its fee.
Administrative Fee
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
Subject to the terms described in
the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, the annualized fee paid to FAS was 0.079% of average daily net assets of the Fund.
Prior to
September 1, 2017, the breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
Distribution Services Fee
The Fund has adopted a Distribution Plan (the
“Plan”) pursuant to Rule 12b-1 under the Act. Under the terms of the Plan, the Fund will compensate Federated Securities Corp. (FSC), the principal distributor, from the daily net assets of the Fund's
Primary Shares and Service Shares to finance activities intended to result in the sale of these shares. The Plan provides that the Fund may incur distribution expenses at the following percentages of average daily net
assets annually, to compensate FSC:
Share Class Name
Percentage of Average
Daily Net Assets of Class
Primary Shares
0.25%
Service Shares
0.25%
Subject to the terms described in
the Expense Limitation note, FSC may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, distribution services fees for the Fund were as follows:
Distribution Services
Fees Incurred
Service Shares
$59,562
When FSC receives fees, it may pay
some or all of them to financial intermediaries whose customers purchase shares. For the year ended December 31, 2017, FSC retained $34 of fees paid by the Fund. For the year ended December 31, 2017, the Fund's
Primary Shares did not incur a distribution services fee; however, it may begin to incur this fee upon approval of the Trustees.
Expense Limitation
The Adviser and certain of its affiliates (which
may include FSC and FAS) on their own initiative have agreed to waive certain amounts of their respective fees and/or reimburse expenses. Total annual fund operating expenses (as shown in the financial highlights,
excluding interest expense, extraordinary expenses, line of credit expenses and proxy-related expenses paid by the Fund, if any) paid by the Fund's Primary Shares and Service Shares (after the voluntary waivers and/or
reimbursements) will not exceed 0.73% and 0.98% (the “Fee Limit”), respectively, up to but not including the later of (the “Termination Date”): (a) May 1, 2018; or (b) the date of the Fund's
next effective Prospectus. While the Adviser and its applicable affiliates currently do not anticipate terminating or increasing these arrangements prior to the Termination Date, these arrangements may only be
terminated or the Fee Limit increased prior to the Termination Date with the agreement of the Trustees.
Directors'/Trustees' and
Miscellaneous Fees
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Adviser which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
6. INVESTMENT TRANSACTIONS
Purchases and sales of investments,
excluding long-term U.S. government securities and short-term obligations, for the year ended December 31, 2017, were as follows:
The Fund participates with certain
other Federated Funds, on a several basis, in an up to $500,000,000 unsecured, 364-day, committed, revolving line of credit (LOC) agreement. The LOC was made available to finance temporarily the repurchase or
redemption of shares of the Fund, failed trades, payment of dividends, settlement of trades and for other short-term, temporary or emergency general business purposes. The Fund cannot borrow under the LOC if an
inter-fund loan is outstanding. The Fund's ability to borrow under the LOC also is subject to the limitations of the Act and various conditions precedent that must be satisfied before the Fund can borrow. Loans under
the LOC are charged interest at a fluctuating rate per annum equal to the highest, on any day, of (a) (i) the federal funds effective rate, (ii) the one month London Interbank Offered Rate (LIBOR), and (iii) 0.0%,
plus (b) a margin. The LOC also requires the Fund to pay, quarterly in arrears and at maturity, its pro rata share of a commitment fee based on the amount of the lenders' commitment that has not been utilized. As of
December 31, 2017, the Fund had no outstanding loans. During the year ended December 31, 2017, the Fund did not utilize the LOC.
8. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission (SEC), the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF THE
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED QUALITY BOND FUND II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated Quality Bond Fund II (the “Fund”), a portfolio of Federated Insurance Series, as of December 31,2017, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively, the
“financial statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all
material respects the financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Fund in accordance with the U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors'- investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other funds used as variable investment options. It is based on an investment of $1,000
invested at the beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of the table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual:
Primary Shares
$1,000
$1,010.10
$3.70
Service Shares
$1,000
$1,008.20
$4.96
Hypothetical (assuming a 5% return before expenses):
Primary Shares
$1,000
$1,021.50
$3.72
Service Shares
$1,000
$1,020.30
$4.99
1
Expenses are equal to the Fund's annualized net expense ratios, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The expenses shown in the table
do not include the charges and expenses imposed by the insurance company under the variable insurance product contract. Please refer to the variable insurance product prospectus for a complete listing of these
expenses. The annualized net expense ratios are as follows:
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
VICE PRESIDENT
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
PRESIDENT
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated Quality Bond Fund II
(the “Fund”)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory contract for
an additional one-year term at its May 2017 meetings. The Board's decision regarding the contract reflects the exercise of its business judgment after considering all of the information received on whether to continue
the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory contract.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory contract generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to institutional and other
clients of Federated Investment Management Company (the “Adviser”) and its advisory affiliates for what might be viewed as like services. The Board was aware of these factors and was guided by them in its
review of the Fund's investment advisory contract to the extent it considered them to be appropriate and relevant, as discussed further below.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings at which the Board's formal approval of the investment advisory contract occurred. At the May meetings in addition to meeting in separate
sessions of the independent trustees without management present, senior management of the Adviser also met with the independent trustees and their counsel to discuss the materials presented and any other matters
thought relevant by the Adviser or the trustees. Between regularly scheduled meetings, the Board also received information on particular matters as the need arose. The Board's consideration of the investment advisory
contract included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Adviser's investment philosophy, revenue, profitability, personnel and processes;
investment and operating strategies; the Fund's short-term and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well as in terms relative to its particular investment program and
certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's investment objectives; the Fund's expenses, including the advisory
fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for contractual or voluntary expense limitations; the use and allocation of
brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other services provided to the Fund by the Adviser and its affiliates. The
Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Adviser in sponsoring the Fund; the continuing state of competition in the mutual fund industry and
market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's relationship to the Federated funds which include a comprehensive array of funds with different investment
objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales
charges; compliance and audit reports
concerning the Federated funds and the Federated companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and relevant
developments in the mutual fund industry and how the Federated funds and/or Federated are responding to them. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on relevant
criteria change in recognition of changing circumstances in the mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses, therefore, appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
Board reviewed the contractual advisory fee rate, net advisory fee rate where partially waived and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses
relative to its peers. In this regard, the Board noted that the contractual advisory fee rate was above the median of the relevant peer group, but the Board noted the applicable waivers and reimbursements, and that
the overall expense structure of the Fund remained competitive in the context of other factors considered by the Board.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory contract.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Adviser and the resources of the Adviser and its affiliates dedicated to the Fund. In this regard, the Board evaluated, among
other things, the Adviser's personnel, experience, track record, overall reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications,
backgrounds and responsibilities of the portfolio management team primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of, and the compliance-related resources
provided to, the Fund by the Adviser. The Fund's ability to deliver competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Adviser is
executing the Fund's investment program. The Adviser's ability to execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent and quality of the Adviser's investment
management services warrant the continuation of the investment advisory contract.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by independent fund ranking organizations, regarding the performance of, and fees charged by, other mutual funds, noting his view that comparisons to fund peer groups may be helpful,
though not conclusive, in judging the reasonableness of the proposed fees. The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and unique differences in
their objectives and management techniques when compared to other funds within an industry peer group.
The
Fund's performance fell below the median of the relevant peer group for the one-year, three-year and five-year periods covered by the Senior Officer's Evaluation. The Board discussed the Fund's performance with the
Adviser and recognized the efforts being taken by the Adviser in the context of other factors considered relevant by the Board.
Following such evaluation, and full deliberations, the Board concluded that the performance of the Fund supported renewal of the Fund's investment advisory contract.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers. The Board considered Federated's previous reductions in contractual management fees to certain funds in response to the Senior Officer's recommendations.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Adviser has made significant and
long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions, as
well as systems technology (including technology relating to cybersecurity) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family as
a whole. The Board noted that the Adviser's investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses and that
this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information relative to
revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints, or to apply breakpoints at
higher levels. It should not be viewed to determine the appropriateness of advisory fees because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any applicable
regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to structuring fund
advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee for the Fund was reasonable. Under these circumstances, no changes were recommended to, and no objection was raised to the continuation of the Fund's investment
advisory contract.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Adviser's industry standing
and reputation and with the expectation that the Adviser will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the investment advisory contract reflected the fact that
it is the shareholders who have effectively selected the Adviser by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature, quality and scope of
the services provided to the Fund by the Adviser and its affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory contract on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of the factors and
considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's decision to approve
the continuation of the contract reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangement.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
I am pleased to present the Annual
Shareholder Report for your fund covering the period from January 1, 2017 through December 31, 2017. This report includes Management's Discussion of Fund Performance, a complete listing of your fund's holdings,
performance information and financial statements along with other important fund information.
In addition, our website,
FederatedInvestors.com, offers easy access to Federated resources that include timely fund updates, economic and market insights from our investment strategists, and financial planning tools. We invite you to register
to take full advantage of its capabilities.
Thank you for investing with
Federated. I hope you find this information useful and look forward to keeping you informed.
Management's Discussion
of Fund Performance (unaudited)
The total return of
Federated Fund for U.S. Government Securities II (the “Fund”), based on net asset value for the 12-month reporting period ended December 31, 2017, was 1.92%. The Fund's custom benchmark (“Blended
Index”),1 which consists of a 67%/33% blend of the Bloomberg Barclays U.S. Mortgage Backed Securities Index and Bloomberg Barclays
U.S. Government Index, returned 2.41% for the same period. The Fund's total return for the most recently completed fiscal year reflected actual cash flows, transaction costs and other expenses, which were not
reflected in the total return of the Blended Index.
During the reporting period, the most significant factors affecting the Fund's performance relative to the Blended Index included: (a) sector allocation; and (b) duration.2
MARKET OVERVIEW
Policymakers took
additional steps toward interest rate normalization with adjustments to the federal funds target rate as well as initiating a reduction of central bank portfolio investments. Rising consumer and business confidence,
along with over 2 million jobs created during the reporting period, provided the Federal Open Market Committee (FOMC) ample evidence that growth was sufficient to support tighter monetary policy. The federal funds
target rate was increased three times to a range of 1.25% to 1.50%. Additionally, the Federal Reserve (the “Fed”) commenced a reduction of reinvestment in the mortgage-backed security (MBS) and Treasury
portfolios in order to slowly shrink its $4.5 trillion portfolio. The combination of a higher federal funds target rate and smaller portfolio resulted in tighter monetary policy. Slack demand and tighter monetary
policy increased yields for short and intermediate maturity Treasuries while the bid for higher yielding, non-Treasury sectors was robust.
Investor demand for spread sectors remained strong as positive excess returns were posted across the spectrum of fixed-income sectors including high yield, investment-grade corporate debt,3 commercial and residential MBS4 and asset-backed securities (ABS). An environment of steady long-term rates and declining volatility was very supportive of
mortgage securities, which posted strong excess returns as mortgage-to-Treasury spreads tightened due to strong buying from real estate investment trusts (REITs) and domestic banks. The Fed reduced MBS and Treasury
reinvestment by a monthly maximum of $4 and $6 billion, respectively, beginning in October 2017. While the Fed tightened monetary policy, European and Asian central banks continued to expand balance sheets, flooding
the market with increased liquidity in order to support growth. While central bank policies diverged, economic growth converged as growth across developed markets improved. Interest rates remained low in developed
markets, supported by easy monetary policy, with the exception of the U.S. where Fed policy led to higher yields for most maturities.5
Short
and intermediate Treasury yields increased in response to the tightening of monetary policy. Longer-term yields were little changed, resulting in a flattening of the yield curve as measured by the yield differential
between 2- and 10-year yields. 2-year yields increased 70 basis points to 1.88% while 10-year Treasury yields decreased 4 basis points to 2.41%.
Sector Allocation
Spread sectors posted
positive excess returns for a variety of sectors held in the portfolio including ABS and agency debt as well as commercial and residential MBS. Commercial MBS posted the strongest excess returns among the listed
sectors and significant exposure proved beneficial. The Fund's overweight to spread sectors and an underweight to U.S. Treasuries resulted in sector allocation producing a positive contribution to Fund gross
performance without the impact of cash flows, transaction costs and other expenses.
Portfolio effective
duration was below that of the benchmark for a significant portion of the reporting period in a strategy designed to reduce the negative impact of rising interest rates. The strategy proved beneficial as rates
increased, most notably for short to intermediate maturity yields. Interest rate strategy incorporated the use of traditional cash bond investments as well as derivatives in the form of Treasury futures
contracts.6 Interest rate strategy had a positive impact on gross Fund performance as compared to the Blended Index.
1
The Bloomberg Barclays U.S. Mortgage Backed Securities Index (BBMBS) and Bloomberg Barclays U.S. Government Bond Index returned 2.47% and 2.30%, respectively. The Blended Index is
being used for comparison purposes because, although it is not the Fund's broad-based securities market index, the Fund's Adviser believes it more closely reflects the market sectors in which the Fund invests. The
Fund's broad-based securities market index is the BBMBS. Please see the footnotes to the line graph under “Fund Performance and Growth of a $10,000 Investment” below for the definition of, and more
information about, the Blended Index.
2
Duration measures the price sensitivity of a fixed-income security to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than
securities of shorter durations.
3
Investment-grade securities are securities that are rated at least “BBB- (minus)” or unrated securities of a comparable quality. Noninvestment-grade securities are
securities that are not rated at least “BBB- (minus)” or unrated securities of a comparable quality. Credit ratings are an indication of the risk that a security will default. They do not protect a
security from credit risk. Lower-rated bonds typically offer higher yields to help compensate investors for the increased risk associated with them. Among these risks are lower credit-worthiness, greater price
volatility, more risk to principal and income than with higher-rated securities and increased possibilities of default.
4
The value of some mortgage-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of
government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations.
5
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
6
The Fund's use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and
other traditional instruments.
FUND PERFORMANCE AND GROWTH OF A
$10,000 INVESTMENT
The graph below
illustrates the hypothetical investment of $10,0001 in the Federated Fund for U.S. Government Securities II from December 31, 2007 to December 31, 2017, compared to the
Bloomberg Barclays U.S. Mortgage Backed Securities Index (BBMBS),2 the Bloomberg Barclays U.S. Government Index (BBGI)3 and a blended index comprised of 67% BBMBS and 33% BBGI (“Blended Index”).2,3 The Average Annual Total Return table below shows returns averaged over the stated periods.
Average Annual Total Returns for
the Period Ended 12/31/2017
1 Year
5 Years
10 Years
Fund
1.92%
1.30%
2.97%
BBMBS
2.47%
2.04%
3.84%
BBGI
2.30%
1.28%
3.23%
Blended Index
2.41%
1.79%
3.64%
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. Performance of a variable investment option changes over time and current performance may be lower or higher than what is stated. For current to the most recent month end performance, contact your insurance
company. The performance information presented does not include the charges and expenses imposed by the insurance company under the variable insurance product contract. The inclusion of such charges would lower
performance. Please refer to the variable insurance product prospectus for a complete listing of these expenses. Fund shares are available exclusively as a funding vehicle for life insurance companies writing variable
life insurance policies and variable annuity contracts. Variable investment options are not obligations of or guaranteed by any bank and are not federally insured.
1
The Fund's performance assumes the reinvestment of all dividends and distributions. The BBMBS, BBGI and Blended Index have been adjusted to reflect reinvestment of dividends on
securities in the indexes.
2
The BBMBS covers agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) issued by Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC). The index is
not adjusted to reflect sales loads, expenses or other fees that the Securities and Exchange Commission (SEC) requires to be reflected in the Fund's performance. The index is unmanaged and, unlike the Fund, is not
affected by cash flows. It is not possible to invest directly in an index.
3
The BBGI is a market value weighted index of U.S. government and government agency securities (other than mortgage securities) with maturities of one year or more.
The index is not adjusted to reflect sales loads, expenses or other fees that the SEC requires to be reflected in the Fund's performance. The index is unmanaged and, unlike the Fund, is not affected by cash flows. It
is not possible to invest directly in an index.
TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES
(IDENTIFIED COST $18,707,747)
18,464,545
REPURCHASE AGREEMENT—3.5%
4,672,000
Interest in $950,000,000 joint repurchase agreement 1.42%, dated 12/29/2017 under which Bank of America, N.A. will
repurchase securities provided as collateral for $950,149,889 on 1/2/2018. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities
maturing on 7/20/2046 and the market value of those underlying securities was $969,152,887.
(IDENTIFIED COST $4,672,000)
4,672,000
TOTAL INVESTMENT IN SECURITIES—99.8%
(IDENTIFIED COST $129,877,438)1
132,695,501
OTHER ASSETS AND LIABILITIES - NET—0.2%2
262,430
TOTAL NET ASSETS—100%
$132,957,931
1
The cost of investments for federal tax purposes amounts to $129,832,510.
2
Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities.
Note: The categories of investments
are shown as a percentage of total net assets at December 31, 2017.
Various inputs are used in
determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level
1—quoted prices in active markets for identical securities.
Level
2—other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost.
Level
3—significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments).
Net realized and unrealized gain (loss) on investments
(0.03)
(0.06)
(0.19)
0.23
(0.49)
TOTAL FROM INVESTMENT OPERATIONS
0.20
0.17
0.06
0.50
(0.23)
Less Distributions:
Distributions from net investment income
(0.25)
(0.27)
(0.30)
(0.33)
(0.37)
Net Asset Value, End of Period
$10.73
$10.78
$10.88
$11.12
$10.95
Total Return2
1.92%
1.61%
0.52%
4.62%
(2.05)%
Ratios to Average Net Assets:
Net expenses
0.78%
0.76%
0.76%
0.76%
0.76%
Net investment income
2.13%
2.12%
2.25%
2.45%
2.34%
Expense waiver/reimbursement3
0.07%
0.06%
0.03%
0.04%
0.03%
Supplemental Data:
Net assets, end of period (000 omitted)
$132,958
$152,795
$168,742
$187,012
$201,117
Portfolio turnover
24%
53%
34%
51%
94%
Portfolio turnover (excluding purchases and sales from dollar-roll transactions)
24%
41%
27%
26%
38%
1
Per share numbers have been calculated using the average shares method.
2
Based on net asset value. Total returns do not reflect any additional fees or expenses that may be imposed by separate accounts of insurance companies or in connection with any variable annuity or variable life
insurance contract.
3
This expense decrease is reflected in both the net expense and the net investment income ratios shown above.
See Notes which are an integral part
of the Financial Statements
Federated Insurance Series (the
“Trust”) is registered under the Investment Company Act of 1940, as amended (the “Act”), as an open-end management investment company. The Trust consists of seven portfolios. The financial
statements included herein are only those of Federated Fund for U.S. Government Securities II (the “Fund”), a diversified portfolio. The financial statements of the other portfolios are presented
separately. The assets of each portfolio are segregated and a shareholder's interest is limited to the portfolio in which shares are held. Each portfolio pays its own expenses. Fund shares are available exclusively as
a funding vehicle for life insurance companies writing variable life insurance policies and variable annuity contracts. The investment objective of the Fund is to provide current income.
2. SIGNIFICANT ACCOUNTING
POLICIES
The following is a summary of
significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP).
Investment Valuation
In calculating its net asset value (NAV), the Fund
generally values investments as follows:
■
Fixed-income securities are fair valued using price evaluations provided by a pricing service approved by the Fund's Board of Trustees (the “Trustees”).
■
Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations.
■
Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees.
■
Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs.
■
For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered such as: the last
traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer's financial statements or other available documents, fundamental analytical data, the nature
and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable issuers,
movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions.
If any price, quotation, price
evaluation or other pricing source is not readily available when the NAV is calculated, if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a
reasonable period of time as set forth in the Fund's valuation policies and procedures, or if information furnished by a pricing service, in the opinion of the valuation committee (“Valuation Committee”),
is deemed not representative of the fair value of such security, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund
could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share.
Fair Valuation Procedures
The Trustees have ultimate responsibility for
determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a Valuation Committee comprised of officers of the Fund, Federated Investment Management
Company (“Adviser”) and certain of the Adviser's affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of pricing
services recommended by the Valuation Committee to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various methods for
reviewing third-party pricing-service evaluations including periodic reviews of third-party pricing services' policies, procedures and valuation methods (including key inputs, methods, models and assumptions),
transactional back-testing, comparisons of evaluations of different pricing services, and review of price challenges by the Adviser based on recent market activity. In the event that market quotations and price
evaluations are not available for an investment, the Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review and approve
the fair valuations made by the Valuation Committee and any changes made to the procedures.
Factors considered
by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions,
indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a “bid” evaluation).
Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a “mid” evaluation). The Fund normally uses bid
evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC
derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the
Trustees.
Repurchase Agreements
The Fund may invest in repurchase agreements for
short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund's custodian or sub-custodian eligible securities or cash with a market value
(after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or sub-custodian in which the Fund
holds a “securities entitlement” and exercises “control” as those terms are defined in the Uniform
Commercial Code. The Fund has established
procedures for monitoring the market value of the transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow
the other party to require securities to be transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value.
The insolvency of
the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase
agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party.
The Fund may enter
into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund's Adviser
and its affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its share of
proceeds from any repurchase or other disposition of such securities.
Repurchase
agreements are subject to Master Netting Agreements (MNA) which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a
single payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash
or securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero.
Investment Income, Gains and
Losses, Expenses and Distributions
Investment transactions are accounted for on a
trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Distributions of net investment income, if any, are declared and paid annually. Non-cash dividends included in dividend income, if any, are recorded at fair value.
Amortization/accretion of premium and discount is included in investment income. Gains and losses realized on principal payment of mortgage-backed securities (paydown gains and losses) are classified as part of
investment income. The detail of the total fund expense waiver of $99,183 is disclosed in Note 5.
Federal Taxes
It is the Fund's policy to comply with the
Subchapter M provision of the Internal Revenue Code (the “Code”) and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary.
As of and during the year ended December 31, 2017, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax
expense in the Statement of Operations. As of December 31, 2017, tax years 2014 through 2017 remain subject to examination by the Fund's major tax jurisdictions, which include the United States of America and the
Commonwealth of Massachusetts.
When-Issued and Delayed-Delivery
Transactions
The Fund may engage in when-issued or
delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities
purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market
conditions or the failure of counterparties to perform under the contract.
The Fund may
transact in To Be Announced Securities (TBAs). As with other delayed-delivery transactions, a seller agrees to issue TBAs at a future date. However, the seller does not specify the particular securities to be
delivered. Instead, the Fund agrees to accept any security that meets specified terms such as issuer, interest rate and terms of underlying mortgages. The Fund records TBAs on the trade date utilizing information
associated with the specified terms of the transaction as opposed to the specific mortgages. TBAs are marked to market daily and begin earning interest on the settlement date. Losses may occur due to the fact that the
actual underlying mortgages received may be less favorable than those anticipated by the Fund.
Dollar-Roll Transactions
The Fund engages in dollar-roll transactions in
which the Fund sells mortgage-backed securities with a commitment to buy similar (same type, coupon and maturity), but not identical mortgage-backed securities on a future date. Both securities involved are TBA
mortgage-backed securities. The Fund treats dollar-roll transactions as purchases and sales. Dollar-rolls are subject to interest rate risks and credit risks.
The Fund purchases and sells financial futures
contracts to manage duration risk and yield curve risk. Upon entering into a financial futures contract with a broker, the Fund is required to deposit in a segregated account, either U.S. government securities or a
specified amount of Restricted cash, which is shown in the Statement of Assets and Liabilities. Futures contracts are valued daily and unrealized gains or losses are recorded in a “variation margin”
account. Daily, the Fund receives from or pays to the broker a specified amount of cash based upon changes in the variation margin account. When a contract is closed, the Fund recognizes a realized gain or loss.
Futures contracts have market risks, including the risk that the change in the value of the contract may not correlate with the changes in the value of the underlying securities. There is minimal counterparty risk to
the Fund since futures contracts are exchange traded and the exchange's clearing house, as counterparty to all exchange traded futures contracts, guarantees the futures contracts against default.
The Fund participates in a securities lending
program providing for the lending of government securities to qualified brokers. The Fund normally receives cash collateral for securities loaned that is invested in short-term securities including repurchase
agreements. Collateral is maintained at a minimum level of 100% of the market value of investments loaned, plus interest, if applicable. In accordance with the Fund's securities lending agreement, the market value of
securities on loan is determined each day at the close of business and any additional collateral required to cover the value of securities on loan is delivered to the Fund on the next business day. Earnings on
collateral are allocated between the borrower of the security, the securities lending agent, as a fee for its services under the program and the Fund, according to agreed-upon rates.
As of December31, 2017, the Fund had no outstanding securities on loan.
Restricted Securities
The Fund may purchase securities which are
considered restricted. Restricted securities are securities that either: (a) cannot be offered for public sale without first being registered, or being able to take advantage of an exemption from registration, under
the Securities Act of 1933; or (b) are subject to contractual restrictions on public sales. In some cases, when a security cannot be offered for public sale without first being registered, the issuer of the restricted
security has agreed to register such securities for resale, at the issuer's expense, either upon demand by the Fund or in connection with another registered offering of the securities. Many such restricted securities
may be resold in the secondary market in transactions exempt from registration. Restricted securities may be determined to be liquid under criteria established by the Trustees. The Fund will not incur any registration
costs upon such resales. The Fund's restricted securities, like other securities, are priced in accordance with procedures established by and under the general supervision of the Trustees.
Other
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from
those estimated. The Fund applies investment company accounting and reporting guidance.
3. SHARES OF BENEFICIAL
INTEREST
The following table summarizes share
activity:
Year Ended December 31
2017
2016
Shares sold
987,615
2,694,329
Shares issued to shareholders in payment of distributions declared
332,891
386,367
Shares redeemed
(3,105,366)
(4,406,170)
NET CHANGE RESULTING FROM FUND SHARE TRANSACTIONS
(1,784,860)
(1,325,474)
4. FEDERAL TAX INFORMATION
The timing and character of income
and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are due to differing treatments for dollar-roll transactions and expiration of
capital loss carryforwards.
For the year
ended December 31, 2017, permanent differences identified and reclassified among the components of net assets were as follows:
Increase (Decrease)
Paid-In Capital
Undistributed
Net Investment
Income (Loss)
Accumulated
Net Realized
Gain (Loss)
$(98,280)
$20,231
$78,049
Net investment income (loss), net
realized gains (losses), and net assets were not affected by this reclassification.
The tax character
of distributions as reported on the Statement of Changes in Net Assets for the years ended December 31, 2017 and 2016, was as follows:
2017
2016
Ordinary income
$3,508,674
$4,161,172
As of December 31, 2017, the
components of distributable earnings on a tax-basis were as follows:
Undistributed ordinary income
$3,071,352
Net unrealized appreciation
$2,727,034
Capital loss carry forwards
$(557,382)
The difference between book-basis
and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for deferral of straddle loss and dollar-roll transactions.
At December 31,2017, the cost of investments for federal tax purposes was $129,832,510. The net unrealized appreciation of investments for federal tax purposes was $2,727,034. This consists of net unrealized appreciation from
investments for those securities having an excess of value over cost of $3,575,564 and net unrealized depreciation from investments for those securities having an excess of cost over value of $848,530.
At December 31,2017, the Fund had a capital loss carryforward of $557,382 which will reduce the Fund's taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code, thereby
reducing the amount of distributions to shareholders which would otherwise be necessary to relieve the Fund of any liability for federal income tax. Pursuant to the Code, a net capital loss incurred in taxable years
beginning after December 22, 2010, retains its character as either short-term or long-term and does not expire. All of the Fund's capital loss carryforwards were incurred in taxable years after December 22, 2010.
The following
schedule summarizes the Fund's capital loss carryforwards:
Short-Term
Long-Term
Total
$324,844
$232,538
$557,382
Capital loss carryforwards of
$98,280 expired during the year ended December 31, 2017.
At December 31, 2017, for federal
income tax purposes, the Fund had $135,957 in straddle loss deferrals.
5. INVESTMENT ADVISER FEE AND
OTHER TRANSACTIONS WITH AFFILIATES
Investment Adviser Fee
The advisory agreement between the Fund and the
Adviser provides for an annual fee equal to 0.60% of the Fund's average daily net assets. Subject to the terms described in the Expense Limitation note, the Adviser may voluntarily choose to waive any portion of its
fee. For the year ended December 31, 2017, the Adviser voluntarily waived $99,183 of its fee.
Administrative Fee
Federated Administrative Services (FAS), under the
Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, “Investment Complex” is defined as all of the
Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.100%
on assets up to $50 billion
0.075%
on assets over $50 billion
Subject to the terms described in
the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended December 31, 2017, the annualized fee paid to FAS was 0.079% of average daily net assets of the Fund.
Prior to
September 1, 2017, the breakpoints of the Administrative Fee paid to FAS, described above, were:
Administrative Fee
Average Daily Net Assets
of the Investment Complex
0.150%
on the first $5 billion
0.125%
on the next $5 billion
0.100%
on the next $10 billion
0.075%
on assets in excess of $20 billion
In addition, FAS may charge certain
out-of-pocket expenses to the Fund.
Expense Limitation
The Adviser and certain of its affiliates (which
may include FAS) on their own initiative have agreed to waive certain amounts of their respective fees and/or reimburse expenses. Total annual fund operating expenses (as shown in the financial highlights, excluding
interest expense, extraordinary expenses, line of credit expenses and proxy-related expenses paid by the Fund, if any) paid by the Fund (after the voluntary waivers and/or reimbursements) will not exceed 0.76% (the
“Fee Limit”) up to but not including the later of (the “Termination Date”): (a) May 1, 2018; or (b) the date of the Fund's next effective Prospectus. While the Adviser and its applicable
affiliates currently do not anticipate terminating or increasing these arrangements prior to the Termination Date, these arrangements may only be terminated or the Fee Limit increased prior to the Termination Date
with the agreement of the Trustees.
Directors'/Trustees' and
Miscellaneous Fees
Certain Officers and Trustees of the Fund are
Officers and Directors or Trustees of certain of the above companies. To efficiently facilitate payment, Directors'/Trustees' fees and certain expenses related to conducting meetings of the Directors/Trustees and
other miscellaneous expenses are paid by an affiliate of the Adviser which in due course are reimbursed by the Fund. These expenses related to conducting meetings of the Directors/Trustees and other miscellaneous
expenses may be included in Accrued and Miscellaneous Expenses on the Statement of Assets and Liabilities and Statement of Operations, respectively.
Purchases and sales of investments,
excluding long-term U.S. government securities and short-term obligations, for the year ended December 31, 2017, were as follows:
Purchases
$—
Sales
$16,777,246
7. LINE OF CREDIT
The Fund participates with certain
other Federated Funds, on a several basis, in an up to $500,000,000 unsecured, 364-day, committed, revolving line of credit (LOC) agreement. The LOC was made available to finance temporarily the repurchase or
redemption of shares of the Fund, failed trades, payment of dividends, settlement of trades and for other short-term, temporary or emergency general business purposes. The Fund cannot borrow under the LOC if an
inter-fund loan is outstanding. The Fund's ability to borrow under the LOC also is subject to the limitations of the Act and various conditions precedent that must be satisfied before the Fund can borrow. Loans under
the LOC are charged interest at a fluctuating rate per annum equal to the highest, on any day, of (a) (i) the federal funds effective rate, (ii) the one month London Interbank Offered Rate (LIBOR), and (iii) 0.0%,
plus (b) a margin. The LOC also requires the Fund to pay, quarterly in arrears and at maturity, its pro rata share of a commitment fee based on the amount of the lenders' commitment that has not been utilized. As of
December 31, 2017, the Fund had no outstanding loans. During the year ended December 31, 2017, the Fund did not utilize the LOC.
8. INTERFUND LENDING
Pursuant to an Exemptive Order
issued by the Securities and Exchange Commission, the Fund, along with other funds advised by subsidiaries of Federated Investors, Inc., may participate in an interfund lending program. This program provides an
alternative credit facility allowing the Fund to borrow from other participating affiliated funds. As of December 31, 2017, there were no outstanding loans. During the year ended December 31, 2017, the program was not
utilized.
Report of Independent
Registered Public Accounting Firm
TO THE BOARD OF TRUSTEES OF the
FEDERATED INSURANCE SERIES AND SHAREHOLDERS OF FEDERATED FUND FOR U.S. GOVERNMENT SECURITIES II:
Opinion on the Financial
Statements
We have audited the
accompanying statement of assets and liabilities, including the portfolio of investments, of the Federated Fund for U.S Government Securities II (the “Fund”), a portfolio of Federated Insurance Series, as
of December 31, 2017, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and the related notes (collectively,
the “financial statements”) and the financial highlights for each of the years in the five-year period then ended. In our opinion, the financial statements and financial highlights present fairly, in all
material respects the financial position of the Fund as of December 31, 2017, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial
statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Fund in accordance with the U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits
in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements and financial highlights, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial
highlights. Such procedures also included confirmation of securities owned as of December 31, 2017, by correspondence with the custodian and brokers, or by other appropriate auditing procedures. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the
auditor for one or more of Federated Investors'- investment companies since 2006.
As a shareholder of the
Fund, you incur ongoing costs, including management fees and to the extent applicable, distribution (12b-1) fees and/or other service fees and other Fund expenses. This Example is intended to help you to understand
your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other variable investment options. It is based on an investment of $1,000 invested at the
beginning of the period and held for the entire period from July 1, 2017 to December 31, 2017.
ACTUAL EXPENSES
The first section of the
table below provides information about actual account values and actual expenses. You may use the information in this section, together with the amount you invested, to estimate the expenses that you incurred over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the
result by the number in the first section under the heading entitled “Expenses Paid During Period” to estimate the expenses attributable to your investment during this period.
HYPOTHETICAL EXAMPLE FOR
COMPARISON PURPOSES
The second section of the
table below provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. Thus, you should not use the hypothetical account values and expenses to estimate the actual ending account balance or your expenses for the period. Rather, these figures are required to be provided
to enable you to compare the ongoing costs of investing in the Fund with other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the
other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only. Therefore, the second section of the table is useful in comparing ongoing costs only, and will not help you determine
the relative total costs of owning different funds.
Beginning
Account Value
7/1/2017
Ending
Account Value
12/31/2017
Expenses Paid
During Period1
Actual
$1,000
$1,004.70
$3.94
Hypothetical (assuming a 5% return before expenses)
$1,000
$1,021.30
$3.97
1
Expenses are equal to the Fund's annualized net expense ratio of 0.78%, multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half-year period). The expenses shown in the
table do not include the charges and expenses imposed by the insurance company under the variable insurance product contract. Please refer to the variable insurance product prospectus for a complete listing of these
expenses.
With profound sadness,
Federated announces the passing of John F. (“Jack”) Donahue and John W. (“John”) McGonigle. They will be greatly missed.
Jack Donahue
(Former Chairman and President,
and Emeritus Director/Trustee, of the Federated Funds, and Founder, Former Chairman, President and Chief Executive Officer, and Chairman Emeritus, of Federated Investors, Inc.)
Jack Donahue, along with
Richard B. Fisher, founded Federated in 1955 and served as a leader and member of the Boards of Directors/Trustees of the Federated Funds and the Board of Directors of Federated Investors, Inc. Mr. Donahue was a
family man of deep faith with exemplary character and fealty, who served his religion, family, community, and the Federated Funds and Federated, as well as their shareholders, officers and employees, with distinction.
His integrity, intelligence, and keen sense of fiduciary duty, coupled with his faith, family and background as a West Point graduate and Strategic Air Command B-29 pilot, served as a foundation for his strong
business acumen and leadership. Among his many achievements, Mr. Donahue's steadfast and innovative leadership of the Federated Funds and Federated, as well as within the investment management industry, led to the
birth of money market funds in the 1970s and their growth as an innovative, efficient and effective cash management vehicle throughout the 1980s, 1990s, 2000s and beyond. Federated expresses deep gratitude to Mr.
Donahue for his inspiring leadership, distinguished service and contributions as a husband, father, founder, Board member and officer, colleague and friend.
John McGonigle
(Former Secretary of the
Federated Funds, Former Director, Secretary and Chief Legal Officer of Federated Investors, Inc.)
John McGonigle served
the Federated Funds and their respective Boards with distinction for more than 50 years as Fund Secretary and also served as Director for several closed-end funds. Mr. McGonigle was a gifted lawyer and wise counselor
with a genial presence, keen intellect and convivial demeanor. A man of deep faith, he was a devoted husband, father and grandfather. A graduate of Duquesne University School of Law, Mr. McGonigle served as an officer
in the U.S. Army for two years, achieving the rank of Captain. He also served on the staff of the Securities and Exchange Commission before joining Federated in 1966. Among many professional accomplishments, Mr.
McGonigle helped fashion the regulatory foundation for money market funds, established Federated's first offshore funds in Ireland, and represented Federated on the Board of Governors of the Investment Company
Institute where he was a member of the Executive Committee. Federated expresses deep gratitude for Mr. McGonigle and his impact on his family, friends, the community, and the mutual fund industry.
Board of Trustees and
Trust Officers
The Board of Trustees is
responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. The following tables give information about each Trustee and the senior
officers of the Fund. Where required, the tables separately list Trustees who are “interested persons” of the Fund (i.e., “Interested” Trustees) and those who are not (i.e.,
“Independent” Trustees). Unless otherwise noted, the address of each person listed is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA15222. The address of all Independent Trustees listed is
4000 Ericsson Drive, Warrendale, PA15086-7561; Attention: Mutual Fund Board. As of December 31, 2017, the Trust comprised seven portfolio(s), and the Federated Fund Family consisted of 40 investment companies
(comprising 108 portfolios). Unless otherwise noted, each Officer is elected annually. Unless otherwise noted, each Trustee oversees all portfolios in the Federated Fund Family and serves for an indefinite term. The
Fund's Statement of Additional Information includes additional information about Trust Trustees and is available, without charge and upon request, by calling 1-800-341-7400.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held and Previous Position(s)
J. Christopher Donahue*
Birth Date: April 11, 1949
Trustee
Indefinite Term
Began serving: September 1993
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of the Funds in the Federated Fund Family; President, Chief Executive
Officer and Director, Federated Investors, Inc.; Chairman and Trustee, Federated Investment Management Company; Trustee, Federated Investment Counseling; Chairman and Director, Federated Global Investment Management
Corp.; Chairman and Trustee, Federated Equity Management Company of Pennsylvania; Trustee, Federated Shareholder Services Company; Director, Federated Services Company.
Previous Positions: President, Federated Investment Counseling; President and Chief Executive Officer, Federated Investment Management Company, Federated Global Investment Management Corp. and Passport
Research, Ltd; Chairman, Passport Research, Ltd.
Thomas R. Donahue*
Birth Date: October 20, 1958
Trustee
Indefinite Term
Began serving: May 2016
Principal Occupations: Director or Trustee of certain of the funds in the Federated Fund Family; Chief Financial Officer, Treasurer, Vice President and Assistant Secretary, Federated Investors, Inc.; Chairman
and Trustee, Federated Administrative Services; Chairman and Director, Federated Administrative Services, Inc.; Trustee and Treasurer, Federated Advisory Services Company; Director or Trustee and Treasurer, Federated
Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, and Federated Investment Management Company; Director, MDTA LLC; Director, Executive Vice
President and Assistant Secretary, Federated Securities Corp.; Director or Trustee and Chairman, Federated Services Company and Federated Shareholder Services Company; and Director and President, FII Holdings,
Inc.
Previous Positions: Director, Federated Investors, Inc.; Assistant Secretary, Federated Investment Management Company, Federated Global Investment Management Company and Passport Research, LTD; Treasurer,
Passport Research, LTD; Executive Vice President, Federated Securities Corp.; and Treasurer, FII Holdings, Inc.
*
Family relationships and reasons for “interested” status: J. Christopher Donahue and Thomas R. Donahue are brothers. Both are “interested” due to their
beneficial ownership of shares of Federated Investors, Inc. and the positions they hold with Federated and its subsidiaries.
INDEPENDENT Trustees
Background
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
John T. Collins
Birth Date: January 24, 1947
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Chairman and CEO, The Collins Group, Inc. (a private equity firm) (Retired).
Other Directorships Held: Director, Current Chair of the Compensation Committee, KLX Corp.
Qualifications: Mr. Collins has served in several business and financial management roles and directorship positions throughout his career. Mr. Collins previously served as Chairman and CEO, The Collins
Group, Inc. (a private equity firm). Mr. Collins serves as Chairman Emeriti, Bentley University. Mr. Collins previously served as Director and Audit Committee Member, Bank of America Corp.; Director, FleetBoston
Financial Corp.; and Director, Beth Israel Deaconess Medical Center (Harvard University Affiliate Hospital).
G. Thomas Hough
Birth Date: February 28, 1955
Trustee
Indefinite Term
Began serving: August 2015
Principal Occupations: Director or Trustee of the Federated Fund Family; formerly, Vice Chair, Ernst & Young LLP (public accounting firm) (Retired).
Other Directorships Held: Director, Chair of the Audit Committee, Governance Committee, Publix Super Markets, Inc.; Director, Member of the Audit Committee and Technology Committee of Equifax, Inc.
Qualifications: Mr. Hough has served in accounting, business management and directorship positions throughout his career. Mr. Hough most recently held the position of Americas Vice Chair of Assurance
with Ernst & Young LLP (public accounting firm). Mr. Hough is an Executive Committee member of the United States Golf Association, he serves on the President's Cabinet and Business School Board of Visitors for the
University of Alabama and is on the Business School Board of Visitors for Wake Forest University.
Name
Birth Date
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years,
Other Directorships Held, Previous Position(s) and Qualifications
Maureen Lally-Green
Birth Date: July 5, 1949
Trustee
Indefinite Term
Began serving: August 2009
Principal Occupations: Director or Trustee of the Federated Fund Family; Dean of the Duquesne University School of Law; Professor and Adjunct Professor of Law, Duquesne University School of Law; formerly,
Interim Dean of the Duquesne University School of Law; Associate General Secretary and Director, Office of Church Relations, Diocese of Pittsburgh.
Other Directorships Held: Director, CNX Resources Corporation (formerly known as CONSOL Energy Inc.).
Qualifications: Judge Lally-Green has served in various legal and business roles and directorship positions throughout her career. Judge Lally-Green previously served as: Associate General Secretary,
Diocese of Pittsburgh; a member of the Superior Court of Pennsylvania; and as a Professor of Law, Duquesne University School of Law. Judge Lally-Green also currently holds the positions on either a public or not for
profit Board of Directors as follows: Director and Chair, UPMC Mercy Hospital; Director and Vice Chair, Our Campaign for the Church Alive!, Inc.; Director, Saint Vincent College; Member, Pennsylvania State Board of
Education (public); and Director CNX Resources Corporation (formerly known as CONSOL Energy Inc.), where she currently serves as a member of the Compensation, Nominating and Corporate Governance Committee (Chair) and
the Health, Safety and Environmental Committee. Judge Lally-Green has held the positions of: Director, Auberle; Director, Epilepsy Foundation of Western and Central Pennsylvania; Director, Ireland Institute of
Pittsburgh; Director, Saint Thomas More Society; Director and Chair, Catholic High Schools of the Diocese of Pittsburgh, Inc.; Director, Pennsylvania Bar Institute; Regent, St. Vincent Seminary; and Director and
Chair, Cardinal Wuerl North Catholic High School, Inc.
Charles F. Mansfield, Jr.
Birth Date: April 10, 1945
Trustee
Indefinite Term
Began serving: September 1999
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant.
Other Directorships Held: None.
Qualifications: Mr. Mansfield has served as a Marine Corps officer and in several banking, business management, educational roles and directorship positions throughout his long career. He remains active
as a Management Consultant.
Thomas M. O'Neill
Birth Date: June 14, 1951
Trustee
Indefinite Term
Began serving: August 2006
Principal Occupations: Director or Trustee, Chair of the Audit Committee of the Federated Fund Family; Sole Proprietor, Navigator Management Company (investment and strategic consulting).
Other Directorships Held: None.
Qualifications: Mr. O'Neill has served in several business, mutual fund and financial management roles and directorship positions throughout his career. Mr. O'Neill serves as Director, Medicines for
Humanity and Director, The Golisano Children's Museum of Naples, Florida. Mr. O'Neill previously served as Chief Executive Officer and President, Managing Director and Chief Investment Officer, Fleet Investment
Advisors; President and Chief Executive Officer, Aeltus Investment Management, Inc.; General Partner, Hellman, Jordan Management Co., Boston, MA; Chief Investment Officer, The Putnam Companies, Boston, MA; Credit
Analyst and Lending Officer, Fleet Bank; Director and Consultant, EZE Castle Software (investment order management software); and Director, Midway Pacific (lumber).
P. Jerome Richey
Birth Date: February 23, 1949
Trustee
Indefinite Term
Began serving: October 2013
Principal Occupations: Director or Trustee of the Federated Fund Family; Management Consultant; formerly, Senior Vice Chancellor and Chief Legal Officer, University of Pittsburgh and Executive Vice President
and Chief Legal Officer, CNX Resources Corporation (formerly known as CONSOL Energy Inc.)
Other Directorships Held: None.
Qualifications: Mr. Richey has served in several business and legal management roles and directorship positions throughout his career. Mr. Richey most recently held the positions of Senior Vice
Chancellor and Chief Legal Officer, University of Pittsburgh. Mr. Richey previously served as Chairman of the Board, Epilepsy Foundation of Western Pennsylvania and Chairman of the Board, World Affairs Council of
Pittsburgh. Mr. Richey previously served as Chief Legal Officer and Executive Vice President, CNX Resources Corporation (formerly known as CONSOL Energy Inc.); and Board Member, Ethics Counsel and Shareholder,
Buchanan Ingersoll & Rooney PC (a law firm).
John S. Walsh
Birth Date: November 28, 1957
Trustee
Indefinite Term
Began serving: January 1999
Principal Occupations: Director or Trustee, and Chair of the Board of Directors or Trustees, of the Federated Fund Family; President and Director, Heat Wagon, Inc. (manufacturer of construction temporary
heaters); President and Director, Manufacturers Products, Inc. (distributor of portable construction heaters); President, Portable Heater Parts, a division of Manufacturers Products, Inc.
Other Directorships Held: None.
Qualifications: Mr. Walsh has served in several business management roles and directorship positions throughout his career. Mr. Walsh previously served as Vice President, Walsh & Kelly, Inc. (paving
contractors).
Name
Birth Date
Address
Positions Held with Trust
Date Service Began
Principal Occupation(s) for Past Five Years
and Previous Position(s)
Lori A. Hensler
Birth Date: January 6, 1967
TREASURER
Officer since: April 2013
Principal Occupations: Principal Financial Officer and Treasurer of the Federated Fund Family; Senior Vice President, Federated Administrative Services; Financial and Operations Principal for Federated
Securities Corp. and Edgewood Services, Inc.; and Assistant Treasurer, Federated Investors Trust Company. Ms. Hensler has received the Certified Public Accountant designation.
Previous Positions: Controller of Federated Investors, Inc.; Senior Vice President and Assistant Treasurer, Federated Investors Management Company; Treasurer, Federated Investors Trust Company; Assistant
Treasurer, Federated Administrative Services, Federated Administrative Services, Inc., Federated Securities Corp., Edgewood Services, Inc., Federated Advisory Services Company, Federated Equity Management Company of
Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company, Passport Research, Ltd., and Federated MDTA, LLC; Financial and Operations
Principal for Federated Securities Corp., Edgewood Services, Inc. and Southpointe Distribution Services, Inc.
Peter J. Germain
Birth Date: September 3, 1959
CHIEF LEGAL OFFICER, SECRETARY and EXECUTIVE VICE PRESIDENT
Officer since: January 2005
Principal Occupations: Mr. Germain is Chief Legal Officer, Secretary and Executive Vice President of the Federated Fund Family. He is General Counsel, Chief Legal Officer, Secretary and Executive Vice
President, Federated Investors, Inc.; Trustee and Senior Vice President, Federated Investors Management Company; Trustee and President, Federated Administrative Services; Director and President, Federated
Administrative Services, Inc.; Director and Vice President, Federated Securities Corp.; Director and Secretary, Federated Private Asset Management, Inc.; Secretary, Federated Shareholder Services Company; and
Secretary, Retirement Plan Service Company of America. Mr. Germain joined Federated in 1984 and is a member of the Pennsylvania Bar Association.
Previous Positions: Deputy General Counsel, Special Counsel, Managing Director of Mutual Fund Services, Federated Investors, Inc.; Senior Vice President, Federated Services Company; and Senior Corporate
Counsel, Federated Investors, Inc.
Richard B. Fisher
Birth Date: May 17, 1923
VICE PRESIDENT
Officer since: September 1993
Principal Occupations: Vice Chairman or Vice President of some of the Funds in the Federated Fund Family; Vice Chairman, Federated Investors, Inc.; Chairman, Federated Securities Corp.
Previous Positions: President and Director or Trustee of some of the Funds in the Federated Fund Family; Executive Vice President, Federated Investors, Inc.; Director and Chief Executive Officer, Federated
Securities Corp.
John B. Fisher
Birth Date: May 16, 1956
PRESIDENT
Officer since: November 2004
Principal Occupations: Principal Executive Officer and President of certain of the Funds in the Federated Fund Family; Director or Trustee of certain of the Funds in the Federated Fund Family; Vice President,
Federated Investors, Inc.; President, Director/Trustee and CEO, Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated
Investment Counseling, Federated Investment Management Company; President and CEO of Passport Research, Ltd.; President of some of the Funds in the Federated Fund Complex and Director, Federated Investors Trust
Company.
Previous Positions: President and Director of the Institutional Sales Division of Federated Securities Corp.; President and Director of Federated Investment Counseling; Director, Edgewood Securities Corp.;
Director, Federated Services Company; Director, Federated Investors, Inc.; Chairman and Director, Southpointe Distribution Services, Inc. and President, Technology, Federated Services Company.
Stephen Van Meter
Birth Date: June 5, 1975
CHIEF COMPLIANCE OFFICER AND SENIOR VICE PRESIDENT
Officer since: July 2015
Principal Occupations: Senior Vice President and Chief Compliance Officer of the Federated Fund Family; Vice President and Chief Compliance Officer of Federated Investors, Inc. and Chief Compliance Officer of
certain of its subsidiaries. Mr. Van Meter joined Federated in October 2011. He holds FINRA licenses under Series 3, 7, 24 and 66.
Previous Positions: Mr. Van Meter previously held the position of Compliance Operating Officer, Federated Investors, Inc. Prior to joining Federated, Mr. Van Meter served at the United States Securities and
Exchange Commission in the positions of Senior Counsel, Office of Chief Counsel, Division of Investment Management and Senior Counsel, Division of Enforcement.
Stephen F. Auth
Birth Date: September 13, 1956
101 Park Avenue
41st Floor New York, NY10178
CHIEF INVESTMENT OFFICER
Officer since: November 2002
Principal Occupations: Stephen F. Auth is Chief Investment Officer of various Funds in the Federated Fund Family; Executive Vice President, Federated Investment Counseling, Federated Global Investment
Management Corp. and Federated Equity Management Company of Pennsylvania.
Previous Positions: Executive Vice President, Federated Investment Management Company and Passport Research, Ltd. (investment advisory subsidiary of Federated); Senior Vice President, Global Portfolio
Management Services Division; Senior Vice President, Federated Investment Management Company and Passport Research, Ltd.; Senior Managing Director and Portfolio Manager, Prudential Investments.
Robert J. Ostrowski
Birth Date: April 26, 1963
Chief Investment Officer
Officer since: May 2004
Principal Occupations: Robert J. Ostrowski joined Federated in 1987 as an Investment Analyst and became a Portfolio Manager in 1990. He was named Chief Investment Officer of Federated's taxable fixed-income
products in 2004 and also serves as a Senior Portfolio Manager. Mr. Ostrowski became an Executive Vice President of the Fund's Adviser in 2009 and served as a Senior Vice President of the Fund's Adviser from 1997 to
2009. Mr. Ostrowski has received the Chartered Financial Analyst designation. He received his M.S. in Industrial Administration from Carnegie Mellon University.
Deborah A. Cunningham
Birth Date: September 15, 1959
Chief Investment Officer
Officer since: June 2012
Principal Occupations: Deborah A. Cunningham was named Chief Investment Officer of Federated's money market products in 2004. She joined Federated in 1981 and has been a Senior Portfolio Manager since
1997 and an Executive Vice President of the Fund's Adviser since 2009. Ms. Cunningham has received the Chartered Financial Analyst designation and holds an M.S.B.A. in Finance from Robert
Morris College.
Evaluation and Approval
of Advisory Contract–May 2017
Federated Fund for U.S.
Government Securities II (the “Fund”)
Following a review and
recommendation of approval by the Fund's independent trustees, the Fund's Board of Trustees (the “Board”) reviewed and unanimously approved the continuation of the Fund's investment advisory contract for
an additional one-year term at its May 2017 meetings. The Board's decision regarding the contract reflects the exercise of its business judgment after considering all of the information received on whether to continue
the existing arrangements.
The
Board had previously appointed a Senior Officer, whose duties include specified responsibilities relating to the process by which advisory fees are to be charged to a Federated fund. The Senior Officer has the
authority to retain consultants, experts, or staff as may be reasonably necessary to assist in the performance of his duties, reports directly to the Board, and may be terminated only with the approval of a majority
of the independent members of the Board. The Senior Officer prepared and furnished to the Board an independent, written evaluation that covered topics discussed below (the “Senior Officer's Evaluation”).
The Board considered the Senior Officer's Evaluation, along with other information, in deciding to approve the investment advisory contract.
The
Board also considered judicial decisions concerning allegedly excessive investment advisory fees in its decision. Using these judicial decisions as a guide, the Board has indicated that the following factors may be
relevant to an adviser's fiduciary duty with respect to its receipt of compensation from a fund: (1) the nature and quality of the services provided by an adviser to a fund and its shareholders (including the
performance of the Fund and of comparable funds); (2) an adviser's cost of providing the services (including the profitability to an adviser of providing advisory services to a fund); (3) the extent to which an
adviser may realize “economies of scale” as a fund grows larger and, if such economies of scale exist, whether they have been shared with a fund and its shareholders or the family of funds; (4) any
“fall-out financial benefits” that accrue to an adviser because of its relationship with a fund (including research services received from brokers that execute fund trades and any fees paid to affiliates
of an adviser for services rendered to a fund); (5) comparative fee and expense structures (including a comparison of fees paid to an adviser with those paid by similar funds); and (6) the extent of care,
conscientiousness and independence with which the Fund's board members perform their duties and their expertise (including whether they are fully informed about all facts the Board deems relevant to its consideration
of an adviser's services and fees). The Board noted that the Securities and Exchange Commission (“SEC”) disclosure requirements regarding the basis for the Board's approval of the Fund's investment
advisory contract generally align with the factors listed above. Consistent with the judicial decisions and SEC disclosure requirements, the Board also considered management fees charged to institutional and other
clients of Federated Investment Management Company (the “Adviser”) and its advisory affiliates for what might be viewed as like services. The Board was aware of these factors and was guided by them in its
review of the Fund's investment advisory contract to the extent it considered them to be appropriate and relevant, as discussed further below.
The
Board considered and weighed these factors in light of its substantial accumulated experience in governing the Fund and working with Federated Investors, Inc. and its affiliates (“Federated”) on matters
relating to the Federated funds. The Board was assisted in its deliberations by independent legal counsel. In addition to the extensive materials that comprise and accompany the Senior Officer's Evaluation, the Board
received detailed information about the Fund and the Federated organization throughout the year, and in connection with its May meetings. Federated provided much of this information at each regular meeting of the
Board, and furnished additional information in connection with the May meetings at which the Board's formal approval of the investment advisory contract occurred. At the May meetings in addition to meeting in separate
sessions of the independent trustees without management present, senior management of the Adviser also met with the independent trustees and their counsel to discuss the materials presented and any other matters
thought relevant by the Adviser or the trustees. Between regularly scheduled meetings, the Board also received information on particular matters as the need arose. The Board's consideration of the investment advisory
contract included review of the Senior Officer's Evaluation, accompanying data and additional information covering such matters as: the Adviser's investment philosophy, revenue, profitability, personnel and processes;
investment and operating strategies; the Fund's short-term and long-term performance (in absolute terms, both on a gross basis and net of expenses, as well as in terms relative to its particular investment program and
certain competitor or “peer group” funds and/or other benchmarks, as appropriate) and comments on the reasons for performance; the Fund's investment objectives; the Fund's expenses, including the advisory
fee and the overall expense structure of the Fund (both in absolute terms and relative to similar and/or competing funds), with due regard for contractual or voluntary expense limitations; the use and allocation of
brokerage commissions derived from trading the Fund's portfolio securities (if any); and the nature, quality and extent of the advisory and other services provided to the Fund by the Adviser and its affiliates. The
Board also considered the preferences and expectations of Fund shareholders; the entrepreneurial risk assumed by the Adviser in sponsoring the Fund; the continuing state of competition in the mutual fund industry and
market practices; the range of comparable fees for similar funds in the mutual fund industry; the Fund's relationship to the Federated funds which include a comprehensive array of funds with different investment
objectives, policies and strategies which are generally available for exchange without the incurrence of additional sales
charges; compliance and audit reports
concerning the Federated funds and the Federated companies that service them (including communications from regulatory agencies), as well as Federated's responses to any issues raised therein; and relevant
developments in the mutual fund industry and how the Federated funds and/or Federated are responding to them. The Board's evaluation process is evolutionary. The criteria considered and the emphasis placed on relevant
criteria change in recognition of changing circumstances in the mutual fund marketplace.
While
mindful that courts have cautioned against giving such comparisons too much weight, the Board has found the use of comparisons of the Fund's fees and expenses to other mutual funds with comparable investment programs
to be relevant to its deliberations. In this regard, the Board was presented with, and considered, information regarding the contractual advisory fee rates, total expense ratios and each element of the Fund's total
expense ratio (i.e., gross and net advisory fees, custody fees, portfolio accounting fees and transfer agency fees) relative to the Fund's peers. The Board focused on comparisons with other similar mutual funds more
heavily than non-mutual fund products or services because it is believed that they are more relevant. For example, other mutual funds are the products most like the Fund, in that they are readily available to Fund
shareholders as alternative investment vehicles. Also, they are the type of investment vehicle, in fact, chosen and maintained by the Fund's investors. The range of their fees and expenses, therefore, appears to be a
relevant indicator of what consumers have found to be reasonable in the marketplace in which the Fund competes.
The
Board reviewed the contractual advisory fee rate, net advisory fee rate where partially waived and other expenses of the Fund and noted the position of the Fund's contractual advisory fee rate and other expenses
relative to its peers. In this regard, the Board noted that the contractual advisory fee rate was above the median of the relevant peer group, but the Board noted the applicable waivers and reimbursements and that the
overall expense structure of the Fund remained competitive in the context of other factors considered by the Board.
For
comparison, the Senior Officer has reviewed Federated's fees for providing advisory services to products outside the Federated funds (e.g., institutional and separate accounts and sub-adviser services). He concluded
that mutual funds and institutional accounts are inherently different products. Those differences include, but are not limited to, different types of targeted investors; being subject to different laws and regulations;
different legal structures; different average account sizes and portfolio management techniques made necessary by different cash flows and different associated costs; and the time spent by portfolio managers and
their teams, funds financial services, legal, compliance and risk management in reviewing securities pricing, addressing different administrative responsibilities, addressing different degrees of risk associated with
management and a variety of different costs. The Senior Officer did not consider the fees for providing advisory services to these outside products to be determinative in judging the appropriateness of mutual fund
advisory fees.
Following such evaluation, and full deliberations, the Board concluded that the expenses of the Fund are reasonable and supported renewal of the Fund's investment advisory contract.
The
Board considered the nature, extent and quality of the services provided to the Fund by the Adviser and the resources of the Adviser and its affiliates dedicated to the Fund. In this regard, the Board evaluated, among
other things, the Adviser's personnel, experience, track record, overall reputation and willingness to invest in personnel and infrastructure that benefit the Fund. In addition, the Board reviewed the qualifications,
backgrounds and responsibilities of the portfolio management team primarily responsible for the day-to-day management of the Fund. The Board noted the compliance programs of, and the compliance-related resources
provided to, the Fund by the Adviser. The Fund's ability to deliver competitive performance when compared to its peer group was also deemed to be relevant by the Board as a useful indicator of how the Adviser is
executing the Fund's investment program. The Adviser's ability to execute this program was one of the Board's considerations in reaching a conclusion that the nature, extent and quality of the Adviser's investment
management services warrant the continuation of the investment advisory contract.
In
evaluating the Fund's investment performance, the Board considered performance results in light of the Fund's investment objective, strategies and risks, as disclosed in the Fund's prospectus. The Board particularly
considered detailed investment reports on the Fund's performance that were provided to the Board throughout the year and in connection with the May meetings. The Senior Officer also reviewed information compiled by
Federated, using data supplied by independent fund ranking organizations, regarding the performance of, and fees charged by, other mutual funds, noting his view that comparisons to fund peer groups may be helpful,
though not conclusive, in judging the reasonableness of the proposed fees. The Board considered, in evaluating such comparisons, that in some cases individual funds may exhibit significant and unique differences in
their objectives and management techniques when compared to other funds within an industry peer group.
For
the one-year, three-year and five-year periods covered by the Senior Officer's Evaluation, the Fund's performance was above the median of the relevant peer group.
Following such evaluation, and full deliberations, the Board concluded that the performance of the Fund supported renewal of the Fund's investment advisory contract.
The
Board also received financial information about Federated, including information regarding the compensation and ancillary (or “fall-out”) benefits Federated derived from its relationships with the
Federated funds. This information covered not only the fees under the investment advisory contracts, but also fees received by Federated's subsidiaries for providing other services to the Federated funds under
separate contracts (e.g., for serving as the Federated funds' administrator). The information also detailed any indirect benefit Federated may derive from its receipt of research services from brokers who execute
Federated fund trades. In addition, the Board considered the fact that, in order for a fund to be competitive in the marketplace, Federated and its affiliates frequently waived fees and/or reimbursed expenses and have
disclosed to Fund investors and/or indicated to the Board their intention to do so in the future. Moreover, the Board receives regular reporting as to the institution, adjustment or elimination of these voluntary
waivers. The Board considered Federated's previous reductions in contractual management fees to certain funds in response to the Senior Officer's recommendations.
Federated furnished information, requested by the Senior Officer, that reported revenues on a fund-by-fund basis and made estimates of the allocation of expenses on a fund-by-fund basis, using allocation
methodologies specified by the Senior Officer. The Senior Officer noted that, while these cost allocation reports apply consistent allocation processes, the inherent difficulties in allocating costs continues to cause
the Senior Officer to question the precision of the process and to conclude that such reports may be unreliable, since a single change in an allocation estimate may dramatically alter the resulting estimate of cost
and/or profitability of a fund and may produce unintended consequences. The allocation information, including the Senior Officer's view that fund-by-fund estimations may be unreliable, was considered in the analysis
by the Board.
The
Board and the Senior Officer also reviewed information compiled by Federated comparing its profitability information to other publicly held fund management companies. In this regard, the Senior Officer concluded that
Federated's profit margins did not appear to be excessive. The Senior Officer also noted that Federated appeared financially sound, with the resources to fulfill its obligations under its contracts with the Fund.
The
Senior Officer's Evaluation also discussed the notion of possible realization of “economies of scale” as a fund grows larger. In this regard, the Board considered that the Adviser has made significant and
long-term investments in areas that support all of the Federated funds, such as personnel and processes for the portfolio management, shareholder services, compliance, internal audit and risk management functions, as
well as systems technology (including technology relating to cybersecurity) and that the benefits of these efforts (as well as any economies of scale, should they exist) were likely to be enjoyed by the fund family as
a whole. The Board noted that the Adviser's investments in these areas are extensive. In addition, the Board considered that Federated and its affiliates have frequently waived fees and/or reimbursed expenses and that
this has allowed fund shareholders to share potential economies of scale from a fund's inception. Federated, as it does throughout the year, and in connection with the Board's review, furnished information relative to
revenue sharing or adviser paid fees. Federated and the Senior Officer noted that this information should be viewed to determine if there was an incentive to either not apply breakpoints, or to apply breakpoints at
higher levels. It should not be viewed to determine the appropriateness of advisory fees because it would represent marketing and distribution expenses. Finally, the Board also noted the absence of any applicable
regulatory or industry guidelines on this subject, which (as discussed in the Senior Officer's Evaluation) is compounded by the lack of any common industry practice or general pattern with respect to structuring fund
advisory fees with “breakpoints” that serve to reduce the fee as a fund attains a certain size.
While
the Senior Officer noted certain items for follow-up reporting to the Board and further consideration by management, he stated that his observations and information accompanying the Senior Officer's Evaluation
supported a finding by the Board that the management fee for the Fund was reasonable. Under these circumstances, no changes were recommended to, and no objection was raised to the continuation of the Fund's investment
advisory contract.
In
its decision to continue an existing investment advisory contract, the Board was mindful of the potential disruptions of the Fund's operations and various risks, uncertainties and other effects that could occur as a
result of a decision to terminate or not renew an investment advisory contract. In particular, the Board recognized that many shareholders have invested in the Fund on the strength of the Adviser's industry standing
and reputation and with the expectation that the Adviser will have a continuing role in providing advisory services to the Fund. Thus, the Board's approval of the investment advisory contract reflected the fact that
it is the shareholders who have effectively selected the Adviser by virtue of having invested in the Fund. The Board concluded that, in light of the factors discussed above, including the nature, quality and scope of
the services provided to the Fund by the Adviser and its affiliates, continuation of the investment advisory contract was appropriate.
The
Board based its decision to approve the investment advisory contract on the totality of the circumstances and relevant factors and with a view to past and future long-term considerations. Not all of the factors and
considerations identified above were necessarily relevant to the Fund, nor did the Board consider any one of them to be determinative. With respect to the factors that were relevant, the Board's decision to approve
the continuation of the contract reflects its determination that Federated's performance and actions provided a satisfactory basis to support the decision to continue the existing arrangement.
A description of the
policies and procedures that the Fund uses to determine how to vote proxies, if any, relating to securities held in the Fund's portfolio is available, without charge and upon request, by calling 1-800-341-7400. A
report on “Form N-PX” of how the Fund voted any such proxies during the most recent 12-month period ended June 30 is available via the Proxy Voting Record (Form N-PX) link associated with the Fund and
share class name at www.FederatedInvestors.com/FundInformation. Form N-PX filings are also available at the SEC's website at www.sec.gov.
Quarterly Portfolio
Schedule
The Fund files with the
SEC a complete schedule of its portfolio holdings, as of the close of the first and third quarters of its fiscal year, on “Form N-Q.” These filings are available on the SEC's website at www.sec.gov and may
be reviewed and copied at the SEC's Public Reference Room in Washington, DC. (Call 1-800-SEC-0330 for information on the operation of the Public Reference Room.) You may also access this information via the link to
the Fund and share class name at www.FederatedInvestors.com/FundInformation.
Variable investment
options are not bank deposits or obligations, are not guaranteed by any bank and are not insured or guaranteed by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other
government agency. Investment in variable investment options involves investment risk, including the possible loss of principal.
This Report is
authorized for distribution to prospective investors only when preceded or accompanied by the Fund's Prospectus, which contains facts concerning its objective and policies, management fees, expenses and other
information.
(a) As of the end of the period covered by this report,
the registrant has adopted a code of ethics (the "Section 406 Standards for Investment Companies - Ethical Standards for Principal
Executive and Financial Officers") that applies to the registrant's Principal Executive Officer and Principal Financial Officer;
the registrant's Principal Financial Officer also serves as the Principal Accounting Officer.
(c) There was no amendment to the registrant’s
code of ethics described in Item 2(a) above during the period covered by the report.
(d) There was no waiver granted, either actual or
implicit, from a provision to the registrant’s code of ethics described in Item 2(a) above during the period covered by the
report.
(e) Not Applicable
(f)(3) The registrant hereby undertakes to provide
any person, without charge, upon request, a copy of the code of ethics. To request a copy of the code of ethics, contact the registrant
at 1-800-341-7400, and ask for a copy of the Section 406 Standards for Investment Companies - Ethical Standards for Principal Executive
and Financial Officers.
Item 3. Audit Committee Financial Expert
The
registrant's Board has determined that each of the following members of the Board's Audit Committee is an “audit committee
financial expert,” and is "independent," for purposes of this Item: John T. Collins, G. Thomas Hough
and Thomas M. O'Neill.
Item 4.
Principal Accountant Fees and Services
(a) Audit
Fees billed to the registrant for the two most recent fiscal years:
Fiscal year ended 2017 - $204,590
Fiscal year ended 2016 - $197,640
(b) Audit-Related
Fees billed to the registrant for the two most recent fiscal years:
Fiscal year ended 2017 - $0
Fiscal year ended 2016 - $0
Amount requiring approval of the registrant’s
audit committee pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X, $0 and $0 respectively.
(c) Tax
Fees billed to the registrant for the two most recent fiscal years:
Fiscal year ended 2017 - $0
Fiscal year ended 2016 - $0
Amount requiring approval of the registrant’s
audit committee pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X, $0 and $0 respectively.
(d) All Other
Fees billed to the registrant for the two most recent fiscal years:
Fiscal year ended 2017 - $0
Fiscal year ended 2016 - $0
Amount requiring approval of the registrant’s
audit committee pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X, $0 and $0 respectively.
(e)(1) Audit Committee Policies regarding Pre-approval
of Services.
The Audit Committee is required
to pre-approve audit and non-audit services performed by the independent auditor in order to assure that the provision of such
services do not impair the auditor’s independence. Unless a type of service to be provided by the independent auditor has
received general pre-approval, it will require specific pre-approval by the Audit Committee. Any proposed services exceeding pre-approved
cost levels will require specific pre-approval by the Audit Committee.
Certain services have the general
pre-approval of the Audit Committee. The term of the general pre-approval is 12 months from the date of pre-approval, unless the
Audit Committee specifically provides for a different period. The Audit Committee will annually review the services that may be
provided by the independent auditor without obtaining specific pre-approval from the Audit Committee and may grant general pre-approval
for such services. The Audit Committee will revise the list of general pre-approved services from time to time, based on subsequent
determinations. The Audit Committee will not delegate its responsibilities to pre-approve services performed by the independent
auditor to management.
The Audit Committee has delegated
pre-approval authority to its Chairman. The Chairman will report any pre-approval decisions to the Audit Committee at its next
scheduled meeting. The Committee will designate another member with such pre-approval authority when the Chairman is unavailable.
AUDIT SERVICES
The annual Audit services engagement
terms and fees will be subject to the specific pre-approval of the Audit Committee. The Audit Committee must approve any changes
in terms, conditions and fees resulting from changes in audit scope, registered investment company (RIC) structure or other matters.
In addition to the annual Audit
services engagement specifically approved by the Audit Committee, the Audit Committee may grant general pre-approval for other
Audit Services, which are those services that only the independent auditor reasonably can provide. The Audit Committee has pre-approved
certain Audit services, all other Audit services must be specifically pre-approved by the Audit Committee.
AUDIT-RELATED SERVICES
Audit-related services are assurance
and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements
or that are traditionally performed by the independent auditor. The Audit Committee believes that the provision of Audit-related
services does not impair the independence of the auditor, and has pre-approved certain Audit-related services, all other Audit-related
services must be specifically pre-approved by the Audit Committee.
TAX SERVICES
The Audit Committee believes that
the independent auditor can provide Tax services to the Company such as tax compliance, tax planning and tax advice without impairing
the auditor’s independence. However, the Audit Committee will not permit the retention of the independent auditor in connection
with a transaction initially recommended by the independent auditor, the purpose of which may be tax avoidance and the tax treatment
of which may not be supported in the Internal Revenue Code and related regulations. The Audit Committee has pre-approved certain
Tax services, all Tax services involving large and complex transactions must be specifically pre-approved by the Audit Committee.
ALL OTHER SERVICES
With respect to the provision
of services other than audit, review or attest services the pre-approval requirement is waived if:
(1)
The aggregate amount of all such services provided
constitutes no more than five percent of the total amount of revenues paid by the registrant, the registrant’s adviser (not
including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment
adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing
services to the registrant to its accountant during the fiscal year in which the services are provided;
(2)
Such services were not recognized by the registrant,
the registrant’s adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted
with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment
adviser that provides ongoing services to the registrant at the time of the engagement to be non-audit services; and
(3)
Such services are promptly brought to the attention
of the Audit Committee of the issuer and approved prior to the completion of the audit by the Audit Committee or by one or more
members of the Audit Committee who are members of the board of directors to whom authority to grant such approvals has been delegated
by the Audit Committee.
The Audit Committee may grant
general pre-approval to those permissible non-audit services classified as All Other services that it believes are routine and
recurring services, and would not impair the independence of the auditor.
The SEC’s rules and relevant
guidance should be consulted to determine the precise definitions of prohibited non-audit services and the applicability of exceptions
to certain of the prohibitions.
PRE-APPROVAL FEE LEVELS
Pre-approval fee levels for all
services to be provided by the independent auditor will be established annually by the Audit Committee. Any proposed services exceeding
these levels will require specific pre-approval by the Audit Committee.
PROCEDURES
Requests or applications to provide
services that require specific approval by the Audit Committee will be submitted to the Audit Committee by both the independent
auditor and the Principal Accounting Officer and/or Internal Auditor, and must include a joint statement as to whether, in their
view, the request or application is consistent with the SEC’s rules on auditor independence.
(e)(2) Percentage of services identified in items
4(b) through 4(d) that were approved by the registrants audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation
S-X:
4(b)
Fiscal year ended 2017 –
0%
Fiscal year ended 2016 - 0%
Percentage of services provided to the registrants
investment adviser and any entity controlling, controlled by, or under common control with the investment adviser that provides
ongoing services to the registrant that were approved by the registrants audit committee pursuant to paragraph (c)(7)(i)(C) of
Rule 2-01 of Regulation S-X, 0% and 0% respectively.
4(c)
Fiscal year ended 2017
– 0%
Fiscal year ended 2016 –
0%
Percentage of services provided to the registrants
investment adviser and any entity controlling, controlled by, or under common control with the investment adviser that provides
ongoing services to the registrant that were approved by the registrants audit committee pursuant to paragraph (c)(7)(i)(C) of
Rule 2-01 of Regulation S-X, 0% and 0% respectively.
4(d)
Fiscal year ended 2017
– 0%
Fiscal year ended 2016 –
0%
Percentage of services provided to the registrants
investment adviser and any entity controlling, controlled by, or under common control with the investment adviser that provides
ongoing services to the registrant that were approved by the registrants audit committee pursuant to paragraph (c)(7)(i)(C) of
Rule 2-01 of Regulation S-X, 0% and 0% respectively.
(f)
NA
(g)
Non-Audit Fees billed to the registrant, the registrant’s
investment adviser, and certain entities controlling, controlled by or under common control with the investment adviser:
Fiscal year ended 2017
- $22,091
Fiscal year ended 2016 - $5,827
(h)
The registrant’s Audit Committee has considered that the provision of non-audit services that were rendered to the registrant’s
adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another
investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides
ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is
compatible with maintaining the principal accountant’s independence.
In its required communications to the Audit Committee
of the registrant’s Board, KPMG LLP (“KPMG”), the registrant’s independent public accountant, informed
the Audit Committee that KPMG and/or covered person professionals within KPMG maintain lending relationships with certain owners
of greater than 10% of the shares of the registrant and/or certain investment companies within the “investment company complex”
as defined under Rule 2-01(f)(14) of Regulation S-X, which are affiliates of the registrant. KPMG has advised the Audit Committee
that these lending relationships implicate Rule 2-01(c)(1)(ii)(A) of Regulation S-X (referred to as the “Loan Rule”).
The Loan Rule prohibits an independent public accountant, or covered person professionals at such firm, from having a financial
relationship (such as a loan) with a lender that is a record or beneficial owner of more than 10% of an audit client’s equity
securities. For purposes of the Loan Rule, audit clients include the registrant, as well as all registered investment companies
audited by KPMG (collectively, the “KPMG Funds”).
KPMG informed the Audit Committee that KPMG believes
that these lending relationships described above do not and will not impair KPMG’s ability to exercise objective and impartial
judgment in connection with financial statement audits of the registrant and a reasonable investor with knowledge of all relevant
facts and circumstances would conclude that KPMG has been and is capable of objective and impartial judgment on all issues encompassed
within KPMG’s audits.
On June 20, 2016, the Division of Investment Management
of the Securities and Exchange Commission (“SEC”) issued a no-action letter to another mutual fund complex (see Fidelity
Management & Research Company et al., No-Action Letter) related to similar Loan Rule matters as those described above (the
“Letter). In the Letter, the SEC Staff confirmed that it would not recommend enforcement action against an investment company
that relied on the audit services performed by an independent public accountant where the Loan Rule was implicated in certain specified
circumstances provided that: (1) the auditor has complied with PCAOB Rule 3526(b)(1) and 3526(b)(2); (2) the Loan Rule is implicated
because of lending relationships; and (3) notwithstanding such lending relationships that implicate the Loan Rule, the auditor
has concluded that it is objective and impartial with respect to the issues encompassed within its engagement as auditor of the
funds. The circumstances described in the Letter are substantially similar to the circumstances that implicated the Loan
Rule with respect to KPMG and the registrant. On September 22, 2017, the SEC issued another no-action letter to Fidelity
Management & Research Company et al extending the expiration of the Letter until the effectiveness of any amendments to the
Loan Rule designed to address the concerns in the Letter (the “Letters”).
If it were to be determined that the relief available
under the Letters was improperly relied upon, or that the independence requirements under the federal securities laws were not
otherwise complied with regarding the registrant, for certain periods, any of the registrant’s filings with the SEC which
contain financial statements of the registrant for such periods may not comply with applicable federal securities laws, the registrant’s
ability to offer shares under its current registration statement may be impacted, and certain financial
reporting and/or other covenants with, and representations and warranties to, the registrant’s lender under its committed
line of credit may be impacted. Such events could have a material adverse effect on the registrant and the KPMG Funds.
Item 5.
Audit Committee of Listed Registrants
Not Applicable
Item 6.
Schedule of Investments
(a) The registrant’s Schedule of Investments is included
as part of the Report to Stockholders filed under Item 1 of this form.
(b) Not Applicable; Fund had no divestments during the
reporting period covered since the previous Form N-CSR filing.
Item 7.
Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies
Not Applicable
Item 8.
Portfolio Managers of Closed-End Management Investment Companies
Not Applicable
Item 9.
Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers
Not Applicable
Item 10.
Submission of Matters to a Vote of Security Holders
No Changes to Report
Item 11.
Controls and Procedures
(a) The registrant’s President and Treasurer have
concluded that the
registrant’s disclosure controls and procedures (as
defined in rule 30a-3(c) under the Act) are effective in design and operation and are sufficient to form the basis of the certifications
required by Rule 30a-(2) under the Act, based on their evaluation of these disclosure controls and procedures within 90 days of
the filing date of this report on Form N-CSR.
(b) There were no changes in the registrant’s internal
control over financial reporting (as defined in rule 30a-3(d) under the Act) during the second fiscal quarter of the period covered
by this report that have materially affected, or are reasonably likely to materially affect, the registrant’s internal control
over financial reporting.
Item 12.
Disclosure of Securities Lending Activities for Closed-End Management Investment Companies
Not Applicable
Item 13.
Exhibits
(a)(1) Code of Ethics- Not Applicable to this Report.
(a)(2) Certifications of Principal Executive Officer and
Principal Financial Officer.
(a)(3) Not Applicable.
(b) Certifications pursuant to 18 U.S.C. Section 1350.
SIGNATURES
Pursuant to the requirements of the Securities Exchange
Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act
of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.