As
filed with the Securities and Exchange Commission on December 10,
2007
1933
Act File No. 333-147121
1940
Act File No. 811-21869
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
N-2
Registration
Statement under the Securities Act of 1933 x
Pre-Effective
Amendment No. 1 x
Post-Effective
Amendment No. o
Registration
Statement under the Investment Company Act of 1940 x
Amendment
No. 11 x
Highland
Credit Strategies Fund
(Exact
Name of Registrant as Specified in the Declaration of Trust)
Two
Galleria Tower
13455
Noel Road, Suite 800
Dallas,
Texas 75240
(Address
of Principal Executive Offices)
(877)
665-1287
(Registrant’s
telephone number, including area code)
James
D. Dondero, President
Highland
Credit Strategies Fund
Two
Galleria Tower
13455
Noel Road, Suite 800
Dallas,
Texas 75240
(Name
and
Address of Agent for Service)
Copies
to:
|
Charles
B. Taylor
Skadden
Arps Slate Meagher & Flom LLP
333
West Wacker Drive
Chicago,
Illinois 60606
|
Leonard
B. Mackey, Jr.
Clifford
Chance US LLP
31
West 52nd
Street
New
York, New York 10019
|
Approximate
date of proposed public offering:
As
soon
as practicable after the effective date of this Registration
Statement
CALCULATION
OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
|
Title
of Securities Being Registered
|
|
Amount
Being
Registered
(1)
|
|
Proposed
Maximum
Offering
Price
per Unit (1)
|
|
Proposed
Maximum
Aggregate
Offering
Price
(1)
|
|
Amount
of
Registration
Fee (2)
|
|
|
Common
Shares, $0.001 par value
|
|
|
100,000
shares
|
|
$
|
18.38
|
|
$
|
1,838,000
|
|
$
|
56.43
|
|
(1)
Estimated solely for the purpose of calculating the registration fee as required
by Rule 457(c) under the Securities Act of 1933, as amended, based upon the
average of the high and low sales prices reported on the New York Stock Exchange
consolidated reporting system of $18.38 on November 1, 2007.
(2)
Previously paid.
The
registrant hereby amends this registration statement on such date or dates
as
may be necessary to delay its effective date until the registrant shall file
a
further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said section 8(a), may determine.
The
information in this preliminary prospectus is not complete and may be changed.
We may not sell these securities until the Registration Statement filed with
the
Securities and Exchange Commission is effective. This preliminary prospectus
is
not an offer to sell these securities and is not soliciting an offer to buy
these securities in any state where the offer or sale is not
permitted.
Subject
to Completion, Dated December 10, 2007
PROSPECTUS
Highland
Credit Strategies Fund
[·]
Common Shares
Issuable
Upon Exercise of Rights to Subscribe for Such Shares
The
Highland Credit Strategies Fund (the “Trust”) is issuing transferable rights
(“Rights”) to its common shareholders of record (“Record Date Shareholders”) as
of the close of business on December 21, 2007 (the “Record Date”), entitling the
holders of those Rights to subscribe for up to an aggregate of [·]of the Trust’s
common shares of beneficial interest (the “Offer”). Record Date Shareholders
will receive one Right for each outstanding whole common share held on the
Record Date. The Rights entitle their holders to purchase one new common
share
for every three Rights held (1-for-3). Record Date Shareholders who fully
exercise their Rights will be entitled to subscribe for additional common
shares
of the Fund that may become available with respect to any unexercised Rights,
subject to certain limitations and subject to allotment. The Trust’s outstanding
common shares are listed and trade on the New York Stock Exchange (“NYSE”) under
the symbol “HCF,” as will the common shares offered for subscription in the
Offer. The Rights are transferable and will be listed for trading on the
NYSE
under the symbol “HCF.RT” during the course of the Offer, which may afford
non-subscribing Record Date Shareholders the opportunity to sell their Rights
for cash value. See “The Offer” on page [·] of this prospectus for a complete
discussion of the terms of the Offer. The subscription price (the “Subscription
Price”) will be determined based upon a formula equal to 90% of the average of
the last reported sale prices of the Trust’s common shares on the NYSE on the
Expiration Date (as defined below) and the four preceding trading days (the
“Formula Price”). If, however, the Formula Price is less than 75% of the Trust’s
net asset value per share on the Expiration Date, then the Subscription Price
will be 75% of the Trust’s net asset value per common share on that day.
The
offer will expire at 5:00 p.m., Eastern time, on January 18, 2008, unless
extended as described in this prospectus.
The
Trust’s net asset value per common share at the close of business on December
[·], 2007 (the last trading date prior to the date of this prospectus on which
the Trust determined its net asset value) was $[·] and the last reported sale
price of a common share on the NYSE on that day was $[·].
Record
Date Shareholders who do not fully exercise their Rights should expect that
they
will, upon completion of the Offer, own a smaller proportional interest in
the
Trust than they owned prior to the Offer. In addition, because the Subscription
Price per common share may be less than the then current net asset value per
common share, the completion of the Offer may result in an immediate dilution
of
the net asset value per common share for all existing shareholders. Such
dilution is not currently determinable because it is not known how many shares
will be subscribed for, what the net asset value or market price of the common
shares will be on the Expiration Date or what the Subscription Price will be.
Such dilution could be substantial. If such dilution occurs, shareholders will
experience a decrease in the net asset value per common share held by them,
irrespective of whether they exercise all or any portion of their Rights. The
distribution to Record Date Shareholders of transferable Rights, which may
themselves have intrinsic value, will afford such shareholders the potential
of
receiving cash payment upon the sale of the Rights, receipt of which may be
viewed as partial compensation for the economic dilution of their interests.
No
assurance can be given that a market for the Rights will develop, or as to
the
value, if any, that the Rights will have. See “The Offer—Investment
Considerations.”
If
you
have questions or need further information about the Offer, please write
The
Altman Group, the Trust’s information agent for the Offer, at 1200 Wall Street
West, 3rd
Fl.,
Lyndhurst, NJ 07071 or call (800) 370-1749.
(continued
on inside front cover)
Before
buying the Trust’s common shares through the exercise of your Rights in the
Offer, you should read the discussion of the material risks of investing in
the
Trust in “Principal Risks of the Trust” beginning on page [·]. Certain of these
risks are summarized in “Prospectus Summary—Principal Investment Risks”
beginning on page [·].
Neither
the Securities and Exchange Commission nor any state securities commission
has
approved or disapproved of these securities or determined that this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
| |
|
Per
Share
|
|
Total(1)
|
|
Estimated
subscription price(2)
|
|
$[·]
|
|
$[·]
|
|
Estimated
sales load(2)(3)
|
|
$[·]
|
|
$[·]
|
|
Estimated
offering expenses
|
|
$[·]
|
|
$[·]
|
|
Estimated
proceeds, after expenses, to the Trust(2)
|
|
$[·]
|
|
$[·]
|
(footnotes
on inside front cover)
UBS
Investment Bank
The
Trust
is a non-diversified closed-end management investment company, which was
organized under the laws of Delaware on March 10, 2006. The
Trust’s investment objectives are to provide both current income and capital
appreciation. The Trust seeks to achieve its investment objectives by investing
primarily in the following categories of securities and instruments of
corporations and other business entities: (i) secured and unsecured floating
and
fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations
of stressed, distressed and bankrupt issuers; (iv) structured products,
including but not limited to, mortgage-backed and other asset-backed securities
and collateralized debt obligations; and (v) equities. The Trust seeks to
achieve its capital appreciation objective by investing in category (iii)
and
(v) obligations and securities, and to a lesser extent, in category (i),
(ii),
and (iv) obligations. Under normal market conditions, at least 80% of the
Trust’s assets are invested in one or more of these principal investment
categories. Subject only to this general guideline, Highland Capital Management,
L.P., the Trust’s investment adviser (“Highland”
or
the
“Investment
Adviser”),
has
broad discretion to allocate the Trust’s assets among these investment
categories and to change allocations as conditions warrant. Within the
categories of obligations and securities in which the Trust invests, Highland
employs various trading strategies, including capital structure arbitrage,
pair
trades and shorting. See “Portfolio Composition” for further description of
these strategies. The Trust may also invest in these categories of obligations
and securities through the use of derivatives. Highland has full discretion
regarding the capital markets from which it can access investment opportunities
in accordance with the investment limitations set forth in this prospectus.
A
significant portion of the Trust’s assets may be invested in securities rated
below investment grade, which are commonly referred to as “junk securities.”
Junk securities are subject to greater risk of loss of principal and interest
and may be less liquid than investment grade securities. Highland does not
anticipate a high correlation between the performance of the Trust’s portfolio
and the performance of the corporate bond and equity markets. The Trust’s
investment objectives may be changed without shareholder approval. There
can be
no assurance that the Trust’s investment objectives will be achieved. See
“The
Trust’s Investments—Investment Objectives and Policies.
You
should read this prospectus, which contains important information about the
Trust, before deciding whether to invest and retain it for future reference.
A
Statement of Additional Information, dated December [·], 2007, containing
additional information about the Trust, has been filed with the Securities
and
Exchange Commission (the “Commission”) and is incorporated by reference in its
entirety into this prospectus. You can review the table of contents of the
Statement of Additional Information on page [·] of this prospectus. You may
request a free copy of the Statement of Additional Information, request the
Trust’s annual and semi-annual reports, request information about the Trust and
make shareholder inquiries by calling 1-877-665-1287 or by writing to the
Trust
at Two Galleria Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. You
may
also obtain a copy of the Statement of Additional Information (and other
information regarding the Trust) from the Commission’s Public Reference Room in
Washington, D.C. by calling 1-202-942-8090. The Commission charges a fee
for
copies. The Trust’s annual and semi-annual reports are available, free of
charge, on the Trust’s web site (http://www.highlandfunds.com). You can obtain
the same information, free of charge, from the Commission’s web site
(http://www.sec.gov).
The
Trust’s common shares do not represent a deposit or obligation of, and are not
guaranteed or endorsed by, any bank or other insured depository institution,
and
are not federally insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other government agency.
(footnotes
from front cover)
(1)
Assumes that all Rights are exercised at the estimated Subscription
Price.
(2)
Estimated on the basis of 90% of the last reported sale price of a share
of the
Trust’s common shares on the NYSE on December [·], 2007.
(3)
UBS
Securities LLC will act as dealer manager for the Offer (the “Dealer Manager”).
The Trust has agreed to pay the Dealer Manager a fee for its financial advisory,
marketing and soliciting services equal to
3.50%
of the
Subscription Price per common share for each common share issued pursuant
to the
exercise of Rights and the over-subscription privilege. The Dealer Manager
will
reallow to broker-dealers in the selling group to be formed and managed by
the
Dealer Manager selling fees equal to 2.50% of the Subscription Price per
Share
for each Share issued pursuant to the Offer as a result of their selling
efforts. In addition, the Dealer Manager will reallow to other broker-dealers
that have executed and delivered a soliciting dealer agreement and have
solicited the exercise of Rights solicitation fees equal to 0.50% of the
Subscription Price per Share for each Share issued pursuant to the exercise
of
Rights as a result of their soliciting efforts, subject to a maximum fee
based
on the number of Shares held by each broker-dealer through The Depository
Trust
Company (“DTC”) on the Record Date. The fees and expenses of the Offer will be
borne by the Trust and indirectly by all of its shareholders, including those
who do not exercise their Rights. The Trust and Highland Capital Management,
L.P., the Trust’s investment adviser, have each agreed to indemnify the Dealer
Manager for or contribute to losses arising out of certain liabilities,
including liabilities under the Securities Act of 1933, as
amended.
TABLE
OF CONTENTS
|
Prospectus
Summary
|
1
|
|
Summary
of Trust Expenses
|
28
|
|
Financial
Highlights
|
29
|
|
The
Offer
|
30
|
|
Use
of Proceeds
|
41
|
|
The
Trust
|
42
|
|
Investment
Objectives and Policies
|
42
|
|
Portfolio
Composition
|
44
|
|
Use
of Leverage
|
59
|
|
Principal
Risks of the Trust
|
60
|
|
Management
of the Trust
|
77
|
|
Net
Asset Value
|
79
|
|
Distributions
|
80
|
|
Dividend
Reinvestment Plan
|
80
|
|
Description
of Capital Structure
|
82
|
|
Market
and Net Asset Value Information
|
83
|
|
Anti-Takeover
Provisions in the Agreement and Declaration of Trust
|
84
|
|
Closed-End
Fund Structure
|
85
|
|
Repurchase
of Common Shares
|
86
|
|
Tax
Matters
|
86
|
|
Custodian
and Transfer Agent
|
87
|
|
Legal
Opinions
|
88
|
|
Privacy
Principles of the Trust
|
88
|
|
Table
of Contents for the Statement of Additional Information
|
89
|
You
should rely only on the information contained or incorporated by reference
in
this prospectus. The Trust has not, and the Dealer Manager has not, authorized
any other person to provide you with different information. If anyone provides
you with different or inconsistent information, you should not rely on it.
The
Trust is not, and the Dealer Manager is not, making an offer to sell these
securities in any jurisdiction where the offer or sale is not permitted. The
information contained in this prospectus is accurate only as of the date of
this
prospectus, regardless of the time of delivery of this prospectus or of any
sale
of common shares. The Trust will amend this prospectus if, during the period
that this prospectus is required to be delivered, there are any subsequent
material changes.
PROSPECTUS
SUMMARY
This
is
only a summary. This summary may not contain all of the information that you
should consider before investing in the Trust. You should review the more
detailed information contained in this prospectus and in the Statement of
Additional Information, especially the information set forth under the heading
“Principal Risks of the Trust.”
| |
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|
|
The
Trust
|
|
Highland
Credit Strategies Fund is a non-diversified, closed-end management
investment company. The Trust commenced operations on June 29,
2006,
following its initial public offering. Throughout this prospectus,
Highland Credit Strategies Fund is referred to simply as the “Trust.” See
“The Trust.”
|
| |
|
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Purpose
of the Offer
|
|
The
Board of Trustees of the Trust (the “Board”) and the Investment Adviser
have determined that it would be in the best interests of the
Trust and
its shareholders to increase the assets of the Trust available
for
investment, thereby enabling the Trust more fully to take advantage
of
current and prospective investment opportunities. The Board and
the
Investment Adviser believe that the Offer is the most effective
way to
raise additional assets for the Trust while offering shareholders
the
opportunity to buy additional common shares at a discounted
price.
|
| |
|
The
Board and the Investment Adviser also believe that increasing
the Trust’s
assets available for investment may result in a modest reduction
of the
Trust’s expense ratio, as the Trust’s fixed costs would be spread over a
larger asset base.
|
| |
|
There
is no assurance that the Offer will be successful, or that by
increasing
the Trust’s assets available for investment its expense ratio will be
lowered. The completion of the Offer may result in an immediate
dilution
of the net asset value per common share for all existing shareholders,
including those who fully exercise their rights. See “The Offer—Purpose of
the Offer” on page [·].
|
|
Important
Terms of the Offer
|
|
The
Trust is issuing transferable rights (“Rights”) to its common shareholders
of record (“Record Date Shareholders”) as of the close of business on
December 21, 2007 (the “Record Date”), entitling the holders of those
Rights to subscribe for up to an aggregate of [·] of the Trust’s common
shares (the “Shares”) (the “Offer”). Record Date Shareholders will receive
one Right for each whole common share of the Trust held on the
Record
Date. These Rights entitle the Record Date Shareholders to purchase
one
new Share for every three
Rights held (1-for-3).
Fractional Shares will not be issued upon the exercise of Rights;
accordingly, Rights may be exercised only in integer multiples
of three,
except that any Record Date Shareholder who is issued fewer than
three
Rights may subscribe, at the Subscription Price (defined below),
for one
full Share. Assuming the exercise of all Rights, the Offer will
result in
an approximately 33.3% increase in the Trust’s common shares outstanding.
The Offer is not contingent upon any number of Rights being exercised.
The
subscription period commences on December 21, 2007 and ends at
5:00 p.m.,
Eastern time, on January 18, 2008, unless otherwise extended
(the
“Expiration Date”). See “The Offer—Terms of the Offer” on page
[·].
|
| |
|
The
Trust will bear the expenses of the Offer, which will be paid from
the
proceeds of the Offer. These expenses include, but are not limited
to, the
expenses of preparing and printing the prospectus for the Offer
and the
expenses of Trust counsel and the Trust’s independent registered public
accounting firm in connection with the
Offer.
|
|
|
|
The
subscription price (the “Subscription Price”) will be determined based on
a formula equal to 90% of the average of the last reported
sale prices of
the Trust’s common shares on the New York Stock Exchange (the “NYSE”) on
the Expiration Date and the four preceding trading days (the
“Formula
Price”). If, however, the Formula Price is less than 75% of the net
asset
value per common share on the Expiration Date, then the Subscription
Price
will be 75% of the Trust’s net asset value per common share on that day.
See “The Offer—The Subscription Price” on page
[·].
|
|
Over-Subscription
Privilege
|
|
Record
Date Shareholders who exercise all the Rights issued to them
(other than
those Rights that cannot be exercised because they represent
the right to
acquire less than one Share) are entitled to subscribe for additional
Shares at the same Subscription Price pursuant to the over-subscription
privilege, subject to certain limitations and subject to allotment.
Investors who are not Record Date Shareholders, but who otherwise
acquire
Rights to purchase Shares pursuant to the Offer, are not entitled
to
subscribe for any Shares pursuant to the over-subscription privilege.
To
the extent sufficient Shares are not available to honor all
over-subscription requests, unsubscribed Shares will be allocated
pro rata
among those Record Date Shareholders who over-subscribe based
on the
number of common shares of the Trust they owned on the Record
Date. See
“The Offer—Over-Subscription Privilege” on page
[·].
|
|
Sale
and Transferability of Rights
|
|
The
Rights will be listed for trading on the NYSE under the symbol
“HCF.RT”
during the course of the Offer. Trading in the Rights on the
NYSE may be
conducted until the close of trading on the NYSE on the last
business day
prior to the Expiration Date. The Trust and UBS Securities LLC,
the dealer
manager of the Offer (“UBS” or the “Dealer Manager”), will use their best
efforts to ensure that an adequate trading market for the Rights
will
exist, although there is no assurance that a market for the Rights
will
develop. Assuming a market exists for the Rights, the Rights
may be
purchased and sold through usual brokerage channels or sold through
the
Subscription Agent (defined below).
|
| |
|
Record
Date Shareholders who do not wish to exercise any of the Rights
issued to
them pursuant to the Offer may instruct the Subscription Agent
to sell any
unexercised Rights through or to the Dealer Manager. Subscription
certificates representing the Rights to be sold through or to
the Dealer
Manager must be received by the Subscription Agent by 5:00 p.m.,
Eastern
time, January 16, 2008 (or, if the subscription period is extended,
by
5:00 p.m., Eastern time, two business days prior to the extended
Expiration Date).
|
| |
|
Alternatively,
the Rights evidenced by a subscription certificate may be transferred
until the Expiration Date in whole or in part by endorsing the
subscription certificate for transfer in accordance with the accompanying
instructions. See “The Offer—Sale and Transferability” on page
[·].
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|
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Method
for Exercising Rights
|
|
Rights
are evidenced by subscription certificates that will be mailed
to Record
Date Shareholders (except as described below under “Requirements for
Foreign Shareholders”) or, if their common shares are held by Cede &
Co. or any other depository or nominee, to Cede & Co. or such other
depository or nominee. Rights may be exercised by filling in and
signing
the subscription certificate and mailing it in the envelope provided,
or
otherwise delivering the completed and signed subscription certificate
to
the Subscription Agent, together with payment at the estimated
Subscription Price for the Shares. Completed subscription certificates
and
payments must be received by the Subscription Agent by 5:00 p.m.,
Eastern
time, on the Expiration Date at the offices of the Subscription
Agent.
Rights also may be exercised by contacting your broker, banker
or trust
company, who can arrange, on your behalf, to guarantee delivery
of payment
and of a properly completed and executed subscription certificate.
A fee
may be charged for this service by your broker, banker or trust
company.
See “The Offer—Exercise of Rights” on page [·] and “The Offer—Payment for
Shares” on page [·].
|
|
Requirements
for Foreign Shareholders
|
|
Subscription
certificates will not be mailed to Record Date Shareholders whose
addresses are outside the United States (for these purposes,
the United
States includes the District of Columbia and the territories
and
possessions of the United States) (“Foreign Shareholders”). The
Subscription Agent will send a letter via regular mail to Foreign
Shareholders to notify them of the Offer. The Rights of Foreign
Shareholders will be held by the Subscription Agent for their
accounts
until instructions are received to exercise the Rights. If instructions
have not been received by 5:00 p.m., Eastern time, on January
15, 2008,
three business days prior to the Expiration Date (or, if the
subscription
period is extended, on or before three business days prior to
the extended
Expiration Date), the Rights of Foreign Shareholders will be
transferred
by the Subscription Agent to the Dealer Manager, who will either
purchase
the Rights or use its best efforts to sell the Rights. The net
proceeds,
if any, from sale of those Rights by or to the Dealer Manager
will be
remitted to these Foreign
Shareholders.
|
|
Important
Dates to Remember
|
Record
Date:
|
December
21, 2007
|
| |
|
|
| |
Subscription
Period:
|
December
21, 2007 to January 18, 2008*
|
| |
|
|
| |
Final
Date Rights Will Trade on NYSE:
|
January
17, 2008*
|
| |
|
|
| |
Expiration
Date and Pricing Date:
|
January
18, 2008*
|
| |
|
|
| |
Payment
for Shares Due or Notices of Guarantees of Delivery Due:
|
January
18, 2008*
|
| |
|
|
| |
|
|
| |
Payment
for Guarantees of Delivery Due:
|
January
24, 2008*
|
| |
|
|
| |
Confirmation
Mailed to Participants:
|
January
28, 2008*
|
| |
|
|
| |
Final
Payment for Shares Due:
|
February
11, 2008*†
|
| |
|
|
| |
*
Unless the Offer
is extended.
|
|
| |
|
| |
†
See “The Offer—Payment
for Shares” on page
[·].
|
|
Distribution
Arrangements.
|
|
UBS
will act as Dealer Manager for this Offer. Under the terms and
subject to
the conditions contained in the Dealer Manager Agreement among
the Dealer
Manager, the Trust and the Investment Adviser, the Dealer Manager
will
provide financial structuring services and marketing assistance
in
connection with the Offer and will solicit the exercise of Rights
and
participation in the over-subscription privilege. The Trust has
agreed to
pay the Dealer Manager a fee for its financial structuring, marketing
and
soliciting services equal to 3.50% of the aggregate Subscription
Price for
the Shares issued pursuant to the exercise of Rights and the
over-subscription privilege. The fees paid to the Dealer Manager
and other
expenses of the Offer will be borne by the Trust and indirectly
by all of
its shareholders, including those who do not exercise the Rights.
The
Dealer Manager will reallow a part of its fees to other broker-dealers
who
have assisted in soliciting the exercise of Rights. The Trust
and the
Investment Adviser have each agreed to indemnify the Dealer Manager
for or
contribute to losses arising out of certain liabilities, including
liabilities under the Securities Act of 1933, as amended (the
“Securities
Act”).
|
| |
|
Prior
to the expiration of the Offer, the Dealer Manager may independently
offer
for sale Shares it has acquired through purchasing and exercising
the
Rights, at prices it sets. Although the Dealer Manager may realize
gains
and losses in connection with purchases and sales of Shares, such
offering
of Shares is intended by the Dealer Manager to facilitate the Offer
and
any such gains or losses are not expected to be material to the
Dealer
Manager. The Dealer Manager’s fee for its financial structuring, marketing
and soliciting services is independent of any gains or losses that
may be
realized by the Dealer Manager through the purchase and exercise
of the
Rights and the sale of Shares. See “Distribution Arrangements” on page
[·].
|
|
Subscription
Agent
|
|
The
subscription agent for the Offer is The Colbent Corporation (“Subscription
Agent”).
|
| |
|
|
|
Information
Agent
|
|
The
information agent for the Offer is The Altman Group (“Information Agent”).
If you have questions or need further information about the Offer,
please
write the Information Agent at 1200 Wall Street West, 3rd
Fl., Lyndhurst, NJ 07071 or call (800) 370-1749.
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Listing
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The
Trust’s outstanding common shares are listed and trade on
the
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NYSE
under the symbol “HCF,” as will the Shares offered for subscription in the
Offer. The Rights are transferable and will be listed for trading
on the
NYSE under the symbol “HCF.RT” during the course of the
Offer.
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Use
of Proceeds
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The
net proceeds of the Offer will be invested in accordance with
the
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Trust’s
investment objectives and policies set forth below. Assuming
current
market conditions, the Trust estimates that the net proceeds
of the Offer
will be substantially invested in accordance with its investment
objectives and policies within one to three months of the completion
of
the Offer. Pending such investment, it is anticipated that the
proceeds of
the Offer will be invested in short-term debt securities. The
Trust does
not expect to use any part of the proceeds to repay some or all
of its
outstanding debt under the Loan Agreement. Following the completion
of the
Offer, the Trust may increase the amount of leverage outstanding.
See “Use
of Leverage.”
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Certain
Effects of the Offer
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The
Investment Adviser will benefit from the Offer because the investment
advisory fee is based on the Trust’s average weekly Managed Assets. It is
not possible to state precisely the amount of additional compensation
the
Investment Adviser will receive as a result of the Offer because
it is not
known how many Shares of the Trust will be subscribed for and
because the
proceeds of the Offer will be invested in additional portfolio
securities
which will fluctuate in value.
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Investment
Objectives and Policies
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The
Trust’s investment objectives are to provide both current income and
capital appreciation. The Trust seeks to achieve its investment
objectives
by investing primarily in the following categories of securities
and
instruments of corporations and other business entities: (i)
secured and
unsecured floating and fixed rate loans; (ii) bonds and other
debt
obligations; (iii) debt obligations of stressed, distressed and
bankrupt
issuers; (iv) structured products, including but not limited
to,
mortgage-backed and other asset-backed securities and collateralized
debt
obligations; and (v) equities. The Trust seeks to achieve its
capital
appreciation objective by investing in category (iii) and (v)
obligations
and securities, and to a lesser extent, in category (i), (ii),
and (iv)
obligations. Under normal market conditions, at least 80% of
the Trust’s
assets are invested in one or more of these principal investment
categories. Subject only to this general guideline, Highland
has broad
discretion to allocate the Trust’s assets among these investment
categories and to change allocations as conditions warrant. Within
the
categories of obligations and securities in which the Trust invests,
Highland employs various trading strategies, including capital
structure
arbitrage, pair trades and shorting. See “Portfolio Composition” for
further description of these strategies. The Trust may also invest
in
these categories of obligations and securities through the use
of
derivatives. A significant portion of the Trust’s assets may be invested
in securities rated below investment grade, which are commonly
referred to
as “junk securities.” Junk securities are subject to greater risk of loss
of principal and interest and may be less liquid than investment
grade
securities. Highland does not anticipate a high correlation between
the
performance of the Trust’s portfolio and the performance of the corporate
bond and equity markets. The Trust’s investment objectives may be changed
without shareholder approval. There can be no assurance that
the Trust’s
investment objectives will be achieved. See “The
Trust’s Investments—Investment Objectives and Policies.”
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Investment
Strategies
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Under
normal market conditions, the Trust invests across various markets
in
which the Investment Adviser holds significant investment experience:
primarily the leveraged loan, high yield, structured products and
stressed
and distressed markets. Highland makes investment decisions based
on
quantitative analysis, which employs sophisticated, data-intensive
models
to drive the investment process. The Highland has full discretion
regarding the capital markets from which it can access investment
opportunities in accordance with the investment limitations set
forth in
this prospectus.
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Highland
uses trading strategies to exploit pricing inefficiencies across
the
credit markets, or debt markets, and within an individual issuer’s capital
structure. Highland varies the Trust’s investments by strategy, industry,
security type and credit market, but reserves the right to re-position
the
Trust’s portfolio among these criteria depending on market dynamics,
and
thus the Trust may experience high portfolio turnover. Highland
manages
interest rate, default, currency and systemic risks through a variety
of
trading methods and market tools, including derivative hedging
instruments, as it deems appropriate.
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This
multi-strategy investment program allows Highland to assess what
it
considers to be the best opportunities across multiple markets
and to
adjust quickly the Trust’s trading strategies and market focus to changing
conditions. The Investment Adviser focuses primarily on the U.S.
marketplace, but may pursue opportunities in the non-U.S. credit
or
securities markets by investing up to 20% of the Trust’s assets in
non-U.S. credit or securities market
investments.
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The
Trust invests and trades in listed and unlisted, public and private,
rated
and unrated, debt and equity instruments and other obligations,
including
structured debt and equity instruments as well as financial derivatives.
Investments may include investments in stressed and distressed
positions,
which may include publicly-traded debt and equity securities, obligations
which were privately placed with banks, insurance companies and
other
lending institutions, trade claims, accounts receivable and any
other form
of obligation recognized as a claim in a bankruptcy or workout
process.
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As
part of its investment program, the Trust may invest, from time
to time,
in debt or synthetic instruments that are sold in direct placement
transactions between their issuers and their purchasers and that
are
neither listed on an exchange, nor traded over the counter. The
Trust may
also receive equity or equity-related securities in connection
with a
workout transaction or may invest directly in equity
securities.
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The
Trust may employ currency hedges (either in the forward or options
markets) in certain circumstances to reduce currency risk and may
engage
in other derivative transactions for hedging purposes or to enhance
total
return. The Trust may also lend securities and engage in short
sales of
securities. In addition, the Trust may invest in the securities
of
companies whose capital structures are highly
leveraged.
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From
time to time, the Investment Adviser may also invest a portion
of the
Trust’s assets in short-term U.S. Government obligations, certificates
of
deposit, commercial paper and other money market instruments, including
repurchase agreements with respect to such obligations to enable
the Trust
to make investments quickly and to serve as collateral with respect
to
certain of its investments. A greater percentage of Trust assets
may be
invested in such obligations if the Investment Adviser believes
that a
defensive position is appropriate because of the outlook for security
prices or in order to respond to adverse market, economic, business
or
political conditions. From time to time cash balances in the Trust’s
brokerage account may be placed in a money market fund. See “The
Trust’s Investments—Investment Strategies.”
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Use
of Leverage
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As
provided in the Investment Company Act of 1940 (the “Investment
Company Act”)
and subject to certain exceptions, the Trust may issue debt or
preferred
shares with the condition that immediately after issuance the value
of its
total assets, less certain ordinary course liabilities, exceed
300% of the
amount of the debt outstanding and exceed 200% of the sum of the
amount of
debt and preferred shares outstanding.
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Thus,
the Trust may issue leverage in the form of borrowings in an
amount up to
33 1/3% of the Trust’s total assets (including the proceeds of such
leverage) and may issue leverage in the form of preferred shares
in an
amount up to 50% of the Trust’s total assets (including the proceeds of
such leverage). The total leverage of the Trust is currently
expected to
range between 20% and 50% of the Trust’s total assets. The Trust seeks a
leverage ratio, based on a variety of factors including market
conditions
and the Investment Adviser’s market outlook, where the rate of return, net
of applicable Trust expenses, on the Trust’s portfolio investments
purchased with leverage exceeds the costs associated with such
leverage.
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The
Trust, as of November 30, 2007, is leveraged through borrowings
from a
credit facility in the amount of $227,000,000 or 26.17% of the
Trust’s
total assets (including the proceeds of such leverage). The Trust’s asset
coverage ratio as of November 30, 2007 was 382.2%. See “Principal
Risks of the Trust—Leverage Risk”
for a brief description of the Trust’s credit facility agreement with The
Bank of Nova Scotia.
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Following
the completion of the Offer, the Trust may increase the amount
of leverage
outstanding. The
Trust may engage in additional borrowings and/or issue preferred
shares in
order to maintain the Trust’s desired leverage ratio. Leverage creates a
greater risk of loss, as well as a potential for more gain, for
the common
shares than if leverage were not used. Interest on borrowings
(or
dividends on preferred shares) may be at a fixed or floating
rate and
generally will be based on short-term rates. The costs associated
with the
Fund’s use of leverage, including the issuance of such leverage and
the
payment of dividends or interest on such leverage, will be borne
entirely
by the holders of common shares. So long as the rate of return,
net of
applicable Trust expenses, on the Trust’s portfolio investments purchased
with leverage exceeds the costs associated with such leverage,
the Trust
will generate more return or income than will be needed to pay
such costs.
In this event, the excess will be available to pay higher dividends
to
holders of common shares. Conversely, if the Trust’s return on such assets
is less than the cost of leverage and other Trust expenses, the
return to
the holders of the common shares will diminish. Where leverage
is
employed, the net asset value and market price of the common
shares and
the yield to holders of common shares will be more volatile.
The Trust’s
leveraging strategy may not be successful. See “Principal
Risks of the Trust—Leverage Risk.”
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Principal
Risks of the Trust
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The
following is a summary of the principal risks associated with an
investment in the Trust’s common shares. Investors should also refer to
“Principal Risks of the Trust” in this prospectus for a more detailed
explanation of the risks associated with investing in the Trust’s common
shares.
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Investment
and Market Discount Risk.
An investment in the Trust’s common shares is subject to investment risk,
including the possible loss of the entire amount that you invest.
As with
any stock, the price of the Trust’s shares will fluctuate with market
conditions and other factors. If common shares are sold, the price
received may be more or less than the original investment. Common
shares
are designed for long-term investors and should not be treated
as trading
vehicles. Shares of closed-end management investment companies
frequently
trade at a discount to their net asset
value.
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Interest
Rate Risk.
Interest rate risk is the risk that debt securities, and the Trust’s net
assets, may decline in value because of changes in interest rates.
Generally, debt securities will decrease in value when interest
rates rise
and increase in value when interest rates decline. This means that
the net
asset value of the common shares will fluctuate with interest rate
changes
and the corresponding changes in the value of the Trust’s debt security
holdings.
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Prepayment
Risk.
If interest rates fall, the principal on bonds held by the Trust
may be
paid earlier than expected. If this happens, the proceeds from
a prepaid
security may be reinvested by the Trust in securities bearing lower
interest rates, resulting in a possible decline in the Trust’s income and
distributions to shareholders. The Trust may invest in pools of
mortgages
or other assets issued or guaranteed by private issuers or U.S.
government
agencies and instrumentalities. Mortgage-related securities are
especially
sensitive to prepayment risk because borrowers often refinance
their
mortgages when interest rates drop.
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Risks
of Investing in High-Yield Securities.
A
portion of the Trust’s investments will consist of investments that may
generally be characterized as “high-yield securities” or “junk
securities.” Such securities are typically rated below investment grade by
one or more nationally recognized statistical rating organizations
or are
unrated but of comparable credit quality to obligations rated below
investment grade, and have greater credit and liquidity risk than
more
highly rated obligations. High-yield securities are generally unsecured
and may be subordinate to other obligations of the obligor. The
lower
rating of high-yield securities reflects a greater possibility
that
adverse changes in the financial condition of the issuer or in
general
economic conditions (including, for example, a substantial period
of
rising interest rates or declining earnings) or both may impair
the
ability of the issuer to make payment of principal and interest.
Many
issuers of high-yield securities are highly leveraged, and their
relatively high debt to equity ratios create increased risks that
their
operations might not generate sufficient cash flow to service their
obligations. Overall declines in the below investment grade bond
and other
markets may adversely affect such issuers by inhibiting their ability
to
refinance their obligations at maturity.
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High-yield
securities are often issued in connection with leveraged acquisitions
or
recapitalizations in which the issuers incur a substantially higher
amount
of indebtedness than the level at which they had previously operated.
High-yield securities that are debt instruments have historically
experienced greater default rates than has been the case for investment
grade securities. The Trust may also invest in equity securities
issued by
entities whose obligations are unrated or are rated below investment
grade.
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The
Trust is authorized to invest in obligations of issuers which are
generally trading at significantly higher yields than had been
historically typical of the applicable issuer’s obligations. Such
investments may include debt obligations that have a heightened
probability of being in covenant or payment default in the future.
Such
investments generally are considered speculative. The repayment
of
defaulted obligations is subject to significant uncertainties.
Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest
or other
payments. Typically such workout or bankruptcy proceedings result
in only
partial recovery of cash payments or an exchange of the defaulted
security
for other debt or equity securities of the issuer or its affiliates,
which
may in turn be illiquid or speculative.
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High-yield
securities purchased by the Trust are subject to certain additional
risks
to the extent that such obligations may be unsecured and subordinated
to
substantial amounts of senior indebtedness, all or a significant
portion
of which may be secured. Moreover, such obligations purchased by
the Trust
may not be protected by financial covenants or limitations upon
additional
indebtedness and are unlikely to be secured by
collateral.
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Illiquidity
of Investments.
The investments made by the Trust may be very illiquid, and consequently,
the Trust may not be able to sell such investments at prices that
reflect
the Investment Adviser’s assessment of their fair value or the amount paid
for such investments by the Trust. Illiquidity may result from
the absence
of an established market for the investments as well as legal,
contractual
or other restrictions on their resale by the Trust and other factors.
Furthermore, the nature of the Trust’s investments, especially those in
financially stressed and distressed companies, may require a long
holding
period prior to being able to determine whether the investment
will be
profitable or not. There is no limit on the amount of the Trust’s
portfolio that can be invested in illiquid securities.
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Risks
of Investing in Senior Loans.
Senior loans, such as bank loans, are typically at the most senior
level
of the capital structure, and are sometimes secured by specific
collateral, including, but not limited to, trademarks, patents,
accounts
receivable, inventory, equipment, buildings, real estate, franchises
and
common and preferred stock of the obligor or its affiliates. A
portion of
the Trust’s investments may consist of loans and participations therein
originated by banks and other financial institutions, typically
referred
to as “bank loans.” The Trust’s investments may include loans of a type
generally incurred by borrowers in connection with highly leveraged
transactions, often to finance internal growth, acquisitions, mergers
or
stock purchases, or for other reasons. As a result of the additional
debt
incurred by the borrower in the course of the transaction, the
borrower’s
creditworthiness is often judged by the rating agencies to be below
investment grade. Such loans are typically private corporate loans
which
are negotiated by one or more commercial banks or financial institutions
and syndicated among a group of commercial banks and financial
institutions. In order to induce the lenders to extend credit and
to offer
a favorable interest rate, the borrower often provides the lenders
with
extensive information about its business which is not generally
available
to the public.
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Bank
loans often contain restrictive covenants designed to limit the
activities
of the borrower in an effort to protect the right of lenders to
receive
timely payments of principal and interest. Such covenants may include
restrictions on dividend payments, specific mandatory minimum financial
ratios, limits on total debt and other financial tests. Bank loans
usually
have shorter terms than subordinated obligations and may require
mandatory
prepayments from excess cash flow, asset dispositions and offerings
of
debt and/or equity securities. The bank loans and other debt obligations
to be acquired by the Trust are likely to be below investment
grade.
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The
Trust may acquire interests in bank loans and other debt obligations
either directly (by way of sale or assignment) or indirectly (by
way of
participation). The purchaser of an assignment typically succeeds
to all
the rights and obligations of the assigning institution and becomes
a
lender under the credit agreement with respect to the debt obligation;
however, its rights can be more restricted than those of the assigning
institution, and, in any event, the Trust may not be able unilaterally
to
enforce all rights and remedies under the loan and any associated
collateral. A participation interest in a portion of a debt obligation
typically results in a contractual relationship only with the institution
participating out the interest, not with the borrower. In purchasing
participations, the Trust generally will have no right to enforce
compliance by the borrower with either the terms of the loan agreement
or
any rights of setoff against the borrower, and the Trust may not
directly
benefit from the collateral supporting the debt obligation in which
it has
purchased the participation. As a result, the Trust will be exposed
to the
credit risk of both the borrower and the institution selling the
participation.
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Purchasers
of bank loans are predominantly commercial banks, investment trusts
and
investment banks. As secondary market trading volumes increase,
new bank
loans frequently adopt standardized documentation to facilitate
loan
trading which should improve market liquidity. There can be no
assurance,
however, that future levels of supply and demand in bank loan trading
will
provide an adequate degree of liquidity or that the current level
of
liquidity will continue. Because of the provision to holders of
such loans
of confidential information relating to the borrower, the unique
and
customized nature of the loan agreement, the limited universe of
eligible
purchasers and the private syndication of the loan, bank loans
are not as
easily purchased or sold as a publicly traded security, and historically
the trading volume in the bank loan market has been small relative
to the
high-yield debt market.
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Second
Lien Loans Risk.
Second lien loans are subject to the same risks associated with
investment
in senior loans and non-investment grade securities. However, second
lien
loans are second in right of payment to senior loans and therefore
are
subject to additional risk that the cash flow of the borrower and
any
property securing the loan may be insufficient to meet scheduled
payments
after giving effect to the senior secured obligations of the borrower.
Second lien loans are expected to have greater price volatility
than
senior loans and may be less liquid. There is also a possibility
that
originators will not be able to sell participations in second lien
loans,
which would create greater credit risk exposure.
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Other
Secured Loans Risk.
Secured loans other than senior loans and second lien loans are
subject to
the same risks associated with investment in senior loans, second
lien
loans and non-investment grade securities. However, such loans
may rank
lower in right of payment than any outstanding senior loans and
second
lien loans of the borrower and therefore are subject to additional
risk
that the cash flow of the borrower and any property securing the
loan may
be insufficient to meet scheduled payments after giving effect
to the
higher ranking secured obligations of the borrower. Lower ranking
secured
loans are expected to have greater price volatility than senior
loans and
second lien loans and may be less liquid. There is also a possibility
that
originators will not be able to sell participations in lower ranking
secured loans, which would create greater credit risk
exposure.
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Unsecured
Loans Risk.
Unsecured loans are subject to the same risks associated with investment
in senior loans, second lien loans, other secured loans and non-investment
grade securities. However, because unsecured loans have lower priority
in
right of payment to any higher ranking obligations of the borrower
and are
not backed by a security interest in any specific collateral, they
are
subject to additional risk that the cash flow of the borrower and
available assets may be insufficient to meet scheduled payments
after
giving effect to any higher ranking obligations of the borrower.
Unsecured
loans are expected to have greater price volatility than senior
loans,
second lien loans and other secured loans and may be less liquid.
There is
also a possibility that originators will not be able to sell
participations in unsecured loans, which would create greater credit
risk
exposure.
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Risks
of Investing in Obligations of Stressed, Distressed and Bankrupt
Issuers.
The Trust is authorized to invest in the securities and other obligations
of stressed, distressed and bankrupt issuers, including debt obligations
that are in covenant or payment default. There is no limit on the
amount
of the Trust’s portfolio that can be invested in stressed, distressed or
bankrupt issuers, and the Trust may invest for purposes of control.
Such
investments generally trade significantly below par and are considered
speculative. The repayment of defaulted obligations is subject
to
significant uncertainties. Defaulted obligations might be repaid
only
after lengthy workout or bankruptcy proceedings, during which the
issuer
might not make any interest or other payments. Typically such workout
or
bankruptcy proceedings result in only partial recovery of cash
payments or
an exchange of the defaulted obligation for other debt or equity
securities of the issuer or its affiliates, which may in turn be
illiquid
or speculative.
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There
are a number of significant risks inherent in the bankruptcy process.
First, many events in a bankruptcy are the product of contested
matters
and adversary proceedings and are beyond the control of the creditors.
While creditors are generally given an opportunity to object to
significant actions, there can be no assurance that a bankruptcy
court in
the exercise of its broad powers would not approve actions that
would be
contrary to the interests of the Trust. Second, a bankruptcy filing
by an
issuer may adversely and permanently affect the issuer. The issuer
may
lose its market position and key employees and otherwise become
incapable
of restoring itself as a viable entity. If for this or any other
reason
the proceeding is converted to a liquidation, the value of the
issuer may
not equal the liquidation value that was believed to exist at the
time of
the investment. Third, the duration of a bankruptcy proceeding
is
difficult to predict. A creditor’s return on investment can be adversely
affected by delays while the plan of reorganization is being negotiated,
approved by the creditors and confirmed by the bankruptcy court
and until
it ultimately becomes effective. Fourth, the administrative costs
in
connection with a bankruptcy proceeding are frequently high and
would be
paid out of the debtor’s estate prior to any return to creditors. For
example, if a proceeding involves protracted or difficult litigation,
or
turns into a liquidation, substantial assets may be devoted to
administrative costs. Fifth, bankruptcy law permits the classification
of
“substantially similar” claims in determining the classification of claims
in a reorganization. Because the standard for classification is
vague,
there exists the risk that the Trust’s influence with respect to the class
of securities or other obligations it owns can be lost by increases
in the
number and amount of claims in that class or by different classification
and treatment. Sixth, in the early stages of the bankruptcy process
it is
often difficult to estimate the extent of, or even to identify,
any
contingent claims that might be made. Seventh, especially in the
case of
investments made prior to the commencement of bankruptcy proceedings,
creditors can lose their ranking and priority if they exercise
“domination
and control” over a debtor and other creditors can demonstrate that they
have been harmed by such actions. Eighth, certain claims that have
priority by law (for example, claims for taxes) may be
substantial.
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In
any investment involving stressed and distressed debt obligations,
there
exists the risk that the transaction involving such debt obligations
will
be unsuccessful, take considerable time or will result in a distribution
of cash or a new security or obligation in exchange for the stressed
and
distressed debt obligations, the value of which may be less than
the
Trust’s purchase price of such debt obligations. Furthermore, if an
anticipated transaction does not occur, the Trust may be required
to sell
its investment at a loss. Given the substantial uncertainties concerning
transactions involving stressed and distressed debt obligations
in which
the Trust invests, there is a potential risk of loss by the Trust
of its
entire investment in any particular
investment.
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Investments
in companies operating in workout modes or under Chapter 11 of
the
Bankruptcy Code are also, in certain circumstances, subject to
certain
additional liabilities which may exceed the value of the Trust’s original
investment in a company. For example, under certain circumstances,
creditors who have inappropriately exercised control over the management
and policies of a debtor may have their claims subordinated or
disallowed
or may be found liable for damages suffered by parties as a result
of such
actions. The Investment Adviser’s active management style may present a
greater risk in this area than would a more passive approach. In
addition,
under certain circumstances, payments to the Trust and distributions
by
the Trust or payments on the debt may be reclaimed if any such
payment is
later determined to have been a fraudulent conveyance or a preferential
payment.
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The
Investment Adviser on behalf of the Trust may participate on committees
formed by creditors to negotiate with the management of financially
troubled companies that may or may not be in bankruptcy or may
negotiate
directly with debtors with respect to restructuring issues. If
the Trust
does choose to join a committee, the Trust would likely be only
one of
many participants, all of whom would be interested in obtaining
an outcome
that is in their individual best interests. There can be no assurance
that
the Trust would be successful in obtaining results most favorable
to it in
such proceedings, although the Trust may incur significant legal
and other
expenses in attempting to do so. As a result of participation by
the Trust
on such committees, the Trust may be deemed to have duties to other
creditors represented by the committees, which might thereby expose
the
Trust to liability to such other creditors who disagree with the
Trust’s
actions. Participation by the Trust on such committees may cause
the Trust
to be subject to certain restrictions on its ability to trade in
a
particular investment and may also make the Trust an “insider” or an
“underwriter” for purposes of the federal securities laws. Either
circumstance will restrict the Trust’s ability to trade in or acquire
additional positions in a particular investment when it might otherwise
desire to do so.
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Insolvency
Considerations with Respect to Issuers of Debt
Obligations.
Various laws enacted for the protection of creditors may apply
to the debt
obligations held by the Trust. The information in this paragraph
is
applicable with respect to U.S. issuers subject to United States
bankruptcy laws. Insolvency considerations may differ with respect
to
other issuers. If a court in a lawsuit brought by an unpaid creditor
or
representative of creditors of an issuer of a debt obligation,
such as a
trustee in bankruptcy, were to find that the issuer did not receive
fair
consideration or reasonably equivalent value for incurring the
indebtedness constituting the debt obligation and, after giving
effect to
such indebtedness, the issuer (i) was insolvent, (ii) was engaged
in a
business for which the remaining assets of such issuer constituted
unreasonably small capital or (iii) intended to incur, or believed
that it
would incur, debts beyond its ability to pay such debts as they
mature,
such court could determine to invalidate, in whole or in part,
such
indebtedness as a fraudulent conveyance, to subordinate such indebtedness
to existing or future creditors of such issuer, or to recover amounts
previously paid by such issuer in satisfaction of such indebtedness.
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The
measure of insolvency for purposes of the foregoing will vary.
Generally,
an issuer would be considered insolvent at a particular time if
the sum of
its debts were then greater than all of its property at a fair
valuation,
or if the present fair saleable value of its assets was then less
than the
amount that would be required to pay its probable liabilities on
its
existing debts as they became absolute and matured. There can be
no
assurance as to what standard a court would apply in order to determine
whether the issuer was “insolvent” after giving effect to the incurrence
of the indebtedness constituting the debt obligation or that, regardless
of the method of valuation, a court would not determine that the
issuer
was “insolvent” upon giving effect to such incurrence. In addition, in the
event of the insolvency of an issuer of a debt obligation, payments
made
on such debt obligation could be subject to avoidance as a “preference” if
made within a certain period of time (which may be as long as one
year)
before insolvency. Similarly, a court might apply the doctrine
of
equitable subordination to subordinate the claim of a lending institution
against an issuer, to claims of other creditors of the borrower,
when the
lending institution, another investor, or any of their transferees,
is
found to have engaged in unfair, inequitable, or fraudulent conduct.
In
general, if payments on a debt obligation are avoidable, whether
as
fraudulent conveyances or preferences, such payments can be recaptured
either from the initial recipient (such as the Trust) or from subsequent
transferees of such payments (such as the investors in the Trust).
To the
extent that any such payments are recaptured from the Trust the
resulting
loss will be borne by the investors. However, a court in a bankruptcy
or
insolvency proceeding would be able to direct the recapture of
any such
payment from such a recipient or transferee only to the extent
that such
court has jurisdiction over such recipient or transferee or its
assets.
Moreover, it is likely that avoidable payments could not be recaptured
directly from any such recipient or transferee that has given value
in
exchange for its note, in good faith and without knowledge that
the
payments were avoidable. Although the Investment Adviser will seek
to
avoid conduct that would form the basis for a successful cause
of action
based upon fraudulent conveyance, preference or equitable subordination,
these determinations are made in hindsight, and, in any event,
there can
be no assurance as to whether any lending institution or other
investor
from which the Trust acquired the debt obligations engaged in any
such
conduct (or any other conduct that would subject the debt obligations
and
the issuer to insolvency laws) and, if it did, as to whether such
creditor
claims could be asserted in a U.S. court (or in the courts of any
other
country) against the Trust.
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Leverage
Risk.
The Trust currently leverages through borrowings from a credit
facility.
The use of leverage, which can be described as exposure to changes in
price at a ratio greater than the amount of equity invested, through
borrowings, the issuance of preferred shares, or other forms of
market
exposure, magnifies both the favorable and unfavorable effects
of price
movements in the investments made by the Trust. Insofar as the
Trust
continues to employ leverage in its investment operations, the
Trust will
be subject to substantial risks of
loss.
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The
Trust currently leverages through borrowings from a credit facility.
The
Trust has entered into a revolving credit agreement with The
Bank of Nova
Scotia (“Scotia”)
to borrow up to $300,000,000 (the “Loan
Agreement”).
Such borrowings constitute financial leverage. The Loan Agreement
contains
covenants that may limit the Trust’s ability to, without the prior consent
of Scotia: (i) pay dividends in certain circumstances, (ii) incur
additional debt, (iii) change its investment objectives, policies
and
restrictions as set forth in the Trust’s prospectus in effect when the
Loan Agreement became effective and (iv) adopt or carry out any
plan of
liquidation, reorganization, incorporation, recapitalization,
merger or
consolidation or sell, transfer or otherwise dispose of all or
a
substantial part of its assets. For instance, the Trust agreed
not to
purchase assets not contemplated by the investment policies and
restrictions in effect when the Loan Agreement became effective.
Furthermore, the Trust may not incur additional debt from any
other party,
except for in limited circumstances (e.g.,
in the ordinary course of business). In addition, the Loan Agreement
contains a covenant requiring asset coverage ratios that may
be more
stringent than those required by the Investment Company Act.
Such
restrictions shall apply only so long as the Loan Agreement remains
in
effect. Any senior security representing indebtedness, as defined
in
Section 18(g) of the Investment Company Act, must have asset
coverage of
at least 300%. Debt incurred under the Loan Agreement will be
considered a
senior security for this purpose.
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In
order to obtain and maintain the required ratings of loans made
under the
Loan Agreement or another credit facility, the Trust must comply
with
investment quality, diversification and other guidelines established
by
Moody’s and/or S&P or the credit facility, respectively. The Trust
does not anticipate that such guidelines will have a material
adverse
effect on the Trust’s common shareholders or its ability to achieve its
investment objectives. Moody’s and S&P receive fees in connection with
their ratings issuances.
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Common
Stock Risk.
The Trust may have exposure to common stocks. Although common
stocks have
historically generated higher average total returns than fixed
income
securities over the long-term, common stocks also have historically
experienced significantly more volatility in those returns. Therefore,
the
Trust’s exposure to common stocks could result in worse performance
than
would be the case had the Trust been invested solely in debt
securities.
An adverse event, such as an unfavorable earnings report, may
depress the
value of a particular common stock held by the Trust. Also, the
price of
common stock is sensitive to general movements in the stock market
and a
drop in the stock market may depress the price of a common stock
to which
the Trust has exposure. Common stock prices fluctuate for several
reasons,
including changes in investors’ perceptions of the financial condition of
an issuer or the general condition of the relevant stock market,
or when
political or economic events affecting the issuers occur. In
addition,
common stock prices may be particularly sensitive to rising interest
rates, as the cost of capital rises and borrowing costs
increase.
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Dividend
Risk.
Dividends on common stock are not fixed but are declared at the
discretion
of an issuer’s board of directors. There is no guarantee that the issuers
of the common stocks in which the Trust invests will declare dividends
in
the future or that, if declared, the dividends will remain at current
levels or increase over time
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Small
and Mid-Cap Securities Risk.
The Trust may invest in companies with small or medium-sized
capitalizations. Securities issued by small and medium-sized companies
can
be more volatile than, and perform differently from, larger company
securities. There may be less trading in a small or medium company’s
securities, which means that buy and sell transactions in those
securities
could have a larger impact on the security’s price than is the case with
larger company securities. Small and medium-sized companies may
have fewer
business lines; changes in any one line of business, therefore,
may have a
greater impact on a small or medium-sized company’s security price than is
the case for a larger company. In addition, small or medium-sized
company
securities may not be well known to the investing
public.
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Non-U.S.
Securities Risk.
The Trust may invest up to 20% of its total assets in non-U.S.
securities,
including emerging market securities. Investing in non-U.S. securities
involves certain risks not involved in domestic investments, including,
but not limited to: (i) fluctuations in foreign currency exchange
rates;
(ii) future foreign economic, financial, political and social
developments; (iii) different legal systems; (iv) the possible
imposition
of exchange controls or other foreign governmental laws or restrictions;
(v) lower trading volume; (vi) much greater price volatility and
illiquidity of certain non-U.S. securities markets; (vii) different
trading and settlement practices; (viii) less governmental supervision;
(ix) high and volatile rates of inflation; (x) fluctuating interest
rates;
(xi) less publicly available information; and (xii) different accounting,
auditing and financial recordkeeping standards and
requirements.
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Certain
countries in which the Trust may invest, especially emerging market
countries, historically have experienced, and may continue to experience,
high rates of inflation, high interest rates, exchange rate fluctuations,
large amounts of external debt, balance of payments and trade difficulties
and extreme poverty and unemployment. Many of these countries are
also
characterized by political uncertainty and instability. These risks
are
especially evident in the Middle East and West Africa. The cost
of
servicing external debt will generally be adversely affected by
rising
international interest rates because many external debt obligations
bear
interest at rates which are adjusted based upon international interest
rates. In addition, with respect to certain foreign countries,
there is a
risk of: (i) the possibility of expropriation or nationalization
of
assets; (ii) confiscatory taxation; (iii) difficulty in obtaining
or
enforcing a court judgment; (iv) economic, political or social
instability; and (v) diplomatic developments that could affect
investments
in those countries. In addition, individual foreign economies may
differ
favorably or unfavorably from the U.S. economy in such respects
as: (i)
growth of gross domestic product; (ii) rates of inflation; (iii)
capital
reinvestment; (iv) resources; (v) self-sufficiency; and (vi) balance
of
payments position.
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As
a result of these potential risks, Highland may determine that,
notwithstanding otherwise favorable investment criteria, it may
not be
practicable or appropriate to invest in a particular country. The
Trust
may invest in countries in which foreign investors, including Highland,
have had no or limited prior experience.
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Emerging
Markets Risk.
The Trust may invest up to 20% of its total assets in securities
of
issuers based in emerging markets. Investing in securities of issuers
based in emerging markets entails all of the risks of investing
in
securities of non-U.S. issuers to a heightened degree. Emerging
market
countries generally include every nation in the world except the
United
States, Canada, Japan, Australia, New Zealand and most countries
located
in Western Europe. These heightened risks include: (i) greater
risks of
expropriation, confiscatory taxation, nationalization, and less
social,
political and economic stability; (ii) the smaller size of the
markets for
such securities and a lower volume of trading, resulting in lack
of
liquidity and in price volatility; and (iii) certain national policies
which may restrict the Trust’s investment opportunities including
restrictions on investing in issuers or industries deemed sensitive
to
relevant national interests.
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Foreign
Currency Risk.
Because the Trust may invest in securities denominated or quoted
in
currencies other than the U.S. dollar, changes in foreign currency
exchange rates may affect the value of securities owned by the
Trust, the
unrealized appreciation or depreciation of investments and gains
on and
income from investments. Currencies of certain countries may be
volatile
and therefore may affect the value of securities denominated in
such
currencies, which means that the Trust’s net asset value could decline as
a result of changes in the exchange rates between foreign currencies
and
the U.S. dollar. These risks often are heightened for investments
in
smaller, emerging capital markets. In addition, the Trust may enter
into
foreign currency transactions in an attempt to enhance total return
which
may further expose the Trust to the risks of foreign currency movements
and other risks. The use of foreign currency transactions can result
in
the Trust incurring losses as a result of the imposition of exchange
controls, suspension of settlements or the inability of the Trust
to
deliver or receive a specified currency.
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Investments
in Unseasoned Companies.
The Trust may invest in the securities of less seasoned companies.
These
investments may present greater opportunities for growth, but also
involve
greater risks than customarily are associated with investments
in
securities of more established companies. Some of the companies
in which
the Trust may invest will be start-up companies which may have
insubstantial operational or earnings history or may have limited
products, markets, financial resources or management depth. Some
may also
be emerging companies at the research and development stage with
no
products or technologies to market or approved for marketing. Securities
of emerging companies may lack an active secondary market and may
be
subject to more abrupt or erratic price movements than securities
of
larger, more established companies or stock market averages in
general.
Competitors of certain companies may have substantially greater
financial
resources than many of the companies in which the Trust may
invest.
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Initial
Public Offerings Risk.
The Trust may invest in shares of companies through initial public
offerings (“IPOs”). IPOs and companies that have recently gone public have
the potential to produce substantial gains for the Trust. However,
there
is no assurance that the Trust will have access to profitable IPOs.
The
investment performance of the Trust during periods when it is unable
to
invest significantly or at all in IPOs may be lower than during
periods
when the Trust is able to do so. Securities issued in IPOs are
subject to
many of the same risks as investing in companies with smaller market
capitalizations. Securities issued in IPOs have no trading history,
and
information about the companies may be available for limited periods
of
time. In addition, the prices of securities sold in IPOs may be
highly
volatile or may decline shortly after the
IPO.
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Securities
Lending Risk.
The Trust may lend its portfolio securities (up to a maximum of
one-third
of its total assets) to banks or dealers which meet the creditworthiness
standards established by the board of trustees of the Trust. Securities
lending is subject to the risk that loaned securities may not be
available
to the Trust on a timely basis and the Trust may, therefore, lose
the
opportunity to sell the securities at a desirable price. Any loss
in the
market price of securities loaned by the Trust that occurs during
the term
of the loan would be borne by the Trust and would adversely affect
the
Trust’s performance. Also, there may be delays in recovery, or no
recovery, of securities loaned or even a loss of rights in the
collateral
provided by the borrower should the borrower of the securities
fail
financially while the loan is outstanding. Although the Trust generally
has the ability to recall loaned securities pursuant to a securities
lending arrangement in the event that a shareholder vote is held,
there is
a risk that any delay in recovery of such security will result
in the
holder of such security being unable to vote. All of the aforementioned
risks may be greater for non-U.S. securities.
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Risks
Associated with Options on Securities.
There are several risks associated with transactions in options
on
securities. For example, there are significant differences between
the
securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction
not to
achieve its objectives. A decision as to whether, when and how
to use
options involves the exercise of skill and judgment, and even a
well
conceived transaction may be unsuccessful to some degree because
of market
behavior or unexpected events.
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As
the writer of a covered call option, the Trust foregoes, during
the
option’s life, the opportunity to profit from increases in the market
value of the security covering the call option above the sum of
the
premium and the strike price of the call, but has retained the
risk of
loss should the price of the underlying security decline. As the
Trust
writes covered calls over more of its portfolio, its ability to
benefit
from capital appreciation becomes more limited. The writer of an
option
has no control over the time when it may be required to fulfill
its
obligation as a writer of the option. Once an option writer has
received
an exercise notice, it cannot effect a closing purchase transaction
in
order to terminate its obligation under the option and must deliver
the
underlying security at the exercise price.
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When
the Trust writes covered put options, it bears the risk of loss
if the
value of the underlying stock declines below the exercise price
minus the
put premium. If the option is exercised, the Trust could incur
a loss if
it is required to purchase the stock underlying the put option
at a price
greater than the market price of the stock at the time of exercise
plus
the put premium the Trust received when it wrote the option. While
the
Trust’s potential gain in writing a covered put option is limited to
distributions earned on the liquid assets securing the put option
plus the
premium received from the purchaser of the put option, the Trust
risks a
loss equal to the entire exercise price of the option minus the
put
premium.
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Exchange-Listed
Option Risks.
There can be no assurance that a liquid market will exist when
the Trust
seeks to close out an option position on an options exchange. Reasons
for
the absence of a liquid secondary market on an exchange include
the
following: (i) there may be insufficient trading interest in certain
options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts,
suspensions or other restrictions may be imposed with respect to
particular classes or series of options; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v)
the
facilities of an exchange or the Options Clearing Corporation may
not at
all times be adequate to handle current trading volume; or (vi)
one or
more exchanges could, for economic or other reasons, decide or
be
compelled at some future date to discontinue the trading of options
(or a
particular class or series of options). If trading were discontinued,
the
secondary market on that exchange (or in that class or series of
options)
would cease to exist. However, outstanding options on that exchange
that
had been issued by the Options Clearing Corporation as a result
of trades
on that exchange would continue to be exercisable in accordance
with their
terms. If the Trust were unable to close out a covered call option
that it
had written on a security, it would not be able to sell the underlying
security unless the option expired without exercise.
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The
hours of trading for options on an exchange may not conform to
the hours
during which the underlying securities are traded. To the extent
that the
options markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying
markets that cannot be reflected in the options markets. Call options
are
marked to market daily and their value will be affected by changes
in the
value and dividend rates of the underlying common stocks, an increase
in
interest rates, changes in the actual or perceived volatility of
the stock
market and the underlying common stocks and the remaining time
to the
options’ expiration. Additionally, the exercise price of an option may be
adjusted downward before the option’s expiration as a result of the
occurrence of certain corporate events affecting the underlying
equity
security, such as extraordinary dividends, stock splits, merger
or other
extraordinary distributions or events. A reduction in the exercise
price
of a call option written by the Trust would reduce the Trust’s capital
appreciation potential on the underlying security.
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Over-the-Counter
Option Risk.
The Trust may write (sell) unlisted (“OTC”
or “over-the-counter”)
options. Options written by the Trust with respect to non-U.S.
securities,
indices or sectors generally will be OTC options. OTC options differ
from
exchange-listed options in that they are two-party contracts, with
exercise price, premium and other terms negotiated between buyer
and
seller, and generally do not have as much market liquidity as
exchange-listed options. The counterparties to these transactions
typically will be major international banks, broker-dealers and
financial
institutions. The Trust may be required to treat as illiquid those
securities being used to cover certain written OTC options. The
OTC
options written by the Trust will not be issued, guaranteed or
cleared by
the Options Clearing Corporation. In addition, the Trust’s ability to
terminate the OTC options may be more limited than with exchange-traded
options. Banks, broker-dealers or other financial institutions
participating in such transaction may fail to settle a transaction
in
accordance with the terms of the option as written. In the event
of
default or insolvency of the counterparty, the Trust may be unable
to
liquidate an OTC option position.
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Index
Option Risk.
The Trust may sell index put and call options from time to time.
The
purchaser of an index put option has the right to any depreciation
in the
value of the index below the exercise price of the option on or
before the
expiration date. The purchaser of an index call option has the
right to
any appreciation in the value of the index over the exercise price
of the
option on or before the expiration date. Because the exercise of
an index
option is settled in cash, sellers of index call options, such
as the
Trust, cannot provide in advance for their potential settlement
obligations by acquiring and holding the underlying securities.
The Trust
will lose money if it is required to pay the purchaser of an index
option
the difference between the cash value of the index on which the
option was
written and the exercise price and such difference is greater than
the
premium received by the Trust for writing the option. The value
of index
options written by the Trust, which will be priced daily, will
be affected
by changes in the value and dividend rates of the underlying common
stocks
in the respective index, changes in the actual or perceived volatility
of
the stock market and the remaining time to the options’ expiration. The
value of the index options also may be adversely affected if the
market
for the index options becomes less liquid or smaller. Distributions
paid
by the Trust on its common shares may be derived in part from the
net
index option premiums it receives from selling index put and call
options,
less the cost of paying settlement amounts to purchasers of the
options
that exercise their options. Net index option premiums can vary
widely
over the short term and long term.
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Asset-Backed
Securities Risk.
Payment of interest and repayment of principal on asset-backed
securities
may be largely dependent upon the cash flows generated by the assets
backing the securities and, in certain cases, supported by letters
of
credit, surety bonds or other credit enhancements. Asset-backed
security
values may also be affected by the creditworthiness of the servicing
agent
for the pool, the originator of the loans or receivables or the
entities
providing the credit enhancement. In addition, the underlying assets
are
subject to prepayments that shorten the securities’ weighted average
maturity and may lower their
return.
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Mortgage-Backed
Securities Risk.
A
mortgage-backed security, which represents an interest in a pool
of assets
such as mortgage loans, will mature when all the mortgages in the
pool
mature or are prepaid. Therefore, mortgage-backed securities do
not have a
fixed maturity, and their expected maturities may vary when interest
rates
rise or fall.
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When
interest rates fall, homeowners are more likely to prepay their
mortgage
loans. An increased rate of prepayments on the Trust’s mortgage-backed
securities will result in an unforeseen loss of interest income
to the
Trust as the Trust may be required to reinvest assets at a lower
interest
rate. Because prepayments increase when interest rates fall, the
price of
mortgage-backed securities does not increase as much as other fixed
income
securities when interest rates fall.
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When
interest rates rise, homeowners are less likely to prepay their
mortgage
loans. A decreased rate of prepayments lengthens the expected maturity
of
a mortgage-backed security. Therefore, the prices of mortgage-backed
securities may decrease more than prices of other fixed income
securities
when interest rates rise.
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Derivatives
Risk.
The Trust may engage in derivative transactions for hedging and
speculative purposes or to enhance total return, including options,
futures, swaps, foreign currency transactions and forward foreign
currency
contracts, currency swaps or options on currency and currency futures
(“Derivative
Transactions”).
Derivative Transactions involve risks, including the imperfect
correlation
between the value of such instruments and the underlying assets,
the
possible default of the other party to the transaction or illiquidity
of
the derivative instruments. The ability to successfully use Derivative
Transactions depends on the Investment Adviser’s ability to predict
pertinent market movements, which cannot be assured. The use of
Derivative
Transactions may result in losses greater than if they had not
been used,
may require the Trust to sell or purchase portfolio securities
at
inopportune times or for prices other than current market values,
may
limit the amount of appreciation the Trust can realize on an investment
or
may cause the Trust to hold a security that it might otherwise
sell. The
use of foreign currency transactions can result in the Trust’s incurring
losses as a result of the imposition of exchange controls, suspension
of
settlements or the inability of the Trust to deliver or receive
a
specified currency. Additionally, amounts paid by the Trust as
premiums
and cash or other assets held in margin accounts with respect to
Derivative Transactions are not otherwise available to the Trust
for
investment purposes.
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To
the extent that the Trust purchases options pursuant to a hedging
strategy, the Trust will be subject to the following additional
risks. If
a put or call option purchased by the Trust is not sold or exercised,
the
Trust will lose its entire investment in the
option.
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Where
a put or call option on a particular security is purchased to hedge
against price movements in a related security, the price of the
put or
call option may move more or less than the price of the related
security.
If restrictions on exercise were imposed, the Trust might be unable
to
exercise an option it had purchased. If the Trust were unable to
close out
an option that it had purchased on a security, it would have to
exercise
the option in order to realize any profit or the option may expire
worthless.
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Market
Risk Generally.
The profitability of a significant portion of the Trust’s investment
program depends to a great extent upon correctly assessing the
future
course of the price movements of securities and other investments
and the
movements of interest rates. There can be no assurance that the
Investment
Adviser will be able to predict accurately these price and interest
rate
movements. With respect to certain investment strategies the Trust
utilizes, there is a high degree of market risk.
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Reinvestment
Risk.
The Trust reinvests the cash flows received from a security. The
additional income from such reinvestment, sometimes called
interest-on-interest, is reliant on the prevailing interest rate
levels at
the time of reinvestment. There is a risk that the interest rate
at which
interim cash flows can be reinvested will fall. Reinvestment risk
is
greater for longer holding periods and for securities with large,
early
cash flows such as high-coupon bonds. Reinvestment risk also applies
generally to the reinvestment of the proceeds the Trust receives
upon the
maturity or sale of a portfolio security.
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Timing
Risk.
Many agency, corporate and municipal bonds, and most mortgage-backed
securities, contain a provision that allows the issuer to “call” all or
part of the issue before the bond’s maturity date, often after five or ten
years. The issuer usually retains the right to refinance the bond
in the
future if market interest rates decline below the coupon rate.
There are
three disadvantages to the call provision. First, the cash flow
pattern of
a callable bond is not known with certainty. Second, because an
issuer is
more likely to call the bonds when interest rates have dropped,
the Trust
is exposed to reinvestment risk, i.e.,
the Trust may have to reinvest at lower interest rates the proceeds
received when the bond is called. Finally, the capital appreciation
potential of a bond will be reduced because the price of a callable
bond
may not rise much above the price at which the issuer may call
the
bond.
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Inflation
Risk.
Inflation risk results from the variation in the value of cash
flows from
a security due to inflation, as measured in terms of purchasing
power. For
example, if the Trust purchases a bond in which it can realize
a coupon
rate of 5%, but the rate of inflation increases from 2% to 6%,
then the
purchasing power of the cash flow has declined. For all but adjustable
bonds or floating rate bonds, the Trust is exposed to inflation
risk
because the interest rate the issuer promises to make is fixed
for the
life of the security. To the extent that interest rates reflect
the
expected inflation rate, floating rate bonds have a lower level
of
inflation risk. In addition, during any periods of rising inflation,
dividend rates of any variable rate preferred stock issued by the
Trust
would likely increase, which would tend to further reduce returns
to
common shareholders.
|
| |
|
Arbitrage
Risks.
The Trust engages in capital structure arbitrage and other arbitrage
strategies. Arbitrage strategies entail various risks, including
the risk
that external events, regulatory approvals and other factors will
impact
the consummation of announced corporate events and/or the prices
of
certain positions. In addition, hedging is an important feature
of capital
structure arbitrage. There is no guarantee that the Investment
Adviser
will be able to hedge the Trust’s portfolio in the manner necessary to
employ successfully the Trust’s strategy.
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| |
|
|
| |
|
Short
Sales Risk.
Short selling involves selling securities which may or may not
be owned
and borrowing the same securities for delivery to the purchaser,
with an
obligation to replace the borrowed securities at a later date.
Short
selling allows the Trust to profit from declines in market prices
to the
extent such decline exceeds the transaction costs and the costs
of
borrowing the securities. However, since the borrowed securities
must be
replaced by purchases at market prices in order to close out the
short
position, any appreciation in the price of the borrowed securities
would
result in a loss. There can be no assurance that the securities
necessary
to cover a short position will be available for purchase. Purchasing
securities to close out the short position can itself cause the
price of
the securities to rise further, thereby exacerbating the loss.
The Trust
may mitigate such losses by replacing the securities sold short
before the
market price has increased significantly. Under adverse market
conditions,
the Trust might have difficulty purchasing securities to meet its
short
sale delivery obligations, and might have to sell portfolio securities
to
raise the capital necessary to meet its short sale obligations
at a time
when fundamental investment considerations would not favor such
sales.
Short sales by the Trust that are not made “against the box” theoretically
involve unlimited loss potential since the market price of securities
sold
short may continuously increase.
|
| |
|
|
| |
|
Risks
of Investing in Structured Finance Securities.
A
portion of the Trust’s investments may consist of equipment trust
certificates, collateralized mortgage obligations, collateralized
bond
obligations, collateralized loan obligations or similar instruments.
Structured finance securities may present risks similar to those
of the
other types of debt obligations in which the Trust may invest and,
in
fact, such risks may be of greater significance in the case of
structured
finance securities. Moreover, investing in structured finance securities
may entail a variety of unique risks. Among other risks, structured
finance securities may be subject to prepayment risk. In addition,
the
performance of a structured finance security will be affected by
a variety
of factors, including the security’s priority in the capital structure of
the issuer thereof, the availability of any credit enhancement,
the level
and timing of payments and recoveries on and the characteristics
of the
underlying receivables, loans or other assets that are being securitized,
remoteness of those assets from the originator or transferor, the
adequacy
of and ability to realize upon any related collateral and the capability
of the servicer of the securitized
assets.
|
| |
|
Risks
of Investing in Preferred Securities.
There are special risks associated with investing in preferred
securities,
including:
|
| |
|
|
| |
|
· Deferral.
Preferred securities may include provisions that permit the issuer,
at its
discretion, to defer distributions for a stated period without
any adverse
consequences to the issuer. If the Trust owns a preferred security
that is
deferring its distributions, the Trust may be required to report
income
for tax purposes although it has not yet received
|
| |
|
|
|
|
|
·
Subordination.
Preferred securities are subordinated to bonds and other debt instruments
in a company’s capital structure in terms of priority to corporate income
and liquidation payments, and therefore will be subject to greater
credit
risk than more senior debt instruments.
|
| |
|
|
|
|
|
·
Liquidity.
Preferred securities may be substantially less liquid than many
other
securities, such as common stock or U.S. government
securities.
|
| |
|
|
|
|
|
·
Limited
Voting Rights.
Generally, preferred security holders have no voting rights with
respect
to the issuing company unless preferred dividends have been in
arrears for
a specified number of periods, at which time the preferred security
holders may elect a number of directors to the issuer’s board. Generally,
once all the arrearages have been paid, the preferred security
holders no
longer have voting rights.
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| |
|
|
| |
|
Risks
of Investing in Synthetic Securities.
With respect to synthetic securities, the Trust will usually have
a
contractual relationship only with the counterparty of such synthetic
securities, and not the Reference Obligor (as defined below) on
the
Reference Obligation (as defined below). The Trust generally will
have no
right to directly enforce compliance by the Reference Obligor with
the
terms of the Reference Obligation nor any rights of set-off against
the
Reference Obligor, nor have any voting rights with respect to the
Reference Obligation. The Trust will not benefit directly from
any
collateral supporting the Reference Obligation or have the benefit
of the
remedies on default that would normally be available to a holder
of such
Reference Obligation. In addition, in the event of insolvency of
its
counterparty, the Trust will be treated as a general creditor of
such
counterparty and will not have any claim with respect to the credit
risk
of the counterparty as well as that of the Reference Obligor. As
a result,
an overabundance of synthetic securities with any one counterparty
subjects the investment to an additional degree of risk with respect
to
defaults by such counterparty as well as by the Reference Obligor. The
Investment Adviser may not perform independent credit analyses
of the
counterparties or any entities guaranteeing such counterparties,
individually or in the aggregate. A “Reference
Obligation”
is the debt security or other obligation upon which the synthetic
security
is based. A “Reference
Obligor”
is the obligor on a Reference Obligation. There is no maximum amount
of
Trust’s assets that may be invested in synthetic
securities.
|
| |
|
Valuation
Risk.
Fair value is defined as the amount for which assets could be sold
in an
orderly disposition over a reasonable period of time, taking into
account
the nature of the asset. Fair value pricing, however, involves
judgments
that are inherently subjective and inexact, since fair valuation
procedures are used only when it is not possible to be sure what
value
should be attributed to a particular asset or when an event will
affect
the market price of an asset and to what extent. As a result, there
can be
no assurance that fair value pricing will reflect actual market
value, and
it is possible that the fair value determined for a security will
be
materially different from the value that actually could be or is
realized
upon the sale of that asset.
|
| |
|
|
| |
|
Risks
of Non-Diversification and Other Focused Strategies.
While the Investment Adviser invests in a number of fixed-income
and
equity instruments issued by different issuers and employs multiple
investment strategies with respect to the Trust’s portfolio, it is
possible that a significant amount of the Trust’s investments could be
invested in the instruments of only a few companies or other issuers
or
that at any particular point in time one investment strategy could
be more
heavily weighted than the others. The focus of the Trust’s portfolio in
any one issuer would subject the Trust to a greater degree of risk
with
respect to defaults by such issuer or other adverse events affecting
that
issuer, and the focus of the portfolio in any one industry or group
of
industries (but not to exceed 25% of the Trust’s total assets) would
subject the Trust to a greater degree of risk with respect to economic
downturns relating to such industry or industries. The focus of
the
Trust’s portfolio in any one investment strategy would subject the Trust
to a greater degree of risk than if the Trust’s portfolio were varied in
its investments with respect to several investment
strategies.
|
| |
|
|
| |
|
Market
Disruption and Geopolitical Risk.
The aftermath of the war in Iraq and the continuing occupation
of Iraq,
instability in the Middle East and terrorist attacks in the United
States
and around the world may result in market volatility and may have
long-term effects on the U.S. and worldwide financial markets and
may
cause further economic uncertainties in the United States and worldwide.
The Investment Adviser does not know how long the securities markets
may
be affected by these events and cannot predict the effects of the
occupation or similar events in the future on the U.S. economy
and
securities markets.
|
| |
|
Risks
of Investing in a Trust with Anti-Takeover Provisions.
The Trust’s Agreement and Declaration of Trust includes provisions that
could limit the ability of other entities or persons to acquire
control of
the Trust or convert the Trust to open-end status. These provisions
could
deprive the holders of common shares of opportunities to sell their
common
shares at a premium over the then current market price of the common
shares or at net asset value.
|
| |
|
|
| |
|
Key
Adviser Personnel Risk.
The Trust’s ability to identify and invest in attractive opportunities is
dependent upon Highland, its investment adviser. If one or more
key
individuals leaves Highland, Highland may not be able to hire qualified
replacements or may require an extended time to do so. This situation
could prevent the Trust from achieving its investment objectives.
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| |
|
|
| |
|
Given
the risks described above, an investment in the common shares may
not be
appropriate for all investors. You should carefully consider your
ability
to assume these risks before making an investment in the
Trust.
|
| |
|
|
|
Investment
Adviser and Administrator
|
|
Highland
is the investment adviser and administrator of the Trust. As
of September
30, 2007, Highland managed approximately $38 billion in assets
on behalf
of investors around the world. In return for its advisory services,
Highland receives an annual fee, payable monthly, in an amount
equal to
1.00% of the average weekly value of the Trust’s Managed Assets. In return
for its administrative services, Highland receives an annual
fee, payable
monthly, in an amount equal to 0.20% of the average weekly value
of the
Trust’s Managed Assets. “Managed Assets” means the total assets of the
Trust, including any form of investment leverage, minus all accrued
expenses incurred in the normal course of operations, but not
excluding
any liabilities or obligations attributable to investment leverage
obtained through (i) indebtedness of any type (including, without
limitation, borrowing through a credit facility or the issuance
of debt
securities), (ii) the issuance of preferred shares or other similar
preference securities, (iii) the reinvestment of collateral received
for
securities loaned in accordance with the Trust’s investment objectives and
policies, and/or (iv) any other means. Highland, at its own expense,
has
the authority to engage both a sub-adviser and a sub-administrator,
each
of which may be an affiliate of Highland. See “Management
of the Trust—Investment Adviser”
and “Management
of the Trust—Administrator/Sub-Administrator.”
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| |
|
|
| |
|
Potential
Conflicts of Interest.
The Trust currently employs investment leverage in the form of
borrowings
through a credit facility. If the Trust continues to employ leverage,
the
Investment Adviser will benefit because the Trust’s Managed Assets will
increase with leverage. The Investment Adviser will also benefit
to the
extent that the Trust’s Managed Assets increase with reinvested collateral
received on portfolio securities loaned. See “Management
of the Trust — Investment Adviser.”
|
SUMMARY
OF TRUST EXPENSES
The
following table is intended to assist investors in understanding the
fees and
expenses (annualized) that an investor in the Trust would bear, directly
or
indirectly, as a result of the Offer being fully subscribed and the
receipt of
net proceeds from the Offer of approximately $167.3 million.
| |
|
Percentage
of
Subscription
Price
|
|
|
Shareholder
Transaction Expenses
|
|
|
|
|
Sales
load
|
|
|
3.50
|
%(1)
|
|
Dividend
reinvestment and cash purchase plan fees
|
|
|
None
|
(2)
|
| |
|
Percentage
of Net Assets
Attributable
to Common Shares (assumes leverage through
borrowings)
|
|
|
Annual
Expenses
|
|
|
|
|
Management
fees
|
|
|
1.63
|
%(3)
|
|
Other
expenses
|
|
|
0.31
|
%(4)
|
|
Interest
payments on borrowed funds
|
|
|
1.98
|
%
|
|
Total
annual expenses
|
|
|
3.92
|
%
|
The
following example illustrates the expenses that you would pay on a $1,000
investment in common shares of the Trust (including the total sales load
of $35
and the other estimated costs of this offering to be borne by the Trust of
$2.53), assuming (1) that the Offer is fully subscribed and the Trust receives
net proceeds from the Offer of approximately $167.3 million, (2) that the
Trust’s current net assets do not increase or decrease, (3) that the Trust
borrows approximately $286.3 million under its credit facility, (3) that
the
Trust incurs total annual expenses of 3.92% of net assets attributable to
common
shares and (4) a 5% annual return:
| |
|
1
Year
|
|
3
Years
|
|
5
Years
|
|
10
Years
|
|
|
Total
expenses incurred
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
The
Dealer Manager will receive a fee for its financial structuring,
marketing
and soliciting services equal to 3.50% of the aggregate Subscription
Price
for Shares issued pursuant to the Offer. The Dealer Manager will
reallow
to broker-dealers in the selling group to be formed and managed
by the
Dealer Manager selling fees equal to 2.50% of the Subscription
Price per
Share for each Share issued pursuant to the Offer as a result
of their
selling efforts. In addition, the Dealer Manager will reallow
to other
broker-dealers that have executed and delivered a soliciting
dealer
agreement and have solicited the exercise of Rights solicitation
fees
equal to 0.50% of the Subscription Price per Share for each Share
issued
pursuant to the exercise of Rights as a result of their soliciting
efforts, subject to a maximum fee based on the number of Shares
held by
each broker-dealer through The Depository Trust Company (“DTC”) on the
Record Date. The fees and expenses of the Offer will be borne
by the Trust
and indirectly by all of its shareholders, including those who
do not
exercise their Rights.
|
| (2) |
Common
shareholders will be charged a $2.50 service charge and pay a brokerage
commission of $0.05 per share sold if they direct the Plan Agent
(as
defined below) to sell common shares held in a dividend reinvestment
account. Each participant in the Trust’s Dividend Reinvestment Plan will
pay a pro rata share of brokerage commissions incurred when dividend
reinvestment occurs in open-market purchases because the Trust
will
purchase its shares in the open market when the net asset value
per common
share is greater than the market value per common
share.
|
| (3) |
Management
fees are the investment advisory and administrative services
fees paid to
Highland which are computed based on Managed Assets. Such fees
have been
converted to net assets for purposes of the fee table presentation
as
follows: management fees, assuming no leverage, divided by (one
minus the
Trust’s leverage of 26.17% of the Trust’s total assets as of November 30,
2007).
|
| (4) |
“Other
Expenses” includes costs associated with the Trust’s short sales on
securities, including dividend and interest expenses associated
with
securities sold short. When a cash dividend is declared or interest
in
payable on a security for which the Trust holds a short position,
the
Trust incurs the obligation to pay an amount equal to that dividend
or
interest to the lender of the shorted security. Thus, the estimate
for
dividend and interest expenses paid is also based on the dividend
yields
or interest payments of securities that would be sold short as
part of
anticipated trading practices (which may involve avoiding dividend
or
interest expenses with respect to certain short sale transactions
by
closing out the position prior to the underlying issuer’s ex-dividend or
ex-interest date). “Other Expenses” includes the dividend and interest
expense that the Trust is expected to incur during the current
fiscal
year.
|
Except
when noted, the information in this table is derived from the Trust’s financial
statements audited by [·],
whose
report on such financial statements is contained in the Trust’s 2006 Annual
Report and incorporated by reference into the Statement of Additional
Information.
| |
|
Six
Months Ended June 30, 2007
|
|
Period
Ended December 30, 2006(a)
|
|
|
Per
Share Operating Performance
|
|
(unaudited)
|
|
|
|
|
Net
Asset Value, Beginning of Period
|
|
$
|
20.08
|
|
$
|
19.06
|
|
|
Income
from Investment Operations
|
|
|
|
|
|
|
|
|
Net
investment income
|
|
|
0.84
|
|
|
0.71
|
|
|
Net
realized and unrealized gain on investments
|
|
|
0.43
|
|
|
0.91
|
|
|
Total
from investment operations applicable to common
shareholders
|
|
|
1.27
|
|
|
1.62
|
|
|
Less
Distributions Declared to Common Shareholders
|
|
|
|
|
|
|
|
|
From
net investment income
|
|
|
(0.90
|
)
|
|
(0.60
|
)
|
|
Net
Asset Value End of Period
|
|
$
|
20.45
|
|
$
|
20.08
|
|
|
Market
Value, End of Period
|
|
$
|
19.80
|
|
$
|
21.16
|
|
|
Market
Value Total Return(b)
|
|
|
6.65
|
%(c)
|
|
9.06
|
%(c)
|
|
Ratios
to Average Net Assets/Supplemental Data
|
|
|
|
|
|
|
|
|
Common
Share Information at End of Period:
|
|
|
|
|
|
|
|
|
Ratios
based on average net assets
|
|
|
|
|
|
|
|
|
Net
assets, end of period (in 000’s)
|
|
$
|
705,903
|
|
$
|
692,964
|
|
|
Net
operating expenses
|
|
|
1.81
|
%
|
|
1.53
|
%
|
|
Interest
expenses
|
|
|
2.07
|
%
|
|
1.03
|
%
|
|
Dividend
income from short positions
|
|
|
0.16
|
%
|
|
N/A
|
|
|
Net
expenses
|
|
|
4.04
|
%
|
|
2.56
|
%
|
|
Net
investment income
|
|
|
8.28
|
%
|
|
7.64
|
%
|
|
Ratios
based on average Managed Assets
|
|
|
|
|
|
|
|
|
Net
assets, end of period (in 000’s)
|
|
$
|
705,903
|
|
$
|
692,964
|
|
|
Net
operating expenses
|
|
|
1.33
|
%
|
|
1.31
|
%
|
|
Interest
expenses
|
|
|
1.52
|
%
|
|
0.89
|
%
|
|
Dividend
income from short positions
|
|
|
0.11
|
%
|
|
N/A
|
|
|
Net
expenses
|
|
|
2.96
|
%
|
|
2.20
|
%
|
|
Net
investment income
|
|
|
6.07
|
%
|
|
6.33
|
%
|
|
Portfolio
turnover rate
|
|
|
52.49
|
%(c)
|
|
45.95
|
%(c)
|
(a)
The
Trust
commenced investment operations on June 29, 2006.
(b)
Based
on
market value per share. Dividends and distributions, if any, are assumed for
purposes of this calculation to be reinvested at prices obtained under the
Trust’s dividend reinvestment plan.
(c)
Not
annualized.
Purpose
of the Offer
The
Board
of Trustees of the Trust (the “Board”) and the Investment Adviser have
determined that it would be in the best interests of the Trust and its
shareholders to increase the assets of the Trust available for investment,
thereby enabling the Trust more fully to take advantage of current and
prospective investment opportunities. The Board and the Investment Adviser
believe that the Offer is the most effective way to raise additional assets
for
the Trust while offering shareholders the opportunity to buy additional common
shares at a discounted price.
The
Board
and the Investment Adviser also believe that increasing the Trust’s assets
available for investment may result in a modest reduction of the Trust’s expense
ratio, as the Trust’s fixed costs would be spread over a larger asset base.
There is no assurance that the Offer will be successful, or that by increasing
the Trust’s assets available for investment its expense ratio will be lowered.
The completion of the Offer may result in an immediate dilution of the net
asset
value per common share for all existing shareholders, including those who
fully
exercise their rights.
The
Offer
provides Record Date Shareholders the opportunity to purchase additional shares
of the Trust’s common shares at a price below the market price. The distribution
to Record Date Shareholders of transferable Rights may afford non-participating
Record Date Shareholders the opportunity to sell their Rights for some cash
value, receipt of which may be viewed as partial compensation for any economic
dilution of their interests resulting from the Offer.
Important
Terms of the Offer
The
Trust
is issuing transferable rights (“Rights”) to its common shareholders of record
(“Record Date Shareholders”) as of the close of business on December 21, 2007
(the “Record Date”), entitling the holders of those Rights to subscribe for up
to an aggregate of [·] the Trust’s common shares (the “Shares”) (the “Offer”).
Record Date Shareholders will receive one Right for each whole common share
of
the Trust held on the Record Date. These Rights entitle the Record Date
Shareholders to purchase one new Share for every three
Rights
held (1-for-3).
Fractional Shares will not be issued upon the exercise of Rights; accordingly,
Rights may be exercised only in integer multiples of three,
except
that any Record Date Shareholder who is issued fewer than three
Rights
may subscribe, at the Subscription Price (defined below), for one full Share.
Assuming the exercise of all Rights, the Offer will result in an approximately
33.3% increase in the Trust’s common shares outstanding.
Record
Date Shareholders who exercise all of the Rights issued to them (other than
those Rights that cannot be exercised because they represent the right to
acquire less than one Share) are entitled to subscribe for additional Shares
at
the same Subscription Price pursuant to the over-subscription privilege, subject
to certain limitations and subject to allotment. Investors who are not
shareholders on the Record Date, but who otherwise acquire Rights to purchase
common shares pursuant to the Offer, are not entitled to subscribe for any
common shares pursuant to the over-subscription privilege. See
“Over-Subscription Privilege” below.
The
subscription period commences on December 21, 2007 and ends at 5:00 p.m.,
Eastern time, on January 18, 2008, unless otherwise extended (the “Expiration
Date”).
For
purposes of determining the maximum number of shares of the Trust’s common stock
a shareholder may acquire pursuant to the Offer, broker-dealers, trust
companies, banks or others whose shares are held of record by Cede & Co.,
the nominee for the Depository Trust Company (“DTC”), or by any other depository
or nominee will be deemed to be the holders of the Rights that are held by
[·]
or such other depository or nominee on their behalf.
The
Rights are transferable and will be listed for trading on the NYSE under
the
symbol “HCF.RT” during the course of the Offer. Trading in the Rights on the
NYSE is expected to be conducted until the close of trading on the NYSE on
January 17, 2008 (or if the Offer is extended, until the last business day
prior
to the extended Expiration Date). See “Sale and Transferability of Rights.” The
Shares, once issued, will be listed on the NYSE under the symbol “HCF.” The
Rights will be evidenced by subscription certificates which will be mailed
to
Record Date Shareholders, except as discussed below under “Requirements for
Foreign Shareholders.”
Rights
may be exercised by completing a subscription certificate and delivering it,
together with payment of the estimated Subscription Price, to the Subscription
Agent. A Rights holder will have no right to rescind a purchase after the
Subscription Agent has received a completed subscription certificate together
with payment for the Shares offered pursuant to the Offer, except as provided
under “Notice of Net Asset Value Decline.” Rights holders who exercise their
Rights will not know at the time of exercise the Subscription Price of the
Shares being acquired and will be required initially to pay for both the Shares
subscribed for during the subscription period and, if eligible, any additional
Shares subscribed for pursuant to the over-subscription privilege at the
estimated Subscription Price of $[·] per Share. For a discussion of the method
by which Rights may be exercised and Shares paid for, see “Exercise of Rights”
and “Payment for Shares.”
The
Board
retained the Dealer Manager to provide the Trust with financial advisory,
marketing and soliciting services relating to the Offer, including advice
with
respect to the structure, timing and terms of the Offer. In determining the
structure of the Offer, the Board considered, among other things, using a
fixed-pricing versus a variable pricing mechanism, the benefits and drawbacks
of
conducting a non-transferable versus a transferable rights offering, the
effect
on the Trust and its existing shareholders if the Offer is not fully subscribed,
the dilutive effects on the Trust and its existing shareholder of the Offer
and
the experience of the Dealer Manager in conducting rights offerings. The
Board
also considered that the Investment Adviser would benefit from the Offer
because
the investment advisory fee paid by the Trust to the Investment Adviser pursuant
to the Investment Advisory Agreement is based on the Trust’s Managed Assets,
which would increase as a result of the Offer. See “Certain Effects of the
Offer” on page [·].
Subscription
Price
The
subscription price (the “Subscription Price”) will be determined based on a
formula equal to 90% of the average of the last reported sale prices of the
Trust’s common shares on the New York Stock Exchange (the “NYSE”) on the
Expiration Date and the four preceding trading days (the “Formula Price”). If,
however, the Formula Price is less than
75%
of the
net asset value per common share on the Expiration Date, then the Subscription
Price will be 75%
of the
Trust’s net asset value per common share on that day.
Because
the Expiration Date of the subscription period will be January 18, 2008 (unless
we extend the subscription period), Rights holders will not know the
Subscription Price at the time of exercise and will be required initially
to pay
for both the Shares subscribed for pursuant to the primary subscription and,
if
eligible, any additional Shares subscribed for pursuant to the over-subscription
privilege at the estimated Subscription Price of $[·] per share. See “Payment
for Shares.” Rights holders who exercise their Rights will have no right to
rescind a purchase after receipt of their completed subscription certificates
together with payment for Shares by the Subscription Agent, except as provided
under “Notice of Net Asset Value Decline.” The Trust does not have the right to
withdraw the Rights or cancel the Offer after the Rights have been
distributed.
The
net
asset value per share of the Trust’s common stock at the close of business on
December [·], 2007 (the last trading date prior to the date of this prospectus
on which the Trust determined its net asset value) was $[·] and the last
reported sale price of a share on the NYSE on that day was
$[·].
Over-Subscription
Privilege
Record
Date Shareholders who exercise all the Rights issued to them (other than those
Rights that cannot be exercised because they represent the right to acquire
less
than one Share) are entitled to subscribe for additional Shares at the same
Subscription Price pursuant to the over-subscription privilege, subject to
certain limitations and subject to allotment. Investors who are not Record
Date
Shareholders, but who otherwise acquire Rights to purchase Shares pursuant
to
the Offer, are not entitled to subscribe for any Shares pursuant to the
over-subscription privilege. To the extent sufficient Shares are not available
to honor all over-subscription requests, unsubscribed Shares will be allocated
pro rata among those Record Date Shareholders who over-subscribe based on the
number of common shares of the Trust they owned on the Record Date. The
allocation process may involve a series of allocations in order to assure that
the total number of shares of common stock available for over-subscriptions
is
distributed on a pro rata basis.
Record
Date Shareholders who are fully exercising their Rights during the subscription
period should indicate, on the subscription certificate which they submit with
respect to the exercise of the Rights issued to them, how many Shares they
desire to acquire pursuant to the over-subscription privilege.
Banks,
broker-dealers, trustees and other nominee holders of Rights will be required
to
certify to the Subscription Agent, before any over-subscription privilege may
be
exercised with respect to any particular beneficial owner, as to the aggregate
number of Rights exercised during the subscription period and the number of
Shares subscribed for pursuant to the over-subscription privilege by such
beneficial owner and that such beneficial owner’s primary subscription was
exercised in full. Nominee holder over-subscription forms will be distributed
to
banks, brokers, trustees and other nominee holders of Rights with the
subscription certificates.
The
Trust
will not offer or sell any Shares of its common stock that are not subscribed
for during the subscription period or pursuant to the over-subscription
privilege.
The
Trust
has been advised that the Investment Adviser and each of the Trust’s trustees
will exercise all of the Rights initially issued to them and may request
additional Shares pursuant to the over-subscription privilege. An exercise
of
the over-subscription privilege by such persons will increase their
proportionate voting power and share of the Trust’s assets. Rule 144 under the
Securities Act (“Rule 144”) generally provides that an “affiliate” of the Trust
(which, for purposes of Rule 144, may include, among other persons, the
Investment Adviser and the Trust’s trustees) is entitled to sell, within any
three-month period, a number of Shares that does not exceed the greater of
1% of
the then outstanding Shares or the average weekly reported trading volume
of the
Shares during the four calendar weeks preceding the sale. Sales under Rule
144
by covered persons are also subject to certain restrictions on the manner
of
sale, to notice requirements and to the availability of current public
information about the Trust. In addition, any profit resulting from a trustee’s
or the Investment Adviser’s sale of Shares within a period of less than six
months from the purchases may have to be returned to the
Trust.
Sale
and Transferability of Rights
The
Rights will be listed for trading on the NYSE under the symbol “HCF.RT” during
the course of the Offer. Trading in the Rights on the NYSE may be conducted
until the close of trading on the NYSE on the last business day prior to
the
Expiration Date. The Trust and the Dealer Manager will use their best efforts
to
ensure that an adequate trading market for the Rights will exist, although
there
is no assurance that a market for the Rights will develop. Assuming a market
exists for the Rights, the Rights may be purchased and sold through usual
brokerage channels or sold through the Subscription Agent (defined below).
Sales
through the Subscription Agent and the Dealer Manager. Record
Date Shareholders who do not wish to exercise any of the Rights issued to
them
pursuant to the Offer may instruct the Subscription Agent to sell any
unexercised Rights through or to the Dealer Manager. Subscription certificates
representing the Rights to be sold through or to the Dealer Manager must
be
received by the Subscription Agent by 5:00 p.m., Eastern time, on January
16,
2008 (or, if the subscription period is extended, by 5:00 p.m., Eastern time,
two business days prior to the extended Expiration Date). Upon the timely
receipt by the Subscription Agent of appropriate instructions to sell Rights,
the Subscription Agent will ask the Dealer Manager either to purchase them
or to
use its best efforts to complete their sale, and the Subscription Agent will
remit the proceeds of the sale to the selling shareholder. If the Rights
are
sold, sales of those Rights will be deemed to have been effected at the weighted
average price received by the Dealer Manager on the day those Rights are
sold.
The sale price of any Rights sold to the Dealer Manager will be based upon
the
then-current market price for the Rights. The Dealer Manager will also attempt
to sell all Rights which remain unclaimed as a result of subscription
certificates being returned by the postal authorities to the Subscription
Agent
as undeliverable as of the fourth business day prior to the Expiration Date.
The
Subscription Agent will hold the proceeds from those sales for the benefit
of
those nonclaiming shareholders until the proceeds are either claimed or revert
to the State of Delaware. There can be no assurance that the Dealer Manager
will
purchase or be able to complete the sale of any of those Rights, and neither
the
Trust nor the Dealer Manager have guaranteed any minimum sale price for the
Rights. If a Record Date Shareholder does not utilize the services of the
Subscription Agent and chooses to use another broker-dealer or other financial
institution to sell Rights issued to that shareholder pursuant to the Offer,
then the other broker-dealer or financial institution may charge a fee to
sell
the Rights.
Other
Transfers. The
Rights evidenced by a subscription certificate may be transferred in whole
by
endorsing the subscription certificate for transfer in accordance with the
instructions accompanying the subscription certificate. A portion of the Rights
evidenced by a single subscription certificate (but not fractional Rights)
may
be transferred by delivering to the Subscription Agent a subscription
certificate properly endorsed for transfer, with instructions to register such
portion of the Rights evidenced thereby in the name of the transferee and to
issue a new subscription certificate to the transferee evidencing the
transferred Rights. If this occurs, a new subscription certificate evidencing
the balance of the Rights, if any, will be issued to the Record Date Shareholder
or, if the Record Date Shareholder so instructs, to an additional transferee.
The signature on the subscription certificate must correspond with the name
as
written upon the face of the subscription certificate in every particular,
without alteration or enlargement, or any change. A signature guarantee must
be
provided by an eligible financial institution as defined in Rule 17Ad-15 of
the
Securities Exchange Act of 1934 (the “Exchange Act”), subject to the standards
and procedures adopted by the Trust.
Record
Date Shareholders wishing to transfer all or a portion of their Rights should
allow at least five business days prior to the Expiration Date for: (i) the
transfer instructions to be received and processed by the Subscription Agent;
(ii) a new subscription certificate to be issued and transmitted to the
transferee or transferees with respect to transferred Rights and to the
transferor with respect to retained Rights, if any; and (iii) the Rights
evidenced by the new subscription certificate to be exercised or sold by the
recipients of the subscription certificate. Neither the Trust nor the
Subscription Agent or the Dealer Manager shall have any liability to a
transferee or transferor of Rights if subscription certificates are not received
in time for exercise or sale prior to the Expiration Date.
Except
for the fees charged by the Information Agent, Subscription Agent and Dealer
Manager (which are expected to be paid from the proceeds of the Offer by the
Trust), all commissions, fees and other expenses (including brokerage
commissions and transfer taxes) incurred or charged in connection with the
purchase, sale or transfer of rights will be for the account of the transferor
of the Rights, and none of these commissions, fees or expenses will be paid
by
the Trust, the Information Agent, the Subscription Agent or the Dealer Manager.
Shareholders who wish to purchase, sell, exercise or transfer Rights through
a
broker, bank or other party should first inquire about any fees and expenses
that the shareholder will incur in connection with the
transactions.
The
Trust
anticipates that the Rights will be eligible for transfer through, and that
the
exercise of the primary subscription and the over-subscription may be effected
through, the facilities of DTC or the Subscription Agent until 5:00 p.m.,
Eastern time, on the Expiration Date.
Method
for Exercising Rights
Rights
are evidenced by subscription certificates that will be mailed to Record Date
Shareholders (except as described under “Requirements for Foreign Shareholders”
below) or, if a shareholder’s shares are held by Cede & Co. or any other
depository or nominee on their behalf, to Cede & Co. or the other depository
or nominee. Rights may be exercised by completing and signing the subscription
certificate and mailing it in the envelope provided, or otherwise delivering
the
completed and signed subscription certificate to the Subscription Agent,
together with payment in full at the estimated Subscription Price for the shares
by the Expiration Date as described under “Payment For Shares.” Rights may also
be exercised by contacting your broker, banker or trust company, which can
arrange, on your behalf, to guarantee by the Expiration Date, delivery of
payment and of a properly completed and executed subscription certificate
pursuant to a notice of guaranteed delivery by the close of business on the
third business day after the Expiration Date. A fee may be charged for this
service. Completed subscription certificates and payments must be received
by
the Subscription Agent by 5:00 p.m., Eastern time, on the Expiration Date
(unless delivery of subscription certificate and payment is effected by means
of
a notice of guaranteed delivery as described below under “Payment for Shares”)
at the offices of the Subscription Agent at the addresses set forth above under
“Subscription Agent.” Fractional Shares will not be issued upon exercise of
Rights.
Shareholders
Who are Record Owners. Shareholders
who are record owners can choose between either option set forth below under
“Payment For Shares.” If time is of the essence, option (2) will permit delivery
of the subscription certificate and payment after the Expiration
Date.
Investors
Whose Shares are Held by a Nominee. Shareholders
whose shares are held by a nominee, such as a broker or trustee, must contact
that nominee to exercise their Rights. In that case, the nominee will complete
the subscription certificate on behalf of the investor and arrange for proper
payment by one of the methods set forth below under “Payment For
Shares.”
Nominees.
Nominees,
such as brokers, trustees or depositories for securities, who hold shares of
the
Trust’s common stock for the account of others should notify the respective
beneficial owners of such shares as soon as possible to ascertain those
beneficial owners’ intentions and to obtain instructions with respect to the
Rights. If the beneficial owner so instructs, the nominee should complete the
subscription certificate and submit it to the Subscription Agent with the proper
payment as described below under “Payment For Shares.”
Banks,
brokers, trustees and other nominee holders of Rights will be required to
certify to the Subscription Agent, before any over-subscription privilege may
be
exercised with respect to any particular beneficial owner on the Record Date,
as
to the aggregate number of Rights exercised during the subscription period
and
the number of Shares subscribed for pursuant to the over-subscription privilege
by the beneficial owner and that the beneficial owner exercised all the Rights
issued to it pursuant to the Offer.
Requirements
for Foreign Shareholders
Subscription
certificates will not be mailed to Record Date Shareholders whose addresses
are
outside the United States (for these purposes, the United States includes
the
District of Columbia and the territories and possessions of the United States)
(“Foreign Shareholders”). The Subscription Agent will send a letter via regular
mail to Foreign Shareholders to notify them of the Offer. The Rights of Foreign
Shareholders will be held by the Subscription Agent for their accounts until
instructions are received to exercise the Rights. If instructions have not
been
received by 5:00 p.m., Eastern time, on January 15, 2008, three business
days
prior to the Expiration Date (or, if the subscription period is extended,
on or
before three business days prior to the extended Expiration Date), the Rights
of
Foreign Shareholders will be transferred by the Subscription Agent to the
Dealer
Manager, who will either purchase the Rights or use its best efforts to sell
the
Rights. The net proceeds, if any, from sale of those Rights by or to the
Dealer
Manager will be remitted to these Foreign Shareholders.
Important
Dates to Remember
|
Record
Date
|
December
21, 2007
|
|
Subscription
Period
|
December
21, 2007 to January 18, 2008*
|
|
Final
Day Rights Will Trade on NYSE
|
January
17, 2008*
|
|
Expiration
Date and Pricing Date
|
January
18, 2008*
|
|
Payment
for Shares Due or Notices of Guarantees of Delivery Due
|
January
18, 2008*
|
|
Payment
for Guarantees of Delivery Due
|
January
24, 2008*
|
|
Confirmation
Mailed to Participants
|
January
28, 2008*
|
|
Final
Payment for Shares Due
|
February
11, 2008*†
|
*
Unless
the Offer is extended.
†
See
“The Offer—Payment for Shares.”
Distribution
Arrangements
UBS
Securities LLC will act as Dealer Manager for this Offer. Under the terms
and
subject to the conditions contained in the Dealer Manager Agreement among
the
Dealer Manager, the Trust and the Investment Adviser, the Dealer Manager
will
provide financial advisory services and marketing assistance in connection
with
the Offer and will solicit the exercise of Rights and participation in the
over-subscription privilege. The Trust has agreed to pay the Dealer Manager
a
fee for its financial advisory, marketing and soliciting services equal to
3.50%
of the aggregate Subscription Price for the Shares issued pursuant to the
exercise of Rights and the over-subscription privilege. The fees paid to
the
Dealer Manager and other expenses of the Offer will be borne by the Trust
and
indirectly by all of its shareholders, including those who do not exercise
the
Rights.
The
Dealer Manager will reallow a part of its fees to other broker-dealers who
have
assisted in soliciting the exercise of Rights. The Dealer Manager will reallow
to broker-dealers included in the selling group to be formed and managed
by the
Dealer Manager selling fees equal to
2.50%
of the
Subscription Price per share for each Share issued pursuant to the Offer
as a
result of their selling efforts. In addition, the Dealer Manager will reallow
to
other broker-dealers that have executed and delivered a soliciting dealer
agreement and have solicited the exercise of Rights solicitation fees equal
to
0.50%
of the
Subscription Price per share for each Share issued pursuant to exercise of
Rights as a result of their soliciting efforts, subject to a maximum fee
based
on the number of Shares held by each broker-dealer through DTC on the Record
Date. Fees will be paid to the broker-dealer designated on the applicable
portion of the subscription certificates or, in the absence of such designation,
to the Dealer Manager.
The
Trust
and the Investment Adviser have each agreed to indemnify the Dealer Manager
for,
or contribute to losses arising out of, certain liabilities, including
liabilities under the Securities Act. The Dealer Manager Agreement also provides
that the Dealer Manager will not be subject to any liability to the Trust in
rendering the services contemplated by the Dealer Manager Agreement except
for
any act of bad faith, willful misconduct or gross negligence of the Dealer
Manager or reckless disregard by the Dealer Manager of its obligations and
duties under the Dealer Manager Agreement.
Prior
to
the expiration of the Offer, the Dealer Manager may independently offer for
sale
Shares acquired through purchasing and exercising Rights, at prices it sets.
Although the Dealer Manager may realize gains and losses in connection with
such
purchases and sales, such offering of Shares is intended by the Dealer Manager
to facilitate the Offer and any such gains or losses are not expected to
be
material to the Dealer Manager. The Dealer Manager’s fee for its financial
advisory, marketing and soliciting services is independent of any gains or
losses that may be realized by the Dealer Manager through the purchase and
exercise of Rights.
In
the
ordinary course of their businesses, the Dealer Manager and/or its affiliates
may engage in investment banking or financial transactions with the Trust,
the
Investment Adviser and their affiliates.
The
principal business address of UBS Securities LLC is 299 Park Avenue, New
York,
New York 10171.
Subscription
Agent
The
Colbent Corporation is the Subscription Agent for the Offer. The Subscription
Agent will receive for its administrative, processing, invoicing and other
services a fee estimated to be approximately $50,000, plus reimbursement
for all
out-of-pocket expenses related to the Offer. Questions regarding the
subscription certificates should be directed by mail to [·], Attention:
[Corporate Actions], [·]. Shareholders
may also subscribe for the Offer by contacting their broker dealer, trust
company, bank or other nominee.
Completed
subscription certificates must be sent together with proper payment of the
estimated Subscription Price for all Shares subscribed for in the primary
subscription and the over-subscription privilege (for Record Date Shareholders)
to the Subscription Agent by one of the methods described below. Alternatively,
shareholders may arrange for their financial institutions to send notices of
guaranteed delivery by facsimile to DTC to be received by the Subscription
Agent
prior to 5:00 p.m., Eastern time, on the Expiration Date. Facsimiles should
be
confirmed by telephone at DTC. The Trust will accept only properly completed
and
executed subscription certificates actually received at any of the addresses
listed below, prior to 5:00 p.m., New York City time, on the Expiration Date
or
by the close of business on the third business day after the Expiration Date
following timely receipt of a notice of guaranteed delivery. See “Payment for
Shares” below.
|
Subscription
Certificate Delivery Method
|
|
Address/Number
|
|
By
Notice of Guaranteed Delivery:
|
|
Contact
your broker-dealer, trust company, bank, or other nominee to notify
the
Trust of your intent to exercise the Rights.
|
|
By
First Class Mail Only: (No Overnight /Express Mail):
|
|
[·]
|
|
By
Hand:
|
|
[·]
|
|
By
Express Mail or Overnight Courier:
|
|
[·]
|
The
Trust will honor only subscription certificates received by the Subscription
Agent on or prior to the Expiration Date at one of the addresses listed above.
Delivery to an address other than those listed above will not constitute good
delivery.
Information
Agent
The
Information Agent for the Offer is The Altman Group. If you have questions
or
need further information about the Offer, please write the Information Agent
at
1200 Wall Street West, 3rd
Fl.,
Lyndhurst, NJ 07071 or call (800) 370-1749. Any questions or requests for
assistance concerning the method of subscribing for Shares or additional
copies
of this prospectus or subscription certificates should be directed to the
Information Agent. Shareholders may also contact their brokers or nominees
for
information with respect to the Offer.
The
Information Agent will receive a fee estimated to be approximately $18,000
for
its services, plus reimbursement for all out-of-pocket expenses related to
the
Offer.
Expiration
of the Offer
The
Offer
will expire at 5:00 p.m., Eastern time, on January 18, 2008, unless the Trust
extends the Expiration Date. Rights will expire on the Expiration Date and
may
not be exercised after this date. If the Trust extends the Expiration Date,
the
Trust will make an announcement as promptly as practicable. This announcement
will be issued no later than 9:00 a.m., Eastern time, on the next business
day
following the previously scheduled Expiration Date. Without limiting the
manner
in which the Trust may choose to make this announcement, the Trust will not,
unless otherwise required by law, have any obligation to publish, advertise
or
otherwise communicate this announcement other than by making a release to
the
Dow Jones News Service or any other means of public announcement as the Trust
may deem proper.
Payment
for Shares
Rights
holders who wish to acquire Shares pursuant to the Offer may choose between
the
following methods of payment:
(1)
A
Rights holder can send the subscription certificate together with payment for
the shares of common stock subscribed for during the subscription period and,
if
eligible, for any additional shares subscribed for pursuant to the
over-subscription privilege to the Subscription Agent based upon an estimated
Subscription Price of $[·]
per
share. Subscription will be accepted when payment, together with the executed
subscription certificate, is received by the Subscription Agent at one of the
addresses set forth above; the payment and subscription certificate must be
received by the Subscription Agent by 5:00 p.m., Eastern time, on the Expiration
Date. The Subscription Agent will deposit all checks received by it for the
purchase of shares into a segregated interest-bearing account of the Trust
(the
interest from which will belong to the Trust) pending proration and distribution
of shares of the Trust’s common stock. A payment pursuant to this method must be
in U.S. dollars by money order or check drawn on a bank located in the United
States, must be payable to “Highland
Credit Strategies Fund” and
must
accompany a properly completed and executed subscription certificate for such
subscription to be accepted.
(2)
Alternatively, a subscription will be accepted by the Subscription Agent
if, by
5:00 p.m., Eastern time, on the Expiration Date, the Subscription Agent has
received a notice of guaranteed delivery by facsimile (telecopy) or otherwise
from a bank, a trust company or NYSE member guaranteeing delivery of (i)
payment
of the full Subscription Price for the shares of the Trust’s common stock
subscribed for during the subscription period and, if eligible, any additional
shares subscribed for pursuant to the over-subscription privilege and (ii)
a
properly completed and executed subscription certificate. The Subscription
Agent
will not honor a notice of guaranteed delivery unless a properly completed
and
executed subscription certificate and full payment for the shares of the
Trust’s
common stock at the estimated subscription price are received by the
Subscription Agent by the close of business on the third business day after
the
Expiration Date.
On
the
confirmation date, which will be five business days following the Expiration
Date, a confirmation will be sent by the Subscription Agent to each Rights
holder exercising its Rights (or, if shares of the Trust’s common shares are
held by DTC or any other depository or nominee, to DTC and that other depository
or nominee) showing (i) the number of Shares of the Trust acquired during
the
subscription period, (ii) the number of Shares, if any, acquired pursuant
to the
over-subscription privilege, (iii) the per share and total purchase price
for
the Shares and (iv) any additional amount payable to the Trust by the Rights
holder or any excess to be refunded by the Trust to the Rights holder, in
each
case based on the Subscription Price as determined on the Expiration Date.
If
any Record Date Shareholder exercises its right to acquire Shares of the
Trust
pursuant to the over-subscription privilege, any excess payment which would
otherwise be refunded to the Record Date Shareholder will be applied by the
Trust toward payment for Shares acquired pursuant to exercise of the
oversubscription privilege. Any additional payment required from a Rights
holder
must be received by the Subscription Agent within ten business days after
the
confirmation date (February 11, 2008, unless the Expiration Date is extended).
Any excess payment to be refunded by the Trust to a Rights holder will be
mailed
by the Subscription Agent to such Rights holder as promptly as practicable.
All
payments by a Rights holder must be in U.S. dollars by money order or check
drawn on a bank located in the United States and payable to “Highland
Credit Strategies Fund.”
Whichever
of the two methods described above is used, issuance and delivery of
certificates for the Shares subscribed for are contingent upon actual payment
for such Shares.
Rights
holders who have exercised their Rights will have no right to rescind their
subscription after receipt of the completed subscription certificate together
with payment for Shares by the Subscription Agent, except as described under
“—
Notice of Net Asset Value Decline” below.
If
a
Rights holder who acquires Shares during the subscription period or pursuant
to
the over-subscription privilege (for Record Date Shareholders) does not make
payment of any amounts due by the Expiration Date or the date payment is due
under a notice of guaranteed delivery, the Trust reserves the right to take
any
or all of the following actions through all appropriate means: (i) find other
Record Date Shareholders for the subscribed and unpaid for Shares; (ii) apply
any payment actually received by the Trust toward the purchase of the greatest
whole number of Shares which could be acquired by the Rights holder upon
exercise of such Rights acquired during the subscription period or pursuant
to
the over-subscription privilege; and/or (iii) exercise any and all other rights
or remedies to which the Trust may be entitled, including, without limitation,
the right to set off against payments actually received by it with respect
to
such subscribed Shares.
The
method of delivery of completed subscription certificates and payment of the
Subscription Price to the Subscription Agent will be at the election and risk
of
exercising Rights holders, but if sent by mail it is recommended that such
forms
and payments be sent by registered mail, properly insured, with return receipt
requested, and that a sufficient number of days be allowed to ensure delivery
to
the Subscription Agent and clearance of payment by 5:00 p.m., Eastern time,
on
the Expiration Date. Because uncertified personal checks may take at least
five
business days to clear, exercising Rights holders are strongly urged to pay,
or
arrange for payment, by means of certified or cashier’s check or money
order.
All
questions concerning the timeliness, validity, form and eligibility of any
exercise of Rights will be determined by the Trust, which determinations will
be
final and binding. The Trust, in its sole discretion, may waive any defect
or
irregularity, or permit a defect or irregularity to be corrected within such
time as it may determine, or reject the purported exercise of any Right.
Subscriptions will not be deemed to have been received or accepted until
substantially all irregularities have been waived or cured within such time
as
the Trust determines in its sole discretion. The Trust will not be under any
duty to give notification of any defect or irregularity in connection with
the
submission of subscription certificates or incur any liability for failure
to
give such notification.
Notice
of Net Asset Value Decline
The
Trust
has, pursuant to the SEC’s regulatory requirements, undertaken to suspend the
Offer until the Trust amends this prospectus if subsequent to December [·],
2007, the effective date of the Trust’s Registration Statement, the Trust’s net
asset value declines more than 10% from the Trust’s net asset value as of that
date. In that event, the Expiration Date will be extended and the Trust will
notify Record Date Shareholders of any such decline and permit Rights holders
to
cancel their exercise of Rights.
Delivery
of Stock Certificates
Participants
in the Trust’s dividend reinvestment plan (the “Plan”) will have any Shares
acquired pursuant to the Offer credited to their shareholder dividend
reinvestment accounts in the Plan. Shareholders whose shares are held of record
by DTC or by any other depository or nominee on their behalf or their
broker-dealers’ behalf will have any Shares acquired during the subscription
period credited to the account of DTC or other depository or nominee. Shares
acquired pursuant to the over-subscription privilege will be certificated and
share certificates representing these Shares will be sent directly to DTC or
other depository or nominee. With respect to all other shareholders, share
certificates for all Shares acquired pursuant to the Offer will be mailed
promptly after payment for the shares subscribed for has cleared.
U.S.
Federal Income Tax Consequences
The
following is a general summary of the material U.S. federal income tax
consequences of the Offer under the provisions of the Internal Revenue Code
of
1986, as amended (the “Code”), and Treasury regulations in effect as of the date
of the prospectus that are generally applicable to Record Date Shareholders
who
are United States persons within the meaning of the Code, and does not address
any foreign, state or local tax consequences. The Code and Treasury regulations
are subject to change or differing interpretations by legislative or
administrative action, which may be retroactive. Record Date Shareholders and
exercising Rights holders should consult their tax advisors regarding the tax
consequences, including U.S. federal, state, local or foreign tax consequences,
relevant to their particular circumstances.
The
value
of a Right will not be includible in the income of a Record Date Shareholder
at
the time the Right is issued.
The
basis
of a Right issued to a Record Date Shareholder will be zero, and the basis
of
the share with respect to which the Right was issued (the old share) will remain
unchanged, unless either (a) the fair market value of the Right on the date
of
distribution is at least 15% of the fair market value of the old share, or
(b)
such shareholder affirmatively elects (in the manner set out in Treasury
regulations under the Code) to allocate to the Right a portion of the basis
of
the old share. If either (a) or (b) applies, such shareholder must allocate
basis between the old share and the Right in proportion to their fair market
values on the date of distribution.
The
basis
of a Right purchased in the market will generally be its purchase
price.
The
holding period of a Right issued to a Record Date Shareholder will include
the
holding period of the old share.
No
loss
will be recognized by a Record Date Shareholder if a Right distributed to such
shareholder expires unexercised because the basis of the old share may be
allocated to a Right only if the Right is exercised. If a Right that has been
purchased in the market expires unexercised, there will be a recognized loss
equal to the basis of the Right.
Any
gain
or loss on the sale of a Right will be a capital gain or loss if the Right
is
held as a capital asset (which in the case of Rights issued to Record Date
Shareholders will depend on whether the old share is held as a capital asset),
and will be a long-term capital gain or loss if the holding period is deemed
to
exceed one year.
No
gain
or loss will be recognized by a shareholder upon the exercise of a Right, and
the basis of any Share acquired upon exercise (the new Share) will equal the
sum
of the basis, if any, of the Right and the Subscription Price for the new Share.
The holding period for the new share will begin on the date when the Right
is
exercised.
Employee
Plan Considerations
Shareholders
whose shares are in employee benefit plans subject to the Employee Retirement
Income Security Act of 1974, as amended (“ERISA”) (including corporate savings
and 401(k) plans), Keogh or H.R. 10 plans of self-employed individuals and
individual retirement accounts should be aware that additional contributions
of
cash to the employee retirement plan (other than rollover contributions or
trustee-to-trustee transfers from other employee retirement plans) in order
to
exercise Rights would be treated as contributions to the employee retirement
plan and, when taken together with contributions previously made, may result
in,
among other things, excise taxes for excess or nondeductible contributions.
In
the case of employee retirement plan qualified under Section 401(a) of the
Code
and certain other employee retirement plans, additional cash contributions
could
cause the maximum contribution limitations of Section 415 of the Code or other
qualification rules to be violated. In addition, there may be other adverse
tax
and ERISA consequences if Rights are sold or transferred by an employee
retirement plan.
Employee
retirement plans and other tax exempt entities, including governmental plans,
should also be aware that if they borrow in order to finance their exercise
of
Rights, they may become subject to the tax on unrelated business taxable income
(“UBTI”) under Section 511 of the Code. If any portion of an individual
retirement account (“IRA”) is used as security for a loan, the portion so used
is also treated as distributed to the IRA depositor.
ERISA
contains fiduciary responsibility requirements, and ERISA and the Code contain
prohibited transaction rules that may affect the exercise of Rights. Due to
the
complexity of these rules and the penalties for noncompliance, employee
retirement plans should consult with their counsel and other advisers regarding
the consequences of their exercise of Rights under ERISA and the
Code.
Certain
Effects of the Offer
The
Investment Adviser will benefit from the Offer because the investment advisory
fee is based on the Trust’s average weekly Managed Assets. It is not possible to
state precisely the amount of additional compensation the Investment Adviser
will receive as a result of the Offer because it is not known how many Shares
of
the Trust will be subscribed for and because the proceeds of the Offer will
be
invested in additional portfolio securities which will fluctuate in value.
However, assuming (i) all Rights are exercised, (ii) the Trust’s average weekly
net asset value during 2008 is $[·] per share (the net asset value per share on
December [·], 2007) and (iii) the Subscription Price is $[·] per share (90% of
the last reported sale price of the Trust’s common shares on December [·],
2007), and after giving effect to Dealer Manager fees and other offering
expenses, the Investment Adviser would receive additional advisory fees of
approximately $[·] for the calendar year 2008 and would continue to receive
additional advisory fees as a result of the Offer, based on the Trust’s average
weekly Managed Assets attributable to the shares issued in the Offer,
thereafter.
Investment
Considerations
Upon
completion of the Offer, shareholders who do not exercise their Rights fully
will own a smaller proportional interest in the Trust than would be the case
if
the Offer had not been made. In addition, because the Subscription Price
per
Share will be less than the then Trust’s net asset value per share, the Offer
will result in a dilution of the Trust’s net asset value per share for all
shareholders, irrespective of whether they exercise all or any portion of
their
Rights. Although it is not possible to state precisely the amount of such
a
decrease in value, because it is not known at this time what the Subscription
Price will be, what the net asset value per share will be at the Expiration
Date
or what proportion of Shares will be subscribed for, the dilution could be
substantial. For example, assuming that all Rights are exercised, that the
Trust’s net asset value on the Expiration Date is $[·] per share (the net asset
value per share on December [·], 2007), and that the Subscription Price is $[·]
per share (90% of the last reported sale price of the Trust’s common shares on
December [·], 2007), the Trust’s net asset value per share on this date would be
reduced by approximately $[·] per share, after giving affect to Dealer Manager
fees and other offering expenses, estimated at $[·], payable by the Trust.
Record Date Shareholders will experience a decrease in the net asset value
per
share held by them, irrespective of whether they exercise all or any portion
of
their Rights. The distribution of transferable Rights, which may themselves
have
value, will afford non-participating shareholders the potential of receiving
a
cash payment upon the sale of the Rights, receipt of which may be viewed
as
partial compensation for the economic dilution of their
interests.
USE
OF PROCEEDS
The
Trust
will invest the net proceeds of any sales of securities in accordance with
the
Trust’s investment objectives and policies as stated below.
Assuming
current market conditions, the Trust estimates that the net proceeds of the
Offer will be substantially invested in accordance with its investment
objectives and policies within one to three months of the completion of the
Offer. Pending such investment, it is anticipated that the proceeds of the
Offer
will be invested in short-term debt securities. The Trust does not expect
to use
any part of the proceeds to repay some or all of its outstanding debt under
the
Loan Agreement. Following the completion of the Offer, the Trust may increase
the amount of leverage outstanding. See “Use of Leverage.”
THE
TRUST
The
Trust
is a non-diversified, closed-end management investment company. The Trust was
organized as a Delaware statutory trust on March 10, 2006, pursuant to an
Agreement and Declaration of Trust governed by the laws of the State of
Delaware. The Trust commenced operations on June 29, 2006, following its initial
public offering. The Trust’s principal office is located at Two Galleria Tower,
13455 Noel Road, Suite 800, Dallas, Texas 75240 and its telephone number is
(877) 665-1287.
INVESTMENT
OBJECTIVES AND POLICIES
Investment
Objectives and Policies
The
Trust’s investment objectives are to provide both current income and capital
appreciation. The Trust seeks to achieve its investment objectives by investing
primarily in the following categories of securities and instruments of
corporations and other business entities: (i) secured and unsecured floating
and
fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations
of stressed, distressed and bankrupt issuers; (iv) structured products,
including but not limited to, mortgage-backed and other asset-backed securities
and collateralized debt obligations; and (v) equities. Highland will seek to
achieve its capital appreciation objective by investing in category (iii) and
(v) obligations and securities, and to a lesser extent, in category (i), (ii),
and (iv) obligations. Under normal market conditions, at least 80% of the
Trust’s assets are invested in one or more of these principal investment
categories. Subject only to this general guideline, Highland has broad
discretion to allocate the Trust’s assets among these investment categories and
to change allocations as conditions warrant. In order to pursue most effectively
its opportunistic investment strategy, the Trust will not maintain fixed
duration, maturity or credit quality policies. The Trust may invest in debt
obligations of any credit quality. The Trust may invest without limitation
in
securities and obligations of domestic issuers, but may invest only up to 20%
of
the assets in non-U.S. obligors or issuers.
Within
the categories of obligations and securities in which the Trust invests,
Highland also employs various trading strategies, including capital structure
arbitrage, pair trades and shorting. See “Portfolio Composition” for further
description of these strategies. The Trust may also invest in these categories
of obligations and securities through the use of derivatives. A significant
portion of the Trust’s assets may be invested in securities rated below
investment grade, which are commonly referred to as “junk securities.” Junk
securities are subject to greater risk of loss of principal and interest
and may
be less liquid than investment grade securities. Highland does not anticipate
a
high correlation between the performance of the Trust’s portfolio and the
performance of the corporate bond and equity markets.
The
Trust’s investment objectives may be changed without shareholder approval. There
can be no assurance that the Trust’s investment objectives will be achieved.
Investment
Strategies
Under
normal market conditions, the Trust invests across various markets in which
Highland holds significant investment experience: primarily the leveraged loan,
high yield, structured products and stressed and distressed markets. Highland
makes investment decisions based on quantitative analysis, which employs
sophisticated, data-intensive models to drive the investment process. Highland
has full discretion regarding the capital markets from which it can access
investment opportunities in accordance with the investment limitations set
forth
in this prospectus.
The
Investment Adviser uses trading strategies to exploit pricing inefficiencies
across the credit markets, or debt markets, and within an individual issuer’s
capital structure. Highland varies its investments by strategy, industry,
security type and credit market, but reserves the right to re-position its
portfolio among these criteria depending on market dynamics, and thus the Trust
may experience high portfolio turnover. The Investment Adviser manages interest
rate, default, currency and systemic risks through a variety of trading methods
and market tools, including derivative hedging instruments, as it deems
appropriate. This multi-strategy investment program allows the Investment
Adviser to assess what it considers to be the best opportunities across multiple
markets and to adjust quickly the Trust’s trading strategies and market focus to
changing conditions. The Investment Adviser focuses primarily on the U.S.
marketplace, but may pursue opportunities in the non-U.S. credit or securities
markets by investing up to 20% of the Trust’s assets in non-U.S. credit or
securities market investments.
The
Investment Adviser may select investments from a wide range of trading
strategies and credit markets in order to vary the Trust’s investments and to
optimize the risk-reward parameters of the Trust. Highland does not intend
to
invest the Trust’s assets according to pre-determined allocations. The
investment team and other Highland personnel uses a wide range of resources
to
identify attractive individual investments and promising investment strategies
for consideration in connection with investments by the Trust. The following
is
a description of the general types of securities in which the Trust may invest.
This description is merely a summary, and the Investment Adviser has discretion
to cause the Trust to invest in other types of securities and to follow other
investment criteria and guidelines as described herein.
The
Trust
invests and trades in listed and unlisted, public and private, rated and
unrated, debt and equity instruments and other obligations, including structured
debt and equity instruments as well as financial derivatives. Investments may
include investments in stressed and distressed positions, which may include
publicly-traded debt and equity securities, obligations which were privately
placed with banks, insurance companies and other lending institutions, trade
claims, accounts receivable and any other form of obligation recognized as
a
claim in a bankruptcy or workout process. The Trust may invest in securities
traded in foreign countries and denominated in foreign currencies.
As
part
of its investment program, the Trust may invest, from time to time, in debt
or
synthetic instruments that are sold in direct placement transactions between
their issuers and their purchasers and that are neither listed on an exchange,
nor traded over the counter. The Trust may also receive equity or equity-related
securities in connection with a workout transaction or may invest directly
in
equity securities.
The
Trust
may employ currency hedges (either in the forward or options markets) in certain
circumstances to reduce currency risk and may engage in other derivative
transactions for hedging purposes or to enhance total return. The Trust may
also
lend securities and engage in short sales of securities. The Trust is currently
leveraged through the use of a credit facility and may continue to use leverage
in the future through borrowings or the issuance of preferred shares. In
addition, the Trust may invest in the securities of companies whose capital
structures are highly leveraged.
From
time
to time, the Investment Adviser may also invest a portion of the Trust’s assets
in short-term U.S. Government obligations, certificates of deposit, commercial
paper and other money market instruments, including repurchase agreements with
respect to such obligations to enable the Trust to make investments quickly
and
to serve as collateral with respect to certain of its investments. A greater
percentage of Trust assets may be invested in such obligations if the Investment
Adviser believes that a defensive position is appropriate because of the outlook
for security prices or in order to respond to adverse market, economic business
or political conditions. From time to time cash balances in the Trust’s
brokerage account may be placed in a money market fund.
For
a
more complete discussion of the Trust’s portfolio composition, see “Portfolio
Composition”
below.
PORTFOLIO
COMPOSITION
The
Trust’s portfolio will be composed principally of the following investments.
Additional information relating to the Trust’s investment policies and
restrictions and the Trust’s portfolio investments is contained in the Statement
of Additional Information.
Senior
Loans. Senior
loans hold the most senior position in the capital structure of a business
entity, are typically secured with specific collateral and have a claim on
the
general assets of the borrower that is senior to that held by subordinated
debtholders and stockholders of the borrower. The proceeds of senior loans
primarily are used to finance leveraged buyouts, recapitalizations, mergers,
acquisitions, stock repurchases, and, to a lesser extent, to finance internal
growth and for other corporate purposes. Senior loans typically have rates
of
interest which are redetermined either daily, monthly, quarterly or
semi-annually by reference to a base lending rate, plus a premium. These base
lending rates generally are the London Interbank Offered Rate (“LIBOR”), the
prime rate offered by one or more major United States banks (“Prime Rate”) or
the certificate of deposit (“CD”) rate or other base lending rates used by
commercial lenders.
Loans
and
other corporate debt obligations are subject to the risk of non-payment of
scheduled interest or principal. Such non-payment would result in a reduction
of
income to the Trust, a reduction in the value of the investment and a potential
decrease in the net asset value of the Trust. There can be no assurance that
the
liquidation of any collateral securing a senior loan would satisfy a borrower’s
obligation in the event of non-payment of scheduled interest or principal
payments, or that such collateral could be readily liquidated. In the event
of
bankruptcy of a borrower, the Trust could experience delays or limitations
with
respect to its ability to realize the benefits of the collateral securing a
senior loan. To the extent that a senior loan is collateralized by stock in
the
borrower or its subsidiaries, such a stock may lose all or substantially all
of
its value in the event of the bankruptcy of a borrower. Some senior loans are
subject to the risk that a court, pursuant to fraudulent conveyance or other
similar laws, could subordinate senior loans to presently existing or future
indebtedness of the borrower or take other action detrimental to the holders
of
senior loans including, in certain circumstances, invalidating such senior
loans
or causing interest previously paid to be refunded to the borrower. If interest
were required to be refunded, it could negatively affect the Trust’s
performance. To the extent a senior loan is subordinated in the capital
structure, it will have characteristics similar to other subordinated
debtholders, including a greater risk of nonpayment of interest or
principal.
Many
loans in which the Trust invests, and the issuers of such loans, are not
rated
by a rating agency, not registered with the Commission or any state securities
commission and not listed on any national securities exchange. The amount
of
public information available with respect to issuers of senior loans will
generally be less extensive than that available for issuers of registered
or
exchange listed securities. In evaluating the creditworthiness of borrowers,
the
Investment Adviser will consider, and may rely in part, on analyses performed
by
others. The Investment Adviser does not view ratings as the determinative
factor
in its investment decisions and relies more upon its credit analysis abilities
than upon ratings. Borrowers may have outstanding debt obligations that are
rated below investment grade by a rating agency. A high percentage of senior
loans held by the Trust may be rated, if at all, below investment grade by
independent rating agencies. In the event senior loans are not rated, they
are
likely to be the equivalent of below investment grade quality. Debt securities
which are unsecured and rated below investment grade (i.e., Ba and below
by
Moody’s Investors Service, Inc. (“Moody’s”)
or BB
and below by Standard & Poor’s Ratings Group, a division of The McGraw-Hill
Companies, Inc. (“S&P”))
and
comparable unrated bonds, are viewed by the rating agencies as having
speculative characteristics and are commonly known as “junk bonds.” A
description of the ratings of corporate bonds by Moody’s and S&P included as
Appendix A to the Statement of Additional Information. Because senior loans
are
senior in a borrower’s capital structure and are often secured by specific
collateral, the Investment Adviser believes that senior loans have more
favorable loss recovery rates as compared to most other types of below
investment grade debt obligations. However, there can be no assurance that
the
Trust’s actual loss recovery experience will be consistent with the Investment
Adviser’s prior experience or that the Trust’s senior loans will achieve any
specific loss recovery rates.
No
active
trading market may exist for many senior loans, and some senior loans may be
subject to restrictions on resale. The Trust is not limited in the percentage
of
its assets that may be invested in senior loans and other securities deemed
to
be illiquid. A secondary market may be subject to irregular trading activity,
wide bid/ask spreads and extended trade settlement periods, which may impair
the
ability to realize full value on the disposition of an illiquid senior loan,
and
cause a material decline in the Trust’s net asset value.
Senior
loans generally are arranged through private negotiations between a borrower
and
a group of financial institutions initially represented by an agent who is
usually one of the originating lenders. In larger transactions, it is common
to
have several agents. Generally, however, only one such agent has primary
responsibility for ongoing administration of a senior loan. Agents are typically
paid fees by the borrower for their services. The agent is primarily responsible
for negotiating the credit agreement which establishes the terms and conditions
of the senior loan and the rights of the borrower and the lenders. The agent
is
also responsible for monitoring collateral and for exercising remedies available
to the lenders such as foreclosure upon collateral.
Credit
agreements may provide for the termination of the agent’s status in the event
that it fails to act as required under the relevant credit agreement, becomes
insolvent, enters FDIC receivership or, if not FDIC insured, enters into
bankruptcy. Should such an agent, lender or assignor with respect to an
assignment inter-positioned between the Trust and the borrower become insolvent
or enter FDIC receivership or bankruptcy, any interest in the senior loan of
such person and any loan payment held by such person for the benefit of the
Trust should not be included in such person’s or entity’s bankruptcy estate. If,
however, any such amount were included in such person’s or entity’s bankruptcy
estate, the Trust would incur certain costs and delays in realizing payment
or
could suffer a loss of principal or interest. In this event, the Trust could
experience a decrease in net asset value.
The
Trust’s investments in senior loans may take one of several forms, including
acting as one of the group of lenders originating a senior loan, purchasing
an
assignment of a portion of a senior loan from a third party or acquiring a
participation in a senior loan. When the Trust is a member of the originating
syndicate for a senior loan, it may share in a fee paid to the syndicate. When
the Trust acquires a participation in, or an assignment of, a senior loan,
it
may pay a fee to, or forego a portion of interest payments from, the lender
selling the participation or assignment. The Trust will act as lender, or
purchase an assignment or participation, with respect to a senior loan only
if
the agent is determined by the Investment Adviser to be
creditworthy.
When
the
Trust is one of the original lenders, it will have a direct contractual
relationship with the borrower and can enforce compliance by the borrower with
terms of the credit agreement. It also may have negotiated rights with respect
to any funds acquired by other lenders through set-off. Original lenders also
negotiate voting and consent rights under the credit agreement. Actions subject
to lender vote or consent generally require the vote or consent of the majority
of the holders of some specified percentage of the outstanding principal amount
of the senior loan. Certain decisions, such as reducing the interest rate,
or
extending the maturity of a senior loan, or releasing collateral securing a
senior loan, among others, frequently require the unanimous vote or consent
of
all lenders affected.
When
the
Trust is a purchaser of an assignment, it typically succeeds to all the rights
and obligations under the credit agreement of the assigning lender and becomes
a
lender under the credit agreement with the same rights and obligations as the
assigning lender. Assignments are, however, arranged through private
negotiations between potential assignees and potential assignors, and the rights
and obligations acquired by the purchaser of an assignment may be more limited
than those held by the assigning lender.
The
Trust
may also invest in participations in senior loans. The rights of the Trust
when
it acquires a participation are likely to be more limited than the rights of
an
original lender or an investor who acquired an assignment. Participation by
the
Trust in a lender’s portion of a senior loan typically means that the Trust has
only a contractual relationship with the lender, not with the borrower. This
means that the Trust has the right to receive payments of principal, interest
and any fees to which it is entitled only from the lender selling the
participation and only upon receipt by the lender of payments from the
borrower.
With
a
participation, the Trust will have no rights to enforce compliance by the
borrower with the terms of the credit agreement or any rights with respect
to
any funds acquired by other lenders through setoff against the borrower. In
addition, the Trust may not directly benefit from the collateral supporting
the
senior loan because it may be treated as a general creditor of the lender
instead of a senior secured creditor of the borrower. As a result, the Trust
may
be subject to delays, expenses and risks that are greater than those that exist
when the Trust is the original lender or holds an assignment. This means the
Trust must assume the credit risk of both the borrower and the lender selling
the participation. The Trust will consider a purchase of participations only
in
those situations where the Investment Adviser considers the participating lender
to be creditworthy.
In
the
event of a bankruptcy or insolvency of a borrower, the obligation of the
borrower to repay the senior loan may be subject to certain defenses that can
be
asserted by such borrower against the Trust as a result of improper conduct
of
the lender selling the participation. A participation in a senior loan will
be
deemed to be a senior loan for the purposes of the Trust’s investment objectives
and policies.
Investing
in senior loans involves investment risk. Some borrowers default on their senior
loan payments. The Trust attempts to manage this credit risk through multiple
different investments within the portfolio and ongoing analysis and monitoring
of borrowers. The Trust also is subject to market, liquidity, interest rate
and
other risks. See “Principal
Risks of the Trust.”
Second
Lien Loans. Second
lien loans are loans made by public and private corporations and other
non-governmental entities and issuers for a variety of purposes. Second lien
loans are second in right of payment to one or more senior loans of the related
borrower. Second lien loans typically are secured by a second priority security
interest or lien to or on specified collateral securing the borrower’s
obligation under the loan and typically have similar protections and rights
as
senior loans. Second lien loans are not (and by their terms cannot) become
subordinate in right of payment to any obligation of the related borrower other
than senior loans of such borrower. Second lien loans, like senior loans,
typically have adjustable floating rate interest payments. Because second lien
loans are second to senior loans, they present a greater degree of investment
risk but often pay interest at higher rates reflecting this additional risk.
Such investments generally are of below investment grade quality. Other than
their subordinated status, second lien loans have many characteristics and
risks
similar to senior loans discussed above. In addition, second lien loans of
below
investment grade quality share many of the risk characteristics of
non-investment grade securities. As in the case of senior loans, the Trust
may
purchase interests in second lien loans through assignments or
participations.
Second
lien loans are subject to the same risks associated with investment in senior
loans and non-investment grade securities. Because second lien loans are second
in right of payment to one or more senior loans of the related borrower, they
therefore are subject to additional risk that the cash flow of the borrower
and
any property securing the loan may be insufficient to meet scheduled payments
after giving effect to the senior secured obligations of the borrower. Second
lien loans are also expected to have greater price volatility than senior loans
and may be less liquid. There is also a possibility that originators will not
be
able to sell participations in second lien loans, which would create greater
credit risk exposure.
Other
Secured Loans.
Secured
loans other than senior loans and second lien loans are made to public and
private corporations and other non-governmental entities and issuers for a
variety of purposes. Such secured loans may rank lower in right of payment
to
one or more senior loans and second lien loans of the borrower. Such secured
loans typically are secured by a lower priority security interest or lien to
or
on specified collateral securing the borrower’s obligation under the loan, and
typically have more subordinated protections and rights than senior loans and
second lien loans. Secured loans may become subordinated in right of payment
to
more senior obligations of the borrower issued in the future. Such secured
loans
may have fixed or adjustable floating rate interest payments. Because such
secured loans may rank lower as to right of payment than senior loans and second
lien loans of the borrower, they may present a greater degree of investment
risk
than senior loans and second lien loans but often pay interest at higher rates
reflecting this additional risk. Such investments generally are of below
investment grade quality. Other than their more subordinated status, such
investments have many characteristics and risks similar to senior loans and
second lien loans discussed above. In addition, secured loans of below
investment grade quality share many of the risk characteristics of
non-investment grade securities. As in the case of senior loans and second
lien
loans, the Trust may purchase interests in other secured loans through
assignments or participations. Other secured loans are subject to the same
risks
associated with investment in senior loans, second lien loans and non-investment
grade securities. Because such loans, however, may rank lower in right of
payment to senior loans and second lien loans of the borrower, they may be
subject to additional risk that the cash flow of the borrower and any property
securing the loan may be insufficient to repay the scheduled payments after
giving effect to more senior secured obligations of the borrower. Such secured
loans are also expected to have greater price volatility than senior loans
and
second lien loans and may be less liquid. There is also a possibility that
originators will not be able to sell participations in other secured loans,
which would create greater credit risk exposure.
Unsecured
Loans.
Unsecured loans are loans made to public and private corporations and other
non-governmental entities and issuers for a variety of purposes. Unsecured
loans
generally have lower priority in right of payment compared to holders of secured
debt of the borrower. Unsecured loans are not secured by a security interest
or
lien to or on specified collateral securing the borrower’s obligation under the
loan. Unsecured loans by their terms may be or may become subordinate in right
of payment to other obligations of the borrower, including senior loans, second
lien loans and other secured loans. Unsecured loans may have fixed or adjustable
floating rate interest payments. Because unsecured loans are subordinate to
the
secured debt of the borrower, they present a greater degree of investment risk
but often pay interest at higher rates reflecting this additional risk. Such
investments generally are of non-investment grade quality. Other than their
subordinated and unsecured status, such investments have many characteristics
and risks similar to senior loans, second lien loans and other secured loans
discussed above. In addition, unsecured loans of non-investment grade quality
share many of the risk characteristics of non-investment grade securities.
As in
the case of secured loans, the Trust may purchase interests in unsecured loans
through assignments or participations.
Unsecured
loans are subject to the same risks associated with investment in senior loans,
second lien loans, other secured loans and non-investment grade securities.
However, because unsecured loans rank lower in right of payment to any secured
obligations of the borrower, they may be subject to additional risk that the
cash flow of the borrower and available assets may be insufficient to meet
scheduled payments after giving effect to the secured obligations of the
borrower. Unsecured loans are also expected to have greater price volatility
than secured loans and may be less liquid. There is also a possibility that
loan
originators will not be able to sell participations in unsecured loans, which
would create greater credit risk exposure.
Investment
Grade Securities.
The
Trust may invest in a wide variety of bonds that are rated or determined by
the
Investment Adviser to be of investment grade quality of varying maturities
issued by U.S. corporations and other business entities. Bonds are fixed or
variable rate debt obligations, including bills, notes, debentures, money market
instruments and similar instruments and securities. Bonds generally are used
by
corporations and other issuers to borrow money from investors for a variety
of
business purposes. The issuer pays the investor a fixed or variable rate of
interest and normally must repay the amount borrowed on or before maturity.
Certain bonds are “perpetual” in that they have no maturity date. Some
investment grade securities, such as zero coupon bonds, do not pay current
interest, but are sold at a discount from their face values. Although more
creditworthy and generally less risky than non-investment grade securities,
investment grade securities are still subject to market and credit risk. Market
risk relates to changes in a security’s value as a result of interest rate
changes generally. Investment grade securities have varying levels of
sensitivity to changes in interest rates and varying degrees of credit quality.
In general, bond prices rise when interest rates fall, and fall when interest
rates rise. Longer-term bonds and zero coupon bonds are generally more sensitive
to interest rate changes. Credit risk relates to the ability of the issuer
to
make payments of principal and interest. The values of investment grade
securities like those of other debt securities may be affected by changes in
the
credit rating or financial condition of an issuer. Investment grade securities
are generally considered medium-and high-quality securities. Some, however,
may
possess speculative characteristics, and may be more sensitive to economic
changes and to changes in the financial condition of issuers. The market prices
of investment grade securities in the lowest investment grade categories may
fluctuate more than higher-quality securities and may decline significantly
in
periods of general or regional economic difficulty. Like non-investment grade
securities, such investment grade securities in the lowest investment grade
categories may be thinly traded, making them difficult to sell promptly at
an
acceptable price.
Other
Fixed Income Securities.
The
Trust also may purchase unsecured loans, other floating rate or fixed rate
debt
securities such as notes, bonds and asset-backed securities (such as securities
issued by special purpose funds investing in bank loans), investment grade
and
below investment grade fixed income debt obligations and money market
instruments, such as commercial paper. The high yield securities in which the
Trust invests are rated Ba or lower by Moody’s or BB or lower by S&P or are
unrated but determined by the Investment Adviser to be of comparable quality.
Debt securities rated below investment grade are commonly referred to as “junk
securities” and are considered speculative with respect to the issuer’s capacity
to pay interest and repay principal. Below investment grade debt securities
involve greater risk of loss, are subject to greater price volatility and are
less liquid, especially during periods of economic uncertainty or change, than
higher rated debt securities. The Trust’s fixed-income securities may have fixed
or variable principal payments and all types of interest rate and dividend
payment and reset terms, including fixed rate, adjustable rate, zero coupon,
contingent, deferred, payment in kind and auction rate features. The Trust
may
invest in fixed-income securities with a broad range of maturities.
The
Trust
may invest in zero coupon bonds, deferred interest bonds and bonds or preferred
stock on which the interest is payable-in-kind (PIK bonds). To the extent the
Trust invests in such instruments, they will not contribute to the Trust’s goal
of current income. Zero coupon and deferred interest bonds are debt obligations
which are issued at a significant discount from face value. While zero coupon
bonds do not require the periodic payment of interest, deferred interest bonds
provide for a period of delay before the regular payment of interest begins.
PIK
bonds are debt obligations that provide that the issuer thereof may, at its
option, pay interest on such bonds in cash or in the form of additional debt
obligations. Such investments may experience greater volatility in market value
due to changes in interest rates. The Trust may be required to accrue income
on
these investments for federal income tax purposes and is required to distribute
its net income each year in order to qualify for the favorable federal income
tax treatment potentially available to regulated investment companies. The
Trust
may be required to sell securities to obtain cash needed for income
distributions.
Non-Investment
Grade Securities.
The
Trust invest a significant portion of its assets in securities rated below
investment grade, such as those rated Ba or lower by Moody’s and BB or lower by
S&P or securities comparably rated by other rating agencies or in unrated
securities determined by Highland to be of comparable quality. Securities rated
Ba by Moody’s are judged to have speculative elements, their future cannot be
considered as well assured and often the protection of interest and principal
payments may be very moderate. Securities rated BB by S&P are regarded as
having predominantly speculative characteristics and, while such obligations
have less near-term vulnerability to default than other speculative grade debt,
they face major ongoing uncertainties or exposure to adverse business, financial
or economic conditions which could lead to inadequate capacity to meet timely
interest and principal payments. Securities rated C are regarded as having
extremely poor prospects of ever attaining any real investment standing.
Securities rated D are in default and the payment of interest and/or repayment
of principal is in arrears. The Trust may purchase securities rated as low
as D
or unrated securities deemed by Highland to be of comparable quality. When
Highland believes it to be in the best interests of the Trust’s shareholders,
the Trust will reduce its investment in lower grade securities.
Lower
grade securities, though high yielding, are characterized by high risk. They
may
be subject to certain risks with respect to the issuing entity and to greater
market fluctuations than certain lower yielding, higher rated securities. The
secondary market for lower grade securities may be less liquid than that of
higher rated securities. Adverse conditions could make it difficult at times
for
the Trust to sell certain securities or could result in lower prices than those
used in calculating the Trust’s net asset value.
The
prices of debt securities generally are inversely related to interest rate
changes; however, the price volatility caused by fluctuating interest rates
of
securities also is inversely related to the coupon of such securities.
Accordingly, lower grade securities may be relatively less sensitive to interest
rate changes than higher quality securities of comparable maturity, because
of
their higher coupon. This higher coupon is what the investor receives in return
for bearing greater credit risk. The higher credit risk associated with lower
grade securities potentially can have a greater effect on the value of such
securities than may be the case with higher quality issues of comparable
maturity, and will be a substantial factor in the Trust’s relative share price
volatility.
Lower
grade securities may be particularly susceptible to economic downturns. It
is
likely that an economic recession could disrupt severely the market for such
securities and may have an adverse impact on the value of such securities.
In
addition, it is likely that any such economic downturn could adversely affect
the ability of the issuers of such securities to repay principal and pay
interest thereon and increase the incidence of default for such
securities.
The
ratings of Moody’s and S&P and the other rating agencies represent their
opinions as to the quality of the obligations which they undertake to rate.
Ratings are relative and subjective and, although ratings may be useful in
evaluating the safety of interest and principal payments, they do not evaluate
the market value risk of such obligations. Although these ratings may be an
initial criterion for selection of portfolio investments, Highland also will
independently evaluate these securities and the ability of the issuers of such
securities to pay interest and principal. To the extent that the Trust invests
in lower grade securities that have not been rated by a rating agency, the
Trust’s ability to achieve its investment objectives will be more dependent on
Highland’s credit analysis than would be the case when the Trust invests in
rated securities.
Asset-Backed
Securities.
The
Trust may invest a portion of its assets in asset-backed securities.
Asset-backed securities are generally issued as pass-through certificates,
which
represent undivided fractional ownership interests in an underlying pool of
assets, or as debt instruments, which are also known as collateralized
obligations, and are generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and issuing such debt.
Asset-backed securities are often backed by a pool of assets representing the
obligations of a number of different parties. Credit card receivables are
generally unsecured, and the debtors are entitled to the protection of a number
of state and federal consumer credit laws which give debtors the right to set
off certain amounts owed on the credit cards, thereby reducing the balance
due.
Most issuers of automobile receivables permit the servicers to retain possession
of the underlying obligations. If the servicer were to sell these obligations
to
another party, there is a risk that the purchaser would acquire an interest
superior to that of the holders of the related automobile receivables. In
addition, because of the large number of vehicles involved in a typical issuance
and technical requirements under state laws, the trustee for the holders of
the
automobile receivables may not have an effective security interest in all of
the
obligations backing such receivables. Therefore, there is a possibility that
recoveries on repossessed collateral may not, in some cases, be able to support
payments on these securities.
Collateralized
Loan Obligations and Bond Obligations.
The
Trust may invest in certain asset-backed securities that are securitizing
certain financial assets by issuing securities in the form of negotiable paper
that are issued by a financing company (generally called a Special Purpose
Vehicle or “SPV”).
These
securitized assets are, as a rule, corporate financial assets brought into
a
pool according to specific diversification rules. The SPV is a company founded
solely for the purpose of securitizing these claims and its only asset is the
diversified asset pool. On this basis, marketable securities are issued which,
due to the diversification of the underlying risk, generally represent a lower
level of risk than the original assets. The redemption of the securities issued
by the SPV takes place at maturity out of the cash flow generated by the
collected claims.
A
collateralized loan obligation (“CLO”)
is a
structured debt security issued by an SPV that was created to reapportion the
risk and return characteristics of a pool of assets. The assets, typically
senior loans, are used as collateral supporting the various debt tranches issued
by the SPV. The key feature of the CLO structure is the prioritization of the
cash flows from a pool of debt securities among the several classes of
securities issued by a CLO.
The
Trust
may also invest in collateralized bond obligations (“CBOs”),
which
are structured debt securities backed by a diversified pool of high yield,
public or private fixed income securities. These may be fixed pools or may
be
“market value” (or managed) pools of collateral. The CBO issues debt securities
that are typically separated into tranches representing different degrees of
credit quality. The top tranche of securities has the greatest collateralization
and pays the lowest interest rate. Lower CBO tranches have a lesser degree
of
collateralization quality and pay higher interest rates intended to compensate
for the attendant risks. The bottom tranche specifically receives the residual
interest payments (i.e., money that is left over after the higher tranches
have
been paid) rather than a fixed interest rate. The return on the lower tranches
of CBOs is especially sensitive to the rate of defaults in the collateral pool.
Under normal market conditions, the Trust expects to invest in the lower
tranches of CBOs.
Distressed
Debt.
The
Trust is authorized to invest in the securities and other obligations of
distressed and bankrupt issuers, including debt obligations that are in covenant
or payment default. Such investments generally trade significantly below par
and
are considered speculative. The repayment of defaulted obligations is subject
to
significant uncertainties. Defaulted obligations might be repaid only after
lengthy workout or bankruptcy proceedings, during which the issuer might not
make any interest or other payments. Typically such workout or bankruptcy
proceedings result in only partial recovery of cash payments or an exchange
of
the defaulted obligation for other debt or equity securities of the issuer
or
its affiliates, which may in turn be illiquid or speculative. The Trust may
invest in securities of a company for purposes of gaining control.
Stressed
Debt.
The
Trust is authorized to invest in securities and other obligations of stressed
issuers. Stressed issuers are issuers that are not yet deemed distressed or
bankrupt and whose debt securities are trading at a discount to par, but not
yet
at distressed levels. An example would be an issuer that is in technical default
of its credit agreement, or undergoing strategic or operational changes, which
results in market pricing uncertainty.
Credit
Default Swaps.
To the
extent consistent with Subchapter M of the Internal Revenue Code of 1986, as
amended (the “Code”),
the
Trust may enter into credit default swap agreements. The “buyer” in a credit
default contract 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 “par value” (full notional value) of the reference
obligation in exchange for the reference obligation. The Trust may be either
the
buyer or seller in the transaction. If the Trust is a buyer and no event of
default occurs, the Trust loses its investment and recovers nothing. However,
if
an event of default occurs, the buyer receives full notional value for a
reference obligation that may have little or no value. As a seller, the Trust
receives income throughout the term of the contract, which typically is between
six months and three years, provided that there is no default
event.
Credit
default swaps involve greater risks than if the Trust had invested in the
reference obligation directly. In addition to general market risks, credit
default swaps are subject to illiquidity risk, counterparty risk and credit
risks. The Trust will enter into swap agreements only with counterparties that
are rated investment grade quality by at least one nationally recognized
statistical rating organization at the time of entering into such transaction
or
whose creditworthiness is believed by the Investment Adviser to be equivalent
to
such rating. A buyer also will lose its investment and recover nothing should
no
event of default occur. If an event of default were to occur, the value of
the
reference obligation received by the seller, coupled with the periodic payments
previously received, may be less than the full notional value it pays to the
buyer, resulting in a loss of value to the seller. When the Trust acts as a
seller of a credit default swap agreement it is exposed to many of the same
risks of leverage described under “Principal
Risks of the Trust — Leverage Risk”
in
this
prospectus since if an event of default occurs the seller must pay the buyer
the
full notional value of the reference obligation.
Senior
Loan Based Derivatives.
The
Trust may obtain exposure to senior loans and baskets of senior loans through
the use of derivative instruments. Such derivative instruments have recently
become increasingly available. The Investment Adviser reserves the right to
utilize these instruments and similar instruments that may be available in
the
future. For example, the Trust may invest in a derivative instrument known
as
the Select Aggregate Market Index (“SAMI”),
which
provides investors with exposure to a reference basket of senior loans. SAMIs
are structured as floating rate instruments. SAMIs consist of a basket of credit
default swaps whose underlying reference securities are senior loans. While
investing in SAMIs will increase the universe of floating rate debt securities
to which the Trust is exposed, such investments entail risks that are not
typically associated with investments in other floating rate debt securities.
The liquidity of the market for SAMIs will be subject to liquidity in the
secured loan and credit derivatives markets. Investment in SAMIs involves many
of the risks associated with investments in derivative instruments discussed
generally below. The Trust may also be subject to the risk that the counterparty
in a derivative transaction will default on its obligations. Derivative
transactions generally involve the risk of loss due to unanticipated adverse
changes in securities prices, interest rates, the inability to close out a
position, imperfect correlation between a position and the desired hedge, tax
constraints on closing out positions and portfolio management constraints on
securities subject to such transactions. The potential loss on derivative
instruments may be substantially greater than the initial investment
therein.
Credit-Linked
Notes. The
Trust
may invest in credit-linked notes (“CLNs”)
for
risk management purposes and to vary its portfolio. A CLN is a derivative
instrument. It is a synthetic obligation between two or more parties where
the
payment of principal and/or interest is based on the performance of some
obligation (a reference obligation). In addition to credit risk of the reference
obligations and interest rate risk, the buyer/seller of the CLN is subject
to
counterparty risk.
Common
Stocks. The
Trust
may acquire an interest in common stocks in various ways, including upon the
default of a senior loan secured by such common stock or by acquiring common
stock for investment. The Trust may also acquire warrants or other rights to
purchase a borrower’s common stock in connection with the making of a senior
loan. Common stocks of a corporation or other entity that entitle the holder
to
a pro rata share of the profits, if any, of the corporation without preference
over any other shareholder or class of shareholders, including holders of such
entity’s preferred stocks and other senior equity securities. Common stock
usually carries with it the right to vote and frequently an exclusive right
to
do so. In selecting common stocks for investment, the Trust generally expects
to
focus primarily on the security’s dividend paying capacity rather than on its
potential for capital appreciation.
Preferred
Stocks.
The
Trust may invest in preferred stocks. Preferred stocks are equity securities,
but they have many characteristics of fixed income securities, such as a fixed
dividend payment rate and/or a liquidity preference over the issuer’s common
shares. However, because preferred stocks are equity securities, they may be
more susceptible to risks traditionally associated with equity investments
than
the Trust’s fixed income securities.
Fixed
rate preferred stocks have fixed dividend rates. They can be perpetual, with
no
mandatory redemption date, or issued with a fixed mandatory redemption date.
Certain issues of preferred stocks are convertible into other equity securities.
Perpetual preferred stocks provide a fixed dividend throughout the life of
the
issue, with no mandatory retirement provisions, but may be callable. Sinking
fund preferred stocks provide for the redemption of a portion of the issue
on a
regularly scheduled basis with, in most cases, the entire issue being retired
at
a future date. The value of fixed rate preferred stocks can be expected to
vary
inversely with interest rates.
Adjustable
rate preferred stocks have a variable dividend rate which is determined
periodically, typically quarterly, according to a formula based on a specified
premium or discount to the yield on particular U.S. Treasury securities,
typically the highest base-rate yield of one of three U.S. Treasury securities:
the 90-day Treasury bill; the 10-year Treasury note; and either the 20-year
or
30-year Treasury bond or other index. The premium or discount to be added to
or
subtracted from this base-rate yield is fixed at the time of issuance and cannot
be changed without the approval of the holders of the adjustable rate preferred
stock. Some adjustable rate preferred stocks have a maximum and a minimum rate
and in some cases are convertible into common stocks.
Auction
rate preferred stocks pay dividends that adjust based on periodic auctions.
Such
preferred stocks are similar to short-term corporate money market instruments
in
that an auction rate preferred stockholder has the opportunity to sell the
preferred stock at par in an auction, normally conducted at least every 49
days,
through which buyers set the dividend rate in a bidding process for the next
period. The dividend rate set in the auction depends on market conditions and
the credit quality of the particular issuer. Typically, the auction rate
preferred stock’s dividend rate is limited to a specified maximum percentage of
an external commercial paper index as of the auction date. Further, the terms
of
the auction rate preferred stocks generally provide that they are redeemable
by
the issuer at certain times or under certain conditions.
Convertible
Securities.
The
Trust’s investment in fixed income securities may include bonds and preferred
stocks that are convertible into the equity securities of the issuer or a
related company. Depending on the relationship of the conversion price to the
market value of the underlying securities, convertible securities may trade
more
like equity securities than debt instruments.
Money
Market Instruments.
Money
market instruments include short-term U.S. government securities, U.S.
dollar-denominated, high quality commercial paper (unsecured promissory notes
issued by corporations to finance their short-term credit needs), certificates
of deposit, bankers’ acceptances and repurchase agreements relating to any of
the foregoing. U.S. government securities include Treasury notes, bonds and
bills, which are direct obligations of the U.S. government backed by the full
faith and credit of the United States and securities issued by agencies and
instrumentalities of the U.S. government, which may be guaranteed by the U.S.
Treasury, may be supported by the issuer’s right to borrow from the U.S.
Treasury or may be backed only by the credit of the federal agency or
instrumentality itself.
U.S.
Government Securities.
U.S.
government securities in which the Trust invests include debt obligations of
varying maturities issued by the U.S. Treasury or issued or guaranteed by an
agency or instrumentality of the U.S. government, including the Federal Housing
Administration, Federal Financing Bank, Farmers Home Administration,
Export-Import Bank of the United States, Small Business Administration,
Government National Mortgage Association (GNMA), General Services
Administration, Central Bank for Cooperatives, Federal Farm Credit Banks,
Federal Home Loan Banks, Federal Home Loan Mortgage Corporation (FHLMC), Federal
National Mortgage Association (FNMA), Maritime Administration, Tennessee Valley
Authority, District of Columbia Armory Board, Student Loan Marketing
Association, Resolution Trust Corporation and various institutions that
previously were or currently are part of the Farm Credit System (which has
been
undergoing reorganization since 1987). Some U.S. government securities, such
as
U.S. Treasury bills, Treasury notes and Treasury bonds, which differ only in
their interest rates, maturities and times of issuance, are supported by the
full faith and credit of the United States government. Others are supported
by
(i) the right of the issuer to borrow from the U.S. Treasury, such as securities
of the Federal Home Loan Banks; (ii) the discretionary authority of the U.S.
government to purchase the agency’s obligations, such as securities of the FNMA;
or (iii) only the credit of the issuer. No assurance can be given that the
U.S.
government will provide financial support in the future to U.S. government
agencies, authorities or instrumentalities that are not supported by the full
faith and credit of the United States. Securities guaranteed as to principal
and
interest by the U.S. government, its agencies, authorities or instrumentalities
include (i) securities for which the payment of principal and interest is backed
by an irrevocable letter of credit issued by the U.S. government or any of
its
agencies, authorities or instrumentalities; and (ii) participations in loans
made to non-U.S. governments or other entities that are so guaranteed. The
secondary market for certain of these participations is limited and therefore
may be regarded as illiquid.
Other
Investment Companies.
The
Trust may invest in the securities of other investment companies to the extent
that such investments are consistent with the Trust’s investment objectives and
principal investment strategies and permissible under the Investment Company
Act. Under one provision of the Investment Company Act, the Trust may not
acquire the securities of other investment companies if, as a result, (i) more
than 10% of the Trust’s total assets would be invested in securities of other
investment companies, (ii) such purchase would result in more than 3% of the
total outstanding voting securities of any one investment company being held
by
the Trust or (iii) more than 5% of the Trust’s total assets would be invested in
any one investment company. Other provisions of the Investment Company Act
are
less restrictive provided that the Trust is able to meet certain conditions.
These limitations do not apply to the acquisition of shares of any investment
company in connection with a merger, consolidation, reorganization or
acquisition of substantially all of the assets of another investment
company.
The
Trust, as a holder of the securities of other investment companies, will bear
its pro rata portion of the other investment companies’ expenses, including
advisory fees. These expenses will be in addition to the direct expenses
incurred by the Trust.
Exchange
Traded Funds.
Subject
to the limitations on investment in other investment companies, the Trust may
invest in exchange traded funds (“ETFs”).
ETFs,
such as SPDRs, NASDAQ 100 Index Trading Stock (QQQs), iShares and various
country index funds, are funds whose shares are traded on a national exchange.
ETFs may be based on underlying equity or fixed income securities. SPDRs, for
example, seek to provide investment results that generally correspond to the
performance of the component common stocks of the S&P 500. ETFs do not sell
individual shares directly to investors and only issue their shares in large
blocks known as “creation units.” The investor purchasing a creation unit may
sell the individual shares on a secondary market. Therefore, the liquidity
of
ETFs depends on the adequacy of the secondary market. There can be no assurance
that an ETF’s investment objective will be achieved. ETFs based on an index may
not replicate and maintain exactly the composition and relative weightings
of
securities in the index. ETFs are subject to the risks of investing in the
underlying securities. The Trust, as a holder of the securities of the ETF,
will
bear its pro rata portion of the ETF’s expenses, including advisory fees. These
expenses are in addition to the direct expenses of the Trust’s own
operations.
Zero
Coupon Securities.
The
securities in which the Trust invests may include zero coupon securities, which
are debt obligations that are issued or purchased at a significant discount
from
face value. The discount approximates the total amount of interest the security
will accrue and compound over the period until maturity or the particular
interest payment date at a rate of interest reflecting the market rate of the
security at the time of issuance. Zero coupon securities do not require the
periodic payment of interest. These investments benefit the issuer by mitigating
its need for cash to meet debt service but generally require a higher rate
of
return to attract investors who are willing to defer receipt of cash. These
investments may experience greater volatility in market value than securities
that make regular payments of interest. The Trust accrues income on these
investments for tax and accounting purposes, which is distributable to
shareholders and which, because no cash is received at the time of accrual,
may
require the liquidation of other portfolio securities to satisfy the Trust’s
distribution obligations, in which case the Trust will forego the purchase
of
additional income producing assets with these funds.
Derivative
Transactions.
In
addition to the credit default swaps and senior loan bond derivatives discussed
above the Trust may, but is not required to, use various Derivative Transactions
described below to earn income, facilitate portfolio management and mitigate
risks. Such Derivative Transactions are generally accepted under modern
portfolio management and are regularly used by many mutual funds and other
institutional investors. Although the Investment Adviser seeks to use the
practices to further the Trust’s investment objectives, no assurance can be
given that these practices will achieve this result. While the Trust reserves
the ability to use these Derivative Transactions, the Investment Adviser does
not anticipate that Derivative Transactions other than senior loan bond
derivatives will initially be a significant part of the Trust’s investment
approach. With changes in the market or the Investment Adviser’s strategy, it is
possible that these instruments may be a more significant part of the Trust’s
investment approach in the future.
The
Trust
may purchase and sell derivative instruments such as exchange-listed and
over-the-counter put and call options on securities, financial futures, equity,
fixed-income and interest rate indices, and other financial instruments,
purchase and sell financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors or collars and
enter into various currency transactions such as currency forward contracts,
currency futures contracts, currency swaps or options on currency or currency
futures or credit transactions and credit default swaps. The Trust also may
purchase derivative instruments that combine features of these instruments.
The
Trust generally seeks to use Derivative Transactions as a portfolio management
or hedging technique to seek to protect against possible adverse changes in
the
market value of senior loans or other securities held in or to be purchased
for
the Trust’s portfolio, protect the value of the Trust’s portfolio, facilitate
the sale of certain securities for investment purposes, manage the effective
interest rate exposure of the Trust, protect against changes in currency
exchange rates, manage the effective maturity or duration of the Trust’s
portfolio, or establish positions in the derivatives markets as a temporary
substitute for purchasing or selling particular securities.
Derivative
Transactions have risks, including the imperfect correlation between the value
of such instruments and the underlying assets, the possible default of the
other
party to the transaction or illiquidity of the derivative instruments.
Furthermore, the ability to use successfully Derivative Transactions depends
on
the Investment Adviser’s ability to predict pertinent market movements, which
cannot be assured. Thus, the use of Derivative Transactions may result in losses
greater than if they had not been used, may require the Trust to sell or
purchase portfolio securities at inopportune times or for prices other than
current market values, may limit the amount of appreciation the Trust can
realize on an investment, or may cause the Trust to hold a security that it
might otherwise sell. The use of currency transactions can result in the Trust
incurring losses as a result of the imposition of exchange controls, suspension
of settlements or the inability of the Trust to deliver or receive a specified
currency. Additionally, amounts paid by the Trust as premiums and cash or other
assets held in margin accounts with respect to Derivative Transactions are
not
otherwise available to the Trust for investment purposes.
A
more
complete discussion of Derivative Transactions and their risks is contained
in
the Statement of Additional Information.
Swaps.
Swap
contracts may be purchased or sold to obtain investment exposure and/or to
hedge
against fluctuations in securities prices, currencies, interest rates or market
conditions, to change the duration of the overall portfolio or to mitigate
default risk. In a standard “swap” transaction, two parties agree to exchange
the returns (or differentials in rates of return) on different currencies,
securities, baskets of currencies or securities, indices or other instruments,
which returns are calculated with respect to a “notional value,” i.e., the
designated reference amount of exposure to the underlying instruments. The
Trust
intends to enter into swaps primarily on a net basis, i.e., the two payment
streams are netted out, with the Trust receiving or paying, as the case may
be,
only the net amount of the two payments. If the other party to a swap contract
defaults, the Trust’s risk of loss will consist of the net amount of payments
that the Trust is contractually entitled to receive. The net amount of the
excess, if any, of the Trust’s obligations over its entitlements will be
maintained in a segregated account by the Trust’s custodian. The Trust will not
enter into a swap agreement unless the claims-paying ability of the other party
thereto is considered to be investment grade by the Investment Adviser. If
there
is a default by the other party to such a transaction, the Trust will have
contractual remedies pursuant to the agreements related to the transaction.
Swap
instruments are not exchange-listed securities and may be traded only in the
over-the-counter market.
Interest
Rate Swaps.
Interest rate swaps involve the exchange by the Trust with another party of
their respective commitments to pay or receive interest (e.g., an exchange
of
fixed rate payments for floating rate payments). The Trust may use interest
rate
swaps for risk management purposes and as a speculative investment.
Total
Return Swaps.
Total
return swaps are contracts in which one party agrees to make payments of the
total return from the designated underlying asset(s), which may include
securities, baskets of securities, or securities indices, during the specified
period, in return for receiving payments equal to a fixed or floating rate
of
interest or the total return from the other designated underlying asset(s).
The
Trust may use total return swaps for risk management purposes and as a
speculative investment.
Currency
Swaps.
Currency swaps involve the exchange of the two parties’ respective commitments
to pay or receive fluctuations with respect to a notional amount of two
different currencies (e.g., an exchange of payments with respect to fluctuations
in the value of the U.S. dollar relative to the Japanese yen). The Trust may
enter into currency swap contracts and baskets thereof for risk management
purposes and as a speculative investment.
Short
Sales.
The
Trust intends to attempt to limit exposure to a possible market decline in
the
value of its portfolio securities through short sales of securities that
Highland believes possess volatility characteristics similar to those being
hedged. In addition, the Trust intends to use short sales for non-hedging
purposes to pursue its investment objectives. Subject to the requirements of
the
Investment Company Act and the Code, the Trust will not make a short sale if,
after giving effect to such sale, the market value of all securities sold short
by the Trust exceeds 25% of the value of its total assets.
A
short
sale is a transaction in which the Trust sells a security it does not own in
anticipation that the market price of that security will decline. When the
Trust
makes a short sale, it must borrow the security sold short from a broker-dealer
and deliver it to the buyer upon conclusion of the sale. The Trust may have
to
pay a fee to borrow particular securities and is often obligated to pay over
any
payments received on such borrowed securities.
The
Trust’s obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer, usually cash, U.S. government
securities or other liquid securities. The Trust will also be required to
designate on its books and records similar collateral with its custodian to
the
extent, if any, necessary so that the aggregate collateral value is at all
times
at least equal to the current market value of the security sold short. Depending
on arrangements made with the broker-dealer from which it borrowed the security
regarding payment over of any payments received by the Trust on such security,
the Trust may not receive any payments (including interest) on its collateral
deposited with such broker-dealer.
If
the
price of the security sold short increases between the time of the short sale
and the time the Trust replaces the borrowed security, the Trust will incur
a
loss; conversely, if the price declines, the Trust will realize a gain. Any
gain
will be decreased, and any loss increased, by the transaction costs described
above. Although the Trust’s gain is limited to the price at which it sold the
security short, its potential loss is unlimited.
The
Trust
may also sell a security short if it owns at least an equal amount of the
security sold short or another security convertible or exchangeable for an
equal
amount of the security sold short without payment of further compensation (a
short sale against-the-box). In a short sale against-the-box, the short seller
is exposed to the risk of being forced to deliver stocks that it holds to close
the position if the borrowed stock is called in by the lender, which would
cause
gain or loss to be recognized on the delivered stock. The Trust expects normally
to close its short sales against-the-box by delivering newly acquired
stock.
Purchasing
securities to close out the short position can itself cause the price of the
securities to rise further, thereby exacerbating the loss. Short-selling exposes
the Trust to unlimited risk with respect to that security due to the lack of
an
upper limit on the price to which an instrument can rise. Although the Trust
reserves the right to utilize short sales, and currently intends to utilize
short sales, Highland is under no obligation to utilize short sales at
all.
Capital
Structure Arbitrage.
Capital
structure arbitrage typically involves establishing long and short positions
in
securities (or their derivatives) at different tiers within an issuer’s capital
structure in ratios designed to maintain a generally neutral overall exposure
to
the issuer while exploiting a pricing inefficiency. Some issuers may also
have
more than one class of shares or an equivalent vehicle that trades in a
different market (e.g., European equities and their American Depository Receipt
counterparts). This strategy seeks to profit from the disparity in prices
between the various related securities in anticipation that over time all
tiers
and classes will become more efficiently priced relative to one
another.
Pair
Trades.
Pair
trades involve the establishment of a long position in one security and a
short
position in another security at the same time. A pair trade attempts to minimize
the effect of larger market trends and emphasizes the performance of one
security relative to another.
Repurchase
Agreements.
The
Trust may invest up to 33 1/3% of its assets in repurchase agreements. It may
enter into repurchase agreements with broker-dealers, member banks of the
Federal Reserve System and other financial institutions. Repurchase agreements
are loans or arrangements under which the Trust purchases securities and the
seller agrees to repurchase the securities within a specific time and at a
specific price. The repurchase price is generally higher than the Trust’s
purchase price, with the difference being income to the Trust. Under the
direction of the board of trustees, the Investment Adviser reviews and monitors
the creditworthiness of any institution which enters into a repurchase agreement
with the Trust. The counterparty’s obligations under the repurchase agreement
are collateralized with U.S. Treasury and/or agency obligations with a market
value of not less than 100% of the obligations, valued daily. Collateral is
held
by the Trust’s custodian in a segregated, safekeeping account for the benefit of
the Trust. Repurchase agreements afford the Trust an opportunity to earn income
on temporarily available cash at low risk. In the event of commencement of
bankruptcy or insolvency proceedings with respect to the seller of the security
before repurchase of the security under a repurchase agreement, the Trust may
encounter delay and incur costs before being able to sell the security. Such
a
delay may involve loss of interest or a decline in price of the security. If
the
court characterizes the transaction as a loan and the Trust has not perfected
a
security interest in the security, the Trust may be required to return the
security to the seller’s estate and be treated as an unsecured creditor of the
seller. As an unsecured creditor, the Trust would be at risk of losing some
or
all of the principal and interest involved in the transaction.
Lending
of Assets.
The
Trust may lend up to 33 1/3% of its assets. It may lend assets to registered
broker-dealers or other institutional investors deemed by the Investment Adviser
to be of good standing under agreements which require that the loans be secured
continuously by collateral in cash, cash equivalents or U.S. Treasury bills
maintained on a current basis at an amount at least equal to the market value
of
the securities loaned. The Trust continues to receive the equivalent of the
interest or dividends paid by the issuer on the securities loaned as well as
the
benefit of an increase and the detriment of any decrease in the market value
of
the securities loaned and would also receive compensation based on investment
of
the collateral. The Trust would not, however, have the right to vote any
securities having voting rights during the existence of the loan, but would
call
the loan in anticipation of an important vote to be taken among holders of
the
securities or of the giving or withholding of consent on a material matter
affecting the investment.
As
with
other extensions of credit, there are risks of delay in recovery or even loss
of
rights in the collateral should the borrower of the securities fail financially.
The Trust will lend portfolio securities only to firms that have been approved
in advance by the board of trustees, which will monitor the creditworthiness
of
any such firms.
Non-U.S.
Securities.
The
Trust may invest up to 20% of its total assets in non-U.S. securities, which
may
include securities denominated in U.S. dollars or in non-U.S. currencies or
multinational currency units. The Trust may invest in non-U.S. securities of
so-called emerging market issuers. For purposes of the Trust, a company is
deemed to be a non-U.S. company if it meets the following tests: (i) such
company was not organized in the United States; (ii) such company’s primary
business office is not in the United States; (iii) the principal trading market
for such company’s securities is not located in the United States; (iv) less
than 50% of such company’s assets are located in the United States; or (v) 50%
or more of such issuer’s revenues are derived from outside the United States.
Non-U.S. securities markets generally are not as developed or efficient as
those
in the United States. Securities of some non-U.S. issuers are less liquid and
more volatile than securities of comparable U.S. issuers. Similarly, volume
and
liquidity in most non-U.S. securities markets are less than in the United States
and, at times, volatility of price can be greater than in the United
States.
Because
evidences of ownership of such securities usually are held outside the United
States, the Trust would be subject to additional risks if it invested in
non-U.S. securities, which include possible adverse political and economic
developments, seizure or nationalization of foreign deposits and adoption of
governmental restrictions which might adversely affect or restrict the payment
of principal and interest on the non-U.S. securities to investors located
outside the country of the issuer, whether from currency blockage or
otherwise.
Since
non-U.S. securities may be purchased with and payable in foreign currencies,
the
value of these assets as measured in U.S. dollars may be affected favorably
or
unfavorably by changes in currency rates and exchange control
regulations.
Options.
An
option on a security is a contract that gives the holder of the option, in
return for a premium, the right to buy from (in the case of a call) or sell
to
(in the case of a put) the writer of the option the security underlying the
option at a specified exercise or “strike” price. The writer of an option on a
security has the obligation upon exercise of the option to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Certain options, known as
“American
style”
options
may be exercised at any time during the term of the option. Other options,
known
as “European
style”
options, may be exercised only on the expiration date of the
option.
If
an
option written by the Trust expires unexercised, the Trust realizes on the
expiration date a capital gain equal to the premium received by the Trust at
the
time the option was written. If an option purchased by the Trust expires
unexercised, the Trust realizes a capital loss equal to the premium paid. Prior
to the earlier of exercise or expiration, an exchange-traded option may be
closed out by an offsetting purchase or sale of an option of the same series
(type, underlying security, exercise price and expiration). There can be no
assurance, however, that a closing purchase or sale transaction can be effected
when the Trust desires. The Trust may sell put or call options it has previously
purchased, which could result in a net gain or loss depending on whether the
amount realized on the sale is more or less than the premium and other
transaction costs paid on the put or call option when purchased. The Trust
will
realize a capital gain from a closing purchase transaction if the cost of the
closing option is less than the premium received from writing the option, or,
if
it is more, the Trust will realize a capital loss. If the premium received
from
a closing sale transaction is more than the premium paid to purchase the option,
the Trust will realize a capital gain or, if it is less, the Trust will realize
a capital loss.
Short-Term
Debt Securities; Temporary Defensive Position; Invest-Up Period.
During
the period in which the net proceeds of this offering of common shares are
being
invested, during periods in which Highland determines that it is temporarily
unable to follow the Trust’s investment strategy or that it is impractical to do
so or pending re-investment of proceeds received in connection with the sale
of
a security, the Trust may deviate from its investment strategy and invest all
or
any portion of its assets in cash or cash equivalents. Highland’s determination
that it is temporarily unable to follow the Trust’s investment strategy or that
it is impractical to do so will generally occur only in situations in which
a
market disruption event has occurred and where trading in the securities
selected through application of the Trust’s investment strategy is extremely
limited or absent. In such a case, shares of the Trust may be adversely affected
and the Trust may not pursue or achieve its investment objectives.
USE
OF LEVERAGE
As
provided in the Investment Company Act of 1940 (the “Investment Company Act”)
and subject to certain exceptions, the Trust may issue debt or preferred
shares
with the condition that immediately after issuance the value of its total
assets, less certain ordinary course liabilities, exceed 300% of the amount
of
the debt outstanding and exceed 200% of the sum of the amount of debt and
preferred shares outstanding.
Thus,
the
Trust may issue leverage in the form of borrowings in an amount up to 33
1/3% of
the Trust’s total assets (including the proceeds of such leverage) and may issue
leverage in the form of preferred shares in an amount up to 50% of the Trust’s
total assets (including the proceeds of such leverage). The total leverage
of
the Trust is currently expected to range between 20% and 50% of the Trust’s
total assets. The Trust seeks a leverage ratio, based on a variety of factors
including market conditions and the Investment Adviser’s market outlook, where
the rate of return, net of applicable Trust expenses, on the Trust’s portfolio
investments purchased with leverage exceeds the costs associated with such
leverage.
The
Trust, as of November 30, 2007, is leveraged through borrowings from a credit
facility in the amount of $227,000,000 or 26.17% of the Trust’s total assets
(including the proceeds of such leverage). The Trust’s asset coverage ratio as
of November 30, 2007 was 382.2%. See “Principal Risks of the Trust—Leverage
Risk” for a brief description of the Trust’s credit facility agreement with The
Bank of Nova Scotia.
Following
the completion of the Offer, the Trust may increase the amount of leverage
outstanding. The Trust may engage in additional borrowings and/or issue
preferred shares in order to maintain the Trust’s desired leverage ratio.
Leverage creates a greater risk of loss, as well as a potential for more
gain,
for the common shares than if leverage were not used. Interest on borrowings
(or
dividends on preferred shares) may be at a fixed or floating rate and generally
will be based on short-term rates. The costs associated with the Fund’s use of
leverage, including the issuance of such leverage and the payment of dividends
or interest on such leverage, will be borne entirely by the holders of common
shares. So long as the rate of return, net of applicable Trust expenses,
on the
Trust’s portfolio investments purchased with leverage exceeds the costs
associated with such leverage, the Trust will generate more return or income
than will be needed to pay such costs. In this event, the excess will be
available to pay higher dividends to holders of common shares. Conversely,
if
the Trust’s return on such assets is less than the cost of leverage and other
Trust expenses, the return to the holders of the common shares will diminish.
Where leverage is employed, the net asset value and market price of the common
shares and the yield to holders of common shares will be more volatile. The
Trust’s leveraging strategy may not be successful. See “Principal Risks of the
Trust—Leverage Risk.”
Assuming
the utilization of leverage in the amount of 26.17% of the Trust’s total assets
and an annual interest rate of 5.58% payable on such leverage based on market
rates as of the date of this prospectus, the additional income that the Trust
must earn (net of expenses) in order to cover such leverage is 1.98%. Actual
costs of leverage may be higher or lower than that assumed in the previous
example.
The
following table is designed to illustrate the effect on the return to a holder
of the Trust’s common shares of leverage in the amount of approximately 26.17%
of the Trust’s total assets, assuming hypothetical annual returns of the Trust’s
portfolio of minus 10% to plus 10%. As the table shows, leverage generally
increases the return to holders of common shares when portfolio return is
positive and greater than the cost of leverage and decreases the return when
the
portfolio return is negative or less than the cost of leverage. The figures
appearing in the table are hypothetical and actual returns may be greater
or
less than those appearing in the table.
|
Assumed
portfolio return (net of expenses)
|
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|
(10
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)%
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|
(5
|
)%
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|
0
|
%
|
|
5
|
%
|
|
10
|
%
|
|
Corresponding
common share return assuming 26.17% leverage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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PRINCIPAL
RISKS OF THE TRUST
Investment
and Market Discount Risk
An
investment in the Trust’s common shares is subject to investment risk, including
the possible loss of the entire amount that you invest. As with any stock,
the
price of the Trust’s shares will fluctuate with market conditions and other
factors. If common shares are sold, the price received may be more or less
than
the original investment. Shares of closed-end management investment companies
frequently trade at a discount to their net asset value. The Trust’s shares may
trade at a price that is less than the initial offering price. This risk may
be
greater for investors who sell their shares in a relatively short period of
time
after completion of the initial offering. Common shares are designed for
long-term investors and should not be treated as trading vehicles.
Interest
Rate Risk
Interest
rate risk is the risk that debt securities, and the Trust’s net assets, may
decline in value because of changes in interest rates. Generally, debt
securities will decrease in value when interest rates rise and increase in
value
when interest rates decline. This means that the net asset value of the common
shares will fluctuate with interest rate changes and the corresponding changes
in the value of the Trust’s debt security holdings.
Prepayment
Risk
If
interest rates fall, the principal on bonds held by the Trust may be paid
earlier than expected. If this happens, the proceeds from a prepaid security
may
be reinvested by the Trust in securities bearing lower interest rates, resulting
in a possible decline in the Trust’s income and distributions to shareholders.
The Trust may invest in pools of mortgages or other assets issued or guaranteed
by private issuers or U.S. government agencies and instrumentalities.
Mortgage-related securities are especially sensitive to prepayment risk because
borrowers often refinance their mortgages when interest rates drop.
Risks
of Investing in High-Yield Securities
A
portion
of the Trust’s investments will consist of investments that may generally be
characterized as “high-yield securities” or “junk securities.” Such securities
are typically rated below investment grade by one or more nationally recognized
statistical rating organizations or are unrated but of comparable credit quality
to obligations rated below investment grade, and have greater credit and
liquidity risk than more highly rated obligations. High-yield securities are
generally unsecured and may be subordinate to other obligations of the obligor.
The lower rating of high-yield securities reflects a greater possibility that
adverse changes in the financial condition of the issuer or in general economic
conditions (including, for example, a substantial period of rising interest
rates or declining earnings) or both may impair the ability of the issuer to
make payment of principal and interest. Many issuers of high-yield securities
are highly leveraged, and their relatively high debt to equity ratios create
increased risks that their operations might not generate sufficient cash flow
to
service their obligations. Overall declines in the below investment grade bond
and other markets may adversely affect such issuers by inhibiting their ability
to refinance their obligations at maturity.
High-yield
securities are often issued in connection with leveraged acquisitions or
recapitalizations in which the issuers incur a substantially higher amount
of
indebtedness than the level at which they had previously operated. High-yield
securities that are debt instruments have historically experienced greater
default rates than has been the case for investment grade securities. The Trust
may also invest in equity securities issued by entities whose obligations are
unrated or are rated below investment grade.
The
Trust
is authorized to invest in obligations of issuers which are generally trading
at
significantly higher yields than had been historically typical of the applicable
issuer’s obligations. Such investments may include debt obligations that have a
heightened probability of being in covenant or payment default in the future.
Such investments generally are considered speculative. The repayment of
defaulted obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest or other
payments. Typically such workout or bankruptcy proceedings result in only
partial recovery of cash payments or an exchange of the defaulted security
for
other debt or equity securities of the issuer or its affiliates, which may
in
turn be illiquid or speculative.
High-yield
securities purchased by the Trust are subject to certain additional risks to
the
extent that such obligations may be unsecured and subordinated to substantial
amounts of senior indebtedness, all or a significant portion of which may be
secured. Moreover, such obligations purchased by the Trust may not be protected
by financial covenants or limitations upon additional indebtedness and are
unlikely to be secured by collateral.
Illiquidity
of Investments
The
investments made by the Trust may be very illiquid, and consequently, the Trust
may not be able to sell such investments at prices that reflect the Investment
Adviser’s assessment of their fair value or the amount paid for such investments
by the Trust. Illiquidity may result from the absence of an established market
for the investments as well as legal, contractual or other restrictions on
their
resale by the Trust and other factors. Furthermore, the nature of the Trust’s
investments, especially those in financially stressed and distressed companies,
may require a long holding period prior to being able to determine whether
the
investment will be profitable or not. There is no limit on the amount of the
Trust’s portfolio that can be invested in illiquid securities.
Risks
of Investing in Senior Loans
Senior
loans are typically at the most senior level of the capital structure, and
are
sometimes secured by specific collateral, including, but not limited to,
trademarks, patents, accounts receivable, inventory, equipment, buildings,
real
estate, franchises and common and preferred stock of the obligor or its
affiliates. A portion of the Trust’s investments may consist of loans and
participations therein originated by banks and other financial institutions,
typically referred to as “bank loans.” The Trust’s investments may include loans
of a type generally incurred by borrowers in connection with highly leveraged
transactions, often to finance internal growth, acquisitions, mergers or stock
purchases, or for other reasons. As a result of the additional debt incurred
by
the borrower in the course of the transaction, the borrower’s creditworthiness
is often judged by the rating agencies to be below investment grade. Such loans
are typically private corporate loans which are negotiated by one or more
commercial banks or financial institutions and syndicated among a group of
commercial banks and financial institutions. In order to induce the lenders
to
extend credit and to offer a favorable interest rate, the borrower often
provides the lenders with extensive information about its business which is
not
generally available to the public.
Bank
loans often contain restrictive covenants designed to limit the activities
of
the borrower in an effort to protect the right of lenders to receive timely
payments of principal and interest. Such covenants may include restrictions
on
dividend payments, specific mandatory minimum financial ratios, limits on total
debt and other financial tests. Bank loans usually have shorter terms than
subordinated obligations and may require mandatory prepayments from excess
cash
flow, asset dispositions and offerings of debt and/or equity securities. The
bank loans and other debt obligations to be acquired by the Trust are likely
to
be below investment grade. For a discussion of the risks associated with below
investment grade investments, see “Risks of Investing in High Yield Securities”
below.
The
Trust
may acquire interests in bank loans and other debt obligations either directly
(by way of sale or assignment) or indirectly (by way of participation). The
purchaser of an assignment typically succeeds to all the rights and obligations
of the assigning institution and becomes a lender under the credit agreement
with respect to the debt obligation; however, its rights can be more restricted
than those of the assigning institution, and, in any event, the Trust may not
be
able unilaterally to enforce all rights and remedies under the loan and any
associated collateral. A participation interest in a portion of a debt
obligation typically results in a contractual relationship only with the
institution participating out the interest, not with the borrower. In purchasing
participations, the Trust generally will have no right to enforce compliance
by
the borrower with neither the terms of the loan agreement nor any rights of
setoff against the borrower, and the Trust may not directly benefit from the
collateral supporting the debt obligation in which it has purchased the
participation. As a result, the Trust will be exposed to the credit risk of
both
the borrower and the institution selling the participation.
Purchasers
of bank loans are predominantly commercial banks, investment funds and
investment banks. As secondary market trading volumes increase, new bank loans
frequently adopt standardized documentation to facilitate loan trading which
should improve market liquidity. There can be no assurance, however, that future
levels of supply and demand in bank loan trading will provide an adequate degree
of liquidity or that the current level of liquidity will continue. Because
of
the provision to holders of such loans of confidential information relating
to
the borrower, the unique and customized nature of the loan agreement, the
limited universe of eligible purchasers and the private syndication of the
loan,
bank loans are not as easily purchased or sold as a publicly traded security,
and historically the trading volume in the bank loan market has been small
relative to the high-yield debt market.
Second
Lien Loans Risk
Second
lien loans are subject to the same risks associated with investment in senior
loans and non-investment grade securities. However, second lien loans are second
in right of payment to senior loans and therefore are subject to additional
risk
that the cash flow of the borrower and any property securing the loan may be
insufficient to meet scheduled payments after giving effect to the senior
secured obligations of the borrower. Second lien loans are expected to have
greater price volatility than senior loans and may be less liquid. There is
also
a possibility that originators will not be able to sell participations in second
lien loans, which would create greater credit risk exposure.
Other
Secured Loans Risk
Secured
loans other than senior loans and second lien loans are subject to the same
risks associated with investment in senior loans, second lien loans and
non-investment grade securities. However, such loans may rank lower in right
of
payment than any outstanding senior loans and second lien loans of the borrower
and therefore are subject to additional risk that the cash flow of the borrower
and any property securing the loan may be insufficient to meet scheduled
payments after giving effect to the higher ranking secured obligations of the
borrower. Lower ranking secured loans are expected to have greater price
volatility than senior loans and second lien loans and may be less liquid.
There
is also a possibility that originators will not be able to sell participations
in lower ranking secured loans, which would create greater credit risk
exposure.
Unsecured
Loans Risk
Unsecured
loans are subject to the same risks associated with investment in senior loans,
second lien loans, other secured loans and non-investment grade securities.
However, because unsecured loans have lower priority in right of payment to
any
higher ranking obligations of the borrower and are not backed by a security
interest in any specific collateral, they are subject to additional risk that
the cash flow of the borrower and available assets may be insufficient to meet
scheduled payments after giving effect to any higher ranking obligations of
the
borrower. Unsecured loans are expected to have greater price volatility than
senior loans, second lien loans and other secured loans and may be less liquid.
There is also a possibility that originators will not be able to sell
participations in unsecured loans, which would create greater credit risk
exposure.
Risks
of Investing in Obligations of Stressed, Distressed and Bankrupt
Issuers
The
Trust
is authorized to invest in the securities and other obligations of stressed,
distressed and bankrupt issuers, including debt obligations that are in covenant
or payment default. There is no limit on the amount of the Trust’s portfolio
that can be invested in stressed, distressed or bankrupt issuers, and the Trust
may invest for purposes of control. Such investments generally trade
significantly below par and are considered speculative. The repayment of
defaulted obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest or other
payments. Typically such workout or bankruptcy proceedings result in only
partial recovery of cash payments or an exchange of the defaulted obligation
for
other debt or equity securities of the issuer or its affiliates, which may
in
turn be illiquid or speculative.
There
are
a number of significant risks inherent in the bankruptcy process. First, many
events in a bankruptcy are the product of contested matters and adversary
proceedings and are beyond the control of the creditors. While creditors are
generally given an opportunity to object to significant actions, there can
be no
assurance that a bankruptcy court in the exercise of its broad powers would
not
approve actions that would be contrary to the interests of the Trust. Second,
a
bankruptcy filing by an issuer may adversely and permanently affect the issuer.
The issuer may lose its market position and key employees and otherwise become
incapable of restoring itself as a viable entity. If for this or any other
reason the proceeding is converted to a liquidation, the value of the issuer
may
not equal the liquidation value that was believed to exist at the time of the
investment. Third, the duration of a bankruptcy proceeding is difficult to
predict. A creditor’s return on investment can be adversely affected by delays
while the plan of reorganization is being negotiated, approved by the creditors
and confirmed by the bankruptcy court and until it ultimately becomes effective.
Fourth, the administrative costs in connection with a bankruptcy proceeding
are
frequently high and would be paid out of the debtor’s estate prior to any return
to creditors. For example, if a proceeding involves protracted or difficult
litigation, or turns into a liquidation, substantial assets may be devoted
to
administrative costs. Fifth, bankruptcy law permits the classification of
“substantially similar” claims in determining the classification of claims in a
reorganization. Because the standard for classification is vague, there exists
the risk that the Trust’s influence with respect to the class of securities or
other obligations it owns can be lost by increases in the number and amount
of
claims in that class or by different classification and treatment. Sixth, in
the
early stages of the bankruptcy process it is often difficult to estimate the
extent of, or even to identify, any contingent claims that might be made.
Seventh, especially in the case of investments made prior to the commencement
of
bankruptcy proceedings, creditors can lose their ranking and priority if they
exercise “domination and control” over a debtor and other creditors can
demonstrate that they have been harmed by such actions. Eighth, certain claims
that have priority by law (for example, claims for taxes) may be
substantial.
In
any
investment involving stressed and distressed debt obligations, there exists
the
risk that the transaction involving such debt obligations will be unsuccessful,
take considerable time or will result in a distribution of cash or a new
security or obligation in exchange for the stressed and distressed debt
obligations, the value of which may be less than the Trust’s purchase price of
such debt obligations. Furthermore, if an anticipated transaction does not
occur, the Trust may be required to sell its investment at a loss. Given the
substantial uncertainties concerning transactions involving stressed and
distressed debt obligations in which the Trust invests, there is a potential
risk of loss by the Trust of its entire investment in any particular
investment.
Investments
in companies operating in workout modes or under Chapter 11 of the Bankruptcy
Code are also, in certain circumstances, subject to certain additional
liabilities which may exceed the value of the Trust’s original investment in a
company. For example, under certain circumstances, creditors who have
inappropriately exercised control over the management and policies of a debtor
may have their claims subordinated or disallowed or may be found liable for
damages suffered by parties as a result of such actions. The Investment
Adviser’s active management style may present a greater risk in this area than
would a more passive approach. In addition, under certain circumstances,
payments to the Trust and distributions by the Trust or payments on the debt
may
be reclaimed if any such payment is later determined to have been a fraudulent
conveyance or a preferential payment.
The
Investment Adviser on behalf of the Trust may participate on committees formed
by creditors to negotiate with the management of financially troubled companies
that may or may not be in bankruptcy or may negotiate directly with debtors
with
respect to restructuring issues. If the Trust does choose to join a committee,
the Trust would likely be only one of many participants, all of whom would
be
interested in obtaining an outcome that is in their individual best interests.
There can be no assurance that the Trust would be successful in obtaining
results most favorable to it in such proceedings, although the Trust may incur
significant legal and other expenses in attempting to do so. As a result of
participation by the Trust on such committees, the Trust may be deemed to have
duties to other creditors represented by the committees, which might thereby
expose the Trust to liability to such other creditors who disagree with the
Trust’s actions. Participation by the Trust on such committees may cause the
Trust to be subject to certain restrictions on its ability to trade in a
particular investment and may also make the Trust an “insider” or an
“underwriter” for purposes of the federal securities laws. Either circumstance
will restrict the Trust’s ability to trade in or acquire additional positions in
a particular investment when it might otherwise desire to do so.
Insolvency
Considerations with Respect to Issuers of Debt Obligations
Various
laws enacted for the protection of creditors may apply to the debt obligations
held by the Trust. The information in this paragraph is applicable with respect
to U.S. issuers subject to United States bankruptcy laws. Insolvency
considerations may differ with respect to other issuers. If a court in a lawsuit
brought by an unpaid creditor or representative of creditors of an issuer of
a
debt obligation, such as a trustee in bankruptcy, were to find that the issuer
did not receive fair consideration or reasonably equivalent value for incurring
the indebtedness constituting the debt obligation and, after giving effect
to
such indebtedness, the issuer (i) was insolvent, (ii) was engaged in a business
for which the remaining assets of such issuer constituted unreasonably small
capital or (iii) intended to incur, or believed that it would incur, debts
beyond its ability to pay such debts as they mature, such court could determine
to invalidate, in whole or in part, such indebtedness as a fraudulent
conveyance, to subordinate such indebtedness to existing or future creditors
of
such issuer, or to recover amounts previously paid by such issuer in
satisfaction of such indebtedness.
The
measure of insolvency for purposes of the foregoing will vary. Generally, an
issuer would be considered insolvent at a particular time if the sum of its
debts were then greater than all of its property at a fair valuation, or if
the
present fair saleable value of its assets was then less than the amount that
would be required to pay its probable liabilities on its existing debts as
they
became absolute and matured. There can be no assurance as to what standard
a
court would apply in order to determine whether the issuer was “insolvent” after
giving effect to the incurrence of the indebtedness constituting the debt
obligation or that, regardless of the method of valuation, a court would not
determine that the issuer was “insolvent” upon giving effect to such incurrence.
In addition, in the event of the insolvency of an issuer of a debt obligation,
payments made on such debt obligation could be subject to avoidance as a
“preference” if made within a certain period of time (which may be as long as
one year) before insolvency. Similarly, a court might apply the doctrine of
equitable subordination to subordinate the claim of a lending institution
against an issuer, to claims of other creditors of the borrower, when the
lending institution, another investor, or any of their transferees, is found
to
have engaged in unfair, inequitable, or fraudulent conduct. In general, if
payments on a debt obligation are avoidable, whether as fraudulent conveyances
or preferences, such payments can be recaptured either from the initial
recipient (such as the Trust) or from subsequent transferees of such payments
(such as the investors in the Trust). To the extent that any such payments
are
recaptured from the Trust the resulting loss will be borne by the investors.
However, a court in a bankruptcy or insolvency proceeding would be able to
direct the recapture of any such payment from such a recipient or transferee
only to the extent that such court has jurisdiction over such recipient or
transferee or its assets. Moreover, it is likely that avoidable payments could
not be recaptured directly from any such recipient or transferee that has given
value in exchange for its note, in good faith and without knowledge that the
payments were avoidable. Although the Investment Adviser will seek to avoid
conduct that would form the basis for a successful cause of action based upon
fraudulent conveyance, preference or equitable subordination, these
determinations are made in hindsight, and, in any event, there can be no
assurance as to whether any lending institution or other investor from which
the
Trust acquired the debt obligations engaged in any such conduct (or any other
conduct that would subject the debt obligations and the issuer to insolvency
laws) and, if it did, as to whether such creditor claims could be asserted
in a
U.S. court (or in the courts of any other country) against the
Trust.
Leverage
Risk
The
Trust
currently leverages through borrowings from a credit facility. The use of
leverage, which can be described as exposure to changes in price at a ratio
greater than the amount of equity invested, either through the issuance of
preferred shares, borrowings or other forms of market exposure, magnifies both
the favorable and unfavorable effects of price movements in the investments
made
by the Trust. Insofar as the Trust continues to employ leverage in its
investment operations, the Trust will be subject to substantial risks of
loss.
The
Trust
currently leverages through borrowings from a credit facility. The Trust
has
entered into a revolving credit agreement with The Bank of Nova Scotia
(“Scotia”)
to
borrow up to $300,000,000 (the “Loan
Agreement”).
Such
borrowings constitute financial leverage. The Loan Agreement contains covenants
that may limit the Trust’s ability to, without the prior consent of Scotia: (i)
pay dividends in certain circumstances, (ii) incur additional debt, (iii)
change
its investment objectives, policies and restrictions as set forth in the
Trust’s
prospectus in effect when the Loan Agreement became effective and (iv) adopt
or
carry out any plan of liquidation, reorganization, incorporation,
recapitalization, merger or consolidation or sell, transfer or otherwise
dispose
of all or a substantial part of its assets. For instance, the Trust agreed
not
to purchase assets not contemplated by the investment policies and restrictions
in effect when the Loan Agreement became effective. Furthermore, the Trust
may
not incur additional debt from any other party, except for in limited
circumstances (e.g.,
in the
ordinary course of business). In addition, the Loan Agreement contains a
covenant requiring asset coverage ratios that may be more stringent than
those
required by the Investment Company Act. Such restrictions shall apply only
so
long as the Loan Agreement remains in effect. Any senior security representing
indebtedness, as defined in Section 18(g) of the Investment Company Act,
must
have asset coverage of at least 300%.
In
order
to obtain and maintain the required ratings of loans from the Loan Agreement
or
another credit facility, the Trust must comply with investment quality,
diversification and other guidelines established by Moody’s and/or S&P or
the credit facility, respectively. The Trust does not anticipate that such
guidelines will have a material adverse effect on the Trust’s of common
shareholders or its ability to achieve its investment objectives. Moody’s and
S&P receive fees in connection with their ratings
issuances.
Successful
use of a leveraging strategy may depend on the Investment Adviser’s ability to
predict correctly interest rates and market movements, and there is no assurance
that a leveraging strategy will be successful during any period in which it
is
employed.
Common
Stock Risk
The
Trust
may have exposure to common stocks. Although common stocks have historically
generated higher average total returns than fixed income securities over
the
long-term, common stocks also have experienced significantly more volatility
in
those returns. Therefore, the Trust’s exposure to common stocks could result in
worse performance than would be the case had the Trust been invested solely
in
debt securities. An adverse event, such as an unfavorable earnings report,
may
depress the value of a particular common stock held by the Trust. Also, the
price of common stock is sensitive to general movements in the stock market
and
a drop in the stock market may depress the price of common stock to which
the
Trust has exposure. Common stock prices fluctuate for several reasons, including
changes in investors’ perceptions of the financial condition of an issuer or the
general condition of the relevant stock market, or when political or economic
events affecting the issuers occur. In addition, common stock prices may
be
particularly sensitive to rising interest rates, as the cost of capital rises
and borrowing costs increase.
Dividend
Risk
Dividends
on common stock are not fixed but are declared at the discretion of an issuer’s
board of directors. There is no guarantee that the issuers of the common stock
in which the Trust invests will declare dividends in the future or that, if
declared, the dividends will remain at current levels or increase over
time
Small
and Mid-Cap Securities Risk
The
Trust
may invest in companies with small or medium-sized capitalizations. Securities
issued by small and medium-sized companies can be more volatile than, and
perform differently from, larger company securities. There may be less trading
in a small or medium company’s securities, which means that buy and sell
transactions in those securities could have a larger impact on the security’s
price than is the case with larger company securities. Small and medium-sized
companies may have fewer business lines; changes in any one line of business,
therefore, may have a greater impact on a small or medium-sized company’s
security price than is the case for a larger company. In addition, small or
medium-sized company securities may not be well known to the investing
public.
Non-U.S.
Securities Risk
The
Trust
may invest up to 20% of its total assets in non-U.S. securities, including
emerging market securities. Investing in non-U.S. securities involves certain
risks not involved in domestic investments, including, but not limited to:
(i)
fluctuations in foreign currency exchange rates; (ii) future foreign economic,
financial, political and social developments; (iii) different legal systems;
(iv) the possible imposition of exchange controls or other foreign governmental
laws or restrictions; (v) lower trading volume; (vi) much greater price
volatility and illiquidity of certain non-U.S. securities markets; (vii)
different trading and settlement practices; (viii) less governmental
supervision; (ix) high and volatile rates of inflation; (x) fluctuating interest
rates; (xi) less publicly available information; and (xii) different accounting,
auditing and financial recordkeeping standards and requirements.
Certain
countries in which the Trust may invest, especially emerging market countries,
historically have experienced, and may continue to experience, high rates of
inflation, high interest rates, exchange rate fluctuations, large amounts of
external debt, balance of payments and trade difficulties and extreme poverty
and unemployment. Many of these countries are also characterized by political
uncertainty and instability. These risks are especially evident in the Middle
East and West Africa. The cost of servicing external debt will generally be
adversely affected by rising international interest rates because many external
debt obligations bear interest at rates which are adjusted based upon
international interest rates. In addition, with respect to certain foreign
countries, there is a risk of: (i) the possibility of expropriation or
nationalization of assets; (ii) confiscatory taxation; (iii) difficulty in
obtaining or enforcing a court judgment; (iv) economic, political or social
instability; and (v) diplomatic developments that could affect investments
in
those countries. In addition, individual foreign economies may differ favorably
or unfavorably from the U.S. economy in such respects as: (i) growth of gross
domestic product; (ii) rates of inflation; (iii) capital reinvestment; (iv)
resources; (v) self-sufficiency; and (vi) balance of payments
position.
As
a
result of these potential risks, Highland may determine that, notwithstanding
otherwise favorable investment criteria, it may not be practicable or
appropriate to invest in a particular country. The Trust may invest in countries
in which foreign investors, including Highland, have had no or limited prior
experience.
Emerging
Markets Risk
The
Trust
may invest up to 20% of its total assets in securities of issuers based in
emerging markets. Investing in securities of issuers based in underdeveloped
emerging markets entails all of the risks of investing in securities of non-U.S.
issuers to a heightened degree. Emerging market countries generally include
every nation in the world except the United States, Canada, Japan, Australia,
New Zealand and most countries located in Western Europe. These heightened
risks
include: (i) greater risks of expropriation, confiscatory taxation,
nationalization, and less social, political and economic stability; (ii) the
smaller size of the markets for such securities and a lower volume of trading,
resulting in lack of liquidity and in price volatility; and (iii) certain
national policies which may restrict the Trust’s investment opportunities
including restrictions on investing in issuers or industries deemed sensitive to
relevant national interests.
Foreign
Currency Risk
Because
the Trust may invest in securities denominated or quoted in currencies other
than the U.S. dollar, changes in foreign currency exchange rates may affect
the
value of securities owned by the Trust, the unrealized appreciation or
depreciation of investments and gains on and income from investments. Currencies
of certain countries may be volatile and therefore may affect the value of
securities denominated in such currencies, which means that the Trust’s net
asset value could decline as a result of changes in the exchange rates between
foreign currencies and the U.S. dollar. These risks often are heightened for
investments in smaller, emerging capital markets. In addition, the Trust may
enter into foreign currency transactions in an attempt to enhance total return
which may further expose the Trust to the risks of foreign currency movements
and other risks. The use of foreign currency transactions can result in the
Trust incurring losses as a result of the imposition of exchange controls,
suspension of settlements or the inability of the Trust to deliver or receive
a
specified currency.
Investments
in Unseasoned Companies
The
Trust
may invest in the securities of less seasoned companies. These investments
may
present greater opportunities for growth, but also involve greater risks than
customarily are associated with investments in securities of more established
companies. Some of the companies in which the Trust may invest will be start-up
companies which may have insubstantial operational or earnings history or may
have limited products, markets, financial resources or management depth. Some
may also be emerging companies at the research and development stage with no
products or technologies to market or approved for marketing. Securities of
emerging companies may lack an active secondary market and may be subject to
more abrupt or erratic price movements than securities of larger, more
established companies or stock market averages in general. Competitors of
certain companies may have substantially greater financial resources than many
of the companies in which the Trust may invest.
Initial
Public Offerings Risk
The
Trust
may invest in shares of companies through initial public offerings (“IPOs”).
IPOs and companies that have recently gone public have the potential to produce
substantial gains for the Trust. However, there is no assurance that the Trust
will have access to profitable IPOs. The investment performance of the Trust
during periods when it is unable to invest significantly or at all in IPOs
may
be lower than during periods when the Trust is able to do so. Securities issued
in IPOs are subject to many of the same risks as investing in companies with
smaller market capitalizations. Securities issued in IPOs have no trading
history, and information about the companies may be available for limited
periods of time. In addition, the prices of securities sold in IPOs may be
highly volatile or may decline shortly after the IPO.
Securities
Lending Risk
The
Trust
may lend its portfolio securities (up to a maximum of one-third of its total
assets) to banks or dealers which meet the creditworthiness standards
established by the board of trustees of the Trust. Securities lending is subject
to the risk that loaned securities may not be available to the Trust on a timely
basis and the Trust may, therefore, lose the opportunity to sell the securities
at a desirable price. Any loss in the market price of securities loaned by
the
Trust that occurs during the term of the loan would be borne by the Trust and
would adversely affect the Trust’s performance. Also, there may be delays in
recovery, or no recovery, of securities loaned or even a loss of rights in
the
collateral should the borrower of the securities fail financially while the
loan
is outstanding. Although the Trust generally has the ability to recall loaned
securities pursuant to a securities lending arrangement in the event that a
shareholder vote is held, there is a risk that any delay in recovery of such
security will result in the holder of such security being unable to vote. All
of
the aforementioned risks may be greater for non-U.S. securities.
Risks
Associated with Options on Securities
There
are
several risks associated with transactions in options on securities. For
example, there are significant differences between the securities and options
markets that could result in an imperfect correlation between these markets,
causing a given transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
As
the
writer of a covered call option, the Trust foregoes, during the option’s life,
the opportunity to profit from increases in the market value of the security
covering the call option above the sum of the premium and the strike price
of
the call, but has retained the risk of loss should the price of the underlying
security decline. As the Trust writes covered calls over more of its portfolio,
its ability to benefit from capital appreciation becomes more limited. The
writer of an option has no control over the time when it may be required to
fulfill its obligation as a writer of the option. Once an option writer has
received an exercise notice, it cannot effect a closing purchase transaction
in
order to terminate its obligation under the option and must deliver the
underlying security at the exercise price.
When
the
Trust writes covered put options, it bears the risk of loss if the value of
the
underlying stock declines below the exercise price minus the put premium. If
the
option is exercised, the Trust could incur a loss if it is required to purchase
the stock underlying the put option at a price greater than the market price
of
the stock at the time of exercise plus the put premium the Trust received when
it wrote the option. While the Trust’s potential gain in writing a covered put
option is limited to distributions earned on the liquid assets securing the
put
option plus the premium received from the purchaser of the put option, the
Trust
risks a loss equal to the entire exercise price of the option minus the put
premium.
Exchange-Listed
Option Risks
There
can
be no assurance that a liquid market will exist when the Trust seeks to close
out an option position on an options exchange. Reasons for the absence of a
liquid secondary market on an exchange include the following: (i) there may
be
insufficient trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v) the facilities
of an exchange or the Options Clearing Corporation may not at all times be
adequate to handle current trading volume; or (vi) one or more exchanges could,
for economic or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or series of options).
If trading were discontinued, the secondary market on that exchange (or in
that
class or series of options) would cease to exist. However, outstanding options
on that exchange that had been issued by the Options Clearing Corporation as
a
result of trades on that exchange would continue to be exercisable in accordance
with their terms. If the Trust were unable to close out a covered call option
that it had written on a security, it would not be able to sell the underlying
security unless the option expired without exercise.
The
hours
of trading for options on an exchange may not conform to the hours during which
the underlying securities are traded. To the extent that the options markets
close before the markets for the underlying securities, significant price and
rate movements can take place in the underlying markets that cannot be reflected
in the options markets. Call options are marked to market daily and their value
will be affected by changes in the value and dividend rates of the underlying
common shares, an increase in interest rates, changes in the actual or perceived
volatility of the stock market and the underlying common shares and the
remaining time to the options’ expiration. Additionally, the exercise price of
an option may be adjusted downward before the option’s expiration as a result of
the occurrence of certain corporate events affecting the underlying equity
security, such as extraordinary dividends, stock splits, merger or other
extraordinary distributions or events. A reduction in the exercise price of
an
option would reduce the Trust’s capital appreciation potential on the underlying
security.
Over-the-Counter
Option Risk
The
Trust
may write (sell) unlisted (“OTC”
or
“over-the-counter”)
options. Options written by the Trust with respect to non-U.S. securities,
indices or sectors generally will be OTC options. OTC options differ from
exchange-listed options in that they are two-party contracts, with exercise
price, premium and other terms negotiated between buyer and seller, and
generally do not have as much market liquidity as exchange-listed options.
The
counterparties to these transactions typically will be major international
banks, broker-dealers and financial institutions. The Trust may be required
to
treat as illiquid those securities being used to cover certain written OTC
options. The OTC options written by the Trust will not be issued, guaranteed
or
cleared by the Options Clearing Corporation. In addition, the Trust’s ability to
terminate the OTC options may be more limited than with exchange-traded options.
Banks, broker-dealers or other financial institutions participating in such
transaction may fail to settle a transaction in accordance with the terms of
the
option as written. In the event of default or insolvency of the counterparty,
the Trust may be unable to liquidate an OTC option position.
Index
Option Risk
The
Trust
may sell index put and call options from time to time. The purchaser of an
index
put option has the right to any depreciation in the value of the index below
the
exercise price of the option on or before the expiration date. The purchaser
of
an index call option has the right to any appreciation in the value of the
index
over the exercise price of the option on or before the expiration date. Because
the exercise of an index option is settled in cash, sellers of index call
options, such as the Trust, cannot provide in advance for their potential
settlement obligations by acquiring and holding the underlying securities.
The
Trust will lose money if it is required to pay the purchaser of an index option
the difference between the cash value of the index on which the option was
written and the exercise price and such difference is greater than the premium
received by the Trust for writing the option. The value of index options written
by the Trust, which will be priced daily, will be affected by changes in the
value and dividend rates of the underlying common shares in the respective
index, changes in the actual or perceived volatility of the stock market and
the
remaining time to the options’ expiration. The value of the index options also
may be adversely affected if the market for the index options becomes less
liquid or smaller. Distributions paid by the Trust on its common shares may
be
derived in part from the net index option premiums it receives from selling
index put and call options, less the cost of paying settlement amounts to
purchasers of the options that exercise their options. Net index option premiums
can vary widely over the short term and long term.
Asset-Backed
Securities Risk
Payment
of interest and repayment of principal on asset-backed securities may be largely
dependent upon the cash flows generated by the assets backing the securities
and, in certain cases, supported by letters of credit, surety bonds or other
credit enhancements. Asset-backed security values may also be affected by the
creditworthiness of the servicing agent for the pool, the originator of the
loans or receivables or the entities providing the credit enhancement. In
addition, the underlying assets are subject to prepayments that shorten the
securities’ weighted average maturity and may lower their return.
Mortgage-Backed
Securities Risk
A
mortgage-backed security, which represents an interest in a pool of assets
such
as mortgage loans, will mature when all the mortgages in the pool mature or
are
prepaid. Therefore, mortgage-backed securities do not have a fixed maturity,
and
their expected maturities may vary when interest rates rise or
fall.
When
interest rates fall, homeowners are more likely to prepay their mortgage loans.
An increased rate of prepayments on the Trust’s mortgage-backed securities will
result in an unforeseen loss of interest income to the Trust as the Trust may
be
required to reinvest assets at a lower interest rate. Because prepayments
increase when interest rates fall, the price of mortgage-backed securities
does
not increase as much as other fixed income securities when interest rates
fall.
When
interest rates rise, homeowners are less likely to prepay their mortgage loans.
A decreased rate of prepayments lengthens the expected maturity of a
mortgage-backed security. Therefore, the prices of mortgage-backed securities
may decrease more than prices of other fixed income securities when interest
rates rise.
Derivatives
Risk
The
Trust
may engage in derivative transactions for hedging and speculative purposes
or to
enhance total return, including options, futures, swaps, foreign currency
transactions and forward foreign currency contracts, currency swaps or options
on currency and currency futures (“Derivative
Transactions”).
Derivatives allow an investor to hedge or speculate upon the price movements
of
a particular security, financial benchmark currency or index at a fraction
of
the cost of investing in the underlying asset. The value of a derivative depends
largely upon price movements in the underlying asset. Therefore, many of the
risks applicable to trading the underlying asset are also applicable to
derivatives of such asset. However, there are a number of other risks associated
with derivatives trading, including the imperfect correlation between the value
of such instruments and the underlying assets, the possible default of the
other
party to the transaction or illiquidity of the derivative instruments. The
ability to successfully use Derivative Transactions depends on the Investment
Adviser’s ability to predict pertinent market movements, which cannot be
assured. Because many derivatives are “leveraged,” and thus provide
significantly more market exposure than the money paid or deposited when the
transaction is entered into, a relatively small adverse market movement can
not
only result in the loss of the entire investment, but may also expose the Trust
to the possibility of a loss exceeding the original amount invested. The use
of
Derivative Transactions may result in losses greater than if they had not been
used, may require the Trust to sell or purchase portfolio securities at
inopportune times or for prices other than current market values, may limit
the
amount of appreciation the Trust can realize on an investment or may cause
the
Trust to hold a security that it might otherwise sell. The use of foreign
currency transactions can result in the Trust incurring losses as a result
of
the imposition of exchange controls, suspension of settlements or the inability
of the Trust to deliver or receive a specified currency. Additionally, amounts
paid by the Trust as premiums and cash or other assets held in margin accounts
with respect to Derivative Transactions are not otherwise available to the
Trust
for investment purposes.
To
the
extent that the Trust purchases options pursuant to a hedging strategy, the
Trust will be subject to the following additional risks. If a put or call option
purchased by the Trust is not sold when it has remaining value, and if the
market price of the underlying security remains equal to or greater than the
exercise price (in the case of a put), or remains less than or equal to the
exercise price (in the case of a call), the Trust will lose its entire
investment in the option.
Where
a
put or call option on a particular security is purchased to hedge against price
movements in a related security, the price of the put or call option may move
more or less than the price of the related security. If restrictions on exercise
were imposed, the Trust might be unable to exercise an option it had purchased.
If the Trust were unable to close out an option that it had purchased on a
security, it would have to exercise the option in order to realize any profit
or
the option may expire worthless.
Market
Risk Generally
The
profitability of a significant portion of the Trust’s investment program depends
to a great extent upon correctly assessing the future course of the price
movements of securities and other investments and the movements of interest
rates. There can be no assurance that the Investment Adviser will be able to
predict accurately these price and interest rate movements. With respect to
certain investment strategies the Trust utilizes, there is a high degree of
market risk.
Reinvestment
Risk
The
Trust
reinvests the cash flows received from a security. The additional income from
such reinvestment, sometimes called interest-on-interest, is reliant on the
prevailing interest rate levels at the time of reinvestment. There is a risk
that the interest rate at which interim cash flows can be reinvested will fall.
Reinvestment risk is greater for longer holding periods and for securities
with
large, early cash flows such as high-coupon bonds. Reinvestment risk also
applies generally to the reinvestment of the proceeds the Trust receives upon
the maturity or sale of a portfolio security.
Timing
Risk
Many
agency, corporate and municipal bonds, and most mortgage-backed securities,
contain a provision that allows the issuer to “call” all or part of the issue
before the bond’s maturity date often after 5 or 10 years. The issuer usually
retains the right to refinance the bond in the future if market interest rates
decline below the coupon rate. There are three disadvantages to the call
provision. First, the cash flow pattern of a callable bond is not known with
certainty. Second, because an issuer is more likely to call the bonds when
interest rates have dropped, the Trust is exposed to reinvestment risk,
i.e.,
the
Trust may have to reinvest at lower interest rates the proceeds received when
the bond is called. Finally, the capital appreciation potential of a bond will
be reduced because the price of a callable bond may not rise much above the
price at which the issuer may call the bond.
Inflation
Risk
Inflation
risk results from the variation in the value of cash flows from a security
due
to inflation, as measured in terms of purchasing power. For example, if the
Trust purchases a bond in which it can realize a coupon rate of 5%, but the
rate
of inflation increases from 2% to 6%, then the purchasing power of the cash
flow
has declined. For all but adjustable bonds or floating rate bonds, the Trust
is
exposed to inflation risk because the interest rate the issuer promises to
make
is fixed for the life of the security. To the extent that interest rates reflect
the expected inflation rate, floating rate bonds have a lower level of inflation
risk. In addition, during any periods of rising inflation, dividend rates of
any
variable rate preferred share issued by the Trust would likely increase, which
would tend to further reduce returns to common shareholders.
Arbitrage
Risks
The
Trust
engages in capital structure arbitrage and other arbitrage strategies. Arbitrage
strategies entail various risks, including the risk that external events,
regulatory approvals and other factors will impact the consummation of announced
corporate events and/or the prices of certain positions. In addition, hedging
is
an important feature of capital structure arbitrage. There is no guarantee
that
the Investment Adviser will be able to hedge the Trust’s portfolio in the manner
necessary to employ successfully the Trust’s strategy.
Short
Sales Risk
Short
selling involves selling securities which may or may not be owned and borrowing
the same securities for delivery to the purchaser, with an obligation to replace
the borrowed securities at a later date. Short selling allows the Trust to
profit from declines in market prices to the extent such decline exceeds the
transaction costs and the costs of borrowing the securities. However, since
the
borrowed securities must be replaced by purchases at market prices in order
to
close out the short position, any appreciation in the price of the borrowed
securities would result in a loss. There can be no assurance that the securities
necessary to cover a short position will be available for purchase. Purchasing
securities to close out the short position can itself cause the price of the
securities to rise further, thereby exacerbating the loss. The Trust may
mitigate such losses by replacing the securities sold short before the market
price has increased significantly. Under adverse market conditions, the Trust
might have difficulty purchasing securities to meet its short sale delivery
obligations, and might have to sell portfolio securities to raise the capital
necessary to meet its short sale obligations at a time when fundamental
investment considerations would not favor such sales. Short sales by the Trust
that are not made “against the box” theoretically involve unlimited loss
potential since the market price of securities sold short may continuously
increase.
Risks
of Investing in Structured Finance Securities
A
portion
of the Trust’s investments may consist of equipment trust certificates,
collateralized mortgage obligations, collateralized bond obligations,
collateralized loan obligations or similar instruments. Structured finance
securities may present risks similar to those of the other types of debt
obligations in which the Trust may invest and, in fact, such risks may be of
greater significance in the case of structured finance securities. Moreover,
investing in structured finance securities may entail a variety of unique risks.
Among other risks, structured finance securities may be subject to prepayment
risk. In addition, the performance of a structured finance security will be
affected by a variety of factors, including its priority in the capital
structure of the issuer thereof, the availability of any credit enhancement,
the
level and timing of payments and recoveries on and the characteristics of the
underlying receivables, loans or other assets that are being securitized,
remoteness of those assets from the originator or transferor, the adequacy
of
and ability to realize upon any related collateral and the capability of the
servicer of the securitized assets.
Risks
of Investing in Preferred Securities.
There
are
special risks associated with investing in preferred securities,
including:
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Deferral.
Preferred securities may include provisions that permit the issuer,
at its
discretion, to defer distributions for a stated period without any
adverse
consequences to the issuer. If the Trust owns a preferred security
that is
deferring its distributions, the Trust may be required to report
income
for tax purposes although it has not yet received such
income.
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Subordination.
Preferred securities are subordinated to bonds and other debt instruments
in a company’s capital structure in terms of priority to corporate income
and liquidation payments, and therefore will be subject to greater
credit
risk than more senior debt
instruments.
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Liquidity.
Preferred securities may be substantially less liquid than many other
securities, such as common stock or U.S. government
securities.
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Limited
Voting Rights.
Generally, preferred security holders have no voting rights with
respect
to the issuing company unless preferred dividends have been in arrears
for
a specified number of periods, at which time the preferred security
holders may elect a number of trustees to the issuer’s board. Generally,
once all the arrearages have been paid, the preferred security holders
no
longer have voting rights.
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Risks
of Investing in Swaps
Investments
in swaps involve the exchange with another party of their respective
commitments. Use of swaps subjects the Trust to risk of default by the
counterparty. If there is a default by the counterparty to such a transaction,
there may be contractual remedies pursuant to the agreements related to the
transaction although contractual remedies may not be sufficient in the event
the
counterparty is insolvent. However, the swap market has grown substantially
in
recent years with a large number of banks and investment banking firms acting
both as principals and agents utilizing standardized swap documentation. As
a
result, the swap market has become relatively liquid in comparison with the
markets for other similar instruments which are traded in the interbank market.
The Trust may enter into credit default swaps, currency swaps or other swaps
which may be surrogates for other instruments such as currency forwards or
options.
Risks
of Investing in Synthetic Securities
With
respect to synthetic securities the Trust will usually have a contractual
relationship only with the counterparty of such synthetic securities, and not
the Reference Obligor (as defined below) on the Reference Obligation (as defined
below). The Trust generally will have no right to directly enforce compliance
by
the Reference Obligor with the terms of the Reference Obligation nor any rights
of set-off against the Reference Obligor, nor have any voting rights with
respect to the Reference Obligation. The Trust will not benefit directly from
any collateral supporting the Reference Obligation or have the benefit of the
remedies on default that would normally be available to a holder of such
Reference Obligation. In addition, in the event of insolvency of its
counterparty, the Trust will be treated as a general creditor of such
counterparty and will not have any claim with respect to the credit risk of
the
counterparty as well as that of the Reference Obligor. As a result, an
overabundance of synthetic securities with any one counterparty subjects the
notes to an additional degree of risk with respect to defaults by such
counterparty as well as by the Reference Obligor. The Investment Adviser may
not
perform independent credit analyses of the counterparties or any entities
guaranteeing such counterparties, individually or in the aggregate. A
“Reference
Obligation”
is
the
debt security or other obligation upon which the synthetic security is based.
A
“Reference
Obligor”
is
the
obligor on a Reference Obligation. There is no maximum amount of Trust’s assets
that may be invested in synthetic securities.
Tax
Risk
The
Trust
may invest in derivative instruments, such as swaps, and other instruments,
in
order to obtain investment exposure to its principal investment categories
or
for other purposes. The Trust intends only to invest in such instruments to
an
extent and in a manner consistent with the Trust’s qualification as a regulated
investment company for federal income tax purposes. If the Trust were to fail
to
qualify as a regulated investment company in any year, then the Trust would
be
subject to federal (and state) income tax on its net income and capital gains
at
regular corporate income tax rates (without a deduction for distributions to
shareholders). Trust income distributed to common shareholders would also be
taxable to shareholders as ordinary dividend income to the extent attributable
to the Trust’s earnings and profits. Accordingly, in such event, the Trust’s
ability to achieve its investment objectives would be adversely affected, and
common shareholders would be subject to the risk of diminished investment
returns.
Valuation
Risk
Fair
value is defined as the amount for which assets could be sold in an orderly
disposition over a reasonable period of time, taking into account the nature
of
the asset. Fair value pricing, however, involves judgments that are inherently
subjective and inexact, since fair valuation procedures are used only when
it is
not possible to be sure what value should be attributed to a particular asset
or
when an event will affect the market price of an asset and to what extent.
As a
result, there can be no assurance that fair value pricing will reflect actual
market value, and it is possible that the fair value determined for a security
will be materially different from the value that actually could be or is
realized upon the sale of that asset.
Risks
of Non-Diversification and Other Focused Strategies
While
the
Investment Adviser invests in a number of fixed-income and equity instruments
issued by different issuers and employs multiple investment strategies with
respect to the Trust’s portfolio, it is possible that a significant amount of
the Trust’s investments could be invested in the instruments of only a few
companies or other issuers or that at any particular point in time one
investment strategy could be more heavily weighted than the others. The focus
of
the Trust’s portfolio in any one issuer would subject the Trust to a greater
degree of risk with respect to defaults by such issuer or other adverse events
affecting that issuer, and the focus of the portfolio in any one industry or
group of industries (but not to the extent of 25% of the Trust’s total assets)
would subject the Trust to a greater degree of risk with respect to economic
downturns relating to such industry. The focus of the Trust’s portfolio in any
one investment strategy would subject the Trust to a greater degree of risk
than
if the Trust’s portfolio were varied in its investments with respect to several
investment strategies.
Market
Disruption and Geopolitical Risk
The
aftermath of the war in Iraq and the continuing occupation of Iraq, instability
in the Middle East and terrorist attacks in the United States and around the
world may result in market volatility and may have long-term effects on the
U.S.
and worldwide financial markets and may cause further economic uncertainties
in
the United States and worldwide. The Investment Adviser does not know how long
the securities markets may be affected by these events and cannot predict the
effects of the occupation or similar events in the future on the U.S. economy
and securities markets.
Risks
of Investing in a Trust with Anti-Takeover Provisions
The
Trust’s Agreement and Declaration of Trust includes provisions that could limit
the ability of other entities or persons to acquire control of the Trust or
convert the Trust to open-end status. These provisions could deprive the holders
of common shares of opportunities to sell their common shares at a premium
over
the then current market price of the common shares or at net asset
value.
Key
Adviser Personnel Risk
The
Trust’s ability to identify and invest in attractive opportunities is dependent
upon Highland, its investment adviser. If one or more key individuals leaves
Highland, Highland may not be able to hire qualified replacements or may require
an extended time to do so. This situation could prevent the Trust from achieving
its investment objectives.
Given
the
risks described above, an investment in the common shares may not be appropriate
for all investors. You should carefully consider your ability to assume these
risks before making an investment in the Trust.
MANAGEMENT
OF THE TRUST
Trustees
and Officers
The
board
of trustees is responsible for the overall management of the Trust, including
supervision of the duties performed by Highland. There are five trustees of
the
Trust. Four of the trustees are not “interested persons” (as defined in the
Investment Company Act) of the Trust. The name and business address of the
trustees and officers of the Trust and their principal occupations and other
affiliations during the past five years are set forth under “Management
of the Trust”
in
the
Statement of Additional Information.
Investment
Adviser
Highland
acts as the Trust’s investment adviser. Highland is located at Two Galleria
Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. As of September 30,
2007, the Investment Adviser managed approximately $38 billion in assets
on
behalf of investors around the world. Highland is controlled by James Dondero
and Mark Okada, by virtue of their respective share ownership, and its general
partner, Strand Advisors, Inc. (“Strand”), of which Mr. Dondero is the sole
stockholder. Messrs. Dondero and Okada have managed portfolios together since
1990.
Responsibilities. The
Investment Adviser provides the following services to the Trust: (i) furnishes
an investment program for the Trust; (ii) determines, subject to the overall
supervision and review of the board of trustees, the investments to be
purchased, held, sold or exchanged by the Trust and the portion, if any, of
the
assets of the Trust to be held uninvested; (iii) makes changes in the
investments of the Trust; and (iv) votes, exercises consents and exercises
all
other rights pertaining to such investments. Subject to the foregoing, the
Investment Adviser, at its own expense, will have the authority to engage one
or
more sub-advisers in connection with the portfolio management of the Trust,
which sub-advisers may be affiliates of the Investment Adviser; provided,
however, that the Investment Adviser shall remain responsible to the Trust
with
respect to its duties and obligations set forth in the investment advisory
agreement.
Compensation.
In
return for its advisory services, the Investment Adviser receives an annual
fee,
payable monthly, in an amount equal to 1.00% of the average weekly value of
the
Trust’s Managed Assets (the “Advisory
Fee”).
The
accrued fees are payable monthly as promptly as possible after the end of each
month during which the investment advisory agreement is in effect. The
Investment Adviser may waive a portion of its fees. A discussion regarding
the
basis for the approval of the investment advisory agreement by the Trust’s board
is available in the Trust’s report to shareholders for the period ending June
30, 2006.
Potential
Conflicts of Interest.
Since
the Trust employs leverage, the Investment Adviser will benefit because the
Trust’s Managed Assets will increase with leverage. Furthermore, the Investment
Adviser will also benefit to the extent that the Trust’s Managed Assets are
derived from the reinvested collateral received on portfolio securities
loaned.
In
addition to the Advisory Fee of Highland, the Trust pays all other costs and
expenses of its operations, including, but not limited to, compensation of
its
trustees (other than those affiliated with Highland), custodian, transfer and
dividend disbursing agent expenses, legal fees, listing fees and expenses,
expenses of independent auditors, expenses of preparing, printing and
distributing shareholder reports, notices, proxy statements and reports to
governmental agencies, and reimbursement of actual expenses of the Investment
Adviser or others for registration and maintenance of the Trust’s registrations
with the Commission and other jurisdictions and taxes, if any.
Administrator/Sub-Administrator
Under
an
administration agreement dated June 29, 2006, Highland provides administration
services to the Trust, provides executive and other personnel necessary to
administer the Trust and furnishes office space. Highland receives an annual
fee, payable monthly, in an amount equal to 0.20% of the average weekly value
of
the Trust’s Managed Assets. The accrued fees are payable monthly as promptly as
possible after the end of each month during which this Agreement is in effect.
Highland may waive a portion of its fees. Under a separate sub-administration
services agreement, dated June 29, 2006, Highland has delegated certain
administrative functions to PFPC Inc., at an annual rate, payable by Highland,
of 0.01% of the average weekly value of the Trust’s Managed
Assets.
Portfolio
Managers
The
Trust’s portfolio managers are Kurtis Plumer, James Dondero and Mark Okada.
Their investment decisions are not subject to the oversight, approval or
ratification of a committee.
Kurtis
Plumer,
CFA.
Mr. Plumer is a Senior Portfolio Manager and head of the Multi-Strategies
group
at Highland where he is responsible for managing the sourcing, investing
and
monitoring process. He has over 15 years of experience in distressed, high
yield
bond and leveraged loan products. Prior to joining Highland in 1999, Mr.
Plumer
was a distressed high yield bond trader at Lehman Brothers in New York, where
he
managed a $250 million portfolio invested in global distressed securities.
While
at Lehman, he also traded emerging market sovereign bonds. Prior to joining
Lehman Brothers, Mr. Plumer was a corporate finance banker at NationsBanc
Capital Markets, Inc. (now Bank of America Capital Markets, Inc.) where he
focused on M&A and financing transactions for the bank’s clients. Mr. Plumer
earned a BBA in Economics and Finance from Baylor University and an MBA in
Strategy and Finance from the Kellogg School at Northwestern University.
Mr.
Plumer is a Chartered Financial Analyst.
James
Dondero,
CFA,
CPA, CMA. Mr. Dondero is a founder and President of Highland. Formerly, Mr.
Dondero served as Chief Investment Officer of Protective Life’s GIC subsidiary
and helped grow the business from concept to over $2 billion between 1989 and
1993. His portfolio management experience includes mortgage-backed securities,
investment grade corporates, leveraged bank loans, emerging markets,
derivatives, preferred stocks and common stocks. From 1985 to 1989, he managed
approximately $1 billion in fixed income funds for American Express. Prior
to
American Express, he completed his financial training at Morgan Guaranty Trust
Company. Mr. Dondero is a Beta Gamma Sigma graduate of the University of
Virginia, 1984 with degrees in Accounting and Finance. Mr. Dondero is a
Certified Public Accountant, Chartered Financial Analyst and a Certified
Management Accountant.
Mark
Okada,
CFA.
Mr. Okada is Executive Vice President of Strand and the funds in the Highland
Fund Complex. Mr. Okada is a founder and Chief Investment Officer of Highland
and has served as Chief Investment Officer since 2000. From 1993 to 2000, Mr.
Okada served as Executive Vice President of Highland. He is responsible for
overseeing Highland’s investment activities for its various funds and has over
19 years of experience in the leveraged finance market. Formerly, Mr. Okada
served as Manager of Fixed Income for Protective Life’s GIC subsidiary from 1990
to 1993. He was primarily responsible for the bank loan portfolio and other
risk
assets. Protective was one of the first non-bank entrants into the syndicated
loan market. From 1986 to 1990, he served as Vice President for Hibernia
National Bank, managing over $1 billion of high-yield bank loans. Mr. Okada
is
an honors graduate of the University of California Los Angeles with degrees
in
Economics and Psychology. He completed his credit training at Mitsui and is
a
Chartered Financial Analyst. Mr. Okada is also Chairman of the Board of
Directors of Common Grace Ministries Inc.
The
Statement of Additional Information provides additional information about the
portfolio managers’ compensation, other accounts managed by the portfolio
managers and the portfolio managers’ ownership of securities issued by the
Trust.
NET
ASSET VALUE
The
net
asset value of the common shares of the Trust is computed based upon the value
of the Trust’s portfolio securities and other assets. Net asset value per common
share is determined daily on each day that the New York Stock Exchange is open
for business as of the close of the regular trading session on the New York
Stock Exchange. The Trust calculates net asset value per common share by
subtracting liabilities (including accrued expenses or dividends) from the
total
assets of the Trust (the value of the securities plus cash or other assets,
including interest accrued but not yet received) and dividing the result by
the
total number of outstanding common shares of the Trust.
Valuations
The
Trust
uses the following valuation methods to determine either current market value
for investments for which market quotations are available, or if not available,
the fair value, as determined in good faith pursuant to policies and procedures
approved by the board of trustees:
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(i) |
The
market value of each security listed or traded on any recognized
securities exchange or automated quotation system will be the
last
reported sale price at the relevant valuation date on the composite
tape
or on the principal exchange on which such security is traded.
If no sale
is reported on that date, the Investment Adviser utilizes,
when available,
pricing quotations from principal market makers. Such quotations
may be
obtained from third-party pricing services or directly from
investment
brokers and dealers in the secondary market. Generally, the
Trust’s loan
and bond positions are not traded on exchanges and consequently
are valued
based on market prices received from third-party pricing services
or
broker-dealer
sources.
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(ii)
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Dividends
declared but not yet received, and rights in respect of securities
which
are quoted ex-dividend or ex-rights, will be recorded at the fair
value
thereof, as determined by the Investment Adviser, which may (but
need not)
be the value so determined on the day such securities are first quoted
ex-dividend or ex-rights.
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(iii)
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Listed
options, or over-the-counter options for which representative brokers’
quotations are available, will be valued in the same manner as listed
or
over-the-counter securities as hereinabove provided. Premiums for
the sale
of such options written by the Trust will be included in the assets
of the
Trust, and the market value of such options shall be included as
a
liability.
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(iv)
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The
Trust’s non-marketable investments will generally be valued in such manner
as the Investment Adviser determines in good faith to reflect their
fair
values under procedures established by, and under the general supervision
and responsibility of, the Trust’s board of trustees. The pricing of all
assets that are fair valued in this manner will be subsequently reported
to and ratified by the Trust’s board of
trustees.
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When
determining the fair value of an asset, the Investment Adviser seeks to
determine the price that the Trust might reasonably expect to receive from
the
current sale of that asset in an arm’s-length transaction. Fair value
determinations are based upon all available factors that the Investment Adviser
deems relevant.
DISTRIBUTIONS
Subject
to market conditions, the Trust expects to declare dividend on the Trust’s
common shares on a monthly basis. The Trust intends to pay any capital gain
distributions annually.
Various
factors will affect the level of the Trust’s current income and current gains,
such as its asset mix and the Trust’s use of options. To permit the Trust to
maintain more stable monthly dividends and annual distributions, the Trust
may
from time to time distribute less than the entire amount of income and gains
earned in the relevant month or year, respectively. The undistributed income
and
gains would be available to supplement future distributions. As a result, the
distributions paid by the Trust for any particular period may be more or less
than the amount of income and gains actually earned by the Trust during the
applicable period. Undistributed income and gains will add to the Trust’s net
asset value and, correspondingly, distributions from undistributed income and
gains and from capital, if any, will be deducted from the Trust’s net asset
value. Shareholders will automatically have all dividends and distributions
reinvested in common shares issued by the Trust or common shares of the Trust
purchased in the open market in accordance with the Trust’s Dividend
Reinvestment Plan unless an election is made to receive cash. Each participant
in the Trust’s Dividend Reinvestment Plan will pay a pro rata portion of
brokerage commissions incurred in connection with open market purchases, and
participants requesting a sale of securities through the plan agent of the
Trust’s Dividend Reinvestment Plan are subject to a sales fee and a brokerage
commission. See “Dividend
Reinvestment Plan.”
DIVIDEND
REINVESTMENT PLAN
Unless
the registered owner of common shares elects to receive cash by contacting
the
Plan Agent, all dividends declared for the common shares of the Trust will
be
automatically paid in the form of or, reinvested by PFPC Inc. (the “Plan
Agent”),
agent
for shareholders in administering the Trust’s Dividend Reinvestment Plan (the
“Plan”)
in
additional common shares of the Trust. If you are a registered owner of common
shares and elect not to participate in the Plan, you will receive all dividends
in cash paid by check mailed directly to you (or, if the shares are held in
street or other nominee name, then to such nominee) by PFPC Inc., as dividend
disbursing agent. You may elect not to participate in the Plan and to receive
all dividends in cash by sending written instructions or by contacting PFPC
Inc., as dividend disbursing agent, at the address set forth below.
Participation in the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by contacting the Plan Agent before the
dividend record date; otherwise such termination or resumption will be effective
with respect to any subsequently declared dividend or other distribution. Some
brokers may automatically elect to receive cash on your behalf and may re-invest
that cash in additional shares of the Trust for you.
The
Plan
Agent will open an account for each shareholder under the Plan in the same
name
in which such shareholder’s shares are registered. Whenever the Trust declares a
dividend or other distribution (together, a “dividend”) payable in cash,
non-participants in the Plan will receive cash and participants in the Plan
will
receive the equivalent in common shares. The common shares will be acquired
by
the Plan Agent for the participants’ accounts, depending upon the circumstances
described below, either (i) through receipt of additional unissued but
authorized shares from the Trust (“newly issued shares”) or (ii) by purchase of
outstanding common shares on the open market (“open-market purchases”) on the
New York Stock Exchange or elsewhere.
If,
on
the payment date for any dividend, the market price per common share plus
estimated brokerage commissions is greater than the net asset value per common
share (such condition being referred to herein as “market premium”), the Trust
will issue common shares, including fractions, to the participants in the amount
of the dividend. The number of newly issued common shares to be credited to
each
participant’s account will be determined by dividing the dollar amount of the
dividend by the net asset value per common share on the payment date; provided
that, if the net asset value per common share is less than 95% of the market
price per common share on the payment date, the dollar amount of the dividend
will be divided by 95% of the market price per common share on the payment
date.
If,
on
the payment date for any dividend, the net asset value per common share is
greater than the market value per common share plus estimated brokerage
commissions (such condition being referred to herein as “market discount”), the
Plan Agent will invest the dividend amount in common shares acquired on behalf
of the participants in open-market purchases.
In
the
event of a market discount on the payment date for any dividend, the Plan Agent
will have until the last business day before the next date on which the common
shares trade on an “ex-dividend” basis or 120 days after the payment date for
such dividend, whichever is sooner (the “last purchase date”), to invest the
dividend amount in common shares acquired in open-market purchases. It is
contemplated that the Trust will pay monthly dividends. Therefore, the period
during which open-market purchases can be made will exist only from the payment
date of each dividend through the date before the “ex-dividend” date of the
third month of the quarter. If, before the Plan Agent has completed its
open-market purchases, the market price of a common share exceeds the net asset
value per common share, the average per common share purchase price paid by
the
Plan Agent may exceed the net asset value of the common shares, resulting in
the
acquisition of fewer common shares than if the dividend had been paid in newly
issued common shares on the dividend payment date. Because of the foregoing
difficulty with respect to open market purchases, if the Plan Agent is unable
to
invest the full dividend amount in open market purchases during the purchase
period or if the market discount shifts to a market premium during the purchase
period, the Plan Agent may cease making open-market purchases and may invest
the
uninvested portion of the dividend amount in newly issued common shares at
the
net asset value per common share at the close of business on the last purchase
date; provided that, if the net asset value per common share is less than 95%
of
the market price per common share on the payment date, the dollar amount of
the
dividend will be divided by 95% of the market price per common share on the
payment date.
The
Plan
Agent maintains all shareholders’ accounts in the Plan and furnishes written
confirmation of all transactions in the accounts, including information needed
by shareholders for tax records. Common shares in the account of each Plan
participant will be held by the Plan Agent on behalf of the Plan participant,
and each shareholder proxy will include those shares purchased or received
pursuant to the Plan. The Plan Agent will forward all proxy solicitation
materials to participants and vote proxies for shares held under the Plan in
accordance with the instructions of the participants.
In
the
case of shareholders such as banks, brokers or nominees which hold shares for
others who are the beneficial owners, the Plan Agent will administer the Plan
on
the basis of the number of common shares certified from time to time by the
record shareholder’s name and held for the account of beneficial owners who
participate in the Plan.
There
will be no brokerage charges with respect to common shares issued directly
by
the Trust. However, each participant will pay a pro rata share of brokerage
commissions incurred in connection with open-market purchases. The automatic
reinvestment of dividends will not relieve participants of any federal, state
or
local income tax that may be payable (or required to be withheld) on such
dividends. Accordingly, any taxable dividend received by a participant that
is
reinvested in additional common shares will be subject to federal (and possibly
state and local) income tax even though such participant will not receive a
corresponding amount of cash with which to pay such taxes. See “Tax
Matters.”
Participants who request a sale of shares through the Plan Agent are subject
to
a $2.50 sales fee and pay a brokerage commission of $0.05 per share
sold.
The
Trust
reserves the right to amend or terminate the Plan. There is no direct service
charge to participants in the Plan; however, the Trust reserves the right to
amend the Plan to include a service charge payable by the
participants.
All
correspondence concerning the Plan should be directed to the Plan Agent at
PFPC
Inc.,
301
Bellevue Parkway, Wilmington, Delaware 19809; telephone (877)
665-1287.
DESCRIPTION
OF CAPITAL STRUCTURE
Common
Shares
The
Trust
is a statutory trust organized under the laws of Delaware pursuant to an
Agreement and Declaration of Trust dated as of March 10, 2006. The Trust is
authorized to issue an unlimited number of common shares of beneficial interest,
par value $0.001 per share. Each common share has one vote and, when issued
and
paid for in accordance with the terms of this offering, will be fully paid
and
non-assessable, except that the trustees shall have the power to cause
shareholders to pay expenses of the Trust by setting off charges due from
shareholders from declared but unpaid dividends or distributions owed the
shareholders and/or by reducing the number of common shares owned by each
respective shareholder. The Trust currently is not aware of any expenses that
will be paid pursuant to this provision, except to the extent fees payable
under
its Dividend Reinvestment Plan are deemed to be paid pursuant to this
provision.
The
Trust
intends to hold annual meetings of shareholders so long as the common shares
are
listed on a national securities exchange and such meetings are required as
a
condition to such listing. All common shares are equal as to dividends, assets
and voting privileges and have no conversion, preemptive or other subscription
rights. The Trust will send annual and semi-annual reports, including financial
statements, to all holders of its shares.
The
Trust
has no present intention of offering any additional shares other than the Shares
and common shares issued under the Trust’s Dividend Reinvestment Plan. Any
additional offerings of shares will require approval by the Trust’s board of
trustees. Any additional offering of common shares will be subject to the
requirements of the Investment Company Act, which provides that shares may
not
be issued at a price below the then current net asset value, exclusive of sales
load, except in connection with an offering to existing holders of common shares
or with the consent of a majority of the Trust’s outstanding voting
securities.
The
Trust’s common shares are listed on the New York Stock Exchange under the symbol
“HCF.”
Unlike
open-end funds, closed-end funds like the Trust do not continuously offer shares
and do not provide daily redemptions. Rather, if a shareholder determines to
buy
additional common shares or sell shares already held, the shareholder may do
so
by trading through a broker on the New York Stock Exchange or otherwise. Shares
of closed-end investment companies frequently trade on an exchange at prices
lower than net asset value. Because the market value of the common shares may
be
influenced by such factors as dividend levels (which are in turn affected by
expenses), dividend stability, net asset value, relative demand for and supply
of such shares in the market, general market and economic conditions and other
factors beyond the control of the Trust, the Trust cannot assure you that common
shares will trade at a price equal to or higher than net asset value in the
future. The common shares are designed primarily for long-term investors and
you
should not purchase the common shares if you intend to sell them soon after
purchase. See the Statement of Additional Information under “Repurchase
of Common Shares.”
The
following table provides information about the Trust’s outstanding shares as of
November 30, 2007.
|
Title
of Class
|
|
Amount
Authorized
|
|
Amount
Outstanding
|
|
|
Common
Shares
|
|
|
Unlimited
|
|
|
34,520,549
|
|
Other
Shares
The
board
of trustees (subject to applicable law and the Trust’s Agreement and Declaration
of Trust) may authorize an offering, without the approval of the holders of
common shares, of other classes of shares, or other classes or series of shares,
as they determine to be necessary, desirable or appropriate, having such terms,
rights, preferences, privileges, limitations and restrictions as the board
of
trustees see fit. The Trust currently does not expect to issue any other classes
of shares, or series of shares, except for the common shares.
Credit
Facility
The
Trust
currently leverages through borrowings from a credit facility. The Trust
has
entered into a revolving credit agreement with The Bank of Nova Scotia
(“Scotia”) to borrow up to $300,000,000 (the “Loan Agreement”). Such borrowings
constitute financial leverage. The Loan Agreement contains covenants that
may
limit the Trust’s ability to, without the prior consent of Scotia: (i) pay
dividends in certain circumstances, (ii) incur additional debt, (iii) change
its
investment objectives, policies and restrictions as set forth in the Trust’s
prospectus in effect when the Loan Agreement became effective and (iv) adopt
or
carry out any plan of liquidation, reorganization, incorporation,
recapitalization, merger or consolidation or sell, transfer or otherwise
dispose
of all or a substantial part of its assets. For instance, the Trust agreed
not
to purchase assets not contemplated by the investment policies and restrictions
in effect when the Loan Agreement became effective. Furthermore, the Trust
may
not incur additional debt from any other party, except for in limited
circumstances (e.g.,
in the
ordinary course of business). In addition, the Loan Agreement contains a
covenant requiring asset coverage ratios that may be more stringent than
those
required by the Investment Company Act. Such restrictions shall apply only
so
long as the Loan Agreement remains in effect. Any senior security representing
indebtedness, as defined in Section 18(g) of the Investment Company Act,
must
have asset coverage of at least 300%. Debt incurred under the Loan Agreement
will be considered a senior security for this purpose.
MARKET
AND NET ASSET VALUE INFORMATION
The
Trust’s common shares are listed on the NYSE under the symbol “HCF.”
The
Trust’s common shares commenced trading on the NYSE in June 2006 and thus have
a
limited trading history. The Trust cannot predict whether its shares will
trade
in the future at a premium or discount to net asset value. Issuance of
additional common shares may have an adverse effect on prices in the secondary
market for the Trust’s common shares by increasing the number of shares
available, which may put downward pressure on the market price for the
shares.
The
following table sets forth, for each of the periods indicated, the high and
low
closing market prices of the Trust’s common shares on the NYSE, the high and low
net asset value per share and the high low premium/discount to net asset
value
per share. See “Net
Asset
Value”
for
information as to how the Trust’s net asset value is determined.
|
Quarter
|
|
Market
price
|
|
Net
asset value per share
|
|
Premium/(Discount)
as a % of net asset value
|
|
| |
|
High
|
|
Low
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
|
2nd
Quarter 2006*
|
|
|
20.60
|
|
|
20.18
|
|
|
19.07
|
|
|
19.06
|
|
|
8.02
|
%
|
|
5.87
|
%
|
|
3rd
Quarter 2006
|
|
|
21.30
|
|
|
19.82
|
|
|
20.60
|
|
|
20.58
|
|
|
11.40
|
%
|
|
3.62
|
%
|
|
4th
Quarter 2006
|
|
|
21.48
|
|
|
20.10
|
|
|
21.16
|
|
|
20.18
|
|
|
7.28
|
%
|
|
3.12
|
%
|
|
1st
Quarter 2007
|
|
|
21.69
|
|
|
20.37
|
|
|
21.10
|
|
|
20.87
|
|
|
6.63
|
%
|
|
0.18
|
%
|
|
2nd
Quarter 2007
|
|
|
21.14
|
|
|
19.80
|
|
|
20.98
|
|
|
20.95
|
|
|
3.19
|
%
|
|
(3.18
|
)%
|
|
3rd
Quarter 2007
|
|
|
20.17
|
|
|
16.25
|
|
|
20.15
|
|
|
17.73
|
|
|
(0.68
|
)%
|
|
(15.28
|
)%
|
*
The
Trust commenced operations on June 29, 2006
ANTI-TAKEOVER
PROVISIONS IN THE AGREEMENT AND DECLARATION OF TRUST
The
Agreement and Declaration of Trust includes provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Trust or to change the composition of its board of trustees. This could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control over the Trust. Such attempts could have the effect
of
increasing the expenses of the Trust and disrupting the normal operation of
the
Trust. The board of trustees is divided into three classes, with the terms
of
one class expiring at each annual meeting of shareholders. At each annual
meeting, one class of trustees is elected to a three-year term. This provision
could delay for up to two years the replacement of a majority of the board
of
trustees. A trustee may be removed from office (for cause, and not without
cause) by the action of a majority of the remaining trustees followed by a
vote
of the holders of at least 75% of the shares then entitled to vote for the
election of the respective trustee.
In
addition, the Trust’s Agreement and Declaration of Trust requires the favorable
vote of a majority of the Trust’s board of trustees followed by the favorable
vote of the holders of at least 75% of the outstanding shares of each affected
class or series of the Trust, voting separately as a class or series, to
approve, adopt or authorize certain transactions with 5% or greater holders
of a
class or series of shares and their associates, unless the transaction has
been
approved by at least 80% of the trustees, in which case “a majority of the
outstanding voting securities” (as defined in the Investment Company Act) of the
Trust shall be required. For purposes of these provisions, a 5% or greater
holder of a class or series of shares (a “Principal
Shareholder”)
refers
to any person who, whether directly or indirectly and whether alone or together
with its affiliates and associates, beneficially owns 5% or more of the
outstanding shares of all outstanding classes or series of shares of beneficial
interest of the Trust.
The
5%
holder transactions subject to these special approval requirements are: the
merger or consolidation of the Trust or any subsidiary of the Trust with or
into
any Principal Shareholder; the issuance of any securities of the Trust to any
Principal Shareholder for cash, except pursuant to any automatic dividend
reinvestment plan; the sale, lease or exchange of all or any substantial part
of
the assets of the Trust to any Principal Shareholder, except assets having
an
aggregate fair market value of less than 2% of the total assets of the Trust,
aggregating for the purpose of such computation all assets sold, leased or
exchanged in any series of similar transactions within a twelve-month period;
or
the sale, lease or exchange to the Trust or any subsidiary of the Trust, in
exchange for securities of the Trust, of any assets of any Principal
Shareholder, except assets having an aggregate fair market value of less than
2%
of the total assets of the Trust, aggregating for purposes of such computation
all assets sold, leased or exchanged in any series of similar transactions
within a twelve-month period.
To
convert the Trust to an open-end investment company, the Trust’s Agreement and
Declaration of Trust requires the favorable vote of a majority of the board
of
the trustees followed by the favorable vote of the holders of at least 75%
of
the outstanding shares of each affected class or series of shares of the Trust,
voting separately as a class or series, unless such amendment has been approved
by at least 80% of the trustees, in which case “a majority of the outstanding
voting securities” (as defined in the Investment Company Act) of the Trust shall
be required. The foregoing vote would satisfy a separate requirement in the
Investment Company Act that any conversion of the Trust to an open-end
investment company be approved by the shareholders. If approved in the foregoing
manner, conversion of the Trust to an open-end investment company could not
occur until 90 days after the shareholders’ meeting at which such conversion was
approved and would also require at least 30 days’ prior notice to all
shareholders. Following any such conversion, it is possible that certain of
the
Trust’s investment policies and strategies would have to be modified to assure
sufficient portfolio liquidity. In the event of conversion, the common shares
would cease to be listed on the New York Stock Exchange or other national
securities exchanges or market systems. Shareholders of an open-end investment
company may require the company to redeem their shares at any time, except
in
certain circumstances as authorized by or under the Investment Company Act,
at
their net asset value, less such redemption charge, if any, as might be in
effect at the time of a redemption. The Trust expects to pay all such redemption
requests in cash, but reserves the right to pay redemption requests in a
combination of cash or securities. If such partial payment in securities were
made, investors may incur brokerage costs in converting such securities to
cash.
If the Trust were converted to an open-end fund, it is likely that new shares
would be sold at net asset value plus a sales load. The board of trustees
believes, however, that the closed-end structure is desirable in light of the
Trust’s investment objectives and policies. Therefore, you should assume that it
is not likely that the board of trustees would vote to convert the Trust to
an
open-end fund.
For
the
purposes of calculating “a majority of the outstanding voting securities” under
the Trust’s Agreement and Declaration of Trust, each class and series of the
Trust shall vote together as a single class, except to the extent required
by
the Investment Company Act or the Trust’s Agreement and Declaration of Trust,
with respect to any class or series of shares. If a separate class vote is
required, the applicable proportion of shares of the class or series, voting
as
a separate class or series, also will be required.
The
Declaration of Trust also provides that the Trust may be liquidated upon the
approval of 80% of the trustees.
The
board
of trustees has determined that provisions with respect to the board of trustees
and the shareholder voting requirements described above, which voting
requirements are greater than the minimum requirements under Delaware law or
the
Investment Company Act, are in the best interest of shareholders generally.
Reference should be made to the Trust’s Agreement and Declaration of Trust, on
file with the Commission for the full text of these provisions.
CLOSED-END
FUND STRUCTURE
The
Trust
is a non-diversified, closed-end management investment company (commonly
referred to as a closed-end fund). Closed-end funds differ from open-end funds
(which are generally referred to as mutual funds) in that closed-end funds
generally list their shares for trading on a stock exchange and do not redeem
their shares at the request of the shareholder. This means that if you wish
to
sell your shares of a closed-end fund you must trade them on the market like
any
other stock at the prevailing market price at that time. In a mutual fund,
if
the shareholder wishes to sell shares of the fund, the mutual fund will redeem
or buy back the shares at “net asset value” (less a redemption fee, if
applicable, or contingent deferred sales charge, if applicable). Also, mutual
funds generally offer new shares on a continuous basis to new investors, and
closed-end funds generally do not. The continuous inflows and outflows of assets
in a mutual fund can make it difficult to manage a mutual fund’s investments. By
comparison, closed-end funds are generally able to stay more fully invested
in
securities that are consistent with their investment objective and also have
greater flexibility to make certain types of investments and to use certain
investment strategies, such as financial leverage and investments in illiquid
securities.
Shares
of
closed-end funds frequently trade at a discount to their net asset value.
Because of this possibility and the recognition that any such discount may
not
be in the interest of shareholders, the Trust’s board of trustees might consider
from time to time engaging in open-market repurchases, tender offers for shares
or other programs intended to reduce the discount. We cannot guarantee or
assure, however, that the Trust’s board of trustees will decide to engage in any
of these actions. Nor is there any guarantee or assurance that such actions,
if
undertaken, would result in the shares trading at a price equal or close to
net
asset value per share. The board of trustees might also consider converting
the
Trust to an open-end mutual fund, which would also require a vote of the
shareholders of the Trust.
REPURCHASE
OF COMMON SHARES
Shares
of
closed-end investment companies often trade at a discount to their net asset
value, and the Trust’s common shares may also trade at a discount to their net
asset value, although it is possible that they may trade at a premium above
net
asset value. The market price of the Trust’s common shares will be determined by
such factors as relative demand for and supply of such common shares in the
market, the Trust’s net asset value, general market and economic conditions and
other factors beyond the control of the Trust. See “Net
Asset
Value.”
Although the Trust’s common shareholders will not have the right to redeem their
common shares, the Trust may take action to repurchase common shares in the
open
market or make tender offers for its common shares. This may have the effect
of
reducing any market discount from net asset value.
There
is
no assurance that, if action is undertaken to repurchase or tender for common
shares, such action will result in the common shares trading at a price which
approximates their net asset value. Although share repurchases and tenders
could
have a favorable effect on the market price of the Trust’s common shares, you
should be aware that the acquisition of common shares by the Trust will decrease
the capital of the Trust and, therefore, may have the effect of increasing
the
Trust’s expense ratio and decreasing the asset coverage with respect to any
borrowings. Any share repurchases or tender offers will be made in accordance
with requirements of the Securities Exchange Act of 1934, as amended, the
Investment Company Act and the principal stock exchange on which the common
shares are traded.
TAX
MATTERS
The
following discussion summarizes certain U.S. federal income tax considerations
affecting the Trust and its shareholders that are U.S. persons as defined for
U.S. federal income tax purposes. For more information, please see the Statement
of Additional Information under “Tax
Matters.”
Because each shareholder’s tax situation is unique, ask your tax professional
about the tax consequences to you of an investment in the Trust.
The
Trust
intends to qualify annually as a regulated investment company under the Code.
Accordingly, the Trust generally will not be subject to U.S. federal income
tax
on its net investment income and net realized capital gains that the Trust
distributes to its shareholders. The Trust expects to pay its shareholders
annually at least 90% of such income.
Distributions
paid to both common and preferred shareholders by the Trust from its net
realized long-term capital gains, if any, that the Trust designates as capital
gains dividends (“capital gain dividends”) are taxable as long-term capital
gains, regardless of how long you have held your shares. All other dividends
paid to you by the Trust (including dividends from short-term capital gains)
from its current or accumulated earnings and profits (“ordinary income
dividends”) are generally subject to tax as ordinary income.
In
general, the Trust does not expect that a significant portion of its ordinary
income dividends will be treated as qualified dividend income, which is eligible
for taxation at the rates applicable to long-term capital gains in the case
of
individual shareholders, or that a corporate shareholder will be able to claim
a
dividends received deduction with respect to any significant portion of Trust
distributions.
Dividends
and other taxable distributions are taxable to you even if they are reinvested
in additional common shares of the Trust. Dividends and other distributions
paid
by the Trust are generally treated as received by you at the time the dividend
or distribution is made. If, however, the Trust pays you a dividend in January
that was declared in the previous October, November or December and you were
the
shareholder of record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the Trust and
received by you on December 31 of the year in which the dividend was
declared.
The
price
of common shares purchased at any time may reflect the amount of a forthcoming
distribution. If you purchase common shares just prior to a distribution, you
will receive a distribution that will be taxable to you even though it
represents in part a return of your invested capital.
The
Trust
will send you information after the end of each year setting forth the amount
and tax status of any distributions paid to you by the Trust. Ordinary income
dividends and capital gain dividends may also be subject to state and local
taxes.
If
you
sell or otherwise dispose of common shares of the Trust, you will generally
recognize a gain or loss in an amount equal to the difference between your
tax
basis in such shares of the Trust and the amount you receive in exchange for
such shares. If you hold your common shares as capital assets, any such gain
or
loss generally will be long-term capital gain or loss if you have held such
shares for more than one year at the time of sale.
The
Trust
may be required to withhold, for U.S. federal backup withholding tax purposes,
a
portion of the dividends, distributions and redemption proceeds payable to
a
non-corporate shareholder who fails to provide the Trust (or its agent) with
the
shareholder’s correct taxpayer identification number (in the case of an
individual, generally, such individual’s social security number) or to make the
required certification, or who has been notified by the Internal Revenue Service
(the “IRS”) that such shareholder is subject to backup withholding. Certain
shareholders are exempt from backup withholding. Backup withholding is not
an
additional tax and any amount withheld may be refunded or credited against
your
U.S. federal income tax liability, if any, provided that you furnish the
required information to the IRS.
The
discussions set forth herein and in the Statement of Additional Information
do
not constitute tax advice, and you are urged to consult your own tax advisor
to
determine the specific U.S. federal, state, local and foreign tax consequences
to you of investing in the Trust.
CUSTODIAN
AND TRANSFER AGENT
The
Custodian of the assets of the Trust will be PFPC Trust Company (8800 Tinicum
Blvd., 4th Floor, Philadelphia, PA 19153; telephone (877) 665-1287). The
Custodian will perform custodial, fund accounting and portfolio accounting
services. PFPC Inc. (301 Bellevue Parkway, Wilmington, Delaware 19809; telephone
(877) 665-1287) will serve as the Trust’s transfer agent with respect to its
common shares.
LEGAL
OPINIONS
Certain
legal matters in connection with the common shares will be passed upon for
the
Trust by Skadden, Arps, Slate, Meagher & Flom LLP, Chicago, Illinois, and
certain other legal matters will be passed on for the Dealer Manager by Clifford
Chance US LLP, New York, New York.
PRIVACY
PRINCIPLES OF THE TRUST
The
Trust
is committed to maintaining the privacy of its shareholders and to safeguarding
their non-public personal information. The following information is provided
to
help you understand what personal information the Trust collects, how the Trust
protects that information and why, in certain cases, the Trust may share
information with select other parties.
Generally,
the Trust does not receive any non-public personal information relating to
its
shareholders, although certain non-public personal information of its
shareholders may become available to the Trust. The Trust does not disclose
any
non-public personal information about its shareholders or former shareholders
to
anyone, except as permitted by law or as is necessary in order to service
shareholder accounts (for example, to a transfer agent or third party
administrator).
The
Trust
restricts access to non-public personal information about its shareholders
to
employees of the Trust’s Investment Adviser and its affiliates with a legitimate
business need for the information. The Trust maintains physical, electronic
and
procedural safeguards designed to protect the non-public personal information
of
its shareholders.
TABLE
OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
| |
Page
|
|
Use
of Proceeds
|
B-2
|
|
Investment
Restrictions
|
B-2
|
|
Investment
Policies and Techniques
|
B-3
|
|
Other
Investment Policies and Techniques
|
B-13
|
|
Management
of the Trust
|
B-16
|
|
Portfolio
Transactions and Brokerage
|
B-23
|
|
Repurchase
of Common Shares
|
B-23
|
|
Tax
Matters
|
B-25
|
|
Experts
|
B-29
|
|
Additional
Information
|
B-29
|
|
Financial
Statements
|
|
|
Appendix
A
|
A-1
|
|
Appendix
B
|
B-1
|
Highland
Credit Strategies Fund
Common
Shares
PROSPECTUS
UBS
Investment Bank
December
, 2007
The
information in this preliminary prospectus is not complete and may be
changed.
We may not sell these securities until the Registration Statement filed
with the
Securities and Exchange Commission is effective. This preliminary prospectus
is
not an offer to sell these securities and is not soliciting an offer
to buy
these securities in any state where the offer or sale is not
permitted.
Subject
to Completion, Dated December 10, 2007
Highland
Credit Strategies Fund
Statement
of Additional Information
Highland
Credit Strategies Fund (the “Trust”)
is a
non-diversified, closed-end management investment company registered under
the
Investment Company Act with no operating history. This Statement of Additional
Information registered under the Investment Company Act does not constitute
a
prospectus, but should be read in conjunction with the prospectus relating
thereto dated December [·], 2007. This Statement of Additional Information does
not include all information that a prospective investor should consider before
purchasing common shares, and investors should obtain and read the prospectus
prior to purchasing such shares. A copy of the prospectus may be obtained
without charge by calling 1-877-665-1287. You may also obtain a copy of the
prospectus on the Securities and Exchange Commission’s web site
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the
prospectus.
TABLE
OF CONTENTS
| |
Page
|
|
Use
of Proceeds
|
B-2
|
|
Investment
Restrictions
|
|
|
Investment
Policies and Techniques
|
B-3
|
|
Other
Investment Policies and Techniques
|
B-13
|
|
Management
of the Trust
|
B-16
|
|
Portfolio
Transactions and Brokerage
|
B-23
|
|
Repurchase
of Common Shares
|
B-23
|
|
Tax
Matters
|
B-25
|
|
Experts
|
B-29
|
|
Additional
Information
|
B-29
|
|
Financial
Statements
|
B-29
|
|
Appendix
A
|
A-1
|
|
Appendix
B
|
B-1
|
This
Statement of Additional Information is dated December [•],
2007
USE
OF PROCEEDS
Pending
investment in securities that meet the Trust’s investment objectives and
policies, the net proceeds of the Offer will be invested in short-term debt
securities of the type described under “Investment
Policies and Techniques — Short-Term Debt Securities.”
We
currently anticipate that the Trust will be able to invest primarily in
securities that meet the Trust’s investment objectives and policies within
approximately one to three months after the
completion of the Offer.
INVESTMENT
RESTRICTIONS
Except
as
described below, the Trust, as a fundamental policy, may not, without the
approval of the holders of a “majority of the outstanding”(1) common shares and
any preferred shares, if any, voting together as a single class, and of the
holders of a majority of the outstanding preferred shares, if any, voting as
a
separate class:
(1)
invest 25% or more of the value of its total assets in any single industry
or
group of industries;
(2)
issue
senior securities or borrow money other than as permitted by the Investment
Company Act or pledge its assets other than to secure such issuances or in
connection with hedging transactions, short sales, securities lending, when
issued and forward commitment transactions and similar investment
strategies;
(3)
make
loans of money or property to any person, except through loans of portfolio
securities up to a maximum of 33 1/3% of the Trust’s total assets, the purchase
of debt securities, including bank loans (senior loans) and participations
therein, or the entry into repurchase agreements up to a maximum of 33 1/3%
of
the Trust’s total assets;
(4)
underwrite the securities of other issuers, except to the extent that, in
connection with the disposition of portfolio securities or the sale of its
own
securities, the Trust may be deemed to be an underwriter;
(5)
purchase or sell real estate, except that the Trust may invest in securities
of
companies that deal in real estate or are engaged in the real estate business,
including real estate investment trusts and real estate operating companies,
and
instruments secured by real estate or interests therein and the Trust may
acquire, hold and sell real estate acquired through default, liquidation, or
other distributions of an interest in real estate as a result of the Trust’s
ownership of such other assets; or
(6)
purchase or sell commodities or commodity contracts for any purposes except
as,
and to the extent, permitted by applicable law without the Trust becoming
subject to registration with the Commodity Futures Trading Commission (the
“CFTC”)
as a
commodity pool.
As
currently relevant to the Trust, the Investment Company Act requires an asset
coverage of 200% for a closed-end fund issuing preferred shares and 300%
for a
closed-end fund issuing borrowings exceeding 5% of the Trust’s assets (excluding
temporary borrowings).
The
Trust
will not engage in any activities described under investment restriction
number
2 pursuant to which the lenders would be able to foreclose on more than 33
1/3%
of the Trust’s total assets.
| (1) |
When
used with respect to shares of the Trust, “majority of the outstanding”
shares means (i) 67% or more of the shares present at a meeting,
if the
holders of more than 50% of the shares are present or represented
by
proxy, or (ii) more than 50% of the shares, whichever is
less.
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The
Trust
is also subject to the following non-fundamental restrictions and policies,
which may be changed by the board of trustees and without shareholder approval.
The Trust may not:
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(1)
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make
any short sale of securities except in conformity with applicable
laws,
rules and regulations and unless after giving effect to such sale,
the
market value of all securities sold short does not exceed 25% of
the value
of the Trust’s total assets and the Trust’s aggregate short sales of a
particular class of securities of an issuer does not exceed 25% of
the
then outstanding securities of that class. The Trust may also make
short
sales “against the box” without respect to such limitations. In this type
of short sale, at the time of the sale, the Trust owns or has the
immediate and unconditional right to acquire at no additional cost
the
identical security; and
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(2)
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purchase
securities of open-end or closed-end investment companies except
in
compliance with the Investment Company Act or any exemptive relief
obtained thereunder. Under the Investment Company Act, the Trust
may
invest up to 10% of its total assets in the aggregate in shares of
other
investment companies and up to 5% of its total assets in any one
investment company, provided the investment does not represent more
than
3% of the voting stock of the acquired investment company at the
time such
shares are purchased. As a shareholder in any investment company,
the
Trust will bear its ratable share of that investment company’s expenses,
and will remain subject to payment of the Advisory Fees and other
expenses
with respect to assets so invested. Holders of common shares will
therefore be subject to duplicative expenses to the extent the Trust
invests in other investment companies. In addition, the securities
of
other investment companies may be leveraged and will therefore be
subject
to the risks of leverage. The net asset value and market value of
leveraged shares will be more volatile and the yield to shareholders
will
tend to fluctuate more than the yield generated by unleveraged
shares.
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In
addition, to comply with the federal tax requirements for qualification as
a
registered investment company, the Trust’s investments must meet certain
diversification requirements. See “Tax
Matters.”
The
percentage limitations applicable to the Trust’s portfolio described in the
prospectus and this Statement of Additional Information apply only at the time
of investment, except that the percentage limitation with respect to borrowing
applies at all times, and the Trust will not be required to sell securities
due
to subsequent changes in the value of securities it owns.
INVESTMENT
POLICIES AND TECHNIQUES
The
following information supplements the discussion of the Trust’s investment
objectives, policies and techniques that are described in the
prospectus.
Short-Term
Debt Securities
(1)
For
temporary defensive purposes or to keep cash on hand, the Trust may invest
up to
100% of its total assets in cash equivalents and short-term debt securities.
Short-term debt investments are defined to include, without limitation, the
following: U.S. Government securities, including bills, notes and bonds
differing as to maturity and rates of interest that are either issued or
guaranteed by the U.S. Treasury or by U.S. Government agencies or
instrumentalities. U.S. Government securities include securities issued by
(a)
the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and Government
National Mortgage Association, whose securities are supported by the full faith
and credit of the United States; (b) the Federal Home Loan Banks, Federal
Intermediate Credit Banks, and Tennessee Valley Authority, whose securities
are
supported by the right of the agency to borrow from the U.S. Treasury; (c)
the
Federal National Mortgage Association, whose securities are supported by the
discretionary authority of the U.S. Government to purchase certain obligations
of the agency or instrumentality; and (d) the Student Loan Marketing
Association, whose securities are supported only by its credit. While the U.S.
Government provides financial support to such U.S. Government-sponsored agencies
or instrumentalities, no assurance can be given that it always will do so since
it is not so obligated by law. The U.S. Government, its agencies and
instrumentalities do not guarantee the market value of their securities.
Consequently, the value of such securities may fluctuate.
(2)
Certificates of deposit issued against funds deposited in a bank or a savings
and loan association. Such certificates are for a definite period of time,
earn
a specified rate of return, and are normally negotiable. The issuer of a
certificate of deposit agrees to pay the amount deposited plus interest to
the
bearer of the certificate on the date specified thereon. Certificates of deposit
purchased by the Trust may not be fully insured by the Federal Deposit Insurance
Corporation.
(3)
Repurchase agreements, which involve purchases of debt securities. At the time
the Trust purchases securities pursuant to a repurchase agreement, it
simultaneously agrees to resell and redeliver such securities to the seller,
who
also simultaneously agrees to buy back the securities at a fixed price and
time.
This assures a predetermined yield for the Trust during its holding period,
since the resale price is always greater than the purchase price and reflects
an
agreed-upon market rate. Such actions afford an opportunity for the Trust to
invest temporarily available cash. The Trust may enter into repurchase
agreements only with respect to obligations of the U.S. Government, its agencies
or instrumentalities; certificates of deposit; or bankers’ acceptances in which
the Trust may invest. Repurchase agreements may be considered loans to the
seller, collateralized by the underlying securities. The risk to the Trust
is
limited to the ability of the seller to pay the agreed-upon sum on the
repurchase date; in the event of default, the repurchase agreement provides
that
the Trust is entitled to sell the underlying collateral. If the value of the
collateral declines after the agreement is entered into, and if the seller
defaults under a repurchase agreement when the value of the underlying
collateral is less than the repurchase price, the Trust could incur a loss
of
both principal and interest. Highland monitors the value of the collateral
at
the time the action is entered into and at all times during the term of the
repurchase agreement. Highland does so in an effort to determine that the value
of the collateral always equals or exceeds the agreed-upon repurchase price
to
be paid to the Trust. If the seller were to be subject to a federal bankruptcy
proceeding, the ability of the Trust to liquidate the collateral could be
delayed or impaired because of certain provisions of the bankruptcy
laws.
(4)
Commercial paper, which consists of short-term unsecured promissory notes,
including variable rate master demand notes issued by corporations to finance
their current operations. Master demand notes are direct lending arrangements
between the Trust and a corporation. There is no secondary market for such
notes. However, they are redeemable by the Trust at any time. Highland will
consider the financial condition of the corporation (e.g., earning power, cash
flow and other liquidity ratios) and will continually monitor the corporation’s
ability to meet all of its financial obligations, because the Trust’s liquidity
might be impaired if the corporation were unable to pay principal and interest
on demand. Investments in commercial paper will be limited to commercial paper
rated in the highest categories by a major rating agency and which mature within
one year of the date of purchase or carry a variable or floating rate of
interest.
Equity
Securities
The
Trust
may invest in equity securities including preferred stocks, convertible
securities, warrants and depository receipts.
Preferred
Stock. Preferred
stock has a preference over common stock in liquidation (and generally dividends
as well) but is subordinated to the liabilities of the issuer in all respects.
As a general rule, the market value of preferred stock with a fixed dividend
rate and no conversion element varies inversely with interest rates and
perceived credit risk, while the market price of convertible preferred stock
generally also reflects some element of conversion value. Because preferred
stock is junior to debt securities and other obligations of the issuer,
deterioration in the credit quality of the issuer will cause greater changes
in
the value of a preferred stock than in a more senior debt security with similar
stated yield characteristics. Unlike interest payments on debt securities,
preferred stock dividends are payable only if declared by the issuer’s board of
directors. Preferred stock also may be subject to optional or mandatory
redemption provisions.
Convertible
Securities. A
convertible security is a bond, debenture, note, preferred stock or other
security that may be converted into or exchanged for a prescribed amount of
common stock or other equity security of the same or a different issuer within
a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt or
the
dividend paid on preferred stock until the convertible security matures or
is
redeemed, converted or exchanged. Before conversion, convertible securities
have
characteristics similar to nonconvertible income securities in that they
ordinarily provide a stable stream of income with generally higher yields than
those of common stocks of the same or similar issuers, but lower yields than
comparable nonconvertible securities. The value of a convertible security is
influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline. The credit
standing of the issuer and other factors also may have an effect on the
convertible security’s investment value. Convertible securities rank senior to
common stock in a corporation’s capital structure but are usually subordinated
to comparable nonconvertible securities. Convertible securities may be subject
to redemption at the option of the issuer at a price established in the
convertible security’s governing instrument.
Warrants.
Warrants,
which are privileges issued by corporations enabling the owners to subscribe
to
and purchase a specified number of shares of the corporation at a specified
price during a specified period of time. Subscription rights normally have
a
short life span to expiration. The purchase of warrants involves the risk that
the Trust could lose the purchase value of a right or warrant if the right
to
subscribe to additional shares is not exercised prior to the warrants’
expiration. Also, the purchase of warrants involves the risk that the effective
price paid for the warrant added to the subscription price of the related
security may exceed the value of the subscribed security’s market price such as
when there is no movement in the level of the underlying security.
Depository
Receipts. The
Trust
may invest in both sponsored and unsponsored American Depository Receipts
(“ADRs”),
European Depository Receipts (“EDRs”),
Global Depository Receipts (“GDRs”)
and
other similar global instruments. ADRs typically are issued by an American
bank
or trust company and evidence ownership of underlying securities issued by
a
non-U.S. corporation. EDRs, which are sometimes referred to as Continental
Depository Receipts, are receipts issued in Europe, typically by non-U.S. banks
and trust companies, that evidence ownership of either non-U.S. or U.S.
underlying securities. GDRs are depository receipts structured like global
debt
issues to facilitate trading on an international basis. Unsponsored ADR, EDR
and
GDR programs are organized independently and without the cooperation of the
issuer of the underlying securities. As a result, available information
concerning the issuer may not be as current as for sponsored ADRs, EDRs and
GDRs, and the prices of unsponsored ADRs, EDRs and GDRs may be more volatile
than if such instruments were sponsored by the issuer. Investments in ADRs,
EDRs
and GDRs may present additional investment considerations of non-U.S.
securities.
Variable
and Floating Rate Instruments
The
Trust
may purchase rated and unrated variable and floating rate instruments. These
instruments may include variable amount master demand notes that permit the
indebtedness thereunder to vary in addition to providing for periodic
adjustments in the interest rate. The Trust may invest in leveraged inverse
floating rate debt instruments (“Inverse
Floaters”).
The
interest rate of an Inverse Floater resets in the opposite direction from the
market rate of interest to which it is indexed. An Inverse Floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in Inverse Floaters is
associated with greater volatility in their market values. Issuers of unrated
variable and floating rate instruments must satisfy the same criteria as set
forth above for the Trust. The absence of an active secondary market with
respect to particular variable and floating rate instruments, however, could
make it difficult for the Trust to dispose of a variable or floating rate
instrument if the issuer defaulted on its payment obligation or during periods
when the Trust is not entitled to exercise its demand rights.
With
respect to purchasable variable and floating rate instruments, Highland will
consider the earning power, cash flows and liquidity ratios of the issuers
and
guarantors of such instruments and, if the instruments are subject to a demand
feature, will monitor their financial status to meet payment on demand. Such
instruments may include variable amount master demand notes that permit the
indebtedness thereunder to vary in addition to providing for periodic
adjustments in the interest rate. The absence of an active secondary market
with
respect to particular variable and floating rate instruments could make it
difficult for the Trust to dispose of a variable or floating rate note if the
issuer defaulted on its payment obligation or during periods that the Trust
is
not entitled to exercise its demand rights, and the Trust could, for these
or
other reasons, suffer a loss, with respect to such instruments. In determining
average-weighted portfolio maturity, an instrument will be deemed to have a
maturity equal to either the period remaining until the next interest rate
adjustment or the time the Trust involved can recover payment of principal
as
specified in the instrument, depending on the type of instrument
involved.
Derivative
Transactions and Risk Management
Consistent
with its investment objectives and policies set forth in the prospectus and
in
addition to its option strategy, the Trust may also enter into certain risk
management transactions. In particular, the Trust may purchase and sell futures
contracts, exchange listed and over-the-counter put and call options on
securities, equity and other indices and futures contracts, forward foreign
currency contracts, and may enter into various interest rate transactions.
Derivative Transactions may be used to attempt to protect against possible
changes in the market value of the Trust’s portfolio resulting from fluctuations
in the securities markets and changes in interest rates, to protect the Trust’s
unrealized gains in the value of its portfolio securities, to facilitate the
sale of such securities for investment purposes and to establish a position
in
the securities markets as a temporary substitute for purchasing particular
securities. Any or all of these Derivative Transactions may be used at any
time.
There is no particular strategy that requires use of one technique rather than
another. Use of any Derivative Transaction is a function of market conditions.
The ability of the Trust to manage them successfully will depend on Highland’s
ability to predict pertinent market movements as well as sufficient correlation
among the instruments, which cannot be assured. The Derivative Transactions
that
the Trust may use are described below. Although the Trust recognizes it is
not
likely that it will use certain of these strategies in light of its investment
policies, it nevertheless describes them here because the Trust may seek to
use
these strategies in certain circumstances.
Futures
Contracts and Options on Futures Contracts. In
connection with its Derivative Transactions and other risk management
strategies, the Trust may also enter into contracts for the purchase or sale
for
future delivery (“futures contracts”) of securities, aggregates of securities or
indices or prices thereof, other financial indices and U.S. government debt
securities or options on the above. The Trust will engage in such transactions
only for bona fide risk management and other portfolio management
purposes.
Forward
Foreign Currency Contracts. The
Trust
may enter into forward currency contracts to purchase or sell foreign currencies
for a fixed amount of U.S. dollars or another foreign currency. A forward
currency contract involves an obligation to purchase or sell a specific currency
at a future date, which may be any fixed number of days from the date of the
forward currency contract agreed upon by the parties, at a price set at the
time
the forward currency contract is entered into. Forward currency contracts are
traded directly between currency traders (usually large commercial banks) and
their customers.
The
Trust
may engage in various forward currency contract strategies:
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·
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The
Trust may purchase a forward currency contract to lock in the U.S.
dollar
price of a security denominated in a foreign currency that the Trust
intends to acquire. The Trust may sell a forward currency contract
to lock
in the U.S. dollar equivalent of the proceeds from the anticipated
sale of
a security or a dividend or interest payment denominated in a foreign
currency.
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The
Trust may also use forward currency contracts to shift the Trust’s
exposure to foreign currency exchange rate changes from one currency
to
another. For example, if the Trust owns securities denominated in
a
foreign currency and Highland believes that currency will decline
relative
to another currency, the Trust might enter into a forward currency
contract to sell the appropriate amount of the first foreign currency
with
payment to be made in the second
currency.
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·
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The
Trust may also purchase forward currency contracts to enhance income
when
Highland anticipates that the foreign currency will appreciate in
value
but securities denominated in that currency do not present attractive
investment opportunities.
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·
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The
Trust may also use forward currency contracts to offset against a
decline
in the value of existing investments denominated in a foreign currency.
Such a transaction would tend to offset both positive and negative
currency fluctuations, but would not offset changes in security values
caused by other factors.
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The
Trust could also enter into a forward currency contract to sell another
currency expected to perform similarly to the currency in which the
Trust’s existing investments are denominated. This type of transaction
could offer advantages in terms of cost, yield or efficiency, but
may not
offset currency exposure as effectively as a simple forward currency
transaction to sell U.S. dollars. This type of transaction may result
in
losses if the currency sold does not perform similarly to the currency
in
which the Trust’s existing investments are
denominated.
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The
Trust may also use forward currency contracts in one currency or
a basket
of currencies to attempt to offset against fluctuations in the value
of
securities denominated in a different currency if Highland anticipates
that there will be a correlation between the two
currencies.
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The
cost to the Trust of engaging in forward currency contracts varies
with
factors such as the currency involved, the length of the contract
period
and the market conditions then prevailing. Because forward currency
contracts are usually entered into on a principal basis, no fees
or
commissions are involved.
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When
the Trust enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency
at the
maturity of the contract. Failure by the counterparty to do so would
result in the loss of some or all of any expected benefit of the
transaction. Secondary markets generally do not exist for forward
currency
contracts, with the result that closing transactions generally can
be made
for forward currency contracts only by negotiating directly with
the
counterparty. Thus, there can be no assurance that the Trust will
in fact
be able to close out a forward currency contract at a favorable price
prior to maturity. In addition, in the event of insolvency of the
counterparty, the Trust might be unable to close out a forward currency
contract. In either event, the Trust would continue to be subject
to
market risk with respect to the position, and would continue to be
required to maintain a position in securities denominated in the
foreign
currency or to maintain cash or liquid assets in a segregated account.
The
precise matching of forward currency contract amounts and the value
of the
securities involved generally will not be possible because the value
of
such securities, measured in the foreign currency, will change after
the
forward currency contract has been established. Thus, the Trust might
need
to purchase or sell foreign currencies in the spot (cash) market
to the
extent such foreign currencies are not covered by forward currency
contracts. The projection of short-term currency market movements
is
extremely difficult, and the successful execution of a short-term
strategy
is highly uncertain.
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Calls
on Securities, Indices and Futures Contracts. In
addition to its option strategy, in order to enhance income or reduce
fluctuations on net asset value, the Trust may sell or purchase call options
(“calls”) on securities and indices based upon the prices of futures contracts
and debt or equity securities that are traded on U.S. and non-U.S. securities
exchanges and in the over-the-counter markets. A call option gives the purchaser
of the option the right to buy, and obligates the seller to sell, the underlying
security, futures contract or index at the exercise price at any time or at
a
specified time during the option period. All such calls sold by the Trust must
be “covered” as long as the call is outstanding (i.e.,
the
Trust must own the instrument subject to the call or other securities or assets
acceptable for applicable segregation and coverage requirements). A call sold
by
the Trust exposes the Trust during the term of the option to possible loss
of
opportunity to realize appreciation in the market price of the underlying
security, index or futures contract and may require the Trust to hold an
instrument which it might otherwise have sold. The purchase of a call gives
the
Trust the right to buy a security, futures contract or index at a fixed price.
Calls on futures on securities must also be covered by assets or instruments
acceptable under applicable segregation and coverage requirements.
Puts
on Securities, Indices and Futures Contracts. In
addition to its option strategy, the Trust may purchase put options (“puts”)
that relate to securities (whether or not it holds such securities in its
portfolio), indices or futures contracts. For the same purposes, the Trust
may
also sell puts on securities, indices or futures contracts on such securities
if
the Trust’s contingent obligations on such puts are secured by segregated assets
consisting of cash or liquid debt securities having a value not less than the
exercise price. In selling puts, there is a risk that the Trust may be required
to buy the underlying security at a price higher than the current market
price.
Interest
Rate Transactions. Among
the
Derivative Transactions in which the Trust may enter into are interest rate
swaps and the purchase or sale of interest rate caps and floors. The Trust
expects to enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of its portfolio as a duration
management technique or to protect against any increase in the price of
securities the Trust anticipates purchasing at a later date. The Trust intends
to use these transactions for risk management purposes and not as a speculative
investment. The Trust will not sell interest rate caps or floors that it does
not own. Interest rate swaps involve the exchange by the Trust with another
party of their respective commitments to pay or receive interest, e.g.,
an
exchange of floating rate payments for fixed rate payments with respect to
a
notional amount of principal. The purchase of an interest rate cap entitles
the
purchaser, to the extent that a specified index exceeds a predetermined interest
rate, to receive payments of interest on a notional principal amount from the
party selling such interest rate cap. The purchase of an interest rate floor
entitles the purchaser, to the extent that a specified index falls below a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate floor.
The
Trust
may enter into interest rate swaps, caps and floors on either an asset based
or
liability-based basis, depending on whether it is offsetting volatility with
respect to its assets or liabilities, and will usually enter into interest
rate
swaps on a net basis,
i.e.,
the
two payment streams are netted out, with the Trust receiving or paying, as
the
case may be, only the net amount of the two payments on the payment dates.
Inasmuch as these Derivative Transactions are incurred into for good faith
risk
management purposes. Highland and the Trust believe such obligations do not
constitute senior securities, and, accordingly will not treat them as being
subject to its borrowing restrictions. The Trust will accrue the net amount
of
the excess, if any, of the Trust’s obligations over its entitlements with
respect to each interest rate swap on a daily basis and will designate on its
books and records with a custodian an amount of cash or liquid high grade
securities having an aggregate net asset value at all times at least equal
to
the accrued excess. The Trust will not enter into any interest rate swap, cap
or
floor transaction unless the unsecured senior debt or the claims paying ability
of the other party thereto is rated in the highest rating category of at least
one nationally recognized statistical rating organization at the time of
entering into such transaction. If there is a default by the other party to
such
a transaction, the Trust will have contractual remedies pursuant to the
agreements related to the transaction. The swap market has grown substantially
in recent years with a large number of banks and investment banking firms acting
both as principals and as agents utilizing standardized swap documentation.
Caps
and floors are more recent innovations for which standardized documentation
has
not yet been developed and, accordingly, they are less liquid than
swaps.
Credit
Derivatives. The
Trust
may engage in credit derivative transactions. There are two broad categories
of
credit derivatives: default price risk derivatives and market spread
derivatives. Default price risk derivatives are linked to the price of reference
securities or loans after a default by the issuer or borrower, respectively.
Market spread derivatives are based on the risk that changes in market factors,
such as credit spreads, can cause a decline in the value of a security, loan
or
index.
There
are
three basic transactional forms for credit derivatives: swaps, options and
structured instruments. The use of credit derivatives is a highly specialized
activity which involves strategies and risks different from those associated
with ordinary portfolio security transactions. If Highland is incorrect in
its
forecasts of default risks, market spreads or other applicable factors, the
investment performance of the Trust would diminish compared with what it would
have been if these techniques were not used. Moreover, even if Highland is
correct in its forecasts, there is a risk that a credit derivative position
may
correlate imperfectly with the price of the asset or liability being purchased.
There is no limit on the amount of credit derivative transactions that may
be
entered into by the Trust. The Trust’s risk of loss in a credit derivative
transaction varies with the form of the transaction. For example, if the Trust
purchases a default option on a security, and if no default occurs with respect
to the security, the Trust’s loss is limited to the premium it paid for the
default option. In contrast, if there is a default by the grantor of a default
option, the Trust’s loss will include both the premium that it paid for the
option and the decline in value of the underlying security that the default
option protects.
Below
under “General
Characteristics of Risks of Derivative Transactions”
is
further information about the characteristics, risks and possible benefits
of
Derivative Transactions and the Trust’s other policies and limitations (which
are not fundamental policies) relating to investment in futures contracts and
options. The principal risks relating to the use of futures contracts and other
Derivative Transactions are: (i) less than perfect correlation between the
prices of the instrument and the market value of the securities in the Trust’s
portfolio; (ii) possible lack of a liquid secondary market for closing out
a
position in such instruments; (iii) losses resulting from interest rate or
other
market movements not anticipated by Highland; and (iv) the obligation to meet
additional variation margin or other payment requirements, all of which could
result in the Trust being in a worse position than if such techniques had not
been used.
Certain
provisions of the Code may restrict or affect the ability of the Trust to engage
in Derivative Transactions. See “Tax
Matters.”
General
Characteristics and Risks of Derivative Transactions
In
order
to manage the risk of its securities portfolio, or to enhance income or gain
as
described in the prospectus, the Trust will engage in Derivative Transactions.
The Trust will engage in such activities in the Investment Adviser’s discretion,
and may not necessarily be engaging in such activities when movements in
interest rates that could affect the value of the assets of the Trust occur.
The
Trust’s ability to pursue certain of these strategies may be limited by
applicable regulations of the CFTC. Certain Derivative Transactions may give
rise to taxable income.
Put
and Call Options on Securities and Indices
The
Trust
may purchase and sell put and call options on securities and indices. A put
option gives the purchaser of the option the right to sell and the writer the
obligation to buy the underlying security at the exercise price during the
option period. The Trust may also purchase and sell options on securities
indices (“index options”). Index options are similar to options on securities
except that, rather than taking or making delivery of securities underlying
the
option at a specified price upon exercise, an index option gives the holder
the
right to receive cash upon exercise of the option if the level of the securities
index upon which the option is based is greater, in the case of a call, or
less,
in the case of a put, than the exercise price of the option. The purchase of
a
put option on a security could protect the Trust’s holdings in a security or a
number of securities against a substantial decline in the market value. A call
option gives the purchaser of the option the right to buy and the seller the
obligation to sell the underlying security or index at the exercise price during
the option period or for a specified period prior to a fixed date. The purchase
of a call option on a security could protect the Trust against an increase
in
the price of a security that it intended to purchase in the future. In the
case
of either put or call options that it has purchased, if the option expires
without being sold or exercised, the Trust will experience a loss in the amount
of the option premium plus any related commissions. When the Trust sells put
and
call options, it receives a premium as the seller of the option. The premium
that the Trust receives for selling the option will serve as a partial offset,
in the amount of the option premium, against changes in the value of the
securities in its portfolio. During the term of the option, however, a covered
call seller has, in return for the premium on the option, given up the
opportunity for capital appreciation above the exercise price of the option
if
the value of the underlying security increases, but has retained the risk of
loss should the price of the underlying security decline. Conversely, a secured
put seller retains the risk of loss should the market value of the underlying
security decline below the exercise price of the option, less the premium
received on the sale of the option. The Trust is authorized to purchase and
sell
exchange listed options and over-the-counter options (“OTC
Options”)
which
are privately negotiated with the counterparty. Listed options are issued by
the
Options Clearing Corporation (“OCC”)
which
guarantees the performance of the obligations of the parties to such
options.
The
Trust’s ability to close out its position as a purchaser or seller of an
exchange listed put or call option is dependent upon the existence of a liquid
secondary market on option exchanges. Among the possible reasons for the absence
of a liquid secondary market on an exchange are: (i) insufficient trading
interest in certain options; (ii) restrictions on transactions imposed by an
exchange; (iii) trading halts, suspensions or other restrictions imposed with
respect to particular classes or series of options or underlying securities;
(iv) interruption of the normal operations on an exchange; (v) inadequacy of
the
facilities of an exchange or OCC to handle current trading volume; or (vi)
a
decision by one or more exchanges to discontinue the trading of options (or
a
particular class or series of options), in which event the secondary market
on
that exchange (or in that class or series of options) would cease to exist,
although outstanding options on that exchange that had been listed by the OCC
as
a result of trades on that exchange would generally continue to be exercisable
in accordance with their terms. OTC Options are purchased from or sold to
dealers, financial institutions or other counterparties which have entered
into
direct agreements with the Trust. With OTC Options, such variables as expiration
date, exercise price and premium will be agreed upon between the Trust and
the
counterparty, without the intermediation of a third party such as the OCC.
If
the counterparty fails to make or take delivery of the securities underlying
an
option it has written, or otherwise settle the transaction in accordance with
the terms of that option as written, the Trust would lose the premium paid
for
the option as well as any anticipated benefit of the transaction.
The
hours
of trading for options on securities may not conform to the hours during which
the underlying securities are traded. To the extent that the option markets
close before the markets for the underlying securities, significant price
movements can take place in the underlying markets that cannot be reflected
in
the option markets.
Futures
Contracts and Related Options
Characteristics.
The
Trust
may sell financial futures contracts or purchase put and call options on such
futures as an offset against anticipated market movements. The sale of a futures
contract creates an obligation by the Trust, as seller, to deliver the specific
type of financial instrument called for in the contract at a specified future
time for a specified price. Options on futures contracts are similar to options
on securities except that an option on a futures contract gives the purchaser
the right in return for the premium paid to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put).
Margin
Requirements. At
the
time a futures contract is purchased or sold, the Trust must allocate cash
or
securities as a deposit payment (“initial margin”). It is expected that the
initial margin that the Trust will pay may range from approximately 1% to
approximately 5% of the value of the securities or commodities underlying the
contract. In certain circumstances, however, such as periods of high volatility,
the Trust may be required by an exchange to increase the level of its initial
margin payment. Additionally, initial margin requirements may be increased
generally in the future by regulatory action. An outstanding futures contract
is
valued daily and the payment in case of “variation margin” may be required, a
process known as “marking to the market.” Transactions in listed options and
futures are usually settled by entering into an offsetting transaction, and
are
subject to the risk that the position may not be able to be closed if no
offsetting transaction can be arranged.
Limitations
on Use of Futures and Options on Futures. The
Trust’s use of futures and options on futures will in all cases be consistent
with applicable regulatory requirements and in particular the rules and
regulations of the CFTC. The Trust currently may enter into such transactions
without limit for bona fide strategic purposes, including risk management and
duration management and other portfolio strategies. The Trust may also engage
in
transactions in futures contracts or related options for non-strategic purposes
to enhance income or gain provided that the Trust will not enter into a futures
contract or related option (except for closing transactions) for purposes other
than bona fide strategic purposes, or risk management including duration
management if, immediately thereafter, the sum of the amount of its initial
deposits and premiums on open contracts and options would exceed 5% of the
Trust’s liquidation value, i.e.,
net
assets (taken at current value); provided, however, that in the case of an
option that is in-the-money at the time of the purchase, the in-the-money amount
may be excluded in calculating the 5% limitation. The above policies are
non-fundamental and may be changed by the Trust’s board of trustees at any time.
Also, when required, an account of cash equivalents designated on the books
and
records will be maintained and marked to market on a daily basis in an amount
equal to the market value of the contract.
Segregation
and Cover Requirements. Futures
contracts, interest rate swaps, caps, floors and collars, short sales, reverse
repurchase agreements and dollar rolls, and listed or OTC options on securities,
indices and futures contracts sold by the Trust are generally subject to
earmarking and coverage requirements of either the CFTC or the SEC, with the
result that, if the Trust does not hold the security or futures contract
underlying the instrument, the Trust will be required to designate on its books
and records an ongoing basis, cash, U.S. government securities, or other liquid
high grade debt obligations in an amount at least equal to the Trust’s
obligations with respect to such instruments.
Such
Amounts Fluctuate as the Obligations Increase or
Decrease.
The
earmarking requirement can result in the Trust maintaining securities positions
it would otherwise liquidate, segregating assets at a time when it might be
disadvantageous to do so or otherwise restrict portfolio
management.
Derivative
Transactions Present Certain Risks. With
respect to Derivative Transactions and risk management, the variable degree
of
correlation between price movements of strategic instruments and price movements
in the position being offset create the possibility that losses using the
strategy may be greater than gains in the value of the Trust’s position. The
same is true for such instruments entered into for income or gain. In addition,
certain instruments and markets may not be liquid in all circumstances. As
a
result, in volatile markets, the Trust may not be able to close out a
transaction without incurring losses substantially greater than the initial
deposit. Although the contemplated use of these instruments predominantly for
Derivative Transactions should tend to minimize the risk of loss due to a
decline in the value of the position, at the same time they tend to limit any
potential gain which might result from an increase in the value of such
position. The ability of the Trust to successfully utilize Derivative
Transactions will depend on the Investment Adviser’s and the sub-adviser’s
ability to predict pertinent market movements and sufficient correlations,
which
cannot be assured. Finally, the daily deposit requirements in futures contracts
that the Trust has sold create an on going greater potential financial risk
than
do options transactions, where the exposure is limited to the cost of the
initial premium. Losses due to the use of Derivative Transactions will reduce
net asset value.
Regulatory
Considerations. The
Trust
has claimed an exclusion from the term “commodity pool operator” under the
Commodity Exchange Act and, therefore, is not subject to registration or
regulation as a commodity pool operator under the Commodity Exchange
Act.
OTHER
INVESTMENT POLICIES AND TECHNIQUES
Restricted
and Illiquid Securities
Certain
of the Trust’s investments may be illiquid. Illiquid securities are subject to
legal or contractual restrictions on disposition or lack an established
secondary trading market. The sale of restricted and illiquid securities often
requires more time and results in higher brokerage charges or dealer discounts
and other selling expenses than does the sale of securities eligible for trading
on national securities exchanges or in the over-the-counter markets. Restricted
securities may sell at a price lower than similar securities that are not
subject to restrictions on resale.
When-Issued
and Forward Commitment Securities
The
Trust
may purchase securities on a “when-issued” basis and may purchase or sell
securities on a “forward commitment” basis in order to acquire the security or
to offset against anticipated changes in interest rates and prices. When such
transactions are negotiated, the price, which is generally expressed in yield
terms, is fixed at the time the commitment is made, but delivery and payment
for
the securities take place at a later date. When-issued securities and forward
commitments may be sold prior to the settlement date, but the Trust will enter
into when-issued and forward commitments only with the intention of actually
receiving or delivering the securities, as the case may be. If the Trust
disposes of the right to acquire a when-issued security prior to its acquisition
or disposes of its right to deliver or receive against a forward commitment,
it
might incur a gain or loss. At the time the Trust enters into a transaction
on a
when-issued or forward commitment basis, it will designate on its books and
records cash or liquid debt securities equal to at least the value of the
when-issued or forward commitment securities. The value of these assets will
be
monitored daily to ensure that their marked to market value will at all times
equal or exceed the corresponding obligations of the Trust. There is always
a
risk that the securities may not be delivered and that the Trust may incur
a
loss. Settlements in the ordinary course, which may take substantially more
than
five business days, are not treated by the Trust as when-issued or forward
commitment transactions and accordingly are not subject to the foregoing
restrictions.
Pay-In-Kind
Bonds
The
Trust
may invest in Pay-in-kind, or “PIK”
bonds.
PIK bonds are bonds which pay interest through the issuance of additional debt
or equity securities. Similar to zero coupon obligations, PIK bonds also carry
additional risk as holders of these types of securities realize no cash until
the cash payment date unless a portion of such securities is sold and, if the
issuer defaults, the Trust may obtain no return at all on its investment. The
market price of PIK bonds is affected by interest rate changes to a greater
extent, and therefore tends to be more volatile, than that of securities which
pay interest in cash. Additionally, current federal tax law requires the holder
of certain PIK bonds to accrue income with respect to these securities prior
to
the receipt of cash payments. To maintain its qualification as a regulated
investment company and avoid liability for federal income and excise taxes,
the
Trust may be required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under disadvantageous
circumstances in order to generate cash to satisfy these distribution
requirements.
Brady
Bonds
The
Trust’s emerging market debt securities may include emerging market governmental
debt obligations commonly referred to as Brady Bonds. Brady Bonds are debt
securities, generally denominated in U.S. dollars, issued under the framework
of
the Brady Plan, an initiative announced by U.S. Treasury Secretary Nicholas
F.
Brady in 1989 as a mechanism for debtor nations (primarily emerging market
countries) to restructure their outstanding external indebtedness (generally,
commercial bank debt). Brady Bonds are created through the exchange of existing
commercial bank loans to foreign entities for new obligations in connection
with
debt restructuring. A significant amount of the Brady Bonds that the Trust
may
purchase have no or limited collateralization, and the Trust will be relying
for
payment of interest and (except in the case of principal collateralized Brady
Bonds) principal primarily on the willingness and ability of the foreign
government to make payment in accordance with the terms of the Brady Bonds.
A
substantial portion of the Brady Bonds and other sovereign debt securities
in
which the Trust may invest are likely to be acquired at a discount.
Mezzanine
Investments
The
Trust
may invest in certain high yield securities known as mezzanine investments,
which are subordinated debt securities which are generally issued in private
placements in connection with an equity security (e.g., with attached warrants).
Such mezzanine investments may be issued with or without registration rights.
Similar to other high yield securities, maturities of mezzanine investments
are
typically seven to ten years, but the expected average life is significantly
shorter at three to five years. Mezzanine investments are usually unsecured
and
subordinate to other obligations of the issuer.
Loan
Participations and Assignments
The
Trust
may invest in fixed and floating rate loans (“Loans”)
arranged through private negotiations between a corporation or foreign
government and one or more financial institutions (“Lenders”).
The
Trust’s investments in Loans are expected in most instances to be in the form of
participations in Loans (“Participations”)
and
assignments of all or a portion of Loans (“Assignments”)
from
third parties. Participations typically will result in the Trust having a
contractual relationship only with the Lender not the borrower. The Trust will
have the right to receive payments of principal, interest and any fees to which
it is entitled only from the Lender selling the Participation and the Trust
and
only upon receipt by the Lender of the payments by the borrower. In connection
with purchasing Participations, the Trust generally has no direct right to
enforce compliance by the borrower with the terms of the loan agreement relating
to the Loan, nor any rights of set-off against the borrower, and the Trust
may
not directly benefit from any collateral supporting the Loan in which is has
purchased the Participation. As a result the Trust will assume the credit risk
of both the borrower and the Lender that is selling the Participation. In the
event of the insolvency of the Lender selling a Participation, the Trust may
be
treated as a general creditor of the Lender and may not benefit from any set-off
between the Lender and the borrower. The Trust will acquire Participations
only
if the Lender interpositioned between the Trust and the borrower is determined
by Highland to be creditworthy. When the Trust purchases Assignments from
Lenders, the Trust will acquire direct rights against the borrower on the Loan.
However, since Assignments are arranged through private negotiations between
potential assignees and assignors, the rights and obligations acquired by the
Trust as the purchaser of an Assignment may differ from, and be more limited
than, those held by the assigning Lender.
The
Trust
may have difficulty disposing of Assignments and Participations. Because there
is no liquid market for such securities, the Trust anticipates that such
securities could be sold only to a limited number of institutional investors.
The lack of a liquid secondary market will have an adverse impact on the value
of such securities and on the Trust’s ability to dispose of particular
Assignments or Participations when necessary to meet the Trust’s liquidity needs
or in response to a specific economic event, such as a deterioration in the
creditworthiness of the borrower. The lack of a liquid secondary market for
Assignments and Participations also may make it more difficult for the Trust
to
assign a value to those securities for purposes of valuing the Trust’s portfolio
and calculating its net asset value.
Structured
Investments
The
Trust
may invest a portion of its assets in interests in entities organized and
operated solely for the purpose of restructuring the investment characteristics
of securities. This type of restructuring involves the deposit with or purchase
by an entity, such as a corporation or a trust, of specified instruments and
the
issuance by that entity of one or more classes of securities (“Structured
Investments”)
backed
by, or representing interests in the underlying instruments. The cash flow
on
the underlying instruments may be apportioned among the newly issued Structured
Investments to create securities with different investment characteristics
such
as varying maturities, payment priorities and interest rate provisions, and
the
extent of the payments made with respect to Structured Investments is dependent
on the extent of the cash flow on the underlying instruments. Because Structured
Investments of the type in which the Trust anticipates it will invest typically
involve no credit enhancement, their credit risk generally will be equivalent
to
that of the underlying instruments.
The
Trust
is permitted to invest in a class of Structured Investments that is either
subordinated or not subordinated to the right of payment of another class.
Subordinated Structured Investments typically have higher yields and present
greater risks than unsubordinated Structured Investments.
Certain
issuers of Structured Investments may be deemed to be “investment companies” as
defined in the Investment Company Act. As a result, the Trust’s investment in
these Structured Investments may be limited by the restrictions contained in
the
Investment Company Act. Structured Investments are typically sold in private
placement transaction, and there currently is no active trading market for
Structured Investments.
Project
Loans
The
Trust
may invest in project loans, which are fixed income securities of issuers whose
revenues are primarily derived from mortgage loans to multi-family, nursing
home
and other real estate development projects. The principal payments on these
mortgage loans will be insured by agencies and authorities of the U.S.
Government.
Zero
Coupons and Deferred Payment Obligations
The
Trust
may invest in zero-coupon bonds, which are normally issued at a significant
discount from face value and do not provide for periodic interest payments.
Zero-coupon bonds may experience greater volatility in market value than similar
maturity debt obligations which provide for regular interest payments.
Additionally, current federal tax law requires the holder of certain zero-coupon
bonds to accrue income with respect to these securities prior to the receipt
of
cash payments. To maintain its qualification as a regulated investment company
and to potentially avoid liability for federal income and excise taxes, the
Trust may be required to distribute income accrued with respect to these
securities and may have to dispose of Trust securities under disadvantageous
circumstances in order to generate cash to satisfy these distribution
requirements.
The
Trust
may invest in Deferred Payment Securities. Deferred Payment Securities are
securities that remain Zero-Coupon Securities until a predetermined date, at
which time the stated coupon rate becomes effective and interest becomes payable
at regular intervals. Deferred Payment Securities are subject to greater
fluctuations in value and may have lesser liquidity in the event of adverse
market conditions than comparably rated securities paying cash interest at
regular interest payment periods.
MANAGEMENT
OF THE TRUST
Trustees
The
board
of trustees provides broad oversight over the operations and affairs of the
Trust and protects the interests of shareholders. The board of trustees has
overall responsibility to manage and control the business affairs of the Trust,
including the complete and exclusive authority to establish policies regarding
the management, conduct and operation of the Trust’s business. The names and
ages of the trustees and officers of the Trust, the year each was first elected
or appointed to office, their principal business occupations during the last
five years, the number of funds overseen by each trustee and other directorships
or trusteeships they hold are shown below. The business address of the Trust,
Highland and their board members and officers is Two Galleria Tower, 13455 Noel
Road, Suite 800, Dallas, Texas 75240, unless otherwise specified
below.
|
Name
and Age
|
|
Position
with
Trust
|
|
Term
of Office and Length of Time Served(1)
|
|
Principal
Occupation(s) During Past Five Years
|
|
Number
of Portfolios in Highland Fund Complex Overseen by
Trustee(2)
|
|
Other
Directorships/ Trusteeships Held
|
| |
|
|
|
|
|
|
|
|
| |
|
|
|
INDEPENDENT
TRUSTEES
|
|
|
|
|
|
Timothy
Hui
(Age
59)
|
|
Trustee
|
|
3
years and Trustee since May 19, 2006
|
|
Dean
of Educational Resources
since
July 2006; Assistant
Provost
for Graduate Education
from
July 2004 to June 2006,
and
Assistant Provost for
Educational
Resources from
July
2001 to June 2004,
Philadelphia
Biblical University.
|
|
12
|
|
None
|
| |
|
|
|
|
|
|
|
|
|
|
|
Scott
Kavanaugh
(Age
46)
|
|
Trustee
|
|
3
years and Trustee since May 19, 2006
|
|
Private
Investor since February
2004.
Sales Representative at
Round
Hill Securities from
March
2003 to January 2004;
Executive
at Provident Funding
Mortgage
Corporation, February 2003 to July 2003; Executive Vice President.
Director and CAO, Commercial Capital Bank, January 2000 to February
2003;
Managing Principal and Chief Operating Officer, Financial Institutional
Partners Mortgage Company and the Managing Principal and President
of
Financial Institutional Partners, LLC (an investment banking firm),
April
1998 to February 2003.
|
|
12
|
|
None
|
| |
|
|
|
|
|
|
|
|
|
|
|
James
F. Leary
(Age
77)
|
|
Trustee
|
|
3
years and Trustee since May 19, 2006
|
|
Managing
Director, Benefit
Capital
Southwest, Inc. (a financial consulting firm) since
January
1999.
|
|
12
|
|
Board
Member of
Capstone
Group
of
Funds (7 portfolios).
|
|
Bryan
A. Ward
(Age
52)
|
Trustee
|
3
years and Trustee since May 19, 2006
|
Senior
Manager since January
2002
and Special Projects
Advisor,
Accenture, LLP (consulting firm) with focus on the oil and gas
industry,
from
September
1998 to December
2001.
|
12
|
None
|
| |
|
|
|
|
| |
|
INTERESTED
TRUSTEE
|
|
|
| |
|
|
|
|
|
|
R.
Joseph Dougherty
(Age
37)
|
Trustee
and Chairman of the Board
|
3
years and Trustee since March 10, 2006
|
Senior
Portfolio Manager of the
Investment
Adviser since 2000.
Director
and Senior Vice
President
of the funds in the
Highland
Fund Complex.
|
12
|
None
|
OFFICERS
|
Name
and Age
|
|
Position
with Trust
|
|
Term
of Office and
Length
of Time Served
|
|
Principal
Occupation(s) During Past Five Years
|
|
James
D. Dondero
(Age
45)
|
|
Chief
Executive Officer and President
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
President
and Director of Strand Advisors, Inc. (“Strand”), the General Partner of
the Investment Adviser. President of the funds in the Highland
Fund
Complex.
|
| |
|
|
|
|
|
|
|
Mark
Okada
(Age
45)
|
|
Executive
Vice President
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
Executive
Vice President of Strand and the funds in the Highland Fund
Complex.
|
| |
|
|
|
|
|
|
|
M.
Jason Blackburn
(Age
31)
|
|
Chief
Financial Officer (Principal Accounting Officer), Treasurer and
Secretary
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
Assistant
Controller of the Investment Adviser since November 2001. Treasurer
and
Secretary of the funds in the Highland Fund Complex.
|
| |
|
|
|
|
|
|
|
Michael
Colvin
(Age
38)
|
|
Chief
Compliance Officer
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
General
Counsel and Chief Compliance Officer of the Investment Adviser
since June
2007 and Chief Compliance Officer of the funds in the Highland
Fund Complex since July 2007. Shareholder in the Corporate and
Securities
Group at Greenberg Traurig, LLP, from January 2007 to June 2007.
Partner
from January 2003 to
January
2007 and Associate from 1995 to 2002 in the Private Equity Practice
Group
at Weil,
Gotshal
& Manges, LLP.
|
|
(1)
|
After
a Trustee’s initial term, each Trustee is expected to serve a three-year
term concurrent with the class of Trustees with which he serves.
Messrs.
Leary and Ward, as Class I Trustees, were re-elected in 2007; Messrs.
Hui
and Kavanaugh, as Class II Trustees, are expected to stand for re-election
in 2008; and Mr. Dougherty, the sole Class III Trustee, is expected
to
stand for re-election in 2009.
|
| (2) |
The
Highland Fund Complex consists of all of the registered investment
companies advised by Highland as of the date of this Statement of
Additional Information.
|
Compensation
of Trustees
The
fees
and expenses of the Independent Trustees of the Trust are paid by the Trust.
The
trustees who are members of the Highland organization receive no compensation
from the Trust. It is estimated that the Independent Trustees will receive
from
the Trust the amounts set forth below for the Trust’s calendar year ending
December 31, 2007.
|
Name
of Independent Trustees
|
|
Aggregate
Compensation
from
the Trust
|
|
Total
Compensation from the Trust
and
Highland Fund Complex(1)
|
|
|
Timothy
K. Hui
|
|
$
|
7,500
|
|
$
|
97,500
|
|
|
Scott
F. Kavanaugh
|
|
$
|
7,500
|
|
$
|
97,500
|
|
|
James
F. Leary
|
|
$
|
7,500
|
|
$
|
97,500
|
|
|
Bryan
A. Ward
|
|
$
|
7,500
|
|
$
|
97,500
|
|
| (1) |
Estimates
the total compensation to be earned by that person during the calendar
year ending December 31, 2007 from the registered investment companies
advised by Highland.
|
Share
Ownership
The
following table shows the dollar range of equity securities beneficially owned
by the Trust’s trustees in the Trust and the aggregate dollar range of equity
securities owned by the Trust’s trustees in all funds overseen by the trustee in
the Highland Fund Complex as of December 31, 2006.
|
Name
of Trustee
|
|
Dollar
Range of Equity Securities in the Trust
|
|
Aggregate
Dollar Range of Equity Securities Overseen by Trustees in the Family
of
Registered Investment Companies
|
|
|
Interested
Trustee
|
|
|
|
|
|
|
R.
Joseph Dougherty
|
|
$
|
0
|
|
$
|
100,001
- 500,000
|
|
|
Independent
Trustees
|
|
|
|
|
|
|
|
|
Timothy
K. Hui
|
|
$
|
0
|
|
$
|
1
- 10,0000
|
|
|
Scott
F. Kavanaugh
|
|
$
|
0
|
|
$
|
50,001
- 100,000
|
|
|
James
F. Leary
|
|
$
|
0
|
|
$
|
10,001
- 50,000
|
|
|
Bryan
A. Ward
|
|
$
|
0
|
|
$
|
1
- 10,000
|
|
Committees
In
connection with the board of trustee’s responsibility for the overall management
and supervision of the Trust’s affairs, the trustees meet periodically
throughout the year to oversee the Trust’s activities, review contractual
arrangements with service providers for the Trust and review the Trust’s
performance. To fulfill these duties, the Trust has four committees: an Audit
Committee, a Nominating Committee, a Litigation Committee and a Qualified Legal
Compliance Committee.
The
Audit
Committee consists of Timothy Hui, Scott Kavanaugh, James Leary and Bryan Ward.
The Audit Committee acts according to the Audit Committee charter. Scott
Kavanaugh has been appointed as Chairman of the Audit Committee. The Audit
Committee is responsible for (i) oversight of the Trust’s accounting and
financial reporting processes and the audits of the Trust’s financial statements
and (ii) providing assistance to the board of trustees of the Trust in
connection with its oversight of the integrity of the Trust’s financial
statements, the Trust’s compliance with legal and regulatory requirements and
the independent registered public accounting firm’s qualifications, independence
and performance. The board of trustees of the Trust has determined that the
Trust has one audit committee financial expert serving on its Audit Committee,
Mr. Leary, who is independent for the purpose of the definition of audit
committee financial expert as applicable to the Trust. The
Audit
Committee met [·] times during its first full fiscal year of
operation.
The
Nominating Committee’s function is to canvass, recruit, interview, solicit and
nominate trustees. The Nominating Committee considers recommendations for
nominees from shareholders sent to the Secretary of the Trust, Two Galleria
Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. A nomination submission
must include all information relating to the recommended nominee that is
required to be disclosed in solicitations or proxy statements for the election
of trustees, as well as information sufficient to evaluate the factors listed
above. Nomination submissions must be accompanied by a written consent of the
individual to stand for election if nominated by the Board of trustees and
to
serve if elected by the shareholders, and such additional information must
be
provided regarding the recommended nominee as reasonably requested by the
Nominating Committee. The Nominating Committee is comprised of Messrs. Hui,
Kavanaugh, Leary and Ward. The Nominating Committee met [·] times during its
first full fiscal year of operation.
The
Litigation Committee’s function is to seek to address any potential conflicts of
interest between or among the Trust and the Investment Adviser in connection
with any potential or existing litigation or other legal proceeding relating
to
securities held by the Trust and the Investment Adviser or another client of
the
Investment Adviser. The Litigation Committee is comprised of Messrs. Hui,
Kavanaugh, Leary and Ward. The Litigation Committee met [·] times during its
first full fiscal year of operation.
The
Qualified Legal Compliance Committee (the “QLCC”)
is
charged with compliance with Rules 205.2(k) and 205.3(c) of the Code of Federal
Regulations regarding alternative reporting procedures for attorneys
representing the Trust who appear and practice before the Commission on behalf
of the Trust. The QLCC is comprised of Messrs. Hui, Kavanaugh, Leary and Ward.
The QLCC met [·] times during its first full fiscal year of
operation.
Proxy
Voting Policies and Procedures
The
board
of trustees of the Trust has delegated the voting of proxies for Trust
securities to Highland pursuant to Highland’s proxy voting policies and
procedures. Under these policies and procedures, Highland will vote proxies
related to Trust securities in the best interests of the Trust and its
shareholders. A copy of Highland’s proxy voting policies and procedures is
attached as Appendix B to this Statement of Additional Information. The Trust’s
proxy voting record for the most recent 12-month period ending June 30 is
available (i) without charge, upon request, by calling 1-877-665-1287 and (ii)
on the Commission’s web site (http://www.sec.gov).
Codes
of Ethics
The
Trust
and the Investment Adviser have adopted codes of ethics under Rule 17j-1 of
the
Investment Company Act. These codes permit personnel subject to the codes to
invest in securities, including securities that may be purchased or held by
the
Trust. These codes can be reviewed and copied at the Commission’s Public
Reference Room in Washington, D.C. Information on the operation of the Public
Reference Room may be obtained by calling the Commission at 1-202-551-8090.
The
codes of ethics are available on the EDGAR Database on the Commission’s web site
(http://www.sec.gov), and copies of these codes may be obtained, after paying
a
duplicating fee, by electronic request at the following e-mail address:
publicinfo@sec.gov, or by writing the Commission’s Public Reference Section,
Washington, D.C. 20549-0102.
Administration
Services
Pursuant
to the Trust’s administration services agreement, Highland performs the
following services: (i) prepare monthly security transaction listings; (ii)
supply various normal and customary Trust statistical data as requested on
an
ongoing basis; (iii) prepare for execution and file the Trust’s federal and
state tax returns; prepare a fiscal tax provision in coordination with the
annual audit; prepare an excise tax provision; and prepare all relevant 1099
calculations; (iv) coordinate contractual relationships and communications
between the Trust and its contractual service providers; (v) coordinate printing
of the Trust’s annual and semi-annual shareholder reports; (vi) prepare income
and capital gain distributions; (vii) prepare the semiannual and annual
financial statements; (viii) monitor the Trust’s compliance with Internal
Revenue Code, Commission and prospectus requirements; (ix) prepare, coordinate
with the Trust’s counsel and coordinate the filing with the Commission:
semi-annual reports on Form N-SAR and Form N-CSR; Form N-Q; and Form N-PX based
upon information provided by the Trust, assist in the preparation of Forms
3, 4
and 5 pursuant to Section 16 of the Securities Exchange Act of 1934, as amended,
and Section 30(f) of the Investment Company Act for the officers and trustees
of
the Trust, such filings to be based on information provided by those persons;
(x) assist in the preparation of notices of meetings of shareholders; (xi)
assist in obtaining the fidelity bond and trustees’ and officers’/errors and
omissions insurance policies for the Trust in accordance with the requirements
of Rule 17g-1 and 17d-1(d)(7) under the Investment Company Act as such bond
and
policies are approved by the Trust’s board of trustees; (xii) monitor the
Trust’s assets to assure adequate fidelity bond coverage is maintained; (xiii)
draft agendas and resolutions for quarterly and special board meetings; (xiv)
coordinate the preparation, assembly and distribution of board materials; (xv)
attend board meetings and draft minutes thereof; (xvi) maintain the Trust’s
calendar to assure compliance with various filing and board approval deadlines;
(xvii) furnish the Trust office space in the offices of Highland, or in such
other place or places as may be agreed upon from time to time, and all necessary
office facilities, simple business equipment, supplies, utilities and telephone
service for managing the affairs and investments of the Trust; (xviii) assist
the Trust in the handling of SEC examinations and responses thereto; (xix)
perform clerical, bookkeeping and all other administrative services not provided
by the Trust’s other service providers; (xx) determine or oversee the
determination and publication of the Trust’s net asset value in accordance with
the Trust’s policy as adopted from time to time by the Board of Trustees; (xxi)
oversee the maintenance by the Trust’s custodian and transfer agent and dividend
disbursing agent of certain books and records of the Trust as required under
Rule 31a-1(b)(2)(iv) of the Investment Company Act and maintain (or oversee
maintenance by such other persons as approved by the board of trustees) such
other books and records required by law or for the proper operation of the
Trust; (xxii) prepare such information and reports as may be required by any
stock exchange or exchanges on which the Trust’s shares are listed; (xxiii)
determine the amounts available for distribution as dividends and distributions
to be paid by the Trust to its shareholders; prepare and arrange for the
printing of dividend notices to shareholders; and provide the Trust’s dividend
disbursing agent and custodian with such information as is required for such
parties to effect the payment of dividends and distributions and to implement
the Trust’s dividend reinvestment plan; (xxiv) serve as liaison between the
Trust and each of its service providers; and (xxv) perform such additional
administrative duties relating to the administration of the Trust as may
subsequently be agreed upon in writing between the Trust and Highland. Highland
shall have the authority to engage a sub-administrator in connection with the
administrative services of the Trust, which sub-administrator may be an
affiliate of Highland; provided, however, that Highland shall remain responsible
to the Trust with respect to its duties and obligations set forth in the
administration services agreement.
Portfolio
Managers
The
portfolio managers of the Trust are Kurtis Plumer, James Dondero and Mark
Okada.
As
of
October 31, 2007, Kurtis Plumer managed the following client
accounts:
|
Type
of Account
|
|
Number
of
Accounts
|
|
Assets
of
Accounts
|
|
Number
of
Accounts
Subject
to a
Performance
Fee
|
|
Assets
Subject
to a
Performance
Fee
|
|
|
Registered
Investment Companies
|
|
|
2
|
|
|
978
|
|
|
1
|
|
|
87
|
|
|
Other
Pooled Investment Vehicles
|
|
|
5
|
|
|
2,532
|
|
|
3
|
|
|
1,947
|
|
|
Other
Accounts
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
As
of
October 31, 2007, James Dondero managed the following client
accounts:
|
Type
of Account
|
|
Number
of
Accounts
|
|
Assets
of
Accounts
|
|
Number
of
Accounts
Subject
to a
Performance
Fee
|
|
Assets
Subject
to a
Performance
Fee
|
|
|
Registered
Investment Companies
|
|
|
4
|
|
|
1,387
|
|
|
2
|
|
|
463
|
|
|
Other
Pooled Investment Vehicles
|
|
|
10
|
|
|
6,282
|
|
|
9
|
|
|
6,277
|
|
|
Other
Accounts
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
As
of
October 31, 2007, Mark Okada managed the following client
accounts:
|
Type
of Account
|
|
Number
of
Accounts
|
|
Assets
of
Accounts
|
|
Number
of
Accounts
Subject
to a
Performance
Fee
|
|
Assets
Subject
to a
Performance
Fee
|
|
|
Registered
Investment Companies
|
|
|
14
|
|
|
9,107
|
|
|
—
|
|
|
—
|
|
|
Other
Pooled Investment Vehicles
|
|
|
28
|
|
|
18,058
|
|
|
23
|
|
|
16,457
|
|
|
Other
Accounts
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
The
Investment Adviser has built a professional working environment, a firm-wide
compliance culture and compliance procedures and systems designed to protect
against potential incentives that may favor one account over another. The
Investment Adviser has adopted policies and procedures that address the
allocation of investment opportunities, execution of portfolio transactions,
personal trading by employees and other potential conflicts of interest that
are
designed to ensure that all client accounts are treated equitably over time.
Nevertheless, the Investment Adviser furnishes advisory services to numerous
clients in addition to the Trust, and the Investment Adviser may, consistent
with applicable law, make investment recommendations to other clients or
accounts (including accounts which are hedge funds or have performance or higher
fees paid to the Investment Adviser, or in which portfolio managers have a
personal interest in the receipt of such fees), which may be the same as or
different from those made to the Trust. In addition, the Investment Adviser,
its
affiliates and any officer, director, stockholder or employee may or may not
have an interest in the securities whose purchase and sale the Investment
Adviser recommends to the Trust. Actions with respect to securities of the
same
kind may be the same as or different from the action which the Investment
Adviser, or any of its affiliates, or any officer, director, stockholder,
employee or any member of their families may take with respect to the same
securities. Moreover, the Investment Adviser may refrain from rendering any
advice or services concerning securities of companies of which any of the
Investment Adviser’s (or its affiliates’) officers, directors or employees are
directors or officers, or companies as to which the Investment Adviser or any
of
its affiliates or the officers, directors and employees of any of them has
any
substantial economic interest or possesses material non-public information.
In
addition to its various policies and procedures designed to address these
issues, the Investment Adviser includes disclosure regarding these matters
to
its clients in both its Form ADV and investment advisory
agreements.
The
Investment Adviser, its affiliates or their officers and employees serve or
may
serve as officers, directors or principals of entities that operate in the
same
or related lines of business or of investment funds managed by affiliates of
the
Investment Adviser. Accordingly, these individuals may have obligations to
investors in those entities or funds or to other clients, the fulfillment of
which might not be in the best interests of the Trust. As a result, the
Investment Adviser will face conflicts in the allocation of investment
opportunities to the Trust and other funds and clients. In order to enable
such
affiliates to fulfill their fiduciary duties to each of the clients for which
they have responsibility, the Investment Adviser will endeavor to allocate
investment opportunities in a fair and equitable manner which may, subject
to
applicable regulatory constraints, involve pro rata co-investment by the Trust
and such other clients or may involve a rotation of opportunities among the
Trust and such other clients.
While
the
Investment Adviser does not believe there will be frequent conflicts of
interest, if any, the Investment Adviser and its affiliates have both subjective
and objective procedures and policies in place designed to manage the potential
conflicts of interest between the Investment Adviser’s fiduciary obligations to
the Trust and their similar fiduciary obligations to other clients so that,
for
example, investment opportunities are allocated in a fair and equitable manner
among the Trust and such other clients. An investment opportunity that is
suitable for multiple clients of the Investment Adviser and its affiliates
may
not be capable of being shared among some or all of such clients due to the
limited scale of the opportunity or other factors, including regulatory
restrictions imposed by the Investment Company Act. There can be no assurance
that the Investment Adviser’s or its affiliates’ efforts to allocate any
particular investment opportunity fairly among all clients for whom such
opportunity is appropriate will result in an allocation of all or part of such
opportunity to the Trust. Not all conflicts of interest can be expected to
be
resolved in favor of the Trust.
Under
current Commission regulations, the Trust may be prohibited from co-investing
with any unregistered fund managed now or in the future by the Investment
Adviser in certain private placements in which the Investment Adviser negotiates
non-pricing terms. The Trust intends to file for exemptive relief from the
Commission to enable it to co-invest with other unregistered funds managed
by
the Investment Adviser.
Compensation
The
Investment Adviser’s financial arrangements with its portfolio managers, its
competitive compensation and its career path emphasis at all levels reflect
the
value senior management places on key resources. Compensation may include a
variety of components and may vary from year to year based on a number of
factors including the relative performance of a portfolio managers’ underlying
account, the combined performance of the portfolio managers underlying accounts,
and the relative performance of the portfolio managers underlying accounts
measured against other employees. The principal components of compensation
include a base salary, a discretionary bonus, various retirement benefits and
one or more of the incentive compensation programs established by the Investment
Adviser such as Option It Plan and the Long-Term Incentive Plan.
Base
Compensation. Generally,
portfolio managers receive base compensation based on their seniority and/or
their position with the firm, which may include the amount of assets supervised
and other management roles within the firm.
Discretionary
Compensation. In
addition to base compensation, portfolio managers may receive discretionary
compensation, which can be a substantial portion of total compensation.
Discretionary compensation can include a discretionary cash bonus as well as
one
or more of the following:
| |
·
|
Option
It Plan. The
purpose of this plan is to attract and retain the highest quality
employees for positions of substantial responsibility, and to provide
additional incentives to a select group of management or highly
compensated employees of Highland so as to promote the success of
the
Highland.
|
| |
·
|
Long
Term Incentive Plan. The
purpose of this plan is to create positive morale and teamwork, to
attract
and retain key talent, and to encourage the achievement of common
goals.
This plan seeks to reward participating employees based on the increased
value of Highland through the use of Long-Term Incentive
Units.
|
Senior
portfolio managers who perform additional management functions may receive
additional compensation in these other capacities. Compensation is structured
such that key professionals benefit from remaining with the firm.
Securities
Ownership
of Portfolio Managers
[To
be
filed by amendment.]
PORTFOLIO
TRANSACTIONS AND BROKERAGE
In
placing portfolio transactions for the Trust, the Investment Adviser will give
primary consideration to securing the most favorable price and efficient
execution. Consistent with this policy, the Investment Adviser may consider
the
financial responsibility, research and investment information and other services
provided by brokers or dealers who may effect or be a party to any such
transaction or other transactions to which other clients of the Investment
Adviser may be a party. Neither the Trust nor the Investment Adviser has adopted
a formula for allocation of the Trust’s investment transaction business. The
Investment Adviser has access to supplemental investment and market research
and
security and economic analysis provided by brokers who may execute brokerage
transactions at a higher cost to the Trust than would otherwise result when
allocating brokerage transactions to other brokers on the basis of seeking
the
most favorable price and efficient execution. The Investment Adviser, therefore,
is authorized to place orders for the purchase and sale of securities for the
Trust with such brokers, subject to review by the Trust’s board of trustees from
time to time with respect to the extent and continuation of this practice.
The
services provided by such brokers may be useful or beneficial to the Investment
Adviser in connection with its services to other clients.
On
occasions when the Investment Adviser deems the purchase or sale of a security
to be in the best interest of the Trust as well as other clients, the Investment
Adviser, to the extent permitted by applicable laws and regulations, may, but
shall be under no obligation to, aggregate the securities to be so sold or
purchased in order to obtain the most favorable price or lower brokerage
commissions and efficient execution. In such event, allocation of the securities
so purchased or sold, as well as the expenses incurred in the transaction,
will
be made by the Investment Adviser in the manner it considers to be the most
equitable and consistent with its fiduciary obligations to the Trust and to
such
other clients.
REPURCHASE
OF COMMON SHARES
The
Trust
is a closed-end management investment company and as such its shareholders
will
not have the right to cause the Trust to redeem their shares. Instead, the
Trust’s common shares will trade in the open market at a price that will be a
function of several factors, including dividend levels (which are in turn
affected by expenses), net asset value, call protection, dividend stability,
relative demand for and supply of such shares in the market, general market
and
economic conditions and other factors. Because shares of a closed-end investment
company may frequently trade at prices lower than net asset value, the Trust’s
board of trustees may consider action that might be taken to reduce or eliminate
any material discount from net asset value in respect of common shares, which
may include the repurchase of such shares in the open market or in private
transactions, the making of a tender offer for such shares, or the conversion
of
the Trust to an open-end investment company. The board of trustees may decide
not to take any of these actions. In addition, there can be no assurance that
share repurchases or tender offers, if undertaken, will reduce market
discount.
Notwithstanding
the foregoing, at any time when there are outstanding borrowings, the Trust
may
not purchase, redeem or otherwise acquire any of its common shares unless (i)
all accrued preferred shares dividends have been paid and (ii) at the time
of
such purchase, redemption or acquisition, the net asset value of the Trust’s
portfolio (determined after deducting the acquisition price of the common
shares) is at least 200% of the liquidation value of the outstanding borrowings.
Any service fees incurred in connection with any tender offer made by the Trust
will be borne by the Trust and will not reduce the stated consideration to
be
paid to tendering shareholders.
Subject
to its investment restrictions, the Trust may borrow to finance the repurchase
of shares or to make a tender offer. Interest on any borrowings to finance
share
repurchase transactions or the accumulation of cash by the Trust in anticipation
of share repurchases or tenders will reduce the Trust’s net income. Any share
repurchase, tender offer or borrowing that might be approved by the Trust’s
board of trustees would have to comply with the Securities Exchange Act of
1934,
as amended, the Investment Company Act and the rules and regulations
thereunder.
Although
the decision to take action in response to a discount from net asset value
will
be made by the board of trustees at the time it considers such issue, it is
the
board’s present policy, which may be changed by the board of trustees, not to
authorize repurchases of common shares or a tender offer for such shares if:
(1)
such transactions, if consummated, would (a) result in the delisting of the
common shares from the New York Stock Exchange, or (b) impair the Trust’s status
as a regulated investment company under the Code (which would make the Trust
a
taxable entity, causing the Trust’s income to be taxed at the corporate level in
addition to the taxation of shareholders who receive dividends from the Trust),
or as a registered closed-end investment company under the Investment Company
Act; (2) the Trust would not be able to liquidate portfolio securities in an
orderly manner and consistent with the Trust’s investment objectives and
policies in order to repurchase shares; or (3) there is, in the board’s
judgment, any (a) material legal action or proceeding instituted or threatened
challenging such transactions or otherwise materially adversely affecting the
Trust, (b) general suspension of or limitation on prices for trading securities
on the New York Stock Exchange, (c) declaration of a banking moratorium by
federal or state authorities or any suspension of payment by U.S. or New York
banks, (d) material limitation affecting the Trust or the issuers of its
portfolio securities by federal or state authorities on the extension of credit
by lending institutions or on the exchange of foreign currency, (e) commencement
of war, armed hostilities or other international or national calamity directly
or indirectly involving the United States or (f) other event or condition which
would have a material adverse effect (including any adverse tax effect) on
the
Trust or its shareholders if shares were repurchased. The board of trustees
may
in the future modify these conditions in light of experience.
The
repurchase by the Trust of its shares at prices below net asset value will
result in an increase in the net asset value of those shares that remain
outstanding. However, there can be no assurance that share repurchases or tender
offers at or below net asset value will result in the Trust’s shares trading at
a price equal to their net asset value. Nevertheless, the fact that the Trust’s
shares may be the subject of repurchase or tender offers from time to time,
or
that the Trust may be converted to an open-end investment company, may reduce
any spread between market price and net asset value that might otherwise
exist.
Before
deciding whether to take any action if the common shares trade below net asset
value, the Trust’s board of trustees would likely consider all relevant factors,
including the extent and duration of the discount, the liquidity of the Trust’s
portfolio, the impact of any action that might be taken on the Trust or its
shareholders and market considerations. Based on these considerations, even
if
the Trust’s shares should trade at a discount, the board of trustees may
determine that, in the interest of the Trust and its shareholders, no action
should be taken.
TAX
MATTERS
The
following discussion summarizes certain U.S. federal income tax considerations
affecting the Trust and the purchase, ownership and disposition of the Trust’s
common and preferred shares by shareholders that are U.S. persons, as defined
for U.S. federal income tax purposes. This discussion is based upon current
provisions of the Internal Revenue Code of 1986, as amended (the “Code”), the
regulations promulgated thereunder and judicial and administrative authorities,
all of which are subject to change or differing interpretations by the courts
or
the Internal Revenue Service (the “IRS”), possibly with retroactive effect. No
attempt is made to present a detailed explanation of all U.S. federal tax
concerns affecting the Trust and its shareholders (including non-U.S.
Shareholders owning large positions in the Trust and others subject to special
treatment under U.S. federal income tax law).
The
discussions set forth herein and in the prospectus do not constitute tax advice,
and you are urged to consult with your own tax advisor to determine the specific
U.S. federal, state, local and foreign tax consequences to you of investing
in
the Trust.
Taxation
of the Trust
The
Trust
intends to elect to be treated and to qualify annually as a regulated investment
company under Subchapter M of the Code. Accordingly, the Trust must, among
other
things, meet the following requirements regarding the source of its income
and
the diversification of its assets:
(i)
The
Trust must derive in each taxable year at least 90% of its gross income from
the
following sources: (a) dividends, interest (including tax-exempt interest),
payments with respect to certain securities loans, gains from the sale or other
disposition of stock, securities or foreign currencies, or other income
(including but not limited to gains from options, futures and forward contracts)
derived with respect to its business of investing in such stock, securities
or
foreign currencies; and (b) interests in “qualified publicly traded
partnerships” (as defined in the Code).
(ii)
The
Trust must diversify its holdings so that, at the end of each quarter of each
taxable year: (a) at least 50% of the value of the Trust’s total assets is
represented by cash and cash items, U.S. government securities, the securities
of other regulated investment companies and other securities, with such other
securities limited, in respect of any one issuer, to an amount not greater
than
5% of the value of the Trust’s total assets and not more than 10% of the
outstanding voting securities of such issuer and (b) not more than 25% of the
value of the Trust’s total assets is invested in the securities (other than U.S.
government securities and the securities of other regulated investment
companies) of: (I) any one issuer, (II) any two or more issuers that the Trust
controls (by owning 20% or more of their voting power) and that are determined
to be engaged in the same business or similar or related trades or businesses
or
(III) any one or more “qualified publicly traded partnerships” (as defined in
the Code).
As
a
regulated investment company, the Trust generally will not be subject to U.S.
federal income tax on income and gains that the Trust distributes to its
shareholders, provided that it distributes each taxable year at least the sum
of: (i) 90% of the Trust’s investment company taxable income (which includes,
among other items, dividends, interest and the excess of any net short-term
capital gain over net long-term capital loss and other taxable income, other
than any net long-term capital gain, reduced by deductible expenses) determined
without regard to the deduction for dividends paid and (ii) 90% of the Trust’s
net tax-exempt interest (the excess of its gross tax-exempt interest over
certain disallowed deductions). The Trust intends to distribute substantially
all of such income each year. The Trust will be subject to U.S. federal income
tax at regular corporate rates on any taxable income or gains that it does
not
distribute to its shareholders.
The
Code
imposes a 4% nondeductible excise tax on the Trust to the extent the Trust
does
not distribute by the end of any calendar year at least the sum of: (i) 98%
of
its ordinary income (not taking into account any capital gain or loss) for
the
calendar year and (ii) 98% of its capital gain in excess of its capital loss
(adjusted for certain ordinary losses) for a one-year period generally ending
on
October 31 of the calendar year (unless an election is made to use the Trust’s
fiscal year). In addition, the minimum amounts that must be distributed in
any
year to avoid the excise tax will be increased or decreased to reflect any
under-distribution or over-distribution, as the case may be, from the previous
year. While the Trust intends to distribute any income and capital gain in
the
manner necessary to minimize imposition of the 4% excise tax, there can be
no
assurance that sufficient amounts of the Trust’s taxable income and capital gain
will be distributed to avoid entirely the imposition of the excise tax. In
that
event, the Trust will be liable for the excise tax only on the amount by which
it does not meet the foregoing distribution requirement.
If,
for
any taxable year, the Trust does not qualify as a regulated investment company,
all of its taxable income (including its net capital gain) will be subject
to
tax at regular corporate rates without any deduction for distributions to
shareholders, and such distributions will be taxable to the shareholders as
ordinary dividends to the extent of the Trust’s current or accumulated earnings
and profits. Provided that shareholders satisfy certain holding period and
other
requirements with respect to their common shares, such dividends would be
eligible (i) to be treated as qualified dividend income in the case of
shareholders taxed as individuals and (ii) for the dividends received deduction
in the case of shareholders taxed as corporations. The Trust may be required
to
recognize unrealized gains, pay taxes and make distributions (which may be
subject to interest charges) before requalifying for taxation as a regulated
investment company. If the Trust fails to qualify as a regulated investment
company in any year, it must pay out its earnings and profits accumulated in
that year in order to qualify again as a regulated investment company. If the
Trust fails to qualify as a regulated investment company for a period greater
than one taxable year, the Trust may be required to recognize and pay tax on
any
net built-in gains with respect to certain of its assets (i.e., the excess
of
the aggregate gains, including items of income, over aggregate losses that
would
have been realized with respect to such assets if the Trust had been liquidated)
or, alternatively, to elect to be subject to taxation on such built-in gain
recognized for a period of ten years, in order to qualify as a regulated
investment company in a subsequent year.
Taxation
of the Trust’s Investments
Certain
of the Trust’s investment practices are subject to special and complex U.S.
federal income tax provisions that may, among other things: (i) treat dividends
that would otherwise constitute qualified dividend income as non-qualified
dividend income, (ii) treat dividends that would otherwise be eligible for
the
corporate dividends received deduction as ineligible for such treatment, (iii)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (iv) convert lower-taxed, long-term capital gain into higher-taxed,
short-term capital gain or ordinary income, (v) convert an ordinary loss or
deduction into a capital loss (the deductibility of which is more limited),
(vi)
cause the Trust to recognize income or gain without a corresponding receipt
of
cash, (vii) adversely affect the time as to when a purchase or sale of stocks
or
securities is deemed to occur, (viii) adversely alter the characterization
of
certain complex financial transactions or (ix) produce income that will not
qualify as good income for purposes of the 90% annual gross income requirement
described above. These U.S. federal income tax provisions could therefore affect
the amount, timing and character of distributions to shareholders. The Trust
intends to monitor its transactions and may make certain tax elections and
may
be required to dispose of securities or borrow money to mitigate the effect
of
these provisions and prevent disqualification of the Trust as a regulated
investment company.
If
the
Trust purchases shares in certain foreign investment entities, called passive
foreign investment companies (“PFICs”), the Trust may be subject to U.S. federal
income tax on a portion of any “excess distribution” or gain from the
disposition of such shares. Additional charges in the nature of interest may
be
imposed on the Trust in respect of deferred taxes arising from such
distributions or gains. Elections may be available to the Trust to mitigate
the
effect of this tax, but such elections generally accelerate the recognition
of
income without the receipt of cash. Dividends paid by PFICs will not be
qualified dividend income.
If
the
Trust invests in the shares of a PFIC, or any other investment that produces
income that is not matched by a corresponding cash distribution to the Trust,
such as investments in debt securities that have original issue discount, the
Trust could be required to recognize income that it has not yet received. Any
such income would be treated as income earned by the Trust and therefore would
be subject to the distribution requirements of the Code. This might prevent
the
Trust from distributing 90% of its net investment income as is required in
order
to avoid Trust-level U.S. federal income taxation on all of its income, or
might
prevent the Trust from distributing enough ordinary income and capital gain
net
income to avoid completely the imposition of the excise tax. To avoid this
result, the Trust may be required to borrow money or dispose of securities
to be
able to make required distributions to the shareholders.
Dividend,
interest and other income received by the Trust from investments outside the
United States may be subject to withholding and other taxes imposed by foreign
countries. Tax treaties between the United States and other countries may reduce
or eliminate such taxes. The Trust does not expect that it will be eligible
to
elect to treat any foreign taxes it pays as paid by its shareholders, who
therefore will not be entitled to credits for such taxes on their own tax
returns. Foreign taxes paid by a Trust will reduce the return from the Trust’s
investments.
Taxation
of Shareholders
The
Trust
will determine either to distribute or to retain for reinvestment all or part
of
its net capital gain. If any such gain is retained, the Trust will be subject
to
corporate income tax (currently at a maximum rate of 35%) on such retained
amount. In that event, the Trust expects to designate the retained amount as
undistributed capital gain in a notice to its shareholders, each of whom: (i)
will be required to include in income for U.S. federal income tax purposes
as
long-term capital gain its share of such undistributed amounts, (ii) will be
entitled to credit its proportionate share of the tax paid by the Trust against
its U.S. federal income tax liability and to claim refunds to the extent that
the credit exceeds such liability and (iii) will increase its basis in its
common shares of the Trust by an amount equal to 65% of the amount of
undistributed capital gain included in such shareholder’s gross
income.
Distributions
paid to you by the Trust from its net realized long-term capital gains, if
any,
that the Trust designates as capital gains dividends (“capital gain dividends”)
are taxable as long-term capital gains, regardless of how long you have held
your common shares. All other dividends paid to you by the Trust (including
dividends from short-term capital gains) from its current or accumulated
earnings and profits (“ordinary income dividends”) are generally subject to tax
as ordinary income. The Trust does not expect that a corporate shareholder
will
be able to claim a dividends received deduction with respect to any significant
portion of the Trust distributions.
Special
rules apply, however, to ordinary income dividends paid to individuals with
respect to taxable years beginning on or before December 31, 2010. If you are
an
individual, any such ordinary income dividend that you receive from the Trust
generally will be eligible for taxation at the rates applicable to long-term
capital gains to the extent that: (i) the ordinary income dividend is
attributable to “qualified dividend income” (i.e., generally dividends paid by
U.S. corporations and certain foreign corporations) received by the Trust,
(ii)
the Trust satisfies certain holding period and other requirements with respect
to the stock on which such qualified dividend income was paid and (iii) you
satisfy certain holding period and other requirements with respect to your
common shares. Ordinary income dividends subject to these special rules are
not
actually treated as capital gains, however, and thus will not be included in
the
computation of your net capital gain and generally cannot be used to offset
any
capital losses. In general, you may include as qualified dividend income only
that portion of the dividends that may be and are so designated by the Trust
as
qualified dividend income; however, the Trust does not expect that a significant
portion of its ordinary income dividends will be treated as qualified dividend
income.
Any
distributions that you receive that are in excess of the Trust’s current or
accumulated earnings and profits will be treated as a tax-free return of capital
to the extent of your adjusted tax basis in your common shares, and thereafter
as capital gain from the sale of common shares. The amount of any Trust
distribution that is treated as a tax-free return of capital will reduce your
adjusted tax basis in your common shares, thereby increasing your potential
gain
or reducing your potential loss on any subsequent sale or other disposition
of
your common shares.
For
holders of common shares that participate in the Trust’s Automatic Dividend
Reinvestment Plan, dividends and other taxable distributions are taxable to
you
even if they are reinvested in additional common shares of the Trust. Dividends
and other distributions paid by the Trust are generally treated under the Code
as received by you at the time the dividend or distribution is made. If,
however, the Trust pays you a dividend in January that was declared in the
previous October, November or December and you were the shareholder of record
on
a specified date in one of such months, then such dividend will be treated
for
tax purposes as being paid by the Trust and received by you on December 31
of
the year in which the dividend was declared.
The
price
of common shares purchased at any time may reflect the amount of a forthcoming
distribution. If you purchase common shares just prior to a distribution, you
will receive a distribution that will be taxable to you even though it
represents in part a return of your invested capital.
The
Trust
will send you information after the end of each year setting forth the amount
and tax status of any distributions paid to you by the Trust. Ordinary income
dividends and capital gain dividends may also be subject to state and local
taxes.
If
you
sell or otherwise dispose of common shares of the Trust, you will generally
recognize a gain or loss in an amount equal to the difference between your
adjusted tax basis in such common shares of the Trust and the amount you receive
upon disposition of such common shares. If you hold your common shares as
capital assets, any such gain or loss will be long-term capital gain or loss
if
you have held such common shares for more than one year at the time of sale.
Any
loss upon the sale or exchange of common shares held for six months or less
will
be treated as long-term capital loss to the extent of any capital gain dividends
received (including amounts credited as an undistributed capital gain dividend)
by you with respect to such common shares. Any loss you realize on a sale or
exchange of common shares will be disallowed if you acquire other common shares
(whether through the automatic reinvestment of dividends or otherwise) within
a
61-day period beginning 30 days before and ending 30 days after your sale or
exchange of the common shares. In such case, your tax basis in the common shares
acquired will be adjusted to reflect the disallowed loss.
Current
U.S. federal income tax laws tax both long-term and short-term capital gain
of
corporations at the rates applicable to ordinary income. For non-corporate
taxpayers, short-term capital gain is currently taxed at rates applicable to
ordinary income (currently at a maximum of 35%) while long-term capital gain
generally is taxed at a maximum rate of 15% with respect to taxable years
beginning on or before December 31, 2010 (20% thereafter, unless changed by
future legislation).
Shareholders
may be entitled to offset their capital gain dividends with capital loss. The
Code contains a number of statutory provisions affecting the circumstances
under
which capital loss may be offset against capital gain and limiting the use
of
loss from certain investments and activities. Accordingly, shareholders that
have capital losses are urged to consult their tax advisors.
The
Trust
may be required to withhold, for U.S. federal backup withholding tax purposes,
a
portion of the dividends, distributions and redemption proceeds payable to
a
shareholder who fails to provide the Trust (or its agent) with the shareholder’s
correct taxpayer identification number (in the case of an individual, generally,
such individual’s social security number) or to make the required certification,
or who has been notified by the IRS that such shareholder is subject to backup
withholding. Corporate shareholders and certain other shareholders are exempt
from backup withholding. Backup withholding is not an additional tax and any
amount withheld may be refunded or credited against your U.S. federal income
tax
liability, if any, provided that you furnish the required information to the
IRS.
EXPERTS
[•],
located at [•], provides accounting and auditing services to the
Trust.
ADDITIONAL
INFORMATION
A
Registration Statement on Form N-2, including amendments thereto, relating
to
the shares offered hereby, has been filed by the Trust with the Commission,
Washington, D.C. The prospectus and this Statement of Additional Information
do
not contain all of the information set forth in the Registration Statement,
including any exhibits and schedules thereto. For further information with
respect to the Trust and the Shares offered hereby, reference is made to the
Registration Statement. Statements contained in the prospectus and this
Statement of Additional Information as to the contents of any contract or other
document referred to are not necessarily complete and in each instance reference
is made to the copy of such contract or other document filed as an exhibit
to
the Registration Statement, each such statement being qualified in all respects
by such reference. A copy of the Registration Statement may be inspected without
charge at the Commission’s principal office in Washington, D.C., and copies of
all or any part thereof may be obtained from the Commission upon the payment
of
certain fees prescribed by the Commission.
FINANCIAL
STATEMENTS
The
Trust’s unaudited financial statements appearing in the Trust’s semi-annual
shareholder report for the period ended June 30, 2007 are incorporated by
reference in this Statement of Additional Information. The annual and
semi-annual (unaudited) shareholder reports are available upon request and
without charge by writing to the Trust at Two Galleria Tower, 13455 Noel Road,
Suite 800, Dallas, Texas 75240 or by calling (877) 665-1287.
APPENDIX
A
A
Standard & Poor’s issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium-term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account
the
currency in which the obligation is denominated. The issue credit rating is
not
a recommendation to purchase, sell, or hold a financial obligation, inasmuch
as
it does not comment as to market price or suitability for a particular
investor.
Issue
credit ratings are based on current information furnished by the obligors or
obtained by Standard & Poor’s from other sources it considers reliable.
Standard & Poor’s does not perform an audit in connection with any credit
rating and may, on occasion, rely on unaudited financial information. Credit
ratings may be changed, suspended, or withdrawn as a result of changes in,
or
unavailability of, such information, or based on other
circumstances.
Issue
credit ratings can be either long-term or short-term. Short-term ratings are
generally assigned to those obligations considered short-term in the relevant
market. In the U.S., for example, that means obligations with an original
maturity of no more than 365 days, including commercial paper, are considered
short-term. Short-term ratings are also used to indicate the creditworthiness
of
an obligor with respect to put features on long-term obligations. The result
is
a dual rating, in which the short-term rating addresses the put feature, in
addition to the usual long-term rating. Medium-term notes are assigned long-term
ratings.
Long-Term
Issue Credit Ratings
Issue
credit ratings are based, in varying degrees, on the following
considerations:
| |
·
|
Likelihood
of payment—capacity and willingness of the obligor to meet its financial
commitment on an obligation in accordance with the terms of the
obligation;
|
| |
·
|
Nature
of and provisions of the obligation; and
|
| |
·
|
Protection
afforded by, and relative position of, the obligation in the event
of
bankruptcy, reorganization, or other arrangement under the laws of
bankruptcy and other laws affecting creditors’
rights.
|
The
issue
rating definitions are expressed in terms of default risk. As such, they pertain
to senior obligations of an entity. Junior obligations are typically rated
lower
than senior obligations, to reflect the lower priority in bankruptcy, as noted
above. (Such differentiation applies when an entity has both senior and
subordinated obligations, secured and unsecured obligations, or operating
company and holding company obligations.) Accordingly, in the case of junior
debt, the rating may not conform exactly with the category
definition.
AAA
An
obligation rated “AAA”
has
the
highest rating assigned by Standard & Poor’s. The obligor’s capacity to meet
its financial commitment on the obligation is extremely strong.
AA
An
obligation rated “AA”
differs
from the highest-rated obligations only to a small degree. The obligor’s
capacity to meet its financial commitment on the obligation is very
strong.
A
An
obligation rated “A”
is
somewhat more susceptible to the adverse effects of changes in circumstances
and
economic conditions than obligations in higher-rated categories. However, the
obligor’s capacity to meet its financial commitment on the obligation is still
strong.
BBB
An
obligation rated “BBB”
exhibits adequate protection parameters. However, adverse economic conditions
or
changing circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
BB,
B, CCC, CC, and C
Obligations
rated “BB”,
“B”,
“CCC”,
“CC”,
and
“C”
are
regarded as having significant speculative characteristics. “BB” indicates the
least degree of speculation and “C”
the
highest. While such obligations will likely have some quality and protective
characteristics, these may be outweighed by large uncertainties or major
exposures to adverse conditions.
An
obligation rated “BB”
is
less
vulnerable to nonpayment than other speculative issues. However, it faces major
ongoing uncertainties or exposure to adverse business, financial, or economic
conditions which could lead to the obligor’s inadequate capacity to meet its
financial commitment on the obligation.
B
An
obligation rated “B”
is
more
vulnerable to nonpayment than obligations rated “BB”,
but
the obligor currently has the capacity to meet its financial commitment on
the
obligation. Adverse business, financial, or economic conditions will likely
impair the obligor’s capacity or willingness to meet its financial commitment on
the obligation.
CCC
An
obligation rated “CCC”
is
currently vulnerable to nonpayment, and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its financial
commitment on the obligation. In the event of adverse business, financial,
or
economic conditions, the obligor is not likely to have the capacity to meet
its
financial commitment on the obligation.
CC
An
obligation rated “CC”
is
currently highly vulnerable to nonpayment.
C
A
subordinated debt or preferred stock obligation rated “C”
is
currently highly vulnerable to nonpayment. The “C”
rating
may be used to cover a situation where a bankruptcy petition has been filed
or
similar action taken, but payments on this obligation are being continued.
A
“C”
also
will be assigned to a preferred stock issue in arrears on dividends or sinking
fund payments, but that is currently paying.
D
An
obligation rated “D”
is
in
payment default. The “D”
rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard &
Poor’s believes that such payments will be made during such grace period. The
“D”
rating
also will be used upon the filing of a bankruptcy petition or the taking of
a
similar action if payments on an obligation are jeopardized.
Plus
(+) or minus (—)
The
ratings from “AA”
to
“CCC”
may
be
modified by the addition of a plus (+) or minus (—) sign to show relative
standing within the major rating categories.
NR
This
indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that Standard & Poor’s does not
rate a particular obligation as a matter of policy.
Short-Term
Issue Credit Ratings
A-1
A
short-term obligation rated “A-1”
is
rated in the highest category by Standard & Poor’s. The obligor’s capacity
to meet its financial commitment on the obligation is strong. Within this
category, certain obligations are designated with a plus sign (+). This
indicates that the obligor’s capacity to meet its financial commitment on these
obligations is extremely strong.
A-2
A
short-term obligation rated “A-2”
is
somewhat more susceptible to the adverse effects of changes in circumstances
and
economic conditions than obligations in higher rating categories. However,
the
obligor’s capacity to meet its financial commitment on the obligation is
satisfactory.
A-3
A
short-term obligation rated “A-3”
exhibits adequate protection parameters. However, adverse economic conditions
or
changing circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
B
A
short-term obligation rated “B”
is
regarded as having significant speculative characteristics. Ratings of
“B-1”,
“B-2”,
and
“B-3”
may
be
assigned to indicate finer distinctions within the “B”
category. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor’s inadequate capacity to meet its financial
commitment on the obligation.
B-1
A
short-term obligation rated “B-1”
is
regarded as having significant speculative characteristics, but the obligor
has
a relatively stronger capacity to meet its financial commitments over the
short-term compared to other speculative-grade obligors.
B-2
A
short-term obligation rated “B-2”
is
regarded as having significant speculative characteristics, and the obligor
has
an average speculative-grade capacity to meet its financial commitments over
the
short-term compared to other speculative-grade obligors.
B-3
A
short-term obligation rated “B-3”
is
regarded as having significant speculative characteristics, and the obligor
has
a relatively weaker capacity to meet its financial commitments over the
short-term compared to other speculative-grade obligors.
C
A
short-term obligation rated “C”
is
currently vulnerable to nonpayment and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its financial
commitment on the obligation.
D
A
short-term obligation rated “D”
is
in
payment default. The “D”
rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard &
Poor’s believes that such payments will be made during such grace period. The
“D”
rating
also will be used upon the filing of a bankruptcy petition or the taking of
a
similar action if payments on an obligation are jeopardized.
Active
Qualifiers (Currently applied and/or outstanding)
i
This
subscript is used for issues in which the credit factors, terms, or both, that
determine the likelihood of receipt of payment of interest are different from
the credit factors, terms or both that determine the likelihood of receipt
of
principal on the obligation. The “i”
subscript indicates that the rating addresses the interest portion of the
obligation only. The “i”
subscript will always be used in conjunction with the “p”
subscript, which addresses likelihood of receipt of principal. For example,
a
rated obligation could be assigned ratings of “AAAp
NRi”
indicating that the principal portion is rated “AAA”
and
the
interest portion of the obligation is not rated.
L
Ratings
qualified with “L”
apply
only to amounts invested up to federal deposit insurance limits.
P
This
subscript is used for issues in which the credit factors, the terms, or both,
that determine the likelihood of receipt of payment of principal are different
from the credit factors, terms or both that determine the likelihood of receipt
of interest on the obligation. The “p”
subscript indicates that the rating addresses the principal portion of the
obligation only. The “p”
subscript will always be used in conjunction with the “i”
subscript, which addresses likelihood of receipt of interest. For example,
a
rated obligation could be assigned ratings of “AAAp
N.R.i”
indicating that the principal portion is rated “AAA”
and
the
interest portion of the obligation is not rated.
pi
Ratings
with a “pi”
subscript are based on an analysis of an issuer’s published financial
information, as well as additional information in the public domain. They do
not, however, reflect in-depth meetings with an issuer’s management and are
therefore based on less comprehensive information than ratings without a
“pi”
subscript. Ratings with a “pi”
subscript are reviewed annually based on a new year’s financial statements, but
may be reviewed on an interim basis if a major event occurs that may affect
the
issuer’s credit quality.
pr
The
letters “pr”
indicate that the rating is provisional. A provisional rating assumes the
successful completion of the project financed by the debt being rated and
indicates that payment of debt service requirements is largely or entirely
dependent upon the successful, timely completion of the project. This rating,
however, while addressing credit quality subsequent to completion of the
project, makes no comment on the likelihood of or the risk of default upon
failure of such completion. The investor should exercise his own judgment with
respect to such likelihood and risk.
Preliminary
Preliminary
ratings are assigned to issues, including financial programs, in the following
circumstances.
| |
·
|
Preliminary
ratings may be assigned to obligations, most commonly structured
and
project finance issues, pending receipt of final documentation and
legal
opinions. Assignment of a final rating is conditional on the receipt
and
approval by Standard & Poor’s of appropriate documentation. Changes in
the information provided to Standard & Poor’s could result in the
assignment of a different rating. In addition, Standard & Poor ‘s
reserves the right not to issue a final
rating.
|
| |
·
|
Preliminary
ratings are assigned to Rule 415 Shelf Registrations. As specific
issues,
with defined terms, are offered from the master registration, a final
rating may be assigned to them in accordance with Standard & Poor’s
policies. The final rating may differ from the preliminary
rating.
|
t
This
symbol indicates termination structures that are designed to honor their
contracts to full maturity or, should certain events occur, to terminate and
cash settle all their contracts before their final maturity date.
Inactive
Qualifiers (No longer applied or outstanding)
*
This
symbol indicated continuance of the ratings is contingent upon Standard &
Poor ‘s receipt of an executed copy of the escrow agreement or closing
documentation confirming investments and cash flows. Discontinued use in August
1998.
c
This
qualifier was used to provide additional information to investors that the
bank
may terminate its obligation to purchase tendered bonds if the long-term credit
rating of the issuer is below an investment-grade level and/or the issuer’s
bonds are deemed taxable. Discontinued use in January 2001.
q
A
“q”
subscript indicates that the rating is based solely on quantitative analysis
of
publicly available information. Discontinued use in April 2001.
r
The
“r”
modifier was assigned to securities containing extraordinary risks, particularly
market risks, that are not covered in the credit rating. The absence of an
“r”
modifier should not be taken as an indication that an obligation will not
exhibit extraordinary non-credit related risks. Standard & Poor’s
discontinued the use of the “r”
modifier for most obligations in June 2000 and for the balance of obligations
(mainly structured finance transactions) in November 2002.
Moody’s
Investors Service, Inc.—A
brief
description of the applicable Moody’s Investors Service, Inc. (“Moody’s”)
rating
symbols and their meanings (as published by Moody’s) follows:
Long-Term
Obligation Ratings
Moody’s
long-term obligation ratings are opinions of the relative credit risk of a
fixed
income obligations with an original maturity of one year or more. They address
the possibility that a financial obligation will not be honored as promised.
Such ratings reflect both the likelihood of default and any financial loss
suffered in the event of default.
Moody’s
Long-Term Rating Definitions:
Aaa
Obligations
rated Aaa are judged to be of the highest quality, with minimal credit
risk.
Aa
Obligations
rated Aa are judged to be of high quality and are subject to very low credit
risk.
A
Obligations
rated A are considered upper medium-grade and are subject to low credit
risk.
Baa
Obligations
rated Baa are subject to moderate credit risk. They are considered medium-grade
and as such may possess certain speculative characteristics.
Ba
Obligations
rated Ba are judged to have speculative elements and are subject to substantial
credit risk.
B
Obligations
rated B are considered speculative and are subject to high credit
risk.
Caa
Obligations
rated Caa are judged to be of poor standing and are subject to very high credit
risk.
Ca
Obligations
rated Ca are highly speculative and are likely in, or very near, default, with
some prospect of recovery of principal and interest.
C
Obligations
rated C are the lowest rated class of bonds and are typically in default, with
little prospect for recovery of principal or interest.
Note:
Moody’s
appends numerical modifiers 1, 2, and 3 to each generic rating classification
from Aa through Caa. The modifier 1 indicates that the obligation ranks in
the
higher end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates a ranking in the lower end of that generic
rating category.
Medium-Term
Note Ratings
Moody’s
assigns long-term ratings to individual debt securities issued from medium-term
note (MTN) programs, in addition to indicating ratings to MTN programs
themselves. Notes issued under MTN programs with such indicated ratings are
rated at issuance at the rating applicable to all parí passu notes issued under
the same program, at the program’s relevant indicated rating, provided such
notes do not exhibit any of the characteristics listed below:
| |
·
|
Notes
containing features that link interest or principal to the credit
performance of any third party or parties (i.e., credit-linked
notes);
|
| |
·
|
Notes
allowing for negative coupons, or negative principal
|
| |
·
|
Notes
containing any provision that could obligate the investor to make
any
additional payments
|
| |
·
|
Notes
containing provisions that subordinate the claim.
|
For
notes
with any of these characteristics, the rating of the individual note may differ
from the indicated rating of the program.
For
credit-linked securities, Moody’s policy is to “look through” to the credit risk
of the underlying obligor. Moody’s policy with respect to non-credit linked
obligations is to rate the issuer’s ability to meet the contract as stated,
regardless of potential losses to investors as a result of non-credit
developments. In other words, as long as the obligation has debt standing in
the
event of bankruptcy, we will assign the appropriate debt class level rating
to
the instrument.
Market
participants must determine whether any particular note is rated, and if so,
at
what rating level. Moody’s encourages market participants to contact Moody’s
Ratings Desks or visit www.moodys.com directly if they have questions regarding
ratings for specific notes issued under a medium-term note program. Unrated
notes issued under an MTN program may be assigned an NR (not rated)
symbol.
Short-Term
Ratings:
Moody’s
short-term ratings are opinions of the ability of issuers to honor short-term
financial obligations. Ratings may be assigned to issuers, short-term programs
or to individual short-term debt instruments. Such obligations generally have
an
original maturity not exceeding thirteen months, unless explicitly
noted.
Moody’s
employs the following designations to indicate the relative repayment ability
of
rated issuers:
P-1
Issuers
(or supporting institutions) rated Prime-1 have a superior ability to repay
short-term debt obligations.
P-2
Issuers
(or supporting institutions) rated Prime-2 have a strong ability to repay
short-term debt obligations.
P-3
Issuers
(or supporting institutions) rated Prime-3 have an acceptable ability to repay
short-term obligations.
NP
Issuers
(or supporting institutions) rated Not Prime do not fall within any of the
Prime
rating categories.
Note:
Canadian
issuers rated P-1 or P-2 have their short-term ratings enhanced by the senior
most long-term rating of the issuer, its guarantor or support
provider.
APPENDIX
B
PROXY
VOTING POLICIES AND PROCEDURES
HIGHLAND
CAPITAL MANAGEMENT, L.P.
PROXY
VOTING POLICY
1. Application;
General Principles
1.1 This
proxy voting policy (the “Policy”) applies to securities held in Client accounts
as to which the above-captioned investment adviser (the “Company”) has voting
authority, directly or indirectly. Indirect voting authority exists where the
Company’s voting authority is implied by a general delegation of investment
authority without reservation of proxy voting authority.
1.2 The
Company shall vote proxies in respect of securities owned by or on behalf of
a
Client in the Client’s best economic interests and without regard to the
interests of the Company or any other Client of the Company.
2. Voting;
Procedures
2.1 Monitoring.
A
settlement designee of the Company shall have responsibility for monitoring
portfolios managed by the Company for securities subject to a proxy vote. Upon
the receipt of a proxy notice related to a security held in a portfolio managed
by the Company, the settlement designee shall forward all relevant information
to the portfolio manager(s) with responsibility for the security.
2.2 Voting.
2.2.1. Upon
receipt of notice from the settlement designee, the portfolio manager(s) with
responsibility for purchasing the security subject to a proxy vote shall
evaluate the subject matter of the proxy and cause the proxy to be voted on
behalf of the Client. In determining how to vote a particular proxy, the
portfolio manager (s) shall consider, among other things, the interests of
each
Client account as it relates to the subject matter of the proxy, any potential
conflict of interest the Company may have in voting the proxy on behalf of
the
Client and the procedures set forth in this Policy.
2.2.2 If
a
proxy relates to a security held in a registered investment company or business
development company (“Retail Fund”) portfolio, the portfolio manager(s) shall
notify the Compliance Department and a designee from the Retail Funds group.
Proxies for securities held in the Retail Funds will be voted by the designee
from the Retail Funds group in a manner consistent with the best interests
of
the applicable Retail Fund and a record of each vote will be reported to the
Retail Fund’s Board of Directors in accordance with the procedures set forth in
Section 4 of this Policy.
2.3 Conflicts
of Interest.
If the
portfolio manager(s) determine that the Company may have a potential material
conflict of interest (as defined in Section 3 of this Policy) in voting a
particular proxy, the portfolio manager(s) shall contact the Company’s
Compliance Department prior to causing the proxy to be voted.
2.3.1. For
a
security held by a Retail Fund, the Company shall disclose the conflict and
the
determination of the manner in which it proposes to vote to the Retail Fund’s
Board of Directors. The Company’s determination shall take into account only the
interests of the Retail Fund, and the Compliance Department shall document
the
basis for the decision and furnish the documentation to the Board of
Directors.
2.3.2. For
a
security held by an unregistered investment company, such as a hedge fund and
structured products (“Non-Retail Funds”), where a material conflict of interest
has been identified the Company may resolve the conflict by following the
recommendation of a disinterested third party or by abstaining from voting.
2.4 Non-Votes.
The
Company may determine not to vote proxies in respect of securities of any issuer
if it determines it would be in its Client’s overall best interests not to vote.
Such determination may apply in respect of all Client holdings of the securities
or only certain specified Clients, as the Company deems appropriate under the
circumstances. As examples, the portfolio manager(s) may determine: (a) not
to
recall securities on loan if, in its judgment, the negative consequences to
Clients of disrupting the securities lending program would outweigh the benefits
of voting in the particular instance or (b) not to vote certain foreign
securities positions if, in its judgment, the expense and administrative
inconvenience outweighs the benefits to Clients of voting the
securities.
2.5 Recordkeeping.
Following the submission of a proxy vote, the applicable portfolio manager(s)
shall submit a report of the vote to a settlement designee of the Company.
Records of proxy votes by the Company shall be maintained in accordance with
Section 4 of this Policy.
2.6 Certification.
On a
quarterly basis, each portfolio manager shall certify to the Compliance
Department that they have complied with this Policy in connection with proxy
votes during the period.
3. Conflicts
of Interest
3.1 Voting
the securities of an issuer where the following relationships or circumstances
exist are deemed to give rise to a material conflict of interest for purposes
of
this Policy:
3.1.1 The
issuer is a Client of the Company accounting for more than 5% of the Company’s
annual revenues.
3.1.2 The
issuer is an entity that reasonably could be expected to pay the Company more
than $1 million through the end of the Company’s next two full fiscal
years.
3.1.3 The
issuer is an entity in which a “Covered Person” (as defined in the Retail Funds’
and the Company’s Policies and Procedures Designed to Detect and Prevent Insider
Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940,
as
amended (each, a “Code of Ethics”)) has a beneficial interest contrary to the
position held by the Company on behalf of Clients.
3.1.4 The
issuer is an entity in which an officer or partner of the Company or a
relative
of any
such person is or was an officer, director or employee, or such person or
relative otherwise has received more than $150,000 in fees, compensation and
other payment from the issuer during the Company’s last three fiscal years;
provided,
however,
that
the Compliance Department may deem such a relationship not to be a material
conflict of interest if the Company representative serves as an officer or
director of the issuer at the direction of the Company for purposes of seeking
control over the issuer.
1 For
the
purposes of this Policy, “relative” includes the following family members:
spouse, minor children or stepchildren or children or stepchildren sharing
the
person’s home.
3.1.5 The
matter under consideration could reasonably be expected to result in a material
financial benefit to the Company through the end of the Company’s next two full
fiscal years (for example, a vote to increase an investment advisory fee for
a
Retail Fund advised by the Company or an affiliate).
3.1.6 Another
Client or prospective Client of the Company, directly or indirectly, conditions
future engagement of the Company on voting proxies in respect of any Client’s
securities on a particular matter in a particular way.
3.1.7 The
Company holds various classes and types of equity and debt securities of the
same issuer contemporaneously in different Client portfolios.
3.1.8 Any
other
circumstance where the Company’s duty to serve its Clients’ interests, typically
referred to as its “duty of loyalty,” could be compromised.
3.2 Notwithstanding
the foregoing, a conflict of interest described in Section 3.1 shall not be
considered material for the purposes of this Policy in respect of a specific
vote or circumstance if:
3.2.1 The
securities in respect of which the Company has the power to vote account for
less than 1% of the issuer’s outstanding voting securities, but only if: (i)
such securities do not represent one of the 10 largest holdings of such issuer’s
outstanding voting securities and (ii) such securities do not represent more
than 2% of the Client’s holdings with the Company.
3.2.2 The
matter to be voted on relates to a restructuring of the terms of existing
securities or the issuance of new securities or a similar matter arising out
of
the holding of securities, other than common equity, in the context of a
bankruptcy or threatened bankruptcy of the issuer.
4. Recordkeeping
and Retention
4.1 The
Company shall retain records relating to the voting of proxies,
including:
4.1.1 Copies
of
this Policy and any amendments thereto.
4.1.2 A
copy of
each proxy statement that the Company receives regarding Client
securities.
4.1.3 Records
of each vote cast by the Company on behalf of Clients.
4.1.4 A
copy of
any documents created by the Company that were material to making a decision
how
to vote or that memorializes the basis for that decision.
4.1.5 A
copy of
each written request for information on how the Company voted proxies on behalf
of the Client, and a copy of any written response by the Company to any (oral
or
written) request for information on how the Company voted.
4.2 These
records shall be maintained and preserved in an easily accessible place for
a
period of not less than five years from the end of the Company’s fiscal year
during which the last entry was made in the records, the first two years in
an
appropriate office of the Company.
4.3 The
Company may rely on proxy statements filed on the SEC’s EDGAR system or on proxy
statements and records of votes cast by the Company maintained by a third party,
such as a proxy voting service (provided the Company had obtained an undertaking
from the third party to provide a copy of the proxy statement or record promptly
on request).
4.4 Records
relating to the voting of proxies for securities held by the Retail Funds will
be reported periodically to the Retail Funds’ Boards of Directors and, with
respect to Retail Funds other than business development companies, to the SEC
on
an annual basis pursuant to Form N-PX.
Part
C
Other
Information
Item
25. Financial
Statements and Exhibits
1.
Financial Statements
Part
A —
Financial Highlights.
Part
B —
Unaudited financial statements for the period ended June 30, 2007 are
incorporated by reference to the Trust’s semi-annual report for the period ended
June 30, 2007.
|
2.
Exhibits
|
|
| |
(a)
|
|
Agreement
and Declaration of Trust(1)
|
| |
|
|
|
| |
(b)
|
|
By-Laws(1)
|
| |
|
|
|
| |
(c)
|
|
Not
applicable
|
| |
|
|
|
| |
(d)
|
|
Form
of Specimen Certificate(1)
|
| |
|
|
|
| |
(e)
|
|
Form
of Dividend Reinvestment Plan(1)
|
| |
|
|
|
| |
(f)
|
|
Not
applicable
|
| |
|
|
|
| |
(g)
|
|
Form
of Investment Advisory Agreement(1)
|
| |
|
|
|
| |
(h)
|
|
Form
of Dealer Manager Agreement(3)
|
| |
|
|
|
| |
(i)
|
|
Not
applicable
|
| |
|
|
|
| |
(j)
|
|
Form
of Custodian Services Agreement(1)
|
| |
|
|
|
| |
(k)(1)
|
|
Form
of Transfer Agency Services Agreement(1)
|
| |
|
|
|
| |
(k)(2)
|
|
Form
of Administration Services Agreement(1)
|
| |
|
|
|
| |
(k)(3)
|
|
Form
of Sub-Administration Services Agreement(1)
|
| |
|
|
|
| |
(k)(4)
|
|
Form
of Accounting Services Agreement(1)
|
| |
|
|
|
| |
(k)(5)
|
|
Form
of Marketing and Structuring Fee Agreement(1)
|
| |
|
|
|
| |
(l)
|
|
Opinion
and Consent of Counsel to the Trust(3)
|
| |
|
|
|
| |
(m)
|
|
Not
applicable
|
| |
|
|
|
| |
(n)
|
|
Consent
of Independent Registered Public Accounting Firm(3)
|
| |
|
|
|
| |
(o)
|
|
Not
applicable
|
| |
|
|
|
| |
(p)
|
|
Subscription
Agreement(1)
|
| |
(q)
|
|
Not
applicable
|
| |
|
|
|
| |
(r)(1)
|
|
Code
of Ethics of the Trust(1)
|
| |
|
|
|
| |
(r)(2)
|
|
Code
of Ethics of the Investment Adviser(1)
|
| |
|
|
|
| |
(s)
|
|
Power
of Attorney(2)
|
|
(1)
|
Incorporated
by reference from Pre-Effective Amendment No. 6 to the Trust’s
Registration Statement on Form N-2 (File No. 333-132436), filed
on June
21, 2006.
|
|
(2)
|
Incorporated
by reference from the Trust’s Registration Statement on Form N-2 (File No.
333-147121), filed on November 2,
2007.
|
|
(3)
|
To
be filed by amendment.
|
Item
26. Marketing
Arrangements
Not
applicable.
Item
27. Other
Expenses of Issuance and
Distribution
The
following table sets forth the estimated expenses to be incurred in connection
with the offer described in this Registration Statement:
|
Legal
|
|
$
|
250,00
|
|
|
Subscription
Agent
|
|
|
51,273
|
|
|
Information
Agent
|
|
|
18,000
|
|
|
Printing
and Mailing
|
|
|
42,211
|
|
|
NYSE
Listing Fee
|
|
|
40,274
|
|
|
SEC
Registration Fee
|
|
|
5,836
|
|
|
FINRA
Fee
|
|
|
19,509
|
|
|
Other
|
|
|
5,000
|
|
|
Total
|
|
$
|
432,103
|
|
Item
28. Persons
Controlled by or Under Common Control with the
Registrant
None.
Item
29. Number
of Holders of Shares
As
of
November 30, 2007:
|
Title
of Class
|
|
Number
of
Record Holders
|
|
Common
Shares of Beneficial Interest
|
|
[·]
|
|
Article
V
of the Registrant’s Agreement and Declaration of Trust provides as follows:
| |
5.1
No
Personal Liability of Shareholders, Trustees, etc.
No
Shareholder of the Trust shall be subject in such capacity to any
personal
liability whatsoever to any Person in connection with Trust Property
or
the acts, obligations or affairs of the Trust. Shareholders shall
have the
same limitation of personal liability as is extended to stockholders
of a
private corporation for profit incorporated under the Delaware General
Corporation Law. No trustee or officer of the Trust shall be subject
in
such capacity to any personal liability whatsoever to any Person,
save
only liability to the Trust or its Shareholders arising from bad
faith,
willful misfeasance, gross negligence or reckless disregard for his
duty
to such Person; and, subject to the foregoing exception, all such
Persons
shall look solely to the Trust Property for satisfaction of claims
of any
nature arising in connection with the affairs of the Trust. If any
Shareholder, trustee or officer, as such, of the Trust, is made a
party to
any suit or proceeding to enforce any such liability, subject to
the
foregoing exception, he shall not, on account thereof, be held to
any
personal liability. Any repeal or modification of this Section 5.1
shall
not adversely affect any right or protection of a trustee or officer
of
the Trust existing at the time of such repeal or modification with
respect
to acts or omissions occurring prior to such repeal or
modification.
|
| |
|
| |
5.2
Mandatory
Indemnification.
(a) The Trust hereby agrees to indemnify each person who at any time
serves as a trustee or officer of the Trust (each such person being
an
“indemnitee”) against any liabilities and expenses, including amounts paid
in satisfaction of judgments, in compromise or as fines and penalties,
and
reasonable counsel fees reasonably incurred by such indemnitee in
connection with the defense or disposition of any action, suit or
other
proceeding, whether civil or criminal, before any court or administrative
or investigative body in which he may be or may have been involved
as a
party or otherwise or with which he may be or may have been threatened,
while acting in any capacity set forth in this Article V by reason
of his
having acted in any such capacity, except with respect to any matter
as to
which he shall not have acted in good faith in the reasonable belief
that
his action was in the best interest of the Trust or, in the case
of any
criminal proceeding, as to which he shall have had reasonable cause
to
believe that the conduct was unlawful, provided, however, that no
indemnitee shall be indemnified hereunder against any liability to
any
person or any expense of such indemnitee arising by reason of (i)
willful
misfeasance, (ii) bad faith, (iii) gross negligence, or (iv) reckless
disregard of the duties involved in the conduct of his position (the
conduct referred to in such clauses (i) through (iv) being sometimes
referred to herein as “disabling conduct”). Notwithstanding the foregoing,
with respect to any action, suit or other proceeding voluntarily
prosecuted by any indemnitee as plaintiff, indemnification shall
be
mandatory only if the prosecution of such action, suit or other proceeding
by such indemnitee (1) was authorized by a majority of the trustees
or (2)
was instituted by the indemnitee to enforce his or her rights to
indemnification hereunder in a case in which the indemnitee is found
to be
entitled to such indemnification. The rights to indemnification set
forth
in this Declaration shall continue as to a person who has ceased
to be a
trustee or officer of the Trust and shall inure to the benefit of
his or
her heirs, executors and personal and legal representatives. No amendment
or restatement of this Declaration or repeal of any of its provisions
shall limit or eliminate any of the benefits provided to any person
who at
any time is or was a trustee or officer of the Trust or otherwise
entitled
to indemnification hereunder in respect of any act or omission that
occurred prior to such amendment, restatement or
repeal.
|
| |
(b)
Notwithstanding the foregoing, no indemnification shall be made hereunder
unless there has been a determination (i) by a final decision on
the
merits by a court or other body of competent jurisdiction before
whom the
issue of entitlement to indemnification hereunder was brought that
such
indemnitee is entitled to indemnification hereunder or, (ii) in the
absence of such a decision, by (1) a majority vote of a quorum of
those
trustees who are neither “interested persons” of the Trust (as defined in
Section 2(a)(19) of the Investment Company Act) nor parties to the
proceeding (“Disinterested
Non-Party Trustees”),
that the indemnitee is entitled to indemnification hereunder, or
(2) if
such quorum is not obtainable or even if obtainable, if such majority
so
directs, independent legal counsel in a written opinion concludes
that the
indemnitee should be entitled to indemnification hereunder. All
determinations to make advance payments in connection with the expense
of
defending any proceeding shall be authorized and made in accordance
with
the immediately succeeding paragraph (c) below.
|
| |
|
| |
(c)
The Trust shall make advance payments in connection with the expenses
of
defending any action with respect to which indemnification might
be sought
hereunder if the Trust receives a written affirmation by the indemnitee
of
the indemnitee’s good faith belief that the standards of conduct necessary
for indemnification have been met and a written undertaking to reimburse
the Trust unless it is subsequently determined that the indemnitee
is
entitled to such indemnification and if a majority of the trustees
determine that the applicable standards of conduct necessary for
indemnification appear to have been met. In addition, at least one
of the
following conditions must be met: (i) the indemnitee shall provide
adequate security for his undertaking, (ii) the Trust shall be insured
against losses arising by reason of any lawful advances, or (iii)
a
majority of a quorum of the Disinterested Non-Party Trustees, or
if a
majority vote of such quorum so direct, independent legal counsel
in a
written opinion, shall conclude, based on a review of readily available
facts (as opposed to a full trial-type inquiry), that there is substantial
reason to believe that the indemnitee ultimately will be found entitled
to
indemnification.
|
| |
|
| |
(d)
The rights accruing to any indemnitee under these provisions shall
not
exclude any other right which any person may have or hereafter acquire
under this Declaration, the By-Laws of the Trust, any statute, agreement,
vote of stockholders or trustees who are “disinterested persons” (as
defined in Section 2(a)(19) of the Investment Company Act) or any
other
right to which he or she may be lawfully entitled.
|
| |
|
| |
(e)
Subject to any limitations provided by the Investment Company Act
and this
Declaration, the Trust shall have the power and authority to indemnify
and
provide for the advance payment of expenses to employees, agents
and other
Persons providing services to the Trust or serving in any capacity
at the
request of the Trust to the full extent corporations organized under
the
Delaware General Corporation Law may indemnify or provide for the
advance
payment of expenses for such Persons, provided that such indemnification
has been approved by a majority of the trustees.
|
| |
|
| |
5.3
No
Bond Required of Trustees.
No
trustee shall, as such, be obligated to give any bond or other security
for the performance of any of his duties hereunder.
|
| |
|
| |
5.4
No
Duty of Investigation; Notice in Trust Instruments, etc.
No
purchaser, lender, transfer agent or other person dealing with the
trustees or with any officer, employee or agent of the Trust shall
be
bound to make any inquiry concerning the validity of any transaction
purporting to be made by the trustees or by said officer, employee
or
agent or be liable for the application of money or property paid,
loaned,
or delivered to or on the order of the trustees or of said officer,
employee or agent. Every obligation, contract, undertaking, instrument,
certificate, Share, other security of the Trust, and every other
act or
thing whatsoever executed in connection with the Trust shall be
conclusively taken to have been executed or done by the executors
thereof
only in their capacity as trustees under this Declaration or in their
capacity as officers, employees or agents of the Trust. The trustees
may
maintain insurance for the protection of the Trust Property, its
Shareholders, trustees, officers, employees and agents in such amount
as
the trustees shall deem adequate to cover possible tort liability,
and
such other insurance as the trustees in their sole judgment shall
deem
advisable or is required by the Investment Company
Act.
|
| |
5.5
Reliance
on Experts, etc.
Each trustee and officer or employee of the Trust shall, in the
performance of its duties, be fully and completely justified and
protected
with regard to any act or any failure to act resulting from reliance
in
good faith upon the books of account or other records of the Trust,
upon
an opinion of counsel, or upon reports made to the Trust by any of
the
Trust’s officers or employees or by any advisor, administrator, manager,
distributor, selected dealer, accountant, appraiser or other expert
or
consultant selected with reasonable care by the trustees, officers
or
employees of the Trust, regardless of whether such counsel or expert
may
also be a trustee.
|
| |
|
| |
Insofar
as indemnification for liabilities arising under the Securities Act
of
1933, may be permitted to trustees, officers and controlling persons
of
the Trust, pursuant to the foregoing provisions or otherwise, the
Trust
has been advised that in the opinion of the Commission such
indemnification is against public policy as expressed in the Securities
Act of 1933 and is, therefore, unenforceable. In the event that a
claim
for indemnification against such liabilities (other than the payment
by
the Trust of expenses incurred or paid by a trustee, officer or
controlling person of the Trust in the successful defense of any
action,
suit or proceeding) is asserted by such trustee, officer or controlling
person in connection with the securities being registered, the Trust
will,
unless in the opinion of its counsel the matter has been settled
by
controlling precedent, submit to a court of appropriate jurisdiction
the
question whether such indemnification by it is against public policy
as
expressed in the Securities Act of 1933 and will be governed by the
final
adjudication of such issue. Reference is made to Section 8 of the
underwriting agreement attached as Exhibit (h), which is incorporated
herein by reference and discusses the rights, responsibilities and
limitations with respect to indemnity and
contribution.
|
Item
31. Business
and Other Connections of Investment
Advisor
Highland
Capital Management, L.P. has not engaged in any other substantial business
since
January 1, 2003 other than that disclosed under “Management
of the Trust”
in
each
of the prospectus and the Statement of Additional Information. Information
as to
other businesses, professions, vocations or employment of a substantial nature
engaged in by each partner and executive officer of Highland Capital Management,
L.P. is set forth in its Form ADV, as filed on the Commission’s website (File
No. 801-54874) and is incorporated herein by reference.
Item
32. Location
of Accounts and Records
The
Trust’s accounts, books and other documents are currently located at the offices
of the Registrant, c/o Highland Capital Management, L.P., Two Galleria Tower,
13455 Noel Road, Suite 800, Dallas, Texas 75240 and at the offices of the
Registrant’s Custodian and Transfer Agent.
Item
33. Management
Services
Not
Applicable.
(1)
The
Registrant hereby undertakes to suspend the offering of its shares until
it
amends its prospectus if (a) subsequent to the effective date of its
Registration Statement, the net asset value declines more than 10 percent
from
its net asset value as of the effective date of the Registration Statement
or
(b) the net asset value increases to an amount greater than its net proceeds
as
stated in the prospectus.
(2)
Not
applicable.
(3)
Not
applicable.
(4)
Not
applicable.
(5)
(a)
For the purposes of determining any liability under the Securities Act of 1933,
the information omitted from the form of prospectus filed as part of a
registration statement in reliance upon Rule 430A and contained in the form
of
prospectus filed by the Registrant under Rule 497 (h) under the Securities
Act
of 1933 shall be deemed to be part of the Registration Statement as of the
time
it was declared effective.
(b)
For
the purpose of determining any liability under the Securities Act of 1933,
each
post-effective amendment that contains a form of prospectus shall be deemed
to
be a new registration statement relating to the securities offered therein,
and
the offering of the securities at that time shall be deemed to be the initial
bona fide offering thereof.
(6)
The
Registrant undertakes to send by first class mail or other means designed to
ensure equally prompt delivery within two business days of receipt of a written
or oral request, any Statement of Additional Information.
SIGNATURES
Pursuant
to the requirements of the Securities Act of 1933 and the Investment Company
Act
of 1940, the Registrant has duly caused this Registration Statement to be
signed
on its behalf by the undersigned, thereunto duly authorized, in the City
of
Dallas, and State of Texas, on the 10th
day of
December, 2007.
| |
/s/
James D. Dondero*
James
D. Dondero
|
| |
Chief
Executive Officer and President
|
Pursuant
to the requirements of the Securities Act of 1933 and the Investment Company
Act
of 1940, this Registration Statement has been signed by the following persons
in
the capacities set forth below on the 10th
day of
December, 2007.
|
Name
|
|
Title
|
| |
|
|
|
/s/
R. Joseph Dougherty*
R.
Joseph Dougherty
|
|
Trustee
|
| |
|
|
|
/s/
Timothy Hui*
Timothy
Hui
|
|
Trustee
|
| |
|
|
|
/s/
Scott Kavanaugh*
Scott
Kavanaugh
|
|
Trustee
|
| |
|
|
|
/s/
James Leary*
James
Leary
|
|
Trustee
|
| |
|
|
|
/s/
Bryan Ward*
Bryan
Ward
|
|
Trustee
|
| |
|
|
|
/s/
James D. Dondero*
James
D. Dondero
|
|
Chief
Executive Officer and President
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| |
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/s/
M. Jason Blackburn
M.
Jason Blackburn
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Chief
Financial Officer
(Principal
Accounting Officer), Treasurer and
Secretary
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*By:
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/s/
M. Jason Blackburn
M.
Jason Blackburn
Attorney-in-Fact
December
10, 2007
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Exhibits
None