nv2za
As
filed with the Securities and Exchange Commission on July 29, 2011
1933 Act
File No. 333-173004
1940 Act File No. 811-21869
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-2
(Check appropriate box or boxes)
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REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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Pre-Effective
Amendment No. 3
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Post-Effective Amendment No.
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REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
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Amendment
No. 17
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Highland Credit Strategies Fund
(Exact Name of Registrant as Specified in the Declaration of Trust)
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Address of Principal Executive Offices)
(877) 665-1287
(Registrants Telephone Number, including area code)
R. Joseph Dougherty, President
Highland Credit Strategies Fund
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Name and Address of Agent for Service)
Copies of Communications to:
Gregory D. Sheehan, Esq.
Ropes & Gray LLP
Prudential Tower
800 Boylston Street
Boston, Massachusetts 02199-3600
Approximate Date of Proposed Public Offering:
From time to time after the effective date of this Registration Statement.
If any of the securities being registered on this form are offered on a delayed or continuous
basis in reliance on Rule 415 under the Securities Act of 1933, other than securities offered in connection with a dividend reinvestment plan, check the following
box. þ
It is proposed that this filing will become effective (check appropriate box)
o when declared effective pursuant to section 8(c)
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Maximum |
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Proposed Maximum |
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Amount Being |
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Offering Price Per |
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Aggregate Offering |
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Amount of |
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Title of Securities Being Registered |
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Registered (1) |
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Unit (1) |
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Price (1) |
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Registration Fee (2) |
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Common Shares, par value $.001 (3) |
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Subscription Rights (4) |
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Total |
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$ |
150,000,000 |
(5) |
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17,415 |
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(1) |
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Estimated pursuant to Rule 457 solely for purposes of
calculating the registration fee. |
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(2) |
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Previously paid. |
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(3) |
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Subject to Note 5 below, there is being registered hereunder an indeterminate number of
common shares as may be sold, from time to time. |
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(4) |
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Subject to Note 5 below, there is being registered hereunder an indeterminate number of
subscription rights as may be sold, from time to time, representing rights to purchase common
shares. |
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(5) |
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In no event will the aggregate offering price of all securities issued from time to time pursuant
to this registration statement exceed $150,000,000. |
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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 that
specifically states that this Registration Statement shall thereafter become effective in
accordance with Section 8(a) of the Securities Act of 1933 or until this 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 jurisdiction where the offer or sale is
not permitted.
SUBJECT
TO COMPLETION, DATED JULY 29, 2011
PRELIMINARY PROSPECTUS
Highland Credit Strategies Fund
Common Shares
Subscription Rights
The date of this prospectus is , 2011
Highland Credit Strategies Fund is a non-diversified, closed-end management investment company
that commenced operations on June 29, 2006, following its initial public offering. Throughout this
prospectus, Highland Credit Strategies Fund is referred to as the Trust.
The Trusts 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 and securities. Under normal market conditions, at least 80% of the
Trusts assets are invested in one or more of principal
investment categories (i) through (iv). Subject only
to this general guideline, Highland Capital Management, L.P. (the Investment Adviser) has broad
discretion to allocate the Trusts assets among these investment categories and to change
allocations as conditions warrant. Within the categories of obligations and securities in which the
Trust invests, the Investment Adviser employs various trading strategies, including capital
structure arbitrage, pair trades and shorting.
Capital structure arbitrage is a strategy in which the Trust seeks
opportunities created by mispricing in different markets of various instruments issued by one corporation. Pair trades involve matching a long position with a short
position in two stocks of different issuers in the same sector, betting that the spread between the two will eventually converge. Short
selling (also known as shorting or going short) is a strategy in which the Trust sells a security it does not own in
anticipation that the market price of that security will decline.
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. The Trust is not limited in the amount it may invest in
derivatives, and it may use derivatives for speculative purposes.
There is no limitation on the amount of securities rated below
investment grade (Ba/BB or lower), which are commonly referred to as junk securities, that the
Trust may purchase. Junk securities are subject to greater risk of loss of principal and interest
and may be less liquid than investment grade securities.
As of July 21, 2011, 10.1% of the Trusts investment portfolio consisted of unrated securities, 77.6% of the Trusts
investment portfolio consisted of securities rated below investment
grade, also known as junk securities (including
issuers that are in default or that present a very high risk of default), 1.0% of the Trusts investment portfolio consisted
of securities rated investment grade, and 11.3% of the Trusts investment portfolio consisted of equities.
The Trusts investment objectives may be changed
without shareholder approval. There can be no assurance that the Trusts investment objectives will
be achieved. See Investment Objectives and Policies.
The Trusts currently outstanding common shares are, and the common shares offered in this
prospectus will be, subject to notice of issuance, listed on the New York Stock Exchange under the
trading or ticker symbol HCF. The net asset
value of the Trusts common shares on July 22,
2011 was $7.56 per common share, and the last sale price of the common shares on the New York Stock
Exchange on such date was $7.55.
The Trust may offer, on an immediate, continuous or delayed basis, in one or more offerings,
up to [___] of the Trusts common shares or subscription rights, which we refer to, collectively,
as the securities. The subscription rights offered by means of this prospectus may be convertible
into common shares. The Trust may offer its securities in amounts, at prices and on terms set
forth in a prospectus supplement to this prospectus. In the event we offer common shares
hereunder, the offering price per share of our common shares, less any underwriting commissions or
discounts, must equal or exceed the net asset value per share of our common shares at the time we
make the offering, except (i) in connection with a rights offering to our existing shareholders,
(ii) with the consent of the majority of our common shareholders, or (iii) under such circumstances
as the Securities and Exchange Commission (the
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Commission)
may permit. This prospectus and the related prospectus supplement
will together constitute the prospectus for an offering of the
Trusts securities. You should read this prospectus and the related prospectus
supplement carefully before you decide to invest in any of the securities.
The Trust may offer the common shares directly to one or more purchasers, through agents that
the Trust or the purchasers designate from time to time, or to or through underwriters or dealers.
The prospectus supplement relating to the particular offering will identify any agents or
underwriters involved in the sale of the common shares, and will set forth any applicable purchase
price, fee, commission or discount arrangement between the Trust and such agents or underwriters or
among the underwriters or the basis upon which such amount may be calculated. For more information
about the manner in which the Trust may offer the common shares, see Plan of Distribution. The
common shares may not be sold through agents, underwriters or dealers without delivery of a
prospectus supplement.
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 [________], containing additional information about the Trust, has been filed
with 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 93 of this
prospectus. You may request a free copy of the Statement of Additional Information, request the
Trusts 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 NexBank 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 Commissions Public Reference Room
in Washington, D.C. by calling 1-202-942-8090. The Commission charges a fee for copies. The Trusts
Statement of Additional Information relating to this offering and annual and semi-annual reports
are available, free of charge, on the Trusts web site
www.highlandfunds.com. You can obtain the
same information, free of charge, from the Commissions web site www.sec.gov.
Investing in our securities involves a high degree of risk and may be considered
speculative. Before investing in the Trusts securities, you should read the discussion of the
material risks of investing in the Trust, including the risks of leverage, in Principal Risks of
the Trust beginning on page 58.
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.
The Trusts securities 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.
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Table of Contents
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You should rely only on the information contained or incorporated by reference in this
prospectus. The Trust 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 making an offer to sell these securities in any jurisdiction where the
offer or sale is not permitted.
The information in this prospectus and any accompanying prospectus supplements is accurate only as of the date of this
prospectus or such prospectus supplement, as applicable, and under no circumstances should the delivery of this prospectus
or any accompanying prospectus supplement or the sale of any securities imply that the information in this prospectus or
such accompanying prospectus supplement is accurate as of any later date or that the affairs of the Trust have not changed
since the date hereof or thereof. Our business, financial condition, results of operations and prospects may have changed since then.
We will update the information in these documents to reflect
material changes only as required by law.
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Cautionary Notice Regarding Forward-Looking Statements
This prospectus and the Statement of Additional Information contain forward-looking
statements. Forward-looking statements relate to future events or the Trusts future financial
performance. Forward-looking statements can generally be identified by terminology such as may,
will, should, expects, plans, anticipates, could, intends, target, projects,
contemplates, believes, estimates, predicts, potential or continue or the negative of
these terms or other similar words. Important assumptions in forward-looking statements include the
Trusts ability to acquire or originate new investments and to achieve certain margins and levels
of profitability. In light of these and other uncertainties, the inclusion of a projection or
forward-looking statement should not be regarded as a representation by the Trust that its plans or
objectives will be achieved.
There are a number of important risks and uncertainties that could cause the Trusts actual
results to differ materially from those indicated by such forward-looking statements. These risks
include, but are not limited to, the following:
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Investment risk; |
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Changes in interest rates; |
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Risks associated with investing in high yield securities
(also known as junk securities), senior loans and other debt and
equity securities; |
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Risks of investing in obligations of stressed, distressed and bankrupt issuers; |
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Risks associated with the Trusts use of leverage; |
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Derivatives and structured finance securities risk; and |
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Market risk generally. |
For a discussion of these and additional risks as well as other factors that could cause the
Trusts actual results to differ from forward-looking statements contained in this prospectus and
in the Statement of Additional Information, please see the discussion under Principal Risks of the
Trust. You should not place undue reliance on these forward-looking statements. The
forward-looking statements made in this prospectus and in the Statement of Additional Information
relate only to events as of the date on which the statements are made. The Trust undertakes no
obligation to update any forward-looking statement to reflect events or circumstances occurring
after the date of this prospectus and Statement of Additional Information, except as required by
federal securities laws.
The forward-looking statements contained in this prospectus are excluded from the safe
harbor protection provided by Section 27A of the Securities Act of 1933 and the forward looking
statements contained in our periodic reports are excluded from the safe harbor protection provided
by Section 21E of the Securities Exchange Act of 1934.
5
About This Prospectus
This prospectus is part of a registration statement that we have filed with the
Commission, using the shelf registration process. Under the shelf registration process, we may
offer, from time to time, in one or more offerings or series, up to [_] of our common shares or
subscription rights, on the terms to be determined at the time of the offering. The securities may
be offered at prices and on terms described in one or more supplements to this prospectus. This
prospectus provides you with a general description of the securities that we may offer. Each time
we use this prospectus to offer securities, we will provide a prospectus supplement that will
contain specific information about the terms of that offering. The prospectus supplement may also
add, update or change information contained in this prospectus. Please carefully read this
prospectus and any prospectus supplement, together with any exhibits,
any material terms of which will be summarized in the prospectus and any
applicable prospectus supplement, and the additional information
described under the headings Principal Risks of the Trust and Where You Can Find Additional
Information before you make an investment decision.
6
Prospectus Summary
The following summary highlights information contained elsewhere in this prospectus. 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
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The Trust is a non-diversified,
closed-end management investment
company. The Trust commenced
operations on June 29, 2006,
following its initial public
offering. |
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Offerings
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The Trust may offer, on an immediate,
continuous or delayed basis, in one
or more offerings (the Offerings),
up to [__] of the Trusts common
shares or rights to purchase common shares (sometimes referred to as
subscription rights), which
we refer to collectively as the
securities, on terms to be
determined at the time of the
Offerings. The securities may be
offered at prices and on terms to be
set forth in one or more prospectus
supplements to this prospectus,
unless otherwise required by the
Commission or its staff. Offerings of
the securities will be subject to the
provisions of the Investment Company
Act of 1940, as amended (the
Investment Company Act) which
generally require that the public
offering price of common shares of a
closed-end investment company
(exclusive of distribution
commissions and discounts) must equal
or exceed the net asset value per
share of a companys common shares
(calculated within 48 hours of
pricing),
except (i) in connection with a rights offering to our existing shareholders, (ii) with the consent of the majority
of our common shareholders, or (iii) under such circumstances as the Commission may permit.
See Description of
Capital Structure Common Shares.
Any offering of securities by a closed-end investment company that requires shareholder approval must occur, if at all,
within one year after receiving such shareholder approval.
You should read this prospectus and
the related prospectus supplement
carefully before you decide to invest
in any of the securities. |
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The Trust may offer the securities
directly to one or more purchasers,
through agents that the Trust or the
purchasers designate from time to
time, or to or through underwriters
or dealers. The prospectus supplement
relating to the offering will
identify any agents or underwriters
involved in the sale of the
securities, and will set forth any
applicable purchase price, fee,
commission or discount arrangement
between the Trust and such agents or
underwriters or among underwriters or
the basis upon which such amount may
be calculated. See Plan of
Distribution. The securities may not
be sold through agents, underwriters
or dealers without delivery of a
prospectus supplement describing the
method and terms of the offering of
the securities. The Trust (and thus,
indirectly, the Trusts common
shareholders) will bear all of the
expenses of any such offering. |
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Investment Adviser and Administrator
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Highland Capital Management, L.P.
(the Investment Adviser) is the
investment adviser and administrator
of the Trust. As of December 31,
2010, the Investment Adviser,
together with its affiliates, managed
approximately $22 billion in assets
on behalf of investors around the
world. 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
Trusts Managed Assets. In return for
its administrative services, the
Investment Adviser receives an annual
fee, payable monthly, in an amount
equal to 0.20% of the average weekly
value of the Trusts Managed Assets.
Managed Assets means the total
assets of the Trust, including assets
attributable to 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 Trusts
investment objectives and policies,
and/or (iv) any other means. The
Investment Adviser, at |
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its own
expense, has the authority to engage
both a sub-adviser and a
sub-administrator, each of which may
be an affiliate of the Investment
Adviser. See Management of the Trust
Investment Adviser and
Management of the Trust
Administrator/Sub-Administrator. |
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Potential Conflicts of Interest.
Actual or apparent conflicts of
interest may arise because the
Investment Adviser manages more than
one account. For example, if a
portfolio manager identifies a
limited investment opportunity which
may be suitable for more than one
fund or other account, a fund may not
be able to take full advantage of the
opportunity due to an allocation of
filled purchase or sale orders across
all eligible funds and other
accounts. To deal with these
situations, the Investment Adviser
has adopted procedures for allocating
portfolio transactions across
multiple accounts. Under the
procedures, investment opportunities
are allocated in a fair and equitable
manner among the Trust and other
funds and accounts managed by the
Investment Adviser in accordance with
the Investment Advisers allocation
procedures, but may not be allocated
on a strictly pro rata basis.
Therefore, in certain instances the
Trust may not be able to participate
in limited investment opportunities
that are allocated to other funds or
accounts (or may participate on a
more limited basis than would be the
case if investments were allocated
pro rata). Having separate
transactions with respect to a
security may cause the Trust or other
accounts to pay a higher price or
sell at a lower price than would be
the case if trades were not
aggregated. |
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The Trust currently employs
investment leverage in the form of
borrowings obtained through a secured
revolving credit facility and the
issuance of secured, privately placed
notes. If the Trust continues to
employ leverage, the Investment
Adviser will benefit because the
Trusts Managed Assets will increase
with leverage. The Investment Adviser
will also benefit to the extent that
the Trusts Managed Assets increase
with reinvested collateral received
on portfolio securities loaned or
through leverage gained through other
means. See Management of the Trust
Investment Adviser. |
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Custodian and Transfer Agent
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The custodian of the assets of the
Trust is PFPC Trust Company (301
Bellevue Parkway, Wilmington, DE
19809; telephone (877) 665-1287). The
custodian performs custodial services
for the Trust. BNY Mellon Investment
Servicing (US) Inc. (101 Sabin
Street, Pawtucket, RI 02860;
telephone (877) 665-1287) serves as
the Trusts transfer agent with
respect to its securities. |
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Closed-End Structure
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Closed-end funds differ from open-end
management investment companies
(commonly referred to as mutual
funds) in that closed-end funds
generally list their shares for
trading on a securities exchange and
do not redeem their shares at the
option of the shareholder. By
comparison, mutual funds issue
securities redeemable at net asset
value at the option of the
shareholder and typically engage in a
continuous offering of their shares.
Mutual funds are subject to
continuous asset in-flows and
out-flows that can complicate
portfolio management, whereas
closed-end funds generally can stay
more fully invested in securities
consistent with the closed-end funds
investment objective and policies. In
addition, in comparison to open-end
funds, closed-end funds have greater
flexibility in their ability to make
certain types of investments,
including investments in illiquid
securities. |
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Shares of closed-end investment
companies listed for trading on a
securities exchange frequently trade
at a discount from net asset value,
but in some cases trade at a premium.
The market price may be affected by
net asset value, dividend or
distribution levels (which are
dependent, in part, on expenses),
supply of and demand for the shares,
stability of dividends or
distributions, trading volume of the
shares, general market and economic
conditions and other factors beyond
the control of the closed-end fund.
The foregoing factors may result in
the market price of the common shares
of the Trust being greater than, less
than or equal to, |
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net asset value.
The Board of Trustees has reviewed
the structure of the Trust in light
of its investment objective and
policies and has determined that the
closed-end structure is appropriate.
As described in this prospectus,
however, the Board of Trustees may
review periodically the trading range
and activity of the Trusts common
shares with respect to their net
asset value and may take certain
actions to seek to reduce or
eliminate any such discount. Such
actions may include open market
repurchases or tender offers for the
common shares at net asset value or
the possible conversion of the Trust
to an open-end investment company.
There can be no assurance that the
Board of Trustees will decide to
undertake any of these actions or
that, if undertaken, such actions
would result in the common shares
trading at a price equal to or close
to net asset value per Share. In
addition, as noted above, the Board
of Trustees determined in connection
with the initial offering of common
shares of the Trust that the
closed-end structure is desirable,
given the Trusts investment
objective and policies. Investors
should assume, therefore, that it is
highly unlikely that the Board of
Trustees would vote to convert the
Trust to an open-end investment
company. See Anti-Takeover
Provisions in the Agreement and
Declaration of Trust; Closed-End Fund
Structure; Repurchase of Common
Shares; Discount. |
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Listing
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The Trusts outstanding common shares
are listed on the New York Stock
Exchange under the symbol HCF, as
will be the common shares offered in
this Prospectus, subject to notice of
issuance. |
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Use of Proceeds
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Unless otherwise specified in a
prospectus supplement, the Trust will
use the net proceeds of the sale of
securities to invest in accordance
with the Trusts investment
objectives and policies set forth
below, or use such proceeds for other
general corporate purposes. See Use
of Proceeds. |
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Investment Objectives and Policies
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The Trusts 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 and securities.
Under normal market conditions, at
least 80% of the Trusts assets are
invested in one or more of
principal investment categories (i) through (iv).
Subject only to this general
guideline, the Investment Adviser has
broad discretion to allocate the
Trusts assets among these investment
categories and to change allocations
as conditions warrant. Within the
categories of obligations and
securities in which the Trust
invests, the Investment Adviser
employs various trading strategies,
including capital structure
arbitrage, pair trades and shorting.
Capital structure arbitrage is a strategy in which the Trust seeks
opportunities created by mispricing in different markets of various instruments issued by one corporation. Pair trades involve matching a long position with a
short position in two stocks of different issuers in the same sector, betting that the
spread between the two will eventually converge. Short selling (also known as shorting or going short) is a
strategy in which the Trust sells a security it does not own in anticipation that the market price of that security will
decline.
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. The Trust is not limited in the amount it may invest in
derivatives, and it may use derivatives for speculative purposes. There is no limitation
on the amount of securities rated
below investment grade (Ba/BB or
lower), which are commonly referred
to as junk securities, that the
Trust may purchase. Junk securities
are subject to greater risk of loss
of principal and interest and may be
less liquid than investment grade
securities.
As of July 21, 2011, 10.1% of the Trusts investment portfolio consisted of unrated securities, 77.6% of the Trusts
investment portfolio consisted of securities rated below investment
grade, also known as junk securities (including
issuers that are in default or that present a very high risk of default), 1.0% of the Trusts investment portfolio consisted
of securities rated investment grade, and 11.3% of the Trusts investment portfolio consisted of equities.
The Trusts
investment objectives may be changed
without shareholder approval. There
can be no assurance that the Trusts
investment objectives will be
achieved. See 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, stressed
and distressed markets and equity
markets. The Investment Adviser makes
investment decisions based on
quantitative analysis, which employs
sophisticated, data-intensive models
to drive the investment process. The
Investment Adviser 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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The Investment Adviser uses trading
strategies to seek to exploit pricing
inefficiencies across the credit
markets, or debt markets, and within
an individual issuers capital
structure. The Investment Adviser
varies the Trusts investments by
strategy, industry, security type and
credit market, but reserves the right
to re-position the Trusts investment
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. |
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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
Trusts 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 Trusts
assets in credit or securities market
investments that are either issued by
entities domiciled outside of the
U.S., or denominated in currencies
other than the U.S. dollar, or both
(Non-U.S. Securities). |
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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 securities or other
instruments that are sold in private
placements 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 Trusts 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 and
pooled investment vehicles (for
example, money market funds) that
invest in these obligations, to
enable the Trust to make investments
quickly, to serve as collateral with
respect to certain of its
investments, and for other cash
management purposes. 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 |
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political conditions. See Investment
Objectives and Policies Investment
Strategies. |
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Use of Leverage
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As provided in 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 ordinary course
liabilities, exceeds 300% of the
amount of the debt outstanding and
exceeds 200% of the sum of the amount
of debt and preferred shares
outstanding. |
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Thus, the Trust may use leverage in
the form of borrowings in an amount
up to 33 1/3% of the Trusts total
assets (including the proceeds of
such leverage) and may use leverage
in the form of preferred shares in an
amount up to 50% of the Trusts total
assets (including the proceeds of
such leverage). The total leverage of
the Trust is currently expected to
range between 20% and 30% of the
Trusts total assets. The Trust seeks
a leverage ratio, based on a variety
of factors including market
conditions and the Investment
Advisers market outlook, where the
rate of return, net of applicable
Trust expenses, on the Trusts
investment portfolio investments
purchased with leverage exceeds the
costs associated with such leverage. |
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The Trust, as of July 22, 2011,
is leveraged through borrowings from
a secured revolving credit facility
with a total commitment of
$125,000,000, and from secured,
privately placed notes in the amount
of $120,000,000. As of July 22,
2011, the Trust has drawn $110,000,000 on the
credit facility, and all $120,000,000
of the secured notes remain
outstanding. The Trusts asset
coverage ratio as of July 22,
2011 was 310%. See Principal Risks
of the Trust Leverage Risk for a
brief description of the Trusts
credit agreement with State Street
Bank and Trust Company (SSB) and
the secured notes with Metropolitan
Life Insurance Company and
affiliates. |
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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, issue additional notes,
or issue preferred shares in order to
maintain the Trusts desired leverage
ratio. The Trust has no present
intention, however, to issue
preferred shares within the next
twelve months. 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
Trusts 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. As
long as the rate of return, net of
applicable Trust expenses, on the
Trusts investment 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 Trusts 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. To the extent that the
Trust uses leverage, the net asset
value and market price of the common
shares and the yield to holders of
common shares will be more volatile.
The Trusts leveraging strategy may
not be successful. See Principal
Risks of the Trust Leverage Risk. |
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Distributions
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The Trust plans to pay distributions
monthly and capital gain
distributions annually to common
shareholders. (See Distributions.) |
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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 Trusts securities.
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 Trusts
securities. Given the risks described
below, an investment in the
securities of the Trust may not be
appropriate for all investors. |
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You
should carefully consider your
ability to assume these risks before
making an investment in securities of
the Trust. |
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Investment and Market Discount Risk.
An investment in the Trusts
securities is subject to investment
risk, including the possible loss of
the entire amount that you invest. As
with any stock, the price of the
Trusts common shares fluctuates 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 Trusts net
assets, may decline in value because
of changes in interest rates.
Generally, fixed rate 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 Trusts debt security holdings. |
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Prepayment Risk. If interest rates
fall, the principal on bonds and
loans 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 Trusts
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 decline. |
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Risks of Investing in High-Yield
Securities, also Known as Junk Securities, A substantial portion of
the Trusts investments will consist
of investments that may generally be
characterized as high-yield
securities or junk securities, and
the Trust may invest without limit in
such 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
high-yield 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 that are
generally trading at significantly
higher yields than had been
historically typical of the
applicable issuers obligations. Such
investments may include debt
obligations that have a heightened
probability of being in covenant or
payment default in the |
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future. Such
investments generally are considered
highly 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
highly 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 Advisers 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 Trusts 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 Trusts investment 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 Trusts
investments may consist of loans and
participations therein originated by
banks and other financial
institutions, typically referred to
as bank loans. The Trusts
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 borrowers
creditworthiness is often judged by
the rating agencies to be below
investment grade. Such loans are
typically private corporate loans
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 that is not generally
available to the public. To the
extent the Trust receives material
non-public information, it may be
prohibited from trading in certain
securities, even when it might
otherwise be beneficial to do so. |
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Bank loans often, but not always,
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 distribution
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
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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 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 funds and investment
banks. As secondary market trading
volumes increase, new bank loans
frequently adopt standardized
documentation to facilitate loan
trading, which the Investment Adviser
believes should improve market
liquidity. Future levels of supply
and demand in bank loan trading may
not provide an adequate degree of
liquidity and the current level of
liquidity may not 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. |
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Legislation Risk. To the extent that
legislation or state or federal
regulators impose additional
requirements or restrictions with
respect to the ability of financial
institutions to make loans in
connection with highly leveraged
transactions, the availability of
Senior Loan interests for investment
by the Trust may be adversely
affected. In addition, such
requirements or restrictions may
reduce or eliminate sources of
financing for affected borrowers.
Further, to the extent that
legislation or federal or state
regulators require such institutions
to dispose of Senior Loan interests
relating to highly leveraged
transactions or subject such Senior
Loan interests to increased
regulatory scrutiny, such financial
institutions may determine to sell
Senior Loan interests in a manner
that results in a price that, in the
opinion of the Investment Adviser, is
not indicative of fair value. Were
the Trust to attempt to sell a Senior
Loan interest at a time when a
financial institution was engaging in
such a sale with respect to the
Senior Loan interest, the price at
which the Trust could consummate such
a sale might be adversely affected.
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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 |
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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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Loans other than senior loans may not
be acceptable collateral under the
Trusts current credit facility or
under any future credit facilities,
or may require a higher
collateral-to-loan ratio, and
therefore to the extent the Trust
invests in such loans its ability to
borrow may be reduced. |
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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 Trusts investment
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 highly
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 recoveries, which may be in
the form 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
highly speculative. It is also
possible that there could be limited
or no recovery for creditors in a
bankruptcy or workout. |
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There are a number of significant
risks inherent in the bankruptcy
process, including, without
limitation, those set forth in this
paragraph. 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, a bankruptcy court in the
exercise of its broad powers may
approve actions that are 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 creditors
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 debtors
estate prior to any return to
creditors. For example, if a
proceeding involves protracted or
difficult litigation, |
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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 Trusts
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 Trusts 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 Trusts
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 Advisers 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 (and its other clients) 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. The Trust may not 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 Trusts 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
Trusts ability to trade in or
acquire additional positions in a
particular investment when it might
otherwise desire to do so. |
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Distressed debt obligations that are
at risk of or in default present
special tax issues for the Trust
because the U.S. federal income tax
rules relating to those |
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obligations
are currently unclear. For instance,
tax rules are not entirely clear as
to whether and to what extent the
Trust should recognize market
discount on a distressed debt
obligation and when the Trust may
cease to accrue interest, original
issue discount or market discount on
those obligations. These and other
related issues will be addressed by
the Trust when, as and if it invests
in such obligations, in order to seek
to ensure that it distributes
sufficient income to preserve its
status as a regulated investment
company (RIC) under Subchapter M of
the Internal Revenue Code of 1986, as
amended (the Code), and that it
does not become subject to
Trust-level U.S. federal income or
excise taxes. |
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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 or a creditors committee,
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 a court could disagree with the
Trusts position, and, in any event,
there can be no assurance as to
whether any lending institution or
other |
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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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Litigation Risk. We are sometimes subject to legal proceedings and claims based
on the securities and instruments in which the Trust invests. Litigation may result in substantial costs and may
seriously harm the Trusts investments and overall financial condition. In addition, legal claims that have not yet
been asserted against the Trust may be asserted in the future. See
Certain Legal Proceedings for further information regarding pending litigation. |
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Leverage Risk. When deemed
appropriate by the Investment Adviser
and subject to applicable
regulations, the Trust may use
leverage in its investment program,
including the use of borrowed funds
and investments in certain types of
options, such as puts, calls and
warrants. While such
strategies and techniques increase
the opportunity to achieve higher
returns on the amounts invested, they
also increase the risk of loss. To
the extent the Trust purchases
securities with borrowed funds, its
net assets will tend to increase or
decrease at a greater rate than if
borrowed funds are not used. The
level of interest rates generally,
and the rates at which such funds may
be borrowed in particular, could
affect the operating results of the
Trust. If the interest expense on
borrowings were to exceed the net
return on the portfolio securities
purchased with borrowed funds, the
Trusts use of leverage would result
in a lower rate of return than if the
Trust were not leveraged. |
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Pursuant to regulations and/or
published positions of the
Commission, the Trust may be required
to earmark liquid assets in an amount
equal to the Trusts daily
marked-to-market value of its
transactions in futures and options.
To maintain this required margin, the
Trust may have to sell portfolio
securities at disadvantageous prices
or times because it may not be
possible to liquidate a position at a
reasonable price. In addition, the
earmarking of such assets will have
the effect of limiting the Trusts
ability otherwise to invest those
assets. |
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The Trust has the ability to use
leverage through the issuance of
preferred shares, borrowings from a
credit facility, issuing notes or
other debt securities, or any
combination of the three. The Trust
currently leverages through
borrowings from a credit facility and
the issuance of secured notes, and
has no present intention of issuing
preferred shares. 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. |
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Therefore, if the market value of the
Trusts investment portfolio
declines, any leverage will result in
a greater decrease in net asset value
to common shareholders than if the
Trust were not leveraged. Such
greater net asset value decrease will
also tend to cause a greater decline
in the market price for the common
shares. Further, if at any time while
the Trust has leverage outstanding it
does not meet applicable asset
coverage requirements (as discussed
below), it may be required to suspend
distributions to common shareholders
until the requisite asset coverage is
restored. Any such suspension might
impair the ability of the Trust to
meet the RIC distribution
requirements and to avoid Trust-level
U.S. federal income or excise taxes. |
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As noted above, the Trust currently
leverages through borrowings from a
secured revolving credit facility and
the issuance of secured notes. The
Trust entered into a revolving credit
agreement on February 2, 2011, with
SSB to borrow up to $125,000,000 (the
Credit Agreement). The Trust issued
notes in a private placement on April
16, 2010, to Metropolitan Life
Insurance Company and several of its
affiliates in the total amount of
$120,000,000 with a term of five
years (the Notes). The Notes became
secured by the assets of the Trust at
the |
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time the Trust entered into the
Credit Agreement. |
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The Notes have a term of five years
with call protections in the first
through third years. The Trust pays
interest on the Notes at an annual
rate of 1.70% plus the three month
London Interbank Offered Rate
(LIBOR), which has a floor of
1.00%. The note purchase agreement
contains customary covenant and
default provisions. Under the terms
of the note purchase agreement, the
Trust may be restricted from paying
dividends under certain
circumstances. Such a prohibition on
the payment of dividends might impair
the ability of the Trust to meet the
RIC distribution requirements and to
avoid Trust-level U.S. federal income
or excise taxes. The Notes rank pari
passu in right of payment with the
Trusts obligations under the secured
revolving credit facility. Such
borrowings constitute financial
leverage. |
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The Credit Agreement contains
customary covenant and default
provisions, including covenants that
limit the Trusts ability to incur
additional debt, consolidate or merge
into or with any person, other than
as permitted by the Credit Agreement,
or sell, lease or otherwise transfer,
directly or indirectly, all or
substantially all of its assets. In
addition, the Trust agreed not to
purchase assets not contemplated by
the investment policies and
restrictions in effect when the
Credit Agreement became effective.
Furthermore, the Trust may not incur
additional debt from any other party,
except in limited circumstances
(e.g., in the ordinary course of
business). The Credit Agreement does
not limit the amount of illiquid
investments the Trust can hold. |
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Indebtedness issued under the Credit
Agreement is not convertible into any
other securities of the Trust.
Outstanding amounts would be payable
at maturity or such earlier times as
required by the Credit Agreement or
Notes. The Trust may be required to
prepay outstanding amounts under the
Credit Agreement or incur a penalty
rate of interest in the event of the
occurrence of certain events of
default. The Credit Agreement
provides that the Trust will
indemnify the lenders under the
Credit Agreement against losses,
claims, damages, liabilities and
related expenses arising out of or as
a result of the execution or delivery
by the Trust of the Credit Agreement,
the performance by the Trust of its
obligations under the Credit
Agreement, any loan or the use of the
proceeds thereof, or any actual or
prospective claim, litigation,
investigation or proceeding relating
to any of the foregoing. The Trust
may, however, bring an action against
a lender to recover for any losses
suffered due to the lenders failure
to exercise due care (meaning gross
negligence, bad faith or willful
misconduct). These liabilities may
not be covered by the Trusts
insurance policy. The Trust is
required to pay ongoing commitment
fees on the undrawn portion of the
commitment under the terms of the
Credit Agreement. With the use of
borrowings, there is a risk that the
interest rates paid by the Trust on
the amount it borrows will be higher
than the return on the Trusts
investments. The credit facility with
SSB may in the future be replaced or
refinanced by one or more credit
facilities having substantially
different terms or by the issuance of
preferred shares, or the Trust may be
unable to renew or replace its credit
facility upon the termination of the
current facility, possibly requiring
it to sell portfolio securities at
times or prices that are
disadvantageous. Any of these
situations could adversely impact
income or total return to
shareholders. |
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The Trust must comply with investment
quality, diversification and other
guidelines established by the credit
facility. The Trust does not
anticipate that such guidelines will
have a material adverse effect on the
Trusts common shareholders or its
ability to achieve its investment
objectives. |
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Preferred Share Risk. Preferred
share risk is the risk associated
with the issuance |
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of preferred shares
to leverage the common shares. If
preferred shares are issued, the net
asset value and market value of the
common shares will be more volatile,
and the yield to the holders of
common shares will tend to fluctuate
with changes in the shorter-term
dividend rates on the preferred
shares. The Trust will pay (and the
holders of common shares will bear)
all costs and expenses relating to
the issuance and ongoing maintenance
of the preferred shares, including
higher advisory fees. Accordingly,
the issuance of preferred shares may
not result in a higher yield or
return to the holders of the common
shares. If the dividend rate and
other costs of the preferred shares
approach the net rate of return on
the Trusts investment portfolio, the
benefit of leverage to the holders of
the common shares would be reduced.
If the dividend rate and other costs
of the preferred shares exceed the
net rate of return on the Trusts
investment portfolio, the leverage
will result in a lower rate of return
to the holders of common shares than
if the Trust had not issued preferred
shares. |
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Similarly, any decline in the net
asset value of the Trusts
investments will be borne entirely by
the holders of common shares.
Therefore, if the market value of the
Trusts investment portfolio
declines, the leverage will result in
a greater decrease in net asset value
to the holders of common shares than
if the Trust were not leveraged. This
greater net asset value decrease will
also tend to cause a greater decline
in the market price for the common
shares. The Trust might be in danger
of failing to maintain the required
asset coverage of the preferred
shares or of losing its ratings on
the preferred shares or, in an
extreme case, the Trusts current
investment income might not be
sufficient to meet the dividend
requirements on the preferred shares.
In order to counteract such an event,
the Trust might need to liquidate
investments in order to fund a
redemption of some or all of the
preferred shares. Liquidation at
times of low prices may result in
capital loss and may reduce returns
to the holders of common shares. |
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If preferred shares are issued,
holders of preferred shares may have
differing interests than holders of
common shares and holders of
preferred shares may at times have
disproportionate influence over the
Trusts affairs. If preferred shares
are issued, holders of preferred
shares, voting separately as a single
class, would have the right to elect
two members of the Board at all
times. The remaining members of the
Board would be elected by holders of
common shares and preferred shares,
voting as a single class. The
Investment Company Act requires that,
in addition to any approval by
shareholders that might otherwise be
required, the approval of the holders
of a majority of any outstanding
preferred shares, voting separately
as a class, would be required to (i)
adopt any plan of reorganization that
would adversely affect the preferred
shares and (ii) take any action
requiring a vote of security holders
under Section 13(a) of the Investment
Company Act, including, among other
things, changes in the Trusts
subclassification as a closed-end
investment company or changes in its
fundamental investment restrictions. |
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If the Trust issues preferred shares,
the Trust would likely seek a credit
rating on the preferred shares from
one or more nationally recognized
statistical rating organizations. The
Trust expects that, at anytime when
preferred shares were outstanding,
the composition of its investment
portfolio would reflect guidelines
established by any rating agencies,
including, for example, asset
coverage requirements that are more
restrictive than those under the
Investment Company Act, restrictions
on certain portfolio investments and
investment practices, requirements
that the Trust maintain a portion of
its assets in higher rated debt
securities and certain mandatory
redemption requirements relating to
the preferred shares. No assurance
can be given that the guidelines
actually imposed with respect to
preferred shares by rating agencies
would be more or less restrictive
than these examples. These
restrictions may require the Trust to
alter its investment strategy and
invest in different types of assets,
some of which may be lower yielding
or result in fewer opportunities for
capital appreciation. No minimum
rating is required for the issuance
of preferred shares by the Trust. |
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Common Stock Risk. The Trust may
invest in common stock. Although
investments in common stock have
historically generated higher average
total returns than fixed income
securities over the long-term,
investments in common stock also have
historically experienced
significantly more volatility in
those returns. Therefore, the Trusts
investments in common stock 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
investment in 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 an issuer 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 issuers
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-sized companys
securities, which means that buy and
sell transactions in those securities
could have a larger impact on the
securitys price than is the case
with larger company securities. Small
or 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 companys 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 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) changes in currency exchange
rates; (x) high and volatile rates of
inflation; (xi) fluctuating interest
rates; (xii) less publicly available
information; and (xiii) different
accounting, auditing and financial
recordkeeping standards and
requirements. In addition, certain
investments in Non-U.S. Securities
may be subject to foreign withholding
taxes on interest, dividends, capital
gains or other income. Those taxes
will reduce the Trusts yield on any
such securities. |
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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 Africa. The cost of
servicing external debt will
generally be adversely |
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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,
the Investment Adviser 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
the Investment Adviser, 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, but 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 Trusts
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
Trusts 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 or 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
that 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, the Trust may not have
access to or invest in IPOs that are
ultimately profitable for investors.
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
that are determined by the Investment
Adviser to present acceptable credit
risk to 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
Trusts performance. Also, there may
be delays in recovery, or no
recovery, of securities loaned should
the borrower of the securities fail
financially while the loan is
outstanding. In addition, voting
rights with respect to loaned
securities generally pass to the
borrower. The Trust, as the lender,
retains the right to recall the loans
and obtain the return of the
securities loaned in order to vote
the loaned securities. The Trust will
generally seek to recall securities
on loan in order to vote on matters
if the result of the vote may
materially effect the investment.
However, in some circumstances the
Trust may be unable to recall the
securities in time to vote or may
determine that the benefits to the
Trust of voting are outweighed by the
indirect or direct costs of such a
recall. In these circumstances,
loaned securities may be voted or not
voted in a manner adverse to the best
interests of the Trust. All of the
aforementioned risks may be greater
for Non-U.S. Securities. |
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These lending transactions must be
fully collateralized at all times,
but involve some credit risk to the
Trust if the borrower or the party
(if any) guaranteeing the loan should
default on its obligation and the
Trust is delayed in or prevented from
recovering the collateral. In
addition, any income or gains and
losses from investing and reinvesting
any cash collateral delivered by a
borrower pursuant to a loan are
generally at the Trusts risk, and to
the extent any such losses reduce the
amount of cash below the amount
required to be returned to the
borrower upon the termination of any
loan, the Trust may be required to
pay or cause to be paid to such
borrower or another entity an amount
equal to such shortfall in cash. The
Trust presently only accepts cash as
collateral for these lending
transactions, although in the future
may accept other types of collateral. |
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Risks Associated with Options on
Securities. There are several risks
associated with transactions in
options on securities, such as
exchange-listed, over-the-counter and
index options. 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 forgoes, during the
options 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 |
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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 Trusts 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. A
liquid market may not 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
options 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 Trusts capital
appreciation potential on the
underlying security. |
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Over-the-Counter Option Risk. The
Trust may purchase and 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 |
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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 Trusts 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 transactions
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
purchase and 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
is 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 and any
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 once 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 Trusts
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 that of 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 |
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may
decrease more than prices of other
fixed income securities when interest
rates rise. |
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Timely payment of interest and
principal of mortgage-backed
securities may be supported by
various forms of private insurance or
guarantees, including individual
loan, title, pool and hazard
insurance purchased or held by the
issuer. Private insurers may not,
however, be able to meet their
obligations under the policies. An
unexpectedly high rate of defaults on
the mortgages held by a mortgage pool
may adversely affect the value of a
mortgage-backed security and could
result in losses to the Trust. The
risk of such defaults is generally
higher in the case of mortgage pools
that include sub-prime mortgages
(which are typically granted to
individuals with poor credit
histories who, as a result of their
deficient credit ratings, would not
be able to qualify for conventional
mortgages), Alt-A mortgages
(typically characterized by borrowers
with less than full documentation,
lower credit scores or higher
loan-to-value ratios), interest
only mortgages (which permit
interest-only payments for a
specified period before payment of
principal is required) and/or option
ARM mortgages (which are typically
30-year adjustable rate mortgages
that initially offer a borrower four
monthly payment options: a specified
minimum payment, an interest-only
payment, a 15-year fully amortizing
payment and a 30-year fully
amortizing payment). Some of these
types of mortgages may be subject to
negative amortization, which occurs
whenever the loan payment for any
period is less than the interest
charged over that period so that the
outstanding principal balance of the
loan increases. The types of
mortgages discussed above are made to
borrowers with weakened credit
histories or with a lower capacity to
make timely payments on their
mortgages, and are subject to a
greater risk of default than prime
mortgages. Market factors adversely
affecting mortgage loan repayments
may include a general economic
downturn, high unemployment, a
general slowdown in the real estate
market, a drop in the market prices
of real estate, or an increase in
interest rates resulting in higher
mortgage payments by holders of
adjustable rate mortgages. To the
extent the Trust invests in
securities directly or indirectly
backed by these types of mortgages,
it will be subject to greater risks. |
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Credit ratings on mortgage-backed
securities are subject to the same
limitations that apply to credit
ratings generally. See Limitations
of Credit Ratings on page 76 of this
prospectus. |
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The market for mortgage-backed
securities (and other asset-backed
securities) has in recent years
experienced high volatility and a
lack of liquidity. As a result, the
value of many of these securities has
significantly declined. There can be
no assurance that these markets will
become more liquid or less volatile,
and it is possible that the value of
these securities could decline
further. |
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Risks of Investing in Royalty
Securities. The Trust may invest in
debt and/or equity royalty
securities. The risks of investing in
these securities will include the
risks of investing in the underlying
industry. In addition, royalty
securities are currently not widely
recognized or understood and the
Trust may not be able to sell the
securities when it wants to do so.
Under certain market conditions,
these securities may also become
highly illiquid. Each security will
include different risk factors
specific to that transaction. Risk
factors of royalty securities
generally include risks relating to
the products associated with the
royalty stream, risks relating to the
license agreement, risks relating to
the structure of the financing and
risks relating to bankruptcy or
reorganization proceedings. |
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Repurchase Agreement Risk. The Trust
may enter into repurchase agreements
up to a maximum of 33 1/3% of its
total assets. Repurchase agreements
may be considered loans to the
seller, collateralized by the
underlying securities. If the seller
does not pay the Trust the
agreed-upon sum on the repurchase
date, 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 |
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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. 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. |
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Derivatives Risk. Derivative
transactions in which the Trust may
engage for hedging and speculative
purposes or to enhance total return,
including engaging in transactions
such as options, futures, swaps,
foreign currency transactions,
forward foreign currency contracts,
currency swaps or options on currency
futures and other derivatives
transactions (collectively,
Derivative Transactions), involve
certain risks and special
considerations. 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 successfully use
Derivative Transactions depends on
the Investment Advisers ability to
predict pertinent market movements.
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 may 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. 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 foreign
currency transactions can result in
the Trust incurring losses as a
result of the imposition of exchange
controls, the 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. In addition, the
Trusts Derivative Transactions are
generally subject to numerous special
and complex tax rules. Because the
tax rules applicable to such
transactions may be uncertain under
current law, an adverse determination
or future Internal Revenue Service
(IRS) guidance with respect to
these rules (which determination or
guidance could be retroactive) may
affect whether the Trust has made
sufficient distributions, and
otherwise satisfied the relevant
requirements, to maintain its
qualification as a RIC and avoid
Trust-level U.S. federal income or
excise taxes. Therefore, the Trusts
investments in derivative instruments
may be limited by these or other U.S.
federal income tax considerations. |
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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. |
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Also, 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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Risk of Potential Government
Regulation of Derivatives.
It is possible that government
regulation of various types of
derivative instruments, including
futures and swap agreements, may
limit or prevent the Trust from using
such instruments as part of its
investment strategy, and could
ultimately prevent the |
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Trust from
being able to achieve its investment
goals. For example, some legislative
and regulatory proposals, such as
those in the Dodd-Frank Wall Street
Reform and Consumer Protection Act
(the Dodd-Frank Act)
(which was passed into law in July
2010), would, upon implementation,
impose limits on the maximum position
that could be held by a single trader
in certain contracts and would
subject some derivatives transactions
to new forms of regulation that could
create barriers to some types of
investment activity. Other provisions
would require many swaps to be
cleared and traded on an exchange,
expand entity registration
requirements, impose business conduct
requirements on dealers that enter
into swaps with a pension plan,
endowment, retirement plan or
government entity, and could require
banks to move some derivatives
trading units to a non-guaranteed
affiliate separate from the
deposit-taking bank or divest them
altogether. While many provisions of
the Dodd-Frank Act must be
implemented through future
rulemaking, and any regulatory or
legislative activity may not
necessarily have a direct, immediate
effect upon the Trust, it is possible
that, upon implementation of these
measures or any future measures, they
could potentially limit or completely
restrict the ability of the Trust to
use these instruments as a part of
its investment strategy, increase the
costs of using these instruments or
make them less effective. Limits or
restrictions applicable to the
counterparties with which the Trust
engages in derivative transactions
could also prevent the Trust from
using these instruments or affect the
pricing or other factors relating to
these instruments, or may change
availability of certain investments. |
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Other Derivatives; Future
Developments. The above discussion
relates to the Trusts proposed use
of certain types of derivatives
currently available. However, the
Trust is not limited to the
transactions described above. In
addition, the relevant markets and
related regulations are constantly
changing and, in the future, the
Trust may use derivatives not
currently available or widely in use. |
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Counterparty Risk. The Trust will be
subject to credit risk with respect
to the counterparties to the
derivative contracts purchased or
sold by the Trust. Recently, several
broker-dealers and other financial
institutions have experienced extreme
financial difficulty, sometimes
resulting in bankruptcy of the
institution. Although the Investment
Adviser monitors the creditworthiness
of the Trusts counterparties, there
can be no assurance that the Trusts
counterparties will not experience
similar difficulties, possibly
resulting in losses to the Trust. If
a counterparty becomes bankrupt, or
otherwise fails to perform its
obligations under a derivative
contract due to financial
difficulties, the Trust may
experience significant delays in
obtaining any recovery under the
derivative contract in a bankruptcy
or other reorganization proceeding.
The Trust may obtain only a limited
recovery or may obtain no recovery in
such circumstances. |
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Credit Default Swaps Risk. The Trust
may enter into credit default swap
agreements, which may have as
reference obligations one or more
debt securities or an index of such
securities. In a credit default swap,
one party (the protection buyer) is
obligated to pay the other party (the
protection seller) a stream of
payments over the term of the
contract, provided that no credit
event, such as a default or, in some
instances, a downgrade in credit
rating, occurs on the reference
obligation. If a credit event occurs,
the protection seller must generally
pay the protection buyer the par
value (the agreed-upon notional
value) of the referenced debt
obligation in exchange for an equal
face amount of deliverable reference
obligations. |
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The Trust may be either the
protection buyer or protection seller
in a credit default swap. If the
Trust is a protection buyer, the
Trust would pay the counterparty a
periodic stream of payments over the
term of the contract and would not
recover any of those payments if no
credit event were to occur. However,
if a credit event occurs, the Trust
as a protection buyer has the right
to deliver the referenced debt
obligations or a specified amount of
cash, depending |
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upon the terms of the
swap, and receive the par value of
such debt obligations from the
counterparty protection seller. As a
protection seller, the Trust would
receive fixed payments throughout the
term of the contract if no credit
event occurs. If a credit event
occurs, however, the value of the
obligation received by the Trust
(e.g., bonds which defaulted), plus
the periodic payments previously
received, may be less than the par
value of the obligation, or cash
received, resulting in a loss to the
protection seller. Furthermore, the
Trust as a protection seller would
effectively add leverage to its
portfolio because it will have
investment exposure to the notional
amount of the swap. |
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Credit default swap agreements are
subject to greater risk than a direct
investment in the reference
obligation. Like all swap agreements,
credit default swaps are subject to
liquidity, credit and counterparty
risks. In additional, collateral
posting requirements are individually
negotiated and there is no regulatory
requirement that a counterparty post
collateral to secure its obligations
under a credit default swap.
Furthermore, there is no requirement
that a party be informed in advance
when a credit default swap agreement
is sold. Accordingly, the Trust may
have difficulty identifying the party
responsible for payment of its
claims. The notional value of credit
default swaps with respect to a
particular investment is often larger
than the total par value of such
investment outstanding and, in event
of a default, there may be
difficulties in making the required
deliveries of the reference
investments, possibly delaying
payments. |
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In the past, the market for credit
default swaps has become more
volatile as the creditworthiness of
certain counterparties has been
questioned and/or downgraded. If a
counterpartys credit becomes
significantly impaired, multiple
requests for collateral posting in a
short period of time could increase
the risk that the Trust may not
receive adequate collateral. Credit
default swaps are not currently
traded on any securities exchange.
The Trust generally may exit its
obligations under a credit default
swap only by terminating the contract
and paying applicable breakage fees,
or by entering into an offsetting
credit default swap position, which
may cause the Trust to incur more
losses. |
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In addition, the Trust may invest in
publicly or privately issued
interests in investment pools whose
underlying assets are credit default,
credit-linked, interest rate,
currency exchange, equity-linked or
other types of swap contracts and
related underlying securities or
securities loan agreements. The
pools investment results may be
designed to correspond generally to
the performance of a specified
securities index or basket of
securities, sometimes a single
security. These types of pools are
often used to gain exposure to
multiple securities with a smaller
investment than would be required to
invest directly in the individual
securities. They may also be used to
gain exposure to foreign securities
markets without investing in the
foreign securities themselves or the
relevant foreign market. To the
extent that the Trust invests in
pools of swaps and related underlying
securities or securities loan
agreements whose return corresponds
to the performance of a foreign
securities index or one or more
foreign securities, investing in such
pools will involve risks similar to
the risks of investing in foreign
securities. See Foreign Securities
below. In addition to the risks
associated with investing in swaps
generally, the Trust bears the risks
and costs generally associated with
investing in pooled investment
vehicles, such as paying the fees and
expenses of the pool and the risk
that the pool or the operator of the
pool may default on its obligations
to the holder of interests in the
pool, such as the Trust. Interests in
privately offered investment pools of
swaps may be considered illiquid or
deemed liquid, subject to the Trusts
restrictions on investments in
illiquid securities. |
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Market Risk Generally. The
profitability of a significant
portion of the Trusts 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. The
Investment Adviser may not be able to
predict |
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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 bonds 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. |
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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 Trusts
investment portfolio in the manner
necessary to employ successfully the
Trusts strategy. |
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Short Sales Risk. Short selling
involves selling securities that 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, because 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. The
securities necessary to cover a short
position may not 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 |
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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. |
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Risks of Investing in Structured
Finance Securities. A portion of the
Trusts investments may consist of
equipment trust certificates,
collateralized mortgage obligations,
collateralized bond obligations,
collateralized loan obligations or
similar instruments.
Such structured finance securities are generally backed by an asset or a pool of assets, which serve as collateral.
Depending on the type of security, the collateral may take the form of a portfolio of mortgage loans or bonds or other
assets. The Trust and other investors in structured finance securities ultimately bear the credit risk of the underlying
collateral. In some instances, the structured finance securities are issued in multiple tranches, offering investors
various maturity and credit risk characteristics, often categorized as senior, mezzanine and subordinated/equity
according to their degree of risk. If there are defaults or the relevant collateral otherwise underperforms, scheduled
payments to senior tranches of such securities take precedence over those of mezzanine tranches, and scheduled payments
to mezzanine tranches take precedence over those to subordinated/equity tranches. In light of the above considerations,
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.
In addition to the risks noted above and
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
securitys 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. In addition, the
complex structure of the security may produce
unexpected investment results, especially during times of market
stress or volatility.
Investments in structured finance
securities may also be subject to
illiquidity risk. Collateralized
mortgage obligations may have risks
similar to those of mortgage-backed
securities. See Mortgage-Backed
Securities Risk for more
information. |
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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
the payment of its distributions, the
Trust may be required to report
income for U.S. federal income tax
purposes to the extent of any such
deferred distribution even though the
Trust has not yet received such
income. In order to receive the
special treatment accorded to RICs
and their shareholders under the Code
and to avoid U.S. federal income or
excise taxes at the Trust level, the
Trust may be required to distribute
this reported income to shareholders
in the tax year in which the income
is reported (without a corresponding
receipt of cash). Therefore, the
Trust may be required to pay out as
an income distribution in any such
tax year an amount greater than the
total amount of income the Trust
actually received, and, among other
things, to sell portfolio securities,
including at potentially
disadvantageous times or prices, to
obtain cash needed for these income
distributions. |
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Subordination. Preferred
securities are subordinated to bonds
and other debt instruments in a
companys 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 directors to
the issuers board. Generally, once
all the arrearages have been paid,
the preferred security |
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holders no
longer have voting rights. |
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Risks of Investing in Swaps.
Investments in swaps involve the
exchange by the Trust 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. 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. Swap agreements are
sophisticated financial instruments
that typically involve a small
investment of cash relative to the
magnitude of risks assumed. Swaps can
be highly volatile and may have a
considerable impact on the Trusts
performance, as the potential gain or
loss on any swap transaction is not
necessarily subject to any fixed
limit. |
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Recently, several broker-dealers and
other financial institutions have
experienced extreme financial
difficulty, sometimes resulting in
bankruptcy of the institution.
Although the Investment Adviser
monitors the creditworthiness of the
Trusts counterparties, the Trusts
counterparties could experience
similar difficulties, possibly
resulting in losses to the Trust. |
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Risks of Investing in Synthetic
Securities. In addition to credit
risks associated with holding
non-investment grade loans and
high-yield debt 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 enforce directly
compliance by the Reference Obligor
with the terms of the Reference
Obligation nor any rights of setoff
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,
investments in synthetic securities
are subject to an additional degree
of risk because they are subject to
the credit risk of the counterparty
as well as that of the Reference
Obligor. The Investment Adviser may
not perform independent credit
analyses of any particular
counterparty, or any entity
guaranteeing the obligations of such
counterparty. 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 the Trusts assets
that may be invested in these
securities. |
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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, fair value
pricing may not 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. |
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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 Trusts investment portfolio, it
is possible that a significant amount |
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of the Trusts 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 Trusts investment
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 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 Trusts
investment portfolio in any one
investment strategy would subject the
Trust to a greater degree of risk
than if the Trusts investment
portfolio were varied in its
investments with respect to several
investment strategies. |
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Because the Trust has recently invested a significant portion of its assets in healthcare companies, the Trusts
performance may depend on the overall condition of the healthcare industry and the Trust is susceptible to economic,
political and regulatory risks or other occurrences associated with the healthcare industry. The Trust faces the risk
that economic prospects of healthcare companies may fluctuate dramatically because of changes in the regulatory and
competitive environments. A significant portion of healthcare services are funded or subsidized by the government,
which means that changes in government policies, at the state or federal level, may affect the demand for healthcare
products and services. Other risks include the possibility that regulatory approvals (which often entail lengthy
application and testing procedures) will not be granted for new drugs and medical products, the chance of lawsuits
against healthcare companies related to product liability issues, and the rapid speed at which many healthcare products
and services become obsolete.
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The Trust has instituted several levels of safeguards to ensure the Trust does not
violate its fundamental policy not to invest 25% or more of the value of its total assets in any single industry or
group of industries. The Investment Adviser monitors the Trusts investments on a daily basis to ensure the
Trusts compliance with fundamental investment restrictions. In addition, in accordance with the
Sub-Administration Agreement, BNY Mellon Investment Servicing (US) Inc. (BNY) monitors the Trusts
investments on a weekly basis and provides monthly and quarterly reports to the Trusts Board of Trustees.
At its quarterly meetings, the Board of Trustees reviews the BNY compliance reports and monitors the Trusts
investment activities. Although the Board of Trustees receives periodic compliance reports enabling it to monitor
the Trusts compliance with its fundamental investment restrictions, the Trust holds the ultimate responsibility
to comply with its fundamental investment policy.
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Market Disruption and Geopolitical
Risk. The aftermath of the wars in
Iraq and Afghanistan and the
continuing involvement in Iraq and
Afghanistan, 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 length of time
that the securities markets may be
affected by these events is unclear
and the effects of these or similar
events in the future on the U.S.
economy and securities markets cannot
be predicted. |
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Risks Related to Current Market
Conditions. Recently, domestic and
international markets have
experienced a period of acute stress
starting in the real estate and
financial sectors and then moving to
other sectors of the world economy.
This stress has resulted in unusual
and extreme volatility in the debt
and equity markets. These market
conditions could add to the risk of
short-term volatility of the Trust. |
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In addition, debt markets have
experienced a period of high
volatility, which has negatively
impacted market liquidity conditions
and prices. Initially, the concerns
on the part of market participants
were focused on the subprime segment
of the mortgage-backed securities
market. These concerns expanded to
include derivatives, securitized
assets and a broad range of other
debt securities, including those
rated investment grade, the U.S. and
international credit and interbank
money markets generally, and a wide
range of financial institutions and
markets, asset classes, and sectors.
As a result, debt instruments have
experienced, and may in the future
experience, liquidity issues,
increased price volatility, credit
downgrades, and increased likelihood
of default. These market conditions
may have an adverse effect on the
Trusts investments and hamper the
Trusts ability to sell the debt
securities in which it invests or to
find and purchase suitable debt
instruments. Market conditions may
also make it more difficult or
impossible for the Trust to use
leverage to the degree required, or
make any such leverage more expensive
(for example, by increasing interest
expense). In addition, these
conditions may directly and adversely
affect the setting of dividend rates
on the common shares. |
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The recent market conditions have
also caused domestic and
international issuers to seek capital
infusions to strengthen their
financial positions or to remain
financially viable. These capital
infusions have taken a variety of
forms, including the public or
private issuance of additional debt
securities, equity securities or
both, which have been purchased by,
among others, public and private
investors, government agencies, and
sovereign wealth funds. If the Trust
owns shares of an issuer that sells
additional equity securities and the
Trust cannot or chooses not to
purchase shares in the offering, the
Trusts interest in the issuing
company will be diluted. |
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Risks of Investing in a Trust with
Anti-Takeover Provisions. The
Trusts 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 |
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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. |
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Key Adviser Personnel Risk. The
Trusts ability to identify and
invest in attractive opportunities is
dependent upon the Investment
Adviser. If one or more key
individuals leaves the Investment
Adviser, the Investment Adviser 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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Limited Operating History. The Trust
commenced investment operations in
June 2006 and has a limited operating
history and history of public trading
that investors can use to evaluate
its investment performance and
volatility. |
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Risks Relating to Dilution of
Shareholders Interests.
Shareholders interests in the Trust
may be diluted if they do not fully
exercise their subscription rights in
any rights offering. In addition, if
the subscription price is less than
our net asset value per share, then
there will be an immediate dilution
of the aggregate net asset value of
our shares. In the event we issue
subscription rights, shareholders who
do not fully exercise their rights
should expect that they will, at the
completion of a rights offering
pursuant to this prospectus, own a
smaller proportional interest in us
than would otherwise be the case if
they fully exercised their rights.
Such dilution is not currently
determinable because it is not known
what proportion of the shares will be
purchased as a result of such rights
offering. Any such dilution will
disproportionately affect
non-exercising shareholders. This
dilution could be substantial. The
amount of any decrease in net asset
value is not predictable because it
is not known at this time what the
subscription price and net asset
value per share will be on the
expiration date of the rights
offering or what proportion of the
shares will be purchased as a result
of such rights offering. |
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Risks Relating to Trusts Tax Status.
To remain eligible for the special
tax treatment accorded to RICs and
their shareholders under the Code,
the Trust must meet certain source of
income, asset diversification and
annual distribution requirements. If
for any taxable year, the Trust were
to fail to comply with the income or
asset diversification requirements,
the Trust could in some cases cure
such failure, including by paying a
Trust-level tax and, in the case of
an asset diversification failure, by
disposing of certain assets. If the
Trust were ineligible to or otherwise
did not cure such failure for any
year, or were to otherwise fail to
qualify as a RIC accorded special tax
treatment, including by failing to
comply with the annual distribution
requirement, all of its taxable
income regardless of whether timely
distributed to shareholders will be
subject to corporate-level tax and
all of its distributions from
earnings and profits (including from
net long-term capital gains) will be
taxable to shareholders as ordinary
income. In any such event, the
resulting corporate taxes could
substantially reduce the Trusts net
assets, the amount of income
available for distribution and the
amount of its distributions. Any such
failure would have a material adverse
effect on the Trust and its
shareholders. In addition, in some
cases, the Trust could be required to
recognize unrealized gains, pay
substantial taxes and interest and
make substantial distributions in
order to re-qualify as a RIC. |
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RIC-Related Risks of Investments
Generating Non-Cash Taxable Income.
Certain of the Trusts investments
will require the Trust to recognize
taxable income in a taxable year in
excess of the cash generated on those
investments during that year. In
particular, the Trust expects that a
substantial portion of its
investments in loans and other debt
obligations will be treated as having
market discount and/or original
issue discount for U.S. federal
income tax purposes, which, in some
cases, could be significant. Because
the Trust may be required to
recognize income in respect of these
investments before, or without
receiving, cash representing such
income, the Trust may have difficulty
satisfying the annual distribution
requirements applicable to RICs and
avoiding Trust-level U.S. |
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federal
income or excise taxes. Accordingly,
the Trust may be required to sell
portfolio securities, including at
potentially disadvantageous times or
prices, raise additional debt or
equity capital, or reduce new
investments, to obtain the cash
needed to make these income
distributions. If the Trust
liquidates portfolio securities to
raise cash, the Trust may realize
gain or loss on such liquidations; in
the event the Trust realizes net
long-term or short-term capital gains
from such liquidation transactions,
its shareholders may receive larger
capital gain or ordinary dividends,
respectively, than they would in the
absence of such transactions. |
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Limitations of Credit Ratings.
Credit ratings represent only the
opinion of the rating agency with
respect to the ability of the issuer
to make principal and interest
payments on the securities. In
determining a credit rating, rating
agencies do not evaluate the risks of
fluctuations in market value.
Further, there may be limits on the
effectiveness of the rating agencies
financial models. For these and other
reasons, a credit rating may not
fully reflect the risks inherent in
the relevant security. Further, a
rating organization may have a
conflict of interest with respect to
a security for which it assigns a
particular rating. For example, if
the issuer or sponsor of a security
pays a rating agency for the analysis
of the security, an inherent conflict
of interest may exist that could
affect the reliability of the rating.
In addition, credit rating agencies
may or may not make timely changes in
a rating to reflect changes in the
economy or in the conditions of the
issuer that affect the market value
of the security. In other words, a
security or an issuer may maintain a
certain credit rating even though
conditions have deteriorated since
the rating was issued. Consequently,
credit ratings should not necessarily
be relied upon as an indicator of
investment quality. If a rating
organization changes the rating
assigned to one or more of the
Trusts portfolio securities, the
Trust is not required to sell the
relevant securities. |
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Given the risks described above, an
investment in the securities may not
be appropriate for all investors. You
should carefully consider your
ability to assume these risks before
making an investment in the Trust. |
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Our common shares are registered under the Securities Exchange Act of 1934, and we are
required to file reports, proxy statements and other information with the Commission. The materials
we file are available at the Commissions public reference room at 100 F Street, N.E., Washington,
D.C. 20549. You may obtain information about the operation of the Commissions public reference
room by calling the Commission at 1-800-SEC-0330. In addition, the Commission maintains an Internet
website, at http://www.sec.gov, that contains reports, proxy and information statements, and other
information regarding issuers, including us, that file documents electronically with the
Commission.
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Summary of Trust Fees and Expenses
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Shareholder Transaction Expenses |
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Sales load (as a percentage of offering price) |
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%(1) |
Offering expenses borne by holders of common shares (as a percentage of offering price) |
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%(2) |
Dividend reinvestment and cash purchase plan fees |
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None(3) |
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Percentage of Net Assets |
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Attributable to Common Shares |
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(Gives Effect to Leverage Through |
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Borrowings(4)) |
Annual Expenses |
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Management fees |
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1.80 |
%(5) |
Other expenses(8) |
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0.52 |
%(6) |
Interest payments on borrowed funds |
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1.03 |
%(7) |
Total annual expenses |
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3.35 |
% |
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The purpose of this table is to assist the investor in understanding the various costs
and expenses that an investor in the Trust will bear directly or indirectly.
EXAMPLE
The following example illustrates the projected expenses that you would pay on a $1,000
investment in common shares of the Trust (including the total sales load of $4.50 and the other
estimated costs of this offering to be borne by the Trust of $[___]), assuming (1) that the Trusts
current net assets do not increase or decrease, (2) that the Trust maintains a leverage ratio of
20% from all sources of leverage, (3) that the Trust incurs total annual expenses of 2.67% of net
assets attributable to common shares through year 10, and (4) a 5% annual return. The following
example also assumes all dividends and distributions are reinvested at net asset value. The
example should not be considered a representation of future expenses, and actual expenses
(including leverage and other expenses) may be greater or less than those shown.
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1 Year |
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3 Years |
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5 Years |
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10 Years |
Total expenses incurred |
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$ |
75 |
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$ |
137 |
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$ |
202 |
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$ |
373 |
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The applicable prospectus supplement to be used in connection with any
sales of securities will set forth any applicable sales load and the
estimated offering expenses borne by the Trust. |
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(1) |
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In the event that the securities to which this prospectus relates are
sold to or through underwriters or dealer managers, a corresponding
prospectus supplement will disclose the applicable sales load. |
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(2) |
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The related prospectus supplement will disclose the estimated amount
of offering expenses, the offering price and the offering expenses
borne by the Trust and indirectly by all of its shareholders as a
percentage of the offering price. |
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(3) |
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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 Trusts 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. See Dividend Reinvestment Plan below. |
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(4) |
|
Assumes leverage in the amount of 33.33% of net assets.
As of July 6, 2011, the Trust employed leverage in an amount equal to 32.03% of
net assets. The Trust may use leverage through borrowings and/or preferred shares.
The Trust currently borrows under secured, privately placed notes and
a secured revolving credit facility. See Principal Risks of the Trust
Leverage Risk for a brief description of the Trusts Notes with
Metropolitan Life Insurance Company and affiliates and the Credit
Agreement with SSB. However, the Trust has no present intention to
issue preferred shares in the next twelve months. |
|
|
|
(5) |
|
Management fees are the investment advisory and administrative
services fees paid to the Investment Adviser, which are computed based
on Managed Assets. See Management of the Trust Investment Adviser
and Management of the Trust Administrator/Sub-Administrator
below. 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 assumed leverage of 33.33% of the
Trusts total assets). Because the
base management fees of 1.20% (including an administrative fee of
0.20%) are based on the
Trusts gross assets, when the Trust uses leverage, the base
management fees as a percentage of net assets attributable to common shares will increase
because the Trusts common shareholders bear all of the fees and expenses of the Trust. |
|
37
|
|
|
|
(6) |
|
Other Expenses, which is based on the Trusts estimated current
expenses, includes costs associated with the Trusts short sales on
securities, including dividend and interest expenses associated with
securities sold short. When a cash dividend is declared or interest is
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
issuers ex-dividend or ex-interest date). Other Expenses also
includes the dividend and interest expense that the Trust is expected
to incur during the current fiscal year. |
|
|
|
(7) |
|
Interest payments on borrowed funds is estimated based on the
interest rate currently in effect with respect to the Trusts credit
facility and includes the ongoing commitment fees payable under the
terms of the credit facility. |
|
|
|
(8) |
|
Other expenses include acquired fund fees and expenses accounting for less than 0.01% of
average net assets. |
|
Financial Highlights
The following Financial Highlights table is intended to help you understand the Trusts
financial performance since inception. The information in the table was audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm.
Financial statements for the fiscal year ended December 31, 2010 and the Report of the Independent
Registered Accounting Firm thereon appear in the Trusts Annual Report for the Fiscal Year Ended
December 31, 2010, which is incorporated by reference into the Statement of Additional Information
and available from the Trust upon request. The Trusts performance has been enhanced by the existence of
contractual waivers of fees and expenses, which may not continue into the future.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period from |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 29, |
|
|
Year Ended |
|
2006 |
|
|
December 31, |
|
December 31, |
|
December 31, |
|
December 31, |
|
to December 31, |
|
|
2010 |
|
2009 |
|
2008 |
|
2007 |
|
2006 (a) |
|
|
($ in thousands, except per share) |
Net Asset Value, Beginning of Period |
|
$ |
7.20 |
|
|
$ |
6.51 |
|
|
$ |
17.99 |
|
|
$ |
20.08 |
|
|
$ |
19.06 |
|
Income from Investment Operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
|
0.59 |
|
|
|
0.74 |
|
|
|
1.35 |
|
|
|
1.71 |
|
|
|
0.71 |
|
Net realized and unrealized gain on investments |
|
|
0.56 |
|
|
|
0.74 |
|
|
|
(9.79 |
) |
|
|
(1.85 |
) |
|
|
0.91 |
|
Total from investment operations applicable
to common shareholders |
|
|
1.15 |
|
|
|
1.48 |
|
|
|
(8.44 |
) |
|
|
(0.14 |
) |
|
|
1.62 |
|
Less Distributions Declared to Common
Shareholders |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
From net investment income |
|
|
(0.63 |
) |
|
|
(0.79 |
) |
|
|
(1.46 |
) |
|
|
(1.65 |
) |
|
|
(0.60 |
) |
From net realized gains |
|
|
|
|
|
|
|
|
|
|
(0.26 |
) |
|
|
(0.30 |
) |
|
|
|
|
Total Distributions Declared |
|
|
(0.63 |
) |
|
|
(0.79 |
) |
|
|
(1.72 |
) |
|
|
(1.95 |
) |
|
|
(0.60 |
) |
Dilutive Impact of Rights Offering |
|
|
|
|
|
|
|
|
|
|
(1.32 |
) |
|
|
|
|
|
|
|
|
Net Asset Value, End of Period |
|
$ |
7.72 |
|
|
$ |
7.20 |
|
|
$ |
6.51 |
|
|
$ |
17.99 |
|
|
$ |
20.08 |
|
Per Share Market Value, End of Period |
|
$ |
7.58 |
|
|
$ |
6.31 |
|
|
$ |
5.70 |
|
|
$ |
15.82 |
|
|
$ |
21.16 |
|
Per Share Market Value Total Return (b) |
|
|
30.76 |
% |
|
|
27.69 |
% |
|
|
(57.84 |
)% |
|
|
(17.05 |
)% |
|
|
9.06 |
%(c) |
|
Ratios and Supplemental Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets, end of period (in 000s) |
|
$ |
492,753 |
|
|
$ |
458,764 |
|
|
$ |
361,210 |
|
|
$ |
621,078 |
|
|
$ |
692,964 |
|
|
Common Share Information at End of Period: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios based on average net assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross operating expenses (including interest
and commitment fee expense) |
|
|
3.14 |
% |
|
|
3.90 |
% |
|
|
3.78 |
% |
|
|
4.03 |
% |
|
|
2.56 |
% |
Interest and commitment fee expense |
|
|
1.01 |
% |
|
|
1.49 |
% |
|
|
1.63 |
% |
|
|
2.16 |
% |
|
|
1.03 |
% |
Dividend expense from short positions |
|
|
|
(d) |
|
|
|
(d) |
|
|
0.17 |
% |
|
|
0.03 |
% |
|
|
N/A |
|
|
Fees and expenses waived |
|
|
(0.14 |
)% |
|
|
(0.31 |
)% |
|
|
0.09 |
% |
|
|
N/A |
|
|
|
N/A |
|
|
Net expenses |
|
|
3.00 |
% |
|
|
3.59 |
% |
|
|
3.86 |
% |
|
|
4.06 |
% |
|
|
2.56 |
% |
|
Net investment income |
|
|
7.92 |
% |
|
|
11.09 |
% |
|
|
11.36 |
% |
|
|
8.64 |
% |
|
|
7.37 |
% |
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period from |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 29, |
|
|
Year Ended |
|
2006
to |
|
|
December 31, |
|
December 31, |
|
December 31, |
|
December 31, |
|
December 31, |
|
|
2010 |
|
2009 |
|
2008 |
|
2007 |
|
2006 (a) |
|
|
($ in thousands, except per share) |
Ratios based on managed net assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross operating expenses (including interest and commitment fee expense) |
|
|
2.51 |
% |
|
|
3.12 |
% |
|
|
2.69 |
% |
|
|
2.94 |
% |
|
|
2.20 |
% |
Interest and commitment fee expense |
|
|
0.81 |
% |
|
|
1.19 |
% |
|
|
1.16 |
% |
|
|
1.58 |
% |
|
|
0.89 |
% |
Dividend expense from short positions |
|
|
( |
d) |
|
|
( |
d) |
|
|
0.12 |
% |
|
|
0.02 |
% |
|
|
N/A |
|
Fees and expenses waived |
|
|
(0.11) |
% |
|
|
(0.25) |
% |
|
|
0.06 |
% |
|
|
N/A |
|
|
|
N/A |
|
Net expenses |
|
|
2.40 |
% |
|
|
2.87 |
% |
|
|
2.75 |
% |
|
|
2.96 |
% |
|
|
2.20 |
% |
Net investment income |
|
|
6.34 |
% |
|
|
8.88 |
% |
|
|
8.12 |
% |
|
|
6.31 |
% |
|
|
6.33 |
% |
Portfolio turnover rate |
|
|
91 |
% |
|
|
88 |
% |
|
|
78 |
% |
|
|
66 |
% |
|
|
46 |
%(c) |
The following table sets forth additional information regarding the Trusts credit facility
since inception:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Coverage per $1,000 |
Year |
|
Total Amount Outstanding |
|
of Indebtedness |
2006 |
|
|
285,000,000 |
|
|
$ |
3,429 |
|
2007 |
|
|
248,000,000 |
|
|
$ |
3,504 |
|
2008 |
|
|
141,000,000 |
|
|
$ |
3,562 |
|
2009 |
|
|
112,000,000 |
|
|
$ |
5,096 |
|
2010 |
|
|
120,000,000 |
|
|
$ |
5,106 |
|
|
|
|
(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 Trusts dividend reinvestment plan. |
|
(c) |
|
Not annualized. |
|
(d) |
|
Less than 0.005%. |
Plan of Distribution
We may offer, from time to time, in one or more offerings or series, up to [___] of our common
shares or subscription rights, separately or as units comprising any combination of the foregoing,
on the terms to be determined at the time of the offering. The subscription rights offered by means
of this prospectus may be convertible or exchangeable into common shares. We may sell the
securities through underwriters or dealers, directly to one or more purchasers, including existing
shareholders in a rights offering, through agents or through a combination of any such methods of
sale. In the case of a rights offering, the applicable prospectus supplement will set forth the
number of our common shares issuable upon the exercise of each right and the other terms of such
rights offering. Any underwriter or agent involved in the offer and sale of the securities will be
named in the applicable prospectus supplement.
The distribution of the securities may be effected from time to time in one or more
transactions at a fixed price or prices, which may be changed, at prevailing market prices at the
time of sale, at prices related to such prevailing market prices, or at negotiated prices;
provided, however, that the offering price per share of our common shares, less any underwriting
commissions or discounts, must equal or exceed the net asset value per share of our common shares
at the time of the offering except (i) in connection with a rights offering to our existing
shareholders, (ii) with the consent of the majority of our common shareholders, or (iii) under such
circumstances as the Commission may permit.
In connection with the sale of the securities, underwriters or agents may receive compensation
from us or from purchasers of the securities, for whom they may act as agents, in the form of
discounts, concessions or commissions. Underwriters may sell the securities to or through dealers
and such dealers may receive compensation in the form of discounts, concessions or commissions from
the underwriters and/or commissions from the purchasers for whom they may act as agents.
Underwriters, dealers and agents that participate in the distribution of the securities may be
deemed to be underwriters under the Securities Act of 1933, and any discounts and commissions they
receive from us and any profit realized by them on the resale of the securities may be deemed to be
underwriting discounts and commissions under the Securities Act of 1933. Any such underwriter or
agent will be identified and any such compensation received from us will be described in the
applicable prospectus supplement. The maximum commission or
39
discount to be received by any member of the Financial Industry Regulatory Authority (FINRA)
or independent broker-dealer will not be greater than 8% for the sale of any securities being
registered.
We may sell the securities through agents from time to time. The prospectus supplement will
name any agent involved in the offer or sale of the securities and any commissions we pay to them.
Generally, any agent will be acting on a best efforts basis for the period of its appointment.
Any securities sold pursuant to a prospectus supplement may be traded on the New York Stock
Exchange (NYSE), or another exchange on which the securities are traded.
Under agreements that we may enter, underwriters, dealers and agents who participate in the
distribution of shares of our securities may be entitled to indemnification by us against certain
liabilities, including liabilities under the Securities Act of 1933. Underwriters, dealers and
agents may engage in transactions with, or perform services for, us in the ordinary course of
business.
We may enter into derivative transactions with third parties, or sell securities not covered
by this prospectus to third parties in privately negotiated transactions. If the applicable
prospectus supplement indicates, in connection with those derivatives, the third parties may sell
securities covered by this prospectus and the applicable prospectus supplement, including in short
sale transactions. If so, the third party may use securities pledged by us or borrowed from us or
others to settle those sales or to close out any related open borrowings of shares, and may use
securities received from us in settlement of those derivatives to close out any related open
borrowings of shares. The third parties in such sale transactions will be underwriters and, if not
identified in this prospectus, will be identified in the applicable prospectus supplement.
In order to comply with the securities laws of certain states, if applicable, our securities
offered hereby will be sold in such jurisdictions only through registered or licensed brokers or
dealers.
The Trusts common shareholders will indirectly bear all of the
various expenses incurred in connection with the distribution activities described herein.
Use of Proceeds
Unless otherwise specified in a prospectus supplement, the Trust will invest the net proceeds
of any sales of securities in accordance with the Trusts investment objectives and policies as
stated below, or use such proceeds for other general corporate purposes. Assuming current market
conditions, the Trust estimates that the net proceeds of the Offering will be substantially
invested in accordance with its investment objectives and policies within one to three months of
the completion of the Offering. Pending such investment, it is anticipated that the proceeds of the
Offering will be invested in short-term debt securities. These temporary investments are expected
to provide a lower net return than we hope to achieve from our targeted investments. The Trust does
not expect to use any part of the proceeds to repay any of its outstanding debt under the Credit
Agreement. Following the completion of the Offering, 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 Trusts principal office is located at NexBank
Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 and its telephone number is (877) 665-1287.
Investment Objectives and Policies
The Trusts 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 Investment Adviser 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 and securities. Under normal market conditions,
at least 80% of the Trusts assets are invested in one or more of principal investment
categories (i) through (iv). Subject only to this general guideline, the Investment Adviser has broad discretion to
allocate the Trusts 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 credit or
securities market investments that are either issued by entities domiciled outside of the U.S., or
denominated in currencies other than the U.S. dollar, or both (Non-U.S. Securities).
Within the categories of obligations and securities in which the Trust invests, the Investment
Adviser also employs various trading strategies, including capital structure arbitrage, pair trades
and shorting.
Capital structure arbitrage is a strategy in which the Trust seeks
opportunities created by mispricing in different markets of various instruments issued by one corporation. Pair trades involve matching a long
position with a short position in two stocks of different issuers in the same sector, betting that the spread between the two will
eventually converge. Short selling (also known as shorting or going short) is a strategy in which the Trust
sells a security it does not own in anticipation that the market price of that security will decline.
See Portfolio Composition for further description of these
40
strategies.
The Trust may also invest in these categories of obligations and securities
through the use of derivatives. The Trust is not limited in the
amount it may invest in derivatives, and it may use derivatives for speculative purposes. There is no limitation on the amount of securities rated below
investment grade (Ba/BB or lower), which are commonly referred to as junk securities, that the
Trust may purchase. Junk securities are subject to greater risk of loss of principal and interest
and may be less liquid than investment grade securities.
As of July 21, 2011, 10.1% of the Trusts investment portfolio consisted of unrated securities, 77.6% of the Trusts
investment portfolio consisted of securities rated below investment
grade, also known as junk securities (including
issuers that are in default or that present a very high risk of default), 1.0% of the Trusts investment portfolio consisted
of securities rated investment grade, and 11.3% of the Trusts investment portfolio consisted of equities.
The Trusts investment objectives may be changed without shareholder approval. There can be no
assurance that the Trusts investment objectives will be achieved.
Investment Strategies
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. The Investment Adviser makes
investment decisions based on quantitative analysis, which employs sophisticated, data-intensive
models to drive the investment process. The Investment Adviser 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 seek to exploit pricing inefficiencies
across the credit markets, or debt markets, and within an individual issuers capital structure.
The Investment Adviser 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 Trusts 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 Trusts assets in Non-U.S. Securities.
The Investment Adviser may select investments from a wide range of trading strategies and
credit markets in order to vary the Trusts investments and to optimize the risk-reward parameters
of the Trust. The Investment Adviser does not intend to invest the Trusts assets according to
pre-determined allocations. The investment team and other personnel of the Investment Adviser use 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 securities or
other instruments that are sold in private placements 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.
However, the Trust has no present intention to issue preferred shares within the next twelve
months. 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 Trusts 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 and pooled
investment vehicles (for example, money market funds) that invest in these obligations, to enable
the Trust to make investments quickly, to serve as collateral with respect to certain of its
investments, and for other cash
41
management purposes. 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.
For a more complete discussion of the Trusts investment portfolio composition, see Portfolio
Composition below.
Portfolio Composition
The Trusts investment portfolio will be composed principally of the following investments.
Additional information relating to the Trusts investment policies and restrictions and the Trusts
investment 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 U.S. banks (Prime Rate) or the
certificate of deposit (CD) rate or other base lending rates used by commercial lenders.
Senior loans will generally be supported by liens in the Trusts favor on all or a portion of
the assets of the portfolio company or on assets of affiliates of the portfolio company. Although
the Trust may seek to dispose of such collateral in the event of default, it may be delayed in
exercising such rights or its rights may be contested by others. In addition, the value of the
collateral may deteriorate so that the collateral is insufficient for the Trust to recover its
investment in the event of default.
The Trust also may invest in unsecured loans, other floating rate debt securities such as
notes, bonds and asset-backed securities (such as securities issued by special purchase funds
investing in bank loans), investment grade and below-investment grade fixed income debt obligations
and money market instruments, such as commercial paper. The Trust also may purchase obligations
issued in connection with a restructuring pursuant to Chapter 11 of the U.S. Bankruptcy Code.
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. Liquidation of any collateral securing a senior loan may not satisfy a borrowers 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 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 Trusts 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 Investment Adviser anticipates the Trust will invest, and the issuers
of such loans, may not be rated by a rating agency, will not be registered with the Commission or
any state securities commission and will not be 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 Moodys Investors
Service, Inc. (Moodys) or BB and below by Standard & Poors 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 Moodys and S&P is included as Appendix A to the
Statement of Additional Information. Because senior loans are senior in a borrowers 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, the Trusts actual
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loss recovery experience may not be consistent with the Investment Advisers prior experience
and the Trusts senior loans may not 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 Trusts 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 agents 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 interpositioned 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 persons or entitys bankruptcy estate. If, however, any such amount were included in such
persons or entitys 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 Trusts 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 setoff.
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 lenders 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.
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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 Trusts
investment objectives and policies.
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 Trusts ability to dispose of particular
assignments or participations when necessary to meet the Trusts 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 Trusts
investment portfolio and calculating its net asset value.
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.
Loans other than senior loans may not be acceptable collateral under the Trusts current
credit facility or under any future credit facilities, or may require a higher collateral-to-loan
ratio, and therefore to the extent the Trust invests in such loans its ability to borrow may be
reduced.
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 borrowers 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.
The risks associated with second lien loans are higher than the risks of loans with first
priority over the collateral. In the event of default on a second lien loan, the first priority
lien holder has first claim to the underlying collateral of the loan. It is possible that no
collateral value would remain for the second priority lien holder, resulting in a loss to the
Trust.
Other Secured Loans. Secured loans other than senior loans and second lien loans are made by
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 borrowers 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
44
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 by 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
borrowers 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 the 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.
Mezzanine Debt. The Trusts assets may include mezzanine loans. Structurally, mezzanine loans
usually rank subordinate in priority of payment to senior debt, such as senior bank debt, and are
often unsecured. However, mezzanine loans rank senior to common and preferred equity in a
borrowers capital structure. Mezzanine debt is often used in leveraged buyout and real estate
finance transactions. Typically, mezzanine loans have elements of both debt and equity instruments,
offering the fixed returns in the form of interest payments associated with senior debt, while
providing lenders an opportunity to participate in the capital appreciation of a borrower, if any,
through an equity interest. This equity interest typically takes the form of warrants. Due to their
higher risk profile and often less restrictive covenants as compared to senior loans, mezzanine
loans generally earn a higher return than senior secured loans. The warrants associated with
mezzanine loans are typically detachable, which allows lenders to receive repayment of their
principal on an agreed amortization schedule while retaining their equity interest in the borrower.
Mezzanine loans also may include a put feature, which permits the holder to sell its equity
interest back to the borrower at a price determined through an agreed-upon formula. The Trust
believes that mezzanine loans offer an alternative investment opportunity based upon their
historical returns and resilience during economic downturns.
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 securitys 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
45
yield securities in which the Trust invests are rated Ba or lower by Moodys 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 issuers 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 Trusts 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 Trusts 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 U.S. federal income tax purposes even though the Trust
receives no corresponding interest payment in cash on the investments. As a result, in order to
receive the special treatment accorded to RICs and their shareholders under the Code and to avoid
any U.S. federal income or excise taxes at the Trust level, the Trust may be required to pay out as
an income distribution each year an amount greater than the total amount of interest and other
income the Trust actually received. The Trust may be required to, among other things, sell
securities, including at potentially disadvantageous times or prices, to obtain cash needed for
income distributions, and may realize gain or loss from such liquidations. In the event the Trust
realizes net long-term or short-term capital gains from such liquidation transactions, its
shareholders may receive larger capital gain or ordinary dividends, respectively, than they would
in the absence of such transactions.
Non-Investment Grade Securities. The Trust may invest a significant portion of its assets in
securities rated below investment grade, such as those rated Ba or lower by Moodys and BB or lower
by S&P or securities comparably rated by other rating agencies or in unrated securities determined
by the Investment Adviser to be of comparable quality. Securities rated Ba by Moodys 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. When the Investment Adviser believes it to be in the
best interests of the Trusts shareholders, the Trust will reduce its investment in lower grade
securities.
Lower grade securities, though generally 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 Trusts 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, below investment 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 below investment
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 may cause the value of the Trusts
securities to fluctuate. Distressed debt securities often are priced based on estimated recovery
value and are less sensitive to interest rate movement.
Lower grade securities may be particularly susceptible to economic downturns. It is likely
that an economic recession could severely disrupt 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 Moodys, S&P and any 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, the Investment Adviser 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
46
rated by a rating agency, the Trusts ability to achieve its investment objectives will be
more dependent on the Investment Advisers 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 setoff 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.
Royalty Securitizations. Companies holding rights to intellectual property may create
bankruptcy remote special purpose entities whose underlying assets are royalty license agreements
and intellectual property rights related to a product. A significant portion of the Trusts
investments will be related to pharmaceutical royalties that are secured by rights related to one
or more drugs. The Trust may, however, invest in royalty streams related to other industries.
Royalty securities may include bonds, loans and equity issued by the special purpose entity.
The Investment Adviser believes that the terms of royalty securities that are bonds may be
favorable as compared to the broader debt universe, and that the returns are not highly correlated
with general credit market events.
In a typical structure in the pharmaceutical industry, a small pharmaceutical company that
develops a compound may license the commercial opportunity to a large-cap pharmaceutical company in
exchange for payments upon completion of certain milestones (for example, Food and Drug
Administration (FDA) approval) and a percentage of future product sales. Upon securing the right
to receive royalties on product sales, the small pharmaceutical company finances a loan or bond
secured by the royalty stream, which is typically non-recourse to either of the pharmaceutical
companies.
In addition, a company, the sponsor, may create a wholly owned subsidiary, the issuer, that
issues the royalty securities. The sponsor sells, assigns and contributes to the issuer rights
under one or more license agreements, including the right to receive royalties and certain other
payments from sales of the pharmaceutical or other products. The sponsor also pledges the equity
ownership interests in the issuer to the trustee under the indenture related to the notes. In
return, the sponsor receives the proceeds of the securities from the issuer. The issuer of the
securities grants a security interest in its assets to the trustee and is responsible for the debt
service on the notes. An interest reserve account may be established to provide a source for
payments should there be a cash flow shortfall for one or more periods. Many structures include a
100% cash flow sweep, which means that the principal is paid down by all cash flows received.
Although the notes may have a legal maturity date of up to five to sixteen years from issuance, the
expected weighted average maturity of the notes may be significantly shorter because of expected
required principal repayments if funds are available.
If the issuer of the loan or bond defaults, any recourse will be limited to the issuer (which
is formed for the limited purpose of purchasing and holding the license agreement or related
intellectual property) and the collateral. The pharmaceutical or other company sponsoring the
special purpose entity will generally not have the obligation to contribute additional equity to
the issuer. If the sponsor of the issuer were to become a debtor in a bankruptcy case, a creditor,
debtor in possession or trustee could request that the bankruptcy court substantively consolidate
the issuer of the royalty security with the sponsor and/or recharacterize the transaction pursuant
to which the royalty stream was transferred to the issuer and/or take other actions challenging the
transaction. To the extent that these efforts are successful, these actions may adversely impact
the securities and the Trust.
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,
are generally considered to represent a lower level of risk than the original assets taken
separately. 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.
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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/CLOs is especially sensitive to the rate of defaults in the collateral pool and lower
tranches of CBOs/CLOs typically present the highest risk of loss of entire investment and are
required to bear losses before the higher tranches. Under normal market conditions, the Trust
expects to invest in the lower tranches of CBOs/CLOs.
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 Derivatives. The Trust may engage in credit derivative
transactions for hedging or capital appreciation purposes. 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 currently 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 the Investment Adviser 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 the
Investment Adviser 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
Trusts 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 Trusts 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 Trusts 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.
The sections entitled Derivative Transactions and Risk Management and Additional
Characteristics and Risks of Derivative Transactions in the SAI contain further information about
the characteristics, risks and possible benefits of Derivative Transactions and the Trusts 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 Trusts investment 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 the Investment Adviser; 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.
Credit Default Swaps. The Trust may enter into credit default swap
agreements for hedging or capital appreciation purposes. 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,
48
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 judged by the Investment Adviser to present acceptable credit
risk to the Trust. 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.
Credit default swaps also involve the risk of imperfect correlation between the value of such instruments
and the underlying assets and may involve commissions or other costs. When buying protection under a swap,
the risk of loss with respect to swaps generally is limited to the net amount of payments that the Trust is
contractually obligated to make. When selling protection under a swap, however, the risk of loss is often the
notional value of the underlying asset, which can result in a loss substantially greater than the amount invested
in the swap itself. In addition, collateral posting requirements are individually negotiated and there is no
regulatory requirement that a counterparty post collateral to secure its obligations or a specified amount of cash,
depending upon the terms of the swap, under a credit default swap. Furthermore, there is no requirement that a party
be informed in advance when a credit default swap agreement is transferred. Accordingly, the Trust may have difficulty
identifying the party responsible for payment of its claims. The notional value of credit default swaps with respect to
a particular investment is often larger than the total par value of such investment outstanding and, in event of a
default, there may be difficulties in making the required deliveries of the reference investments, possibly delaying
payments. The market for credit default swaps has become more volatile recently as the creditworthiness of certain
counterparties has been questioned and/or downgraded. If a counterpartys credit becomes significantly impaired,
multiple requests for collateral posting in a short period of time could increase the risk that the Trust may not
receive adequate collateral. There is no readily available market for trading credit default swaps. The Trust generally
may exit its obligations under a credit default swap only by terminating the contract and paying applicable breakage fees,
or by entering into an offsetting credit default swap position, which may cause the Trust to incur more losses.
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. If the
Trust uses credit default swaps to leverage its portfolio, the Trust will be exposed to additional
risks, including the risk that the Trusts use of leverage will magnify the effect of any losses
the Trust incurs since if an event of default occurs the seller must pay the buyer the full
notional value of the reference obligation. The Trust will at all times segregate liquid securities or cash in an
amount at least equal to the notional amount of the credit default swap due to the buyer if the credit event occurs.
Such segregation will ensure that the Trust has assets available to satisfy its obligations and will limit any potential
leveraging of the Trusts portfolio with respect to the transaction. Such segregation will not limit the Trusts
exposure to loss.
The Trust is not limited in the amount it may
invest in credit default swaps and all other derivatives.
The Trust may use derivatives for speculative purposes.
Senior Loan Based Derivatives. The Trust may obtain exposure to senior loans and baskets of
senior loans through the use of derivative instruments. 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 Loan-Only Credit Default Swap
Index (LCDX), a tradeable index with 100 equally-weighted underlying single-name long-only credit
default swaps (LCDS). Each underlying LCDS references an issuer whose loans trade in the
secondary leveraged loan market. The Trust can either buy the Index (take on credit exposure) or
sell the Index (pass credit exposure to a counterparty). In either case, the Trust is in essence
taking a macro view of the market as a whole rather than on a particular issuer. To compensate
investors for the change in the value of the Index over time, an upfront payment is made at the
time of a trade to account for the change in the present value of the Index since inception. The
payment is the difference between par (or 100) and the amount of the purchase price, plus or minus
(depending on whether the Trust is a buyer or seller of the Index) accrued interest. Each version
of the Index launches with a fixed coupon which the seller of the Index pays quarterly (and the
buyer of the Index receives quarterly). The amount of payments received or paid is the coupon times
the notional amount. While investing in these types of derivatives will increase the universe of
debt securities to which the Trust is exposed, such investments entail risks that are not typically
associated with investments in other debt securities. The liquidity of the market for these types
of instruments will be subject to liquidity in the secured loan and derivatives markets. The Trust
may also be subject to the risk that the counterparty in a derivative transaction will default on
its obligations. These 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, uncertainty regarding the tax rules
applicable to these transactions 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.
Investments in the Index may involve greater risks than if the Trust had invested in the
reference obligation directly. The Trust will not engage in these transactions for speculative
purposes and will use them only as a means to hedge or manage the risks associated with assets held
in, or anticipated to be purchased for, the investment portfolio or obligations incurred by the
Trust.
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, in a workout or restructuring or by
acquiring common stock for investment. The Trust may also acquire warrants or other rights to
purchase a borrowers common stock in connection with the making of a senior loan. Common stocks of
a corporation or other entity 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 entitys 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.
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 issuers common shares. However, because
preferred stocks are equity securities, they may be more susceptible to risks traditionally
associated with equity investments than the Trusts fixed income securities.
The market value of preferred stocks may be affected by favorable and unfavorable changes
impacting companies in the utilities and financial services sectors, which are prominent issuers of
preferred stocks, and by actual and anticipated changes in tax laws, such as changes in U.S.
federal corporate income tax rates or the dividends-received deduction. Because the claim on an
issuers earnings represented by traditional preferred stocks may become onerous when interest
rates fall below the rate payable on such stocks, the issuer may redeem the stocks. Thus, in
declining interest rate environments in particular, the Trusts holdings of higher rate-paying
49
fixed rate preferred stocks may be reduced and the Trust would be unable to acquire securities
of comparable credit quality paying comparable rates with the redemption proceeds.
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 stock 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 stocks 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. In early 2008, auction
rate preferred stocks became subject to numerous failed auctions, causing securities previously
thought to be liquid to become illiquid. It is not known when, if ever, these auction markets will
begin to function again. Special tax considerations may apply to the Trusts investments in
preferred stock. See Taxation below.
Convertible Securities. The Trusts investment in fixed income securities may include
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
securitys investment value. Convertible securities rank senior to common stock in a corporations
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 securitys governing instrument.
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. The Trust may invest in money market instruments, which 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, and pooled investment vehicles (for example, money market funds) that invest in these
obligations. 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 U.S. 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 issuers 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 and various
institutions that previously were or currently are part of the Farm Credit System (which has been
undergoing
50
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 U.S. 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 agencys obligations; or (iii) only the credit of the issuer. The U.S. government may not in
the future continue to provide financial support to U.S. government agencies, authorities or
instrumentalities that are not supported by the full faith and credit of the United States. To the
extent the Trust invests in U.S. Government securities that are not backed by the full faith and
credit of the U.S. Treasury, such investments may involve a greater risk of loss of principal and
interest since the Trust must look principally or solely to the issuing or guaranteeing agency or
instrumentality for repayment.
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.
U.S. Government securities also include securities guaranteed by the Federal Deposit Insurance
Corporation (FDIC) under its Temporary Liquidity Guarantee Program. Under the Temporary Liquidity
Guarantee Program, the FDIC guarantees, with the full faith and credit of the U.S. Government, the
payment of principal and interest on the debt issued by private entities through the earlier of the
maturity date of the debt or June 30, 2012.
In September 2008, the U.S. Treasury Department placed FNMA and FHLMC into conservatorship.
The companies remain in conservatorship, and the effect that this conservatorship will have on the
companies debt and equity securities is unclear. Although the U.S. government has recently
provided financial support to FNMA and FHLMC, there can be no assurance that it will support these
or other government-sponsored enterprises in the future. In addition, any such government support
may benefit the holders of only certain classes of an issuers securities.
Other Investment Companies. Although not a principal investment strategy of the Trust,
the Trust may invest in the securities of other investment
companies to the extent that such investments are consistent with the Trusts investment objectives
and principal investment strategies and permissible under the
Investment Company Act. The Trust does not consider investments in other investment companies for
purposes of satisfying its 80% asset test described under Investment Objectives and
Policies. 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 Trusts 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 Trusts 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. Although not a principal investment strategy of the Trust, 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 securities exchange or the National Association of Securities Dealers
Automatic Quotation System (NASDAQ). 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. An ETFs
investment objective may not be achieved. ETFs based on an index may not replicate and maintain
exactly the composition and relative weightings of securities in the index and for these and other
reasons the returns of an ETF may diverge significantly from the index which it is designated to
track. 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 ETFs expenses,
including advisory fees. These expenses are in addition to the direct expenses of the Trusts own
operations.
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
51
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 Trusts 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.
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 is
generally required to accrue income on these investments for U.S. federal income tax purposes even
though the Trust receives no corresponding interest payment in cash on the investments. As a
result, in order to receive the special treatment accorded to RICs and their shareholders under the
Code and to avoid any U.S. federal income or excise taxes at the Trust level, the Trust may be
required to pay out as an income distribution each year an amount greater than the total amount of
interest or other income the Trust actually received. The Trust may be required to, among other
things, sell portfolio securities, including at potentially disadvantageous times or prices, to
obtain cash needed for these income distributions, and may realize gain or loss from such
liquidations. In the event the Trust realizes net long-term or short-term capital gains from such
liquidation transactions, its shareholders may receive larger capital gain or ordinary dividends,
respectively, than they would in the absence of such transactions.
Deferred Payment Obligations. 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. Because, during the period before interest payments begin on deferred payment securities,
the Trust will not receive cash payments on a current basis in respect of income it is required to
accrue on these securities for U.S. federal income tax purposes, the Trust may be required to pay
out as an income distribution each year an amount greater than the total amount of interest and
other income the Trust actually received, in order to receive the special treatment accorded to
RICs and their shareholders under the Code and to avoid any U.S. federal income or excise taxes at
the Trust level. The Trust may be required to, among other things, sell portfolio securities,
including at potentially disadvantageous times or prices, to obtain cash needed for these income
distributions, and may realize gain or loss from such liquidations. In the event the Trust realizes
net long-term or short-term capital gains from such liquidation transactions, its shareholders may
receive larger capital gain or ordinary dividends, respectively, than they would in the absence of
such transactions.
Derivative Transactions. In addition to the credit and senior loan based 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 theory and are regularly used
by many mutual funds and other institutional investors. Although the Investment Adviser seeks to
use the practices to further the Trusts investment objectives, no assurance can be given that
these practices will achieve this result. With changes in the market or the Investment Advisers
strategy, it is possible that these instruments may be a more significant part of the Trusts
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 Trusts
investment portfolio, protect the value of the Trusts investment portfolio, facilitate the sale of
certain securities for investment purposes, manage the effective interest rate exposure of the
Trust, protect against changes in currency
52
exchange rates, manage the effective maturity or duration of the Trusts investment 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
Derivative Transactions successfully depends on the Investment Advisers 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. In
addition, the Trusts Derivative Transactions are generally subject to numerous special and complex
tax rules. Because the tax rules applicable to such transactions may be uncertain under current
law, an adverse determination or future IRS guidance with respect to these rules (which
determination or guidance could be retroactive) may affect whether the Trust has made sufficient
distributions, and otherwise satisfied the relevant requirements, to maintain its qualification as
a RIC and avoid Trust-level U.S. federal income or excise taxes. Therefore, the Trusts investments
in derivative instruments may be limited by these or other U.S. federal income tax considerations.
A more complete discussion of Derivative Transactions and their risks is contained in the
Statement of Additional Information.
Risk of Potential Government Regulation of Derivatives. It is possible that government
regulation of various types of derivative instruments, including futures and swap agreements, may
limit or prevent the Trust from using such instruments as part of its investment strategy, and
could ultimately prevent the Trust from being able to achieve its investment goals. For example,
some legislative and regulatory proposals, such as those in the Dodd-Frank Act (which was passed
into law in July 2010), would, upon implementation, impose limits on the maximum position that
could be held by a single trader in certain contracts and would subject some derivatives
transactions to new forms of regulation that could create barriers to some types of investment
activity. Other provisions would require many swaps to be cleared and traded on an exchange, expand
entity registration requirements, impose business conduct requirements on dealers that enter into
swaps with a pension plan, endowment, retirement plan or government entity, and could require banks
to move some derivatives trading units to a non-guaranteed affiliate separate from the
deposit-taking bank or divest them altogether. While many provisions of the Dodd-Frank Act must be
implemented through future rulemaking, and any regulatory or legislative activity may not
necessarily have a direct, immediate effect upon the Trust, it is possible that, upon
implementation of these measures or any future measures, they could potentially limit or completely
restrict the ability of the Trust to use these instruments as a part of its investment strategy,
increase the costs of using these instruments or make them less effective. Limits or restrictions
applicable to the counterparties with which the Trust engages in derivative transactions could also
prevent the Trust from using these instruments or affect the pricing or other factors relating to
these instruments, or may change availability of certain investments.
Other Derivatives; Future Developments. The above discussion relates to the Trusts proposed
use of certain types of derivatives currently available. However, the Trust is not limited to the
transactions described above. In addition, the relevant markets and related regulations are
constantly changing and, in the future, the Trust may use derivatives not currently available or
widely in use.
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 entered into on net basis defaults, the Trusts 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 Trusts obligations over its entitlements will be maintained in a segregated
account by the Trusts custodian. The Trust will not enter into a swap agreement unless the
claims-paying ability of the other party thereto is considered to be an acceptable credit risk to
the Trust 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.
53
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 may attempt to limit exposure to a possible market decline in the
value of its portfolio securities through short sales of securities that the Investment Adviser
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. The Trust may make short sales against the box (as
described below) without respect to such limitations.
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 Trusts 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 Trusts 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, the Investment Adviser is under no obligation to utilize
short sales at all. Special tax considerations will apply to the Trusts short sales. See
Taxation below.
The Commission adopted certain restrictions on short sales in 2010, including a new short sale
price test that restricts short selling when the price of a ''covered security has triggered a
''circuit breaker by falling at least 10% in one day, at which point short sale orders can be
displayed or executed only if the order price is above the current national best bid, subject to
certain limited exceptions. The new restrictions could restrict the Trusts ability to engage in
short sales in certain circumstances. In addition, the Commission approved a pilot program in 2010
pursuant to which several national securities exchanges and FINRA adopted rules to halt trading in
securities included in the S&P 500 Index, the Russell 1000 Index and over 300 exchange traded funds
if the price of any such security moves 10% or more from a sale in a five-minute period. The
direction and magnitude of the effect that the new restrictions and any additional regulations may
have will depend on a variety of factors, many of which cannot be determined at this time. In
addition, regulatory authorities in certain jurisdictions may adopt bans on short sales of certain
securities in response to market events. Restrictions and/or bans on short selling may make it
impossible for the Trust to execute certain investment strategies.
54
Capital Structure Arbitrage. Capital structure arbitrage typically involves establishing long
and short positions in securities (or their derivatives) at different tiers within an issuers
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 Trusts purchase price, with the difference being income to the Trust. Under the direction
of the Board, the Investment Adviser reviews and monitors the creditworthiness of any institution
which enters into a repurchase agreement with the Trust. The counterpartys 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 Trusts
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 relatively 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 sellers 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.
Reverse Repurchase Agreements. A reverse repurchase agreement is an investment technique
under which the Trust sells an underlying debt security and simultaneously obtains the commitment
of the purchaser (generally, a commercial bank or a broker or dealer) to sell the security back to
the Trust at an agreed upon price on an agreed upon date. The repurchase price is generally higher
than the Trusts sale price. Reverse repurchase agreements could involve certain risks in the event
of default or insolvency of the other party, including possible delays or restrictions upon the
Trusts ability to dispose of the underlying securities. An additional risk is that the market
value of securities sold by the Trust under a reverse repurchase agreement could decline below the
price at which the Trust is obligated to repurchase them. Reverse repurchase agreements will be
considered borrowings by the Trust and as such would be subject to any restrictions on borrowing.
Reverse repurchase agreements are also generally subject to earmarking and coverage
requirements, with the result that the Trust will designate on its books and records on an ongoing
basis cash, U.S. government securities, or other liquid securities in an amount at least equal to
the Trusts obligations under the reverse repurchase agreement.
Restricted and Illiquid Securities. Certain of the Trusts 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.
Pay-in-kind (PIK) Securities. PIK securities are securities which pay interest through the
issuance of additional debt or equity securities. Similar to zero coupon obligations, PIK
securities 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. If the issuer defaults, the
Trust may obtain no return at all on its investment. The market price of PIK securities 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, the Trust may be required to accrue income on
certain PIK securities for U.S. federal income tax purposes even though the Trust receives no
corresponding interest payment in cash on the investments. As a result, in order to receive the
special treatment accorded to RICs and their shareholders under the Code and to avoid any U.S.
federal income or excise taxes at the Trust level, the Trust may be required to pay out as an
income distribution each year an amount greater than the total amount of interest or other income
the Trust actually received. The Trust may be required to, among other things, sell portfolio
securities, including at potentially disadvantageous times or prices, to obtain cash needed for
these income distributions, and may realize gain or loss from such liquidations. In the event the
Trust realizes net long-term or short-term capital gains from such liquidation transactions, its
shareholders may receive larger capital gain or ordinary dividends, respectively, than they would
in the absence of such transactions.
55
When-Issued, Delayed-Delivery and Forward Commitment Purchases. 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 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.
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 have the right to 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 (although it may not always be able to call the loan in time to
vote or consent, or may choose not to for various reasons).
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. In addition, any
income or gains and losses from investing and reinvesting any cash collateral delivered by a
borrower pursuant to a loan are generally at the Trusts risk, and to the extent any such losses
reduce the amount of cash below the amount required to be returned to the borrower upon the
termination of any loan, the Trust may be required to pay or cause to be paid to such borrower or
another entity an amount equal to such shortfall in cash. The Trust will lend portfolio securities
only to firms that are judged by the Investment Adviser to present acceptable credit risk.
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
any of the following tests: (i) such company was not organized in the United States; (ii) such
companys primary business office is not in the United States; (iii) the principal trading market
for such companys securities is not located in the United States; (iv) less than 50% of such
companys assets are located in the United States; or (v) 50% or more of such issuers 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. In addition, certain investments in Non-U.S. Securities
may be subject to foreign withholding taxes on interest, dividends, capital gains or other income.
Those taxes will reduce the Trusts yield on any such securities. See Taxation below.
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.
56
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 or at the price 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.
Futures Contracts and Options on Futures Contracts. 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).
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.
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.
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 of
adverse market conditions, during periods in which the Investment Adviser determines that it is
temporarily unable to follow the Trusts investment strategy or that it would not be in the best
interest of the Trust to do so or pending reinvestment of proceeds received in connection with the
sale of a portfolio security or the issuance of additional securities or borrowing money by the
Trust, all or any portion of the Trusts assets may be invested in cash or cash equivalents. The
Investment Advisers determination that it is temporarily unable to follow the Trusts 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 Trusts investment strategy is extremely limited or absent. In such a case, the
market price of the Trusts securities 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 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 use leverage in the form of borrowings in an amount up to 33 1/3% of the
Trusts total assets (including the proceeds of such leverage) and may use leverage in the form of
preferred shares in an amount up to 50% of the Trusts total assets (including the proceeds of such
leverage). The total leverage of the Trust is currently expected to range between 20% and 30% of
the Trusts total assets. The Trust seeks a leverage ratio, based on a variety of factors including
market conditions and the Investment Advisers market outlook, for which the rate of return, net of
applicable Trust expenses, on the Trusts investment portfolio investments purchased with leverage
exceeds the costs associated with such leverage.
The
Trust, as of July 22, 2011, is leveraged through the issuance of secured notes in the
amount of $120,000,000, or 32% of the Trusts total assets (including the proceeds of such
leverage). The Trusts asset coverage ratio as of July 22, 2011
was 310%. The Trust also has a
secured revolving credit facility with SSB in the amount of
$125,000,000. As of July 22, 2011, the
57
Trust had drawn $110,000,000 on the facility. See Principal Risks of the Trust Leverage Risk for a
brief description of the Trusts Credit Agreement with SSB.
Following the completion of the Offering, the Trust may increase the amount of leverage
outstanding. The Trust may engage in additional borrowings or issue preferred shares in order to
maintain the Trusts desired leverage ratio. The Trust has no present intention, however, to issue
preferred shares in the next twelve months. 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 Trusts 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. As long as the rate of return, net of applicable Trust
expenses, on the Trusts investment 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 Trusts 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. To the
extent that the Trust uses leverage, the net asset value and market price of the common shares and
the yield to holders of common shares will be more volatile. The Trusts leveraging strategy may
not be successful. See Principal Risks of the Trust Leverage Risk.
Assuming the utilization of leverage in
the amount of 32% of the Trusts total assets
(assuming the $120,000,000 notes outstanding and $110,000,000 drawn on the secured revolving credit
facility) and an annual interest rate of 2.07% payable on such leverage based on market rates as of
July 22, 2011, the additional income that the Trust must earn (net of expenses) in order to
cover such leverage is 2.80%. 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
Trusts common shares of leverage in the amount of approximately 30% of the Trusts total assets,
assuming hypothetical annual returns of the Trusts investment 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) |
|
|
(10 |
)% |
|
|
(5 |
)% |
|
|
0 |
% |
|
|
5 |
% |
|
|
10 |
% |
Corresponding common share return assuming 30% leverage |
|
|
(15.2 |
)% |
|
|
(8.1 |
)% |
|
|
(0.9 |
)% |
|
|
6.2 |
% |
|
|
13.4 |
% |
Principal Risks of the Trust
The following is a description of the principal risks associated with an investment in the
Trusts common shares. Given the risks described below, an investment in the common shares of the
Trust may not be appropriate for all investors. You should carefully consider your ability to
assume these risks before making an investment in common shares of the Trust.
INVESTMENT AND MARKET DISCOUNT RISK
An investment in the Trusts 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 Trusts
shares fluctuates 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 Trusts shares
may trade at a price that is less than the offering price. This risk may be greater for investors
who sell their shares in a relatively short period of time after completion of the 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 Trusts 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 Trusts debt security holdings.
PREPAYMENT RISK
If interest rates fall, the principal on bonds and loans 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
58
decline in the Trusts 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 decline.
RISKS OF INVESTING IN HIGH-YIELD SECURITIES
A substantial portion of the Trusts investments will consist of investments that may
generally be characterized as high-yield securities or junk securities, and the Trust may
invest without limit in such 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 high-yield 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 that are generally trading at
significantly higher yields than had been historically typical of the applicable issuers
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
highly 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 highly 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 Advisers 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 Trusts
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 Trusts investment portfolio that can be invested in
illiquid securities.
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 Trusts
investments may consist of loans and participations therein originated by banks and other financial
institutions, typically referred to as bank loans. The Trusts 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
borrowers creditworthiness is often judged by the rating agencies to be below investment grade.
Such loans are typically private corporate loans 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 that is not
generally available to the public. To the extent the Trust receives material non-public
information, it may be prohibited from trading in certain securities, even when it might otherwise
be beneficial to do so.
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Bank loans often, but not always, 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 distribution 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.
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 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.
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 the Investment Adviser believes should improve
market liquidity. Future levels of supply and demand in bank loan trading may not provide an
adequate degree of liquidity and the current level of liquidity may not 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.
LEGISLATION RISK
To the extent that legislation or state or federal regulators impose additional requirements
or restrictions with respect to the ability of financial institutions to make loans in connection
with highly leveraged transactions, the availability of Senior Loan interests for investment by the
Trust may be adversely affected. In addition, such requirements or restrictions may reduce or
eliminate sources of financing for affected borrowers. Further, to the extent that legislation or
federal or state regulators require such institutions to dispose of Senior Loan interests relating
to highly leveraged transactions or subject such Senior Loan interests to increased regulatory
scrutiny, such financial institutions may determine to sell Senior Loan interests in a manner that
results in a price that, in the opinion of the Investment Adviser, is not indicative of fair value.
Were the Trust to attempt to sell a Senior Loan interest at a time when a financial institution was
engaging in such a sale with respect to the Senior Loan interest, the price at which the Trust
could consummate such a sale might be adversely affected.
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.
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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.
Loans other than senior loans may not be acceptable collateral under the Trusts current
credit facility or under any future credit facilities, or may require a higher collateral-to-loan
ratio, and therefore to the extent the Trust invests in such loans its ability to borrow may be
reduced.
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 Trusts investment 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 highly 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 recoveries, which may be in the form 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 highly speculative. It is also possible that there could be limited or no recovery
for creditors in a bankruptcy or workout.
There are a number of significant risks inherent in the bankruptcy process, including, without
limitation, those set forth in this paragraph. 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, a bankruptcy court
in the exercise of its broad equitable powers may approve actions that are 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 creditors return on investment can be adversely affected by delays while the plan of
reorganization is being negotiated (or, in some cases, litigated), 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 debtors 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 Trusts 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 certain circumstances in which the Trust acquires claims against the issuer to
obtain a control position with respect to a class or classes of claims, the Trusts influence
with respect to all of the class or classes of securities or other obligations it
owns can be lost if the bankruptcy court designates the Trusts vote or votes on
the Chapter 11 plan as a result of the Trusts claim purchases. Seventh, 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. Eighth, 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. Ninth, 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 Trusts 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 Trusts 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 Advisers 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 (and its other clients) 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. The Trust may not 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 Trusts 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
Trusts ability to trade in or acquire additional positions in a particular investment when it
might otherwise desire to do so.
Investments in distressed debt obligations that are at risk of or in default present special
tax issues for the Trust. Tax rules are not entirely clear about issues such as whether and to what
extent the Trust should recognize market discount on certain distressed debt obligations, when
the Trust may cease to accrue interest, original issue discount or market discount, when and to
what extent the Trust may take deductions for bad debts or worthless securities and how the Trust
should allocate payments received on obligations in default between principal and income. These and
other related issues will be addressed by the Trust when, as and if it invests in such obligations,
in order to seek to ensure that it distributes sufficient income to preserve its status as a RIC
under the Code and that it does not become subject to Trust-level U.S. federal income or excise
taxes.
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 or a creditors committee, 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 a
court could disagree with the Trusts position, 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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LITIGATION RISK
We are sometimes subject to legal proceedings and claims based
on the securities and instruments in which the Trust invests. Litigation may result in substantial costs and may
seriously harm the Trusts investments and overall financial condition. In addition, legal claims that have not yet
been asserted against the Trust may be asserted in the future. See Certain Legal Proceedings for further information
regarding pending litigation.
LEVERAGE RISK
When deemed appropriate by the Investment Adviser and subject to applicable regulations, the
Trust may use leverage in its investment program, including the use of borrowed funds and
investments in certain types of options, such as puts, calls and warrants. While such strategies and
techniques increase the opportunity to achieve higher returns on the amounts invested, they also
increase the risk of loss. To the extent the Trust purchases securities with borrowed funds, its
net assets will tend to increase or decrease at a greater rate than if borrowed funds are not used.
The level of interest rates generally, and the rates at which such funds may be borrowed in
particular, could affect the operating results of the Trust. If the interest expense on borrowings
were to exceed the net return on the portfolio securities purchased with borrowed funds, the
Trusts use of leverage would result in a lower rate of return than if the Trust were not
leveraged.
Pursuant to regulations and/or published positions of the Commission, the Trust may be
required to earmark liquid assets in an amount equal to the Trusts daily marked-to-market value of
its transactions in futures and options. To maintain this required margin, the Trust may have to
sell portfolio securities at disadvantageous prices or times because it may not be possible to
liquidate a position at a reasonable price. In addition, the earmarking of such assets will have
the effect of limiting the Trusts ability otherwise to invest those assets.
The Trust also has the ability to use leverage through the issuance of preferred shares,
borrowings from a credit facility, issuance of secured notes or other debt securities, or any
combination of the three. The Trust currently leverages through borrowings from a revolving credit
facility and the issuance of secured notes in a private placement, and has no present intention of
issuing preferred shares. 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.
Therefore, if the market value of the Trusts investment portfolio declines, any leverage will
result in a greater decrease in net asset value to common shareholders than if the Trust were not
leveraged. Such greater net asset value decrease will also tend to cause a greater decline in the
market price for the common shares. Further, if at any time while the Trust has leverage
outstanding it does not meet applicable asset coverage requirements (as discussed below), it may be
required to suspend distributions to common shareholders until the requisite asset coverage is
restored. Any such suspension might impair the ability of the Trust to meet the RIC distribution
requirements and to avoid Trust-level U.S. federal income or excise taxes.
As noted above, the Trust currently leverages through borrowings from a revolving credit
facility and secured, privately placed notes. The Trust has entered into a secured Credit Agreement
with SSB, under which the Trust may borrow up to $125,000,000 (the Credit Agreement). Such
borrowings constitute financial leverage. The Credit Agreement contains customary covenant and
default provisions, including covenants that limit the Trusts ability to incur additional debt,
consolidate or merge into or with any person, other than as permitted by the Credit Agreement, or
sell, lease or otherwise transfer, directly or indirectly, all or substantially all of its assets.
In addition, the Trust agreed not to purchase assets not contemplated by the investment policies
and restrictions in effect when the Credit Agreement became effective. Furthermore, the Trust may
not incur additional debt from any other party, except in limited circumstances (e.g., in the
ordinary course of business). The Credit Agreement does not limit the amount of illiquid
investments the Trust can hold.
Additionally, on April 16, 2010, the Trust issued its notes with a term of five years to
Metropolitan Life Insurance and some of its affiliates in a total amount of $120,000,000, and
subsequently provided security for the notes. Such borrowings constitute financial leverage. The
note purchase agreement contains customary covenant, negative covenant and default provisions.
Under the terms of the note purchase agreement, the Trust may be restricted from paying dividends
under certain circumstances. Such a prohibition on the payment of dividends might impair the
ability of the Trust to meet the RIC distribution requirements and to avoid Trust-level U.S.
federal income or excise taxes.
Neither the Notes nor the indebtedness incurred under the Credit Agreement are convertible
into any other securities of the Trust. Outstanding amounts would be payable at maturity or such
earlier times as required by the Credit Agreement and the Notes, respectively. The Trust may be
required to prepay outstanding amounts under the Credit Agreement or incur a penalty rate of
interest in the event of the occurrence of certain events of default. The Notes are also subject to
acceleration upon an event of default and are subject to a penalty rate of interest during certain
events of default. The Credit Agreement provides that the Trust will indemnify the agent and the
lenders under the Credit Agreement and each of their affiliates, officers, directors and employees
against losses, claims, damages, liabilities and related expenses arising out of or as a result of
the execution or delivery by the Trust of the Credit Agreement, the performance by the Trust of its
obligations under the Credit Agreement, any loan or the use of the proceeds thereof, or any actual
or prospective claim, litigation, investigation or proceeding relating to any of the foregoing,
other than any losses suffered due to the lenders failure to exercise due care (meaning gross
negligence, bad faith or willful misconduct). Further, the note purchase agreement provides that
the Trust pay the reasonable costs and expenses of the holders of the Notes in connection with
enforcing and defending
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their rights under the note purchase agreement or the Notes, or in responding to any subpoena
or other legal process or informal investigative demand issued in connection with the Notes or the
note purchase agreement, or by reason of being a holder of any Note. These liabilities may not be
covered by the Trusts insurance policy. The Trust is required to pay ongoing commitment fees under
the terms of the Credit Agreement. With the use of borrowings, there is a risk that the interest
rates paid by the Trust on the amount it borrows will be higher than the return on the Trusts
investments. The credit facility with SSB may in the future be replaced or refinanced by one or
more credit facilities having substantially different terms or by the issuance of preferred shares,
or the Trust may be unable to renew or replace its credit facility upon the termination of the
current facility, possibly requiring it to sell portfolio securities at times or prices that are
disadvantageous. Any of these situations could adversely impact income or total return to
shareholders. The Notes rank pari passu in right of payment with the Trusts obligations
under the secured revolving credit facility.
The Trust must comply with investment quality, diversification and other guidelines
established by the Credit Agreement and Notes. The Trust does not anticipate that such guidelines
will have a material adverse effect on the Trusts common shareholders or its ability to achieve
its investment objectives.
Successful use of a leveraging strategy may depend on the Investment Advisers 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.
PREFERRED SHARE RISK
Preferred share risk is the risk associated with the issuance of preferred shares to leverage
the common shares. If preferred shares are issued, the net asset value and market value of the
common shares will be more volatile, and the yield to the holders of common shares will tend to
fluctuate with changes in the shorter-term dividend rates on the preferred shares. The Trust will
pay (and the holders of common shares will bear) all costs and expenses relating to the issuance
and ongoing maintenance of the preferred shares, including higher advisory fees. Accordingly, the
issuance of preferred shares may not result in a higher yield or return to the holders of the
common shares. If the dividend rate and other costs of the preferred shares approach the net rate
of return on the Trusts investment portfolio, the benefit of leverage to the holders of the common
shares would be reduced. If the dividend rate and other costs of the preferred shares exceed the
net rate of return on the Trusts investment portfolio, the leverage will result in a lower rate of
return to the holders of common shares than if the Trust had not issued preferred shares.
Similarly, any decline in the net asset value of the Trusts investments will be borne
entirely by the holders of common shares. Therefore, if the market value of the Trusts investment
portfolio declines, the leverage will result in a greater decrease in net asset value to the
holders of common shares than if the Trust were not leveraged. This greater net asset value
decrease will also tend to cause a greater decline in the market price for the common shares. The
Trust might be in danger of failing to maintain the required asset coverage of the preferred shares
or of losing its ratings on the preferred shares or, in an extreme case, the Trusts current
investment income might not be sufficient to meet the dividend requirements on the preferred
shares. In order to counteract such an event, the Trust might need to liquidate investments in
order to fund a redemption of some or all of the preferred shares. Liquidation at times of low
prices may result in capital loss and may reduce returns to the holders of common shares.
If preferred shares are issued, holders of preferred shares may have differing interests than
holders of common shares and holders of preferred shares may at times have disproportionate
influence over the Trusts affairs. If preferred shares are issued, holders of preferred shares,
voting separately as a single class, would have the right to elect two members of the Board at all
times. The remaining members of the Board would be elected by holders of common shares and
preferred shares, voting as a single class. The Investment Company Act requires that, in addition
to any approval by shareholders that might otherwise be required, the approval of the holders of a
majority of any outstanding preferred shares, voting separately as a class, would be required to
(i) adopt any plan of reorganization that would adversely affect the preferred shares and (ii) take
any action requiring a vote of security holders under Section 13(a) of the Investment Company Act,
including, among other things, changes in the Trusts subclassification as a closed-end investment
company or changes in its fundamental investment restrictions.
If the Trust issues preferred shares, the Trust would likely seek a credit rating on the
preferred shares from one or more nationally recognized statistical rating organizations. The Trust
expects that, at anytime when preferred shares were outstanding, the composition of its investment
portfolio would reflect guidelines established by any rating agencies, including for example, asset
coverage requirements that are more restrictive than those under the Investment Company Act,
restrictions on certain portfolio investments and investment practices, requirements that the Trust
maintain a portion of its assets in higher rated debt securities and certain mandatory redemption
requirements relating to the preferred shares. No assurance can be given that the guidelines
actually imposed with respect to preferred shares by rating agencies would be more or less
restrictive than these examples. These restrictions may require the Trust to alter its investment
strategy and invest in different types of assets some of which may be lower yielding or result in
less opportunities for capital appreciation. No minimum rating is required for the issuance of
preferred shares by the Trust.
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COMMON STOCK RISK
The Trust may invest in common stock. Although investments in common stock have historically
generated higher average total returns than fixed income securities over the long-term, investments
in common stock also have historically experienced significantly more volatility in those returns.
Therefore, the Trusts investments in common stock 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 investment in 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 an issuer 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 issuers
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-sized companys
securities, which means that buy and sell transactions in those securities could have a larger
impact on the securitys price than is the case with larger company securities. Small or
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 companys 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 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) changes in currency exchange rates; (x) high and volatile rates of inflation;
(xi) fluctuating interest rates; (xii) less publicly available information; and (xiii) different
accounting, auditing and financial recordkeeping standards and requirements. In addition, certain
investments in Non-U.S. Securities may be subject to foreign withholding taxes on interest,
dividends, capital gains or other income. Those taxes will reduce the Trusts yield on any such
securities. See Taxation below.
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 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, the Investment Adviser 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 the Investment Adviser, 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 emerging markets entails all of the risks of
investing in securities of non-U.S. issuers, but to a heightened degree.
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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 Trusts 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 Trusts 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 or 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 that 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, the Trust may not have access to or invest in IPOs that are ultimately
profitable for investors. 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 that are determined by the Investment Adviser to present acceptable credit risk
to 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
Trusts performance. Also, there may be delays in recovery, or no recovery, of securities loaned
should the borrower of the securities fail financially while the loan is outstanding. In addition,
voting rights with respect to loaned securities generally pass to the borrower. The Trust, as the
lender, retains the right to recall the loans and obtain the return of the securities loaned in
order to vote the loaned securities. The Trust will generally seek to recall securities on loan in
order to vote on matters if the result of the vote may materially effect the investment. However,
in some circumstances the Trust may be unable to recall the securities in time to vote or may
determine that the benefits to the Trust of voting are outweighed by the indirect or direct costs
of such a recall. In these circumstances, loaned securities may be voted or not voted in a manner
adverse to the best interests of the Trust. All of the aforementioned risks may be greater for
Non-U.S. Securities.
These lending transactions must be fully collateralized at all times, but involve some credit
risk to the Trust if the borrower or the party (if any) guaranteeing the loan should default on its
obligation and the Trust is delayed in or prevented from recovering the collateral. In addition,
any income or gains and losses from investing and reinvesting any cash collateral delivered by a
borrower pursuant to a loan are generally at the Trusts risk, and to the extent any such losses
reduce the amount of cash below the amount
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required to be returned to the borrower upon the termination of any loan, the Trust may be
required to pay or cause to be paid to such borrower or another entity an amount equal to such
shortfall in cash. The Trust presently only accepts cash as collateral for these lending
transactions, although in the future may accept other types of collateral.
RISKS ASSOCIATED WITH OPTIONS ON SECURITIES
There are several risks associated with transactions in options on securities, such as
exchange-listed, over-the-counter and index options. 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 forgoes, during the options 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 Trusts 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
A liquid market may not 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 options 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 would
reduce the Trusts capital appreciation potential on the underlying security.
OVER-THE-COUNTER OPTION RISK
The Trust may purchase or sell/write unlisted (OTC or over-the-counter) options. Options
entered into 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 Trusts 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 transactions may fail to settle a transaction in
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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 purchase or sell/write 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 is 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 and any 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 once 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 Trusts 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 that of 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.
Timely payment of interest and principal of mortgage-backed securities may be supported by
various forms of private insurance or guarantees, including individual loan, title, pool and hazard
insurance purchased or held by the issuer. Private insurers may not, however, be able to meet their
obligations under the policies. An unexpectedly high rate of defaults on the mortgages held by a
mortgage pool may adversely affect the value of a mortgage-backed security and could result in
losses to the Trust. The risk of such defaults is generally higher in the case of mortgage pools
that include sub-prime mortgages (which are typically granted to individuals with poor credit
histories who, as a result of their deficient credit ratings, would not be able to qualify for
conventional mortgages), Alt-A mortgages (typically characterized by borrowers with less than
full documentation, lower credit scores or higher loan-to-value ratios), interest only mortgages
(which permit interest-only payments for a specified period before payment of principal is
required) and/or option ARM mortgages (which are typically 30-year adjustable rate mortgages that
initially offer a borrower four monthly payment options: a specified minimum payment, an
interest-only payment, a 15-year fully amortizing payment and a 30-year fully amortizing payment).
Some of these types of mortgages may be subject to negative amortization, which occurs whenever
the loan payment for any period is less than the interest charged over that period so that the
outstanding principal balance of the loan increases. The types of mortgages discussed above are
made to borrowers with weakened credit histories or with a lower capacity to make timely payments
on their mortgages, and are subject to a greater risk of default than prime mortgages. Market
factors adversely affecting mortgage loan repayments may include a general economic downturn, high
unemployment, a general slowdown in the real estate market, a drop in the market prices of real
estate, or an increase in interest rates resulting in higher mortgage payments by holders of
adjustable rate mortgages. To the extent the Trust invests in securities directly or indirectly
backed by these types of mortgages, it will be subject to greater risks.
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Credit ratings on mortgage-backed securities are subject to the same limitations that apply to
credit ratings generally. See Limitations of Credit Ratings on page 76 of this prospectus. In the
past, the market for mortgage-backed and asset-backed securities has experienced high volatility
and a lack of liquidity. As a result, the value of many of these securities has significantly
declined. These markets may not become more liquid or less volatile, and it is possible that the
value of these securities could decline further.
Mortgage-backed securities may not be readily marketable. To the extent any of these
securities are not readily marketable in the judgment of the Investment Adviser, the Trusts
restrictions on investments in illiquid instruments will apply.
RISKS OF INVESTING IN ROYALTY SECURITIES
The Trust may invest in debt and/or equity royalty securities. The risks of investing in these
securities will include the risks of investing in the underlying industry. In addition, royalty
securities are currently not widely recognized or understood and the Trust may not be able to sell
the securities when it wants to do so. Under certain market conditions, these securities may also
become highly illiquid. Each security will include different risk factors specific to that
transaction. Risk factors of royalty securities generally include risks relating to the products
associated with the royalty stream, risks relating to the license agreement, risks relating to the
structure of the financing and risks relating to bankruptcy or reorganization proceedings.
REPURCHASE AGREEMENT RISK
The Trust may enter into repurchase agreements up to a maximum of 33 1/3% of its total assets.
Repurchase agreements may be considered loans to the seller, collateralized by the underlying
securities. If the seller does not pay the Trust the agreed-upon sum on the repurchase date, 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. 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.
DERIVATIVES RISK
The
Trust may engage in derivative transactions for hedging and speculative purposes or
to enhance total return, including engaging in transactions such as options, futures, swaps,
foreign currency transactions, forward foreign currency contracts, currency swaps or options on
currency futures and other derivatives transactions (collectively,
Derivative Transactions). The Trust may use any or all types of Derivative
Transactions which it is authorized to use at any time; no particular strategy will dictate the
use of one type of Derivative Transaction rather than another, as use of any authorized
Derivative Transaction will be a function of numerous variables, including market conditions.
Derivative Transactions involve certain risks and special considerations. Risks of Derivative Transactions include 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 successfully use Derivative Transactions depends on the Investment
Advisers ability to predict pertinent market movements. 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 may 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. 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 foreign currency transactions can result in the Trust incurring
losses as a result of the imposition of exchange controls, the 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.
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.
Also, 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.
The Trusts Derivative Transactions are generally subject to numerous special and complex tax
rules. Because the tax rules applicable to such transactions may be uncertain under current law, an
adverse determination or future IRS guidance with respect to these rules (which determination or
guidance could be retroactive) may affect whether the Trust has made sufficient distributions, and
otherwise satisfied the relevant requirements, to maintain its qualification as a RIC and avoid
Trust-level U.S. federal income or excise
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taxes. See Risks Relating to the Trusts Tax Status below for more information about the
risks of a failure to qualify as a RIC. The Trusts investments in derivative instruments may be
limited by the RIC qualification requirements or other U.S. federal income tax considerations.
It is possible that government regulation of various types of derivative instruments,
including futures and swap agreements, may limit or prevent the Trust from using such instruments
as part of its investment strategy, and could ultimately prevent the Trust from being able to
achieve its investment goals. For example, some legislative and regulatory proposals, such as those
in the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act)
(which was passed into law in July 2010), would, upon implementation, impose limits on the maximum
position that could be held by a single trader in certain contracts and would subject some
derivatives transactions to new forms of regulation that could create barriers to some types of
investment activity. Other provisions would require many swaps to be cleared and traded on an
exchange, expand entity registration requirements, impose business conduct requirements on dealers
that enter into swaps with a pension plan, endowment, retirement plan or government entity, and
could require banks to move some derivatives trading units to a non-guaranteed affiliate separate
from the deposit-taking bank or divest them altogether. While many provisions of the Dodd-Frank Act
must be implemented through future rulemaking, and any regulatory or legislative activity may not
necessarily have a direct, immediate effect upon the Trust, it is possible that, upon
implementation of these measures or any future measures, they could potentially limit or completely
restrict the ability of the Trust to use these instruments as a part of its investment strategy,
increase the costs of using these instruments or make them less effective. Limits or restrictions
applicable to the counterparties with which the Trust engages in derivative transactions could also
prevent the Trust from using these instruments or affect the pricing or other factors relating to
these instruments, or may change availability of certain investments.
The above discussion relates to the Trusts proposed use of certain types of derivatives
currently available. However, the Trust is not limited to the transactions described above. In
addition, the relevant markets and related regulations are constantly changing and, in the future,
the Trust may use derivatives not currently available or widely in use.
COUNTERPARTY RISK
The Trust will be subject to credit risk with respect to the counterparties to the derivative
contracts purchased or sold by the Trust. Recently, several broker-dealers and other financial
institutions have experienced extreme financial difficulty, sometimes resulting in bankruptcy of
the institution. Although the Investment Adviser monitors the creditworthiness of the Trusts
counterparties, there can be no assurance that the Trusts counterparties will not experience
similar difficulties, possibly resulting in losses to the Trust. If a counterparty becomes
bankrupt, or otherwise fails to perform its obligations under a derivative contract due to
financial difficulties, the Trust may experience significant delays in obtaining any recovery under
the derivative contract in a bankruptcy or other reorganization proceeding. The Trust may obtain
only a limited recovery or may obtain no recovery in such circumstances.
CREDIT DEFAULT SWAPS RISK
The Trust may enter into credit default swap agreements, which may have as reference
obligations one or more debt securities or an index of such securities. In a credit default swap,
one party (the protection buyer) is obligated to pay the other party (the protection seller) a
stream of payments over the term of the contract, provided that no credit event, such as a default
or, in some instances, a downgrade in credit rating, occurs on the reference obligation. If a
credit event occurs, the protection seller must generally pay the protection buyer the par value
(the agreed-upon notional value) of the referenced debt obligation in exchange for an equal face
amount of deliverable reference obligations.
The Trust may be either the protection buyer or protection seller in a credit default swap. If
the Trust is a protection buyer, the Trust would pay the counterparty a periodic stream of payments
over the term of the contract and would not recover any of those payments if no credit event were
to occur. However, if a credit event occurs, the Trust as a protection buyer has the right to
deliver the referenced debt obligations or a specified amount of cash, depending upon the terms of
the swap, and receive the par value of such debt obligations from the counterparty protection
seller. As a protection seller, the Trust would receive fixed payments throughout the term of the
contract if no credit event occurs. If a credit event occurs, however, the value of the obligation
received by the Trust (e.g., bonds which defaulted), plus the periodic payments previously
received, may be less than the par value of the obligation, or cash received, resulting in a loss
to the protection seller. Furthermore, the Trust as a protection seller would effectively add
leverage to its portfolio because it will have investment exposure to the notional amount of the
swap.
Credit default swap agreements are subject to greater risk than a direct investment in the
reference obligation. Like all swap agreements, credit default swaps are subject to liquidity,
credit and counterparty risks. In addition, collateral posting requirements are individually
negotiated and there is no regulatory requirement that a counterparty post collateral to secure its
obligations under a credit default swap. Furthermore, there is no requirement that a party be
informed in advance when a credit default swap agreement is sold. Accordingly, the Trust may have
difficulty identifying the party responsible for payment of its claims. The notional value of
credit
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default swaps with respect to a particular investment is often larger than the total par value
of such investment outstanding and, in event of a default, there may be difficulties in making the
required deliveries of the reference investments, possibly delaying payments.
In the past, the market for credit default swaps has become more volatile as the
creditworthiness of certain counterparties has been questioned and/or downgraded. If a
counterpartys credit becomes significantly impaired, multiple requests for collateral posting in a
short period of time could increase the risk that the Trust may not receive adequate collateral.
There is no readily available market for trading credit default swaps. The Trust generally may exit
its obligations under a credit default swap only by terminating the contract and paying applicable
breakage fees, or by entering into an offsetting credit default swap position, which may cause the
Trust to incur more losses.
In addition, the Trust may invest in publicly or privately issued interests in investment
pools whose underlying assets are credit default, credit-linked, interest rate, currency exchange,
equity-linked or other types of swap contracts and related underlying securities or securities loan
agreements. The pools investment results may be designed to correspond generally to the
performance of a specified securities index or basket of securities, sometimes a single security.
These types of pools are often used to gain exposure to multiple securities with a smaller
investment than would be required to invest directly in the individual securities. They may also be
used to gain exposure to foreign securities markets without investing in the foreign securities
themselves or the relevant foreign market. To the extent that the Trust invests in pools of swaps
and related underlying securities or securities loan agreements whose return corresponds to the
performance of a foreign securities index or one or more foreign securities, investing in such
pools will involve risks similar to the risks of investing in foreign securities. See Foreign
Securities below. In addition to the risks associated with investing in swaps generally, the Trust
bears the risks and costs generally associated with investing in pooled investment vehicles, such
as paying the fees and expenses of the pool and the risk that the pool or the operator of the pool
may default on its obligations to the holder of interests in the pool, such as the Trust. Interests
in privately offered investment pools of swaps may be considered illiquid or deemed liquid, subject
to the Trusts restrictions on investments in illiquid securities.
MARKET RISK GENERALLY
The profitability of a significant portion of the Trusts 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. The Investment Adviser may not 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 bonds 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.
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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 Trusts investment
portfolio in the manner necessary to employ successfully the Trusts strategy.
SHORT SALES RISK
Short selling involves selling securities that 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,
because 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. The securities necessary to cover a short position may not 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.
The Commission adopted certain restrictions on short sales in 2010, including a new short sale
price test that restricts short selling when the price of a covered security has triggered a
circuit breaker by falling at least 10% in one day, at which point short sale orders can be
displayed or executed only if the order price is above the current national best bid, subject to
certain limited exceptions. The new restrictions could restrict the Trusts ability to engage in
short sales in certain circumstances. In addition, the Commission approved a pilot program in 2010
pursuant to which several national securities exchanges and FINRA adopted rules to halt trading in
securities included in the S&P 500 Index, the Russell 1000 Index and over 300 exchange traded funds
if the price of any such security moves 10% or more from a sale in a five-minute period. The
direction and magnitude of the effect that the new restrictions and any additional regulations may
have will depend on a variety of factors, many of which cannot be determined at this time. In
addition, regulatory authorities in certain jurisdictions may adopt bans on short sales of certain
securities in response to market events. Restrictions and/or bans on short selling may make it
impossible for the Trust to execute certain investment strategies.
RISKS OF INVESTING IN STRUCTURED FINANCE SECURITIES
A portion of the Trusts investments may consist of equipment trust certificates,
collateralized mortgage obligations, collateralized bond obligations, collateralized loan
obligations or similar instruments.
Such structured finance securities are generally backed by an asset or a pool of assets, which serve as collateral.
Depending on the type of security, the collateral may take the form of a portfolio of mortgage loans or bonds or
other assets. The Trust and other investors in structured finance securities ultimately bear the credit risk of
the underlying collateral. In some instances, the structured finance securities are issued in multiple tranches,
offering investors various maturity and credit risk characteristics, often categorized as senior, mezzanine and
subordinated/equity according to their degree of risk. If there are defaults or the relevant collateral otherwise
underperforms, scheduled payments to senior tranches of such securities take precedence over those of mezzanine tranches,
and scheduled payments to mezzanine tranches take precedence over those to subordinated/equity tranches. In light of the
above considerations, 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. In addition to the risks noted above and 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 securitys 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. In addition, the complex
structure of the security may produce
unexpected investment results, especially during times of market
stress or volatility.
Investments in structured finance securities may also be subject to illiquidity risk.
Collateralized mortgage obligations may have risks similar to those of mortgage-backed securities.
See Mortgage-Backed Securities Risk for more information.
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 the payment of its
distributions, the Trust may be required to report income for U.S. federal income tax
purposes to the extent of any such deferred distribution even though the Trust has not yet
received such income. In order to receive the special treatment accorded to RICs and their
shareholders under the Code and to avoid U.S. federal income and/or excise taxes at the
Trust level, the Trust may be required to distribute this reported income to shareholders in
the tax year in which the income is reported (without a corresponding receipt of cash).
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amount greater than the total amount of income the Trust actually received, and may, among
other things, sell portfolio securities, including at potentially disadvantageous times or
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Subordination. Preferred securities are subordinated to bonds and other debt instruments
in a companys 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
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Liquidity. Preferred securities may be substantially less liquid than many other
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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 issuers board. Generally, once all the arrearages have been paid, the
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RISKS OF INVESTING IN SWAPS
Investments in swaps involve the exchange by the Trust 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. 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. Swap agreements are sophisticated financial instruments that typically involve a small
investment of cash relative to the magnitude of risks assumed. Swaps can be highly volatile and may
have a considerable impact on the Trusts performance, as the potential gain or loss on any swap
transaction is not necessarily subject to any fixed limit.
Recently, several broker-dealers and other financial institutions have experienced extreme
financial difficulty, sometimes resulting in bankruptcy of the institution. Although the Investment
Adviser monitors the creditworthiness of the Trusts counterparties, the Trusts counterparties
could experience similar difficulties, possibly resulting in losses to the Trust.
RISKS OF INVESTING IN SYNTHETIC SECURITIES
In addition to credit risks associated with holding non-investment grade loans and high-yield
debt 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 enforce directly compliance by the Reference Obligor with the terms of the Reference
Obligation nor any rights of setoff 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 or of
the Reference Obligor. As a result, investments in synthetic securities are subject to an
additional degree of risk because they are subject to the credit risk of the counterparty as well
as that of the Reference Obligor. The Investment Adviser may not perform independent credit
analyses of any particular counterparty, or any entity guaranteeing the obligations of such
counterparty. 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 the Trusts assets that may be invested in these 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, fair value pricing may not 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 Trusts
investment portfolio, it is possible that a significant amount of the Trusts 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 Trusts investment portfolio in any one issuer
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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 would subject the Trust to a greater degree of risk with respect to economic
downturns relating to such industry. The focus of the Trusts investment portfolio in any one
investment strategy would subject the Trust to a greater degree of risk than if the Trusts
investment portfolio were varied in its investments with respect to several investment strategies.
Because the Trust has recently
invested a significant portion of its assets in healthcare companies,
the Trusts performance may depend on the overall
condition of the healthcare industry and the Trust is susceptible to economic, political and regulatory risks or other
occurrences associated with the healthcare industry. The Trust faces the risk that economic prospects of healthcare
companies may fluctuate dramatically because of changes in the regulatory and competitive environments.
A significant portion of healthcare services are funded or subsidized by the government, which means that
changes in government policies, at the state or federal level, may affect the demand for healthcare products
and services. Other risks include the possibility that regulatory approvals (which often entail lengthy application
and testing procedures) will not be granted for new drugs and medical products, the chance of lawsuits against
healthcare companies related to product liability issues, and the rapid speed at which many healthcare products
and services become obsolete.
The Trust has instituted several
levels of safeguards to ensure the Trust does not violate its fundamental policy not to invest 25% or more of the value
of its total assets in any single industry or group of industries.
The Investment Adviser monitors the Trusts investments
on a daily basis to ensure the Trusts compliance with fundamental investment policy. In addition, in accordance with the
Sub-Administration Agreement, BNY monitors the Trusts investments on a weekly basis and provides monthly and quarterly
reports to the Trusts Board of Trustees. At its quarterly meetings, the Board of Trustees reviews the BNY compliance
reports and monitors the Trusts investment activities. Although the Board of Trustees receives periodic compliance reports
enabling it to monitor the Trusts compliance with its fundamental investment policy, the Trust holds the ultimate
responsibility to comply with its fundamental investment policy.
MARKET DISRUPTION AND GEOPOLITICAL RISK
The aftermath of the wars in Iraq and Afghanistan and the continuing involvement in Iraq and
Afghanistan, 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 length of time that the securities markets may be affected by these events is unclear and the
effects of these or similar events in the future on the U.S. economy and securities markets cannot
be predicted.
RISKS RELATED TO CURRENT MARKET CONDITIONS
Recently, domestic and international markets have experienced a period of acute stress
starting in the real estate and financial sectors and then moving to other sectors of the world
economy. This stress has resulted in unusual and extreme volatility in the equity markets and in
the prices of individual stocks. These market conditions could add to the risk of short-term
volatility of the Trust.
In addition, debt markets have experienced a period of high volatility, which has negatively
impacted market liquidity conditions and prices. Initially, the concerns on the part of market
participants were focused on the subprime segment of the mortgage-backed securities market. These
concerns expanded to include derivatives, securitized assets and a broad range of other debt
securities, including those rated investment grade, the U.S. and international credit and interbank
money markets generally, and a wide range of financial institutions and markets, asset classes, and
sectors. As a result, debt instruments have experienced, and may in the future experience,
liquidity issues, increased price volatility, credit downgrades, and increased likelihood of
default. These market conditions may have an adverse effect on the Trusts investments and hamper
the Trusts ability to sell the debt securities in which it invests or to find and purchase
suitable debt instruments. Market conditions may also make it more difficult or impossible for the
Trust to use leverage to the degree required, or make any such leverage more expensive (for
example, by increasing interest expense). In addition, these conditions may directly and adversely
affect the setting of dividend rates on the common shares.
The recent market conditions have also caused domestic and international issuers to seek
capital infusions to strengthen their financial positions or to remain financially viable. These
capital infusions have taken a variety of forms, including the public or private issuance of
additional debt securities, equity securities or both, which have been purchased by, among others,
public and private investors, government agencies, and sovereign wealth funds. If the Trust owns
shares of an issuer that sells additional equity securities and the Trust cannot or chooses not to
purchase shares in the offering, the Trusts interest in the issuing company will be diluted.
RISKS OF INVESTING IN A TRUST WITH ANTI-TAKEOVER PROVISIONS
The Trusts 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. See Anti-Takeover Provisions in the Agreement and Declaration of Trust on page
86 of this prospectus.
KEY ADVISER PERSONNEL RISK
The Trusts ability to identify and invest in attractive opportunities is dependent upon the
Investment Adviser. If one or more key individuals leaves the Investment Adviser, the Investment
Adviser 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.
LIMITED OPERATING HISTORY
The Trust commenced investment operations in June 2006 and has a limited operating history and
history of public trading that investors can use to evaluate its investment performance and
volatility.
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.
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RISKS RELATING TO DILUTION OF SHAREHOLDERS INTERESTS
Shareholders interests in the Trust may be diluted if they do not fully exercise their
subscription rights in any rights offering. In addition, if the subscription price is less than our
net asset value per share, then there will be an immediate dilution of the aggregate net asset
value of our shares. In the event we issue subscription rights, shareholders who do not fully
exercise their rights should expect that they will, at the completion of a rights offering pursuant
to this prospectus, own a smaller proportional interest in us than would otherwise be the case if
they fully exercised their rights. Such dilution is not currently determinable because it is not
known what proportion of the shares will be purchased as a result of such rights offering. Any such
dilution will disproportionately affect non-exercising shareholders. This dilution could be
substantial. The amount of any decrease in net asset value is not predictable because it is not
known at this time what the subscription price and net asset value per share will be on the
expiration date of the rights offering or what proportion of the shares will be purchased as a
result of such rights offering.
RISKS RELATING TO TRUSTS TAX STATUS
To remain eligible for the special tax treatment accorded to RICs and their shareholders under
the Code, the Trust must meet certain source of income, asset diversification and annual
distribution requirements. Very generally, in order to qualify as a RIC, the Trust must derive at
least 90% of its gross income for each taxable year from dividends, interest, payments with respect
to certain securities loans, gains from the sale or other disposition of stock, securities or
foreign currencies, or other income derived with respect to its business of investing in stock or
other securities. In some cases, if the Trust fails to meet these income requirements at the end of
a taxable year, it will be able to cure such failure by paying a Trust-level tax to avoid the loss
of its RIC status; such tax could be substantial. The Trust must also meet certain asset
diversification requirements at the end of each quarter of each of its taxable years. Failure to
meet these diversification requirements on the last day of a quarter will result in the Trusts
loss of RIC status, unless it is able to cure such failure, for instance, by disposing of certain
investments, including at disadvantageous times and prices, and, in some cases, by paying a
Trust-level tax.
In addition, in order to be eligible for the special tax treatment accorded RICs, the Trust
must meet the annual distribution requirement, requiring it to distribute with respect to each
taxable year at least 90% of the sum of its investment company taxable income (generally-its
taxable ordinary income and realized net short-term capital gains in excess of realized net
long-term capital losses, if any) and its net tax-exempt income (if any), to its shareholders.
Because the Trust currently maintains a credit facility, has outstanding secured, privately placed
notes, and may use additional debt financing in the future, the Trust is subject to certain asset
coverage ratio requirements under the Investment Company Act and financial covenants under its Note
Purchase Agreement that could, under certain circumstances, restrict the Trust from making the
distributions necessary to satisfy this annual distribution requirement and to avoid
corporate-level U.S. federal income or excise taxes. Any taxable income (including net long-term
capital gains) that the Trust is unable to distribute will be subject to corporate-level tax at
regular corporate rates. Further, if the Trust fails to meet the annual distribution requirements
or any of the other RIC qualification requirements in respect of a taxable year and, in the case of
the income and asset diversification requirements, is ineligible to or otherwise does not cure such
failure for any such year, all of its taxable income regardless of whether timely distributed to
shareholders will be subject to corporate-level tax and all of its distributions from earnings and
profits (including from net long-term capital gains) will be taxable to shareholders as ordinary
income.
In any such event, the resulting corporate taxes could substantially reduce its net assets,
the amount of income available for distribution and the amount of its distributions. Such a failure
would have a material adverse effect on the Trust and its shareholders. In addition, in some cases,
the Trust could be required to recognize unrealized gains, pay substantial taxes and interest and
make substantial distributions in order to re-qualify as a RIC.
RIC-RELATED RISKS OF INVESTMENTS GENERATING NON-CASH TAXABLE INCOME
Certain of the Trusts investments will require the Trust to recognize taxable income in a taxable
year in excess of the cash generated on those investments during that year. In particular, the
Trust expects that a substantial portion of its investments in loans and other debt obligations
will be treated as having market discount and/or original issue discount for U.S. federal
income tax purposes, which, in some cases, could be significant. Because the Trust may be required
recognize income in respect of these investments before, or without receiving, cash representing
such income, the Trust may have difficulty satisfying the annual distribution requirements
applicable to RICs and avoiding Trust-level U.S. federal income or excise taxes. Accordingly, the
Trust may be required to sell portfolio securities, including at potentially disadvantageous times
or prices, raise additional debt or equity capital, or reduce new investments, to obtain the cash
needed to make these income distributions. If the Trust liquidates portfolio securities to raise
cash, the Trust may realize gain or loss on such liquidations; in the event the Trust realizes net
long-term or short-term capital gains from such liquidation transactions, its shareholders may
receive larger capital gain or ordinary dividends, respectively, than they would in the absence of
such transactions.
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LIMITATIONS OF CREDIT RATINGS
Credit ratings represent only the opinion of the rating agency with respect to the ability of
the issuer to make principal and interest payments on the securities. In determining a credit
rating, rating agencies do not evaluate the risks of fluctuations in market value. Further, there
may be limits on the effectiveness of the rating agencies financial models. For these and other
reasons, a credit rating may not fully reflect the risks inherent in the relevant security.
Further, a rating organization may have a conflict of interest with respect to a security for which
it assigns a particular rating. For example, if the issuer or sponsor of a security pays a rating
agency for the analysis of the security, an inherent conflict of interest may exist that could
affect the reliability of the rating. In addition, credit rating agencies may or may not make
timely changes in a rating to reflect changes in the economy or in the conditions of the issuer
that affect the market value of the security. In other words, a security or an issuer may maintain
a certain credit rating even though conditions have deteriorated since the rating was issued.
Consequently, credit ratings should not necessarily be relied upon as an indicator of investment
quality. If a rating organization changes the rating assigned to one or more of the Trusts
portfolio securities, the Trust is not required to sell the relevant securities.
Management of the Trust
TRUSTEES AND OFFICERS
The Board of Trustees of the Trust (the Board) is responsible for the overall management of
the Trust, including supervision of the duties performed by the Investment Adviser. 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 names and business addresses 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
The Investment Adviser acts as the Trusts investment adviser. The Investment Adviser is
located at NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. As of December 31, 2010,
the Investment Adviser, together with its affiliates, managed approximately $22 billion in assets
on behalf of investors around the world. The Investment Adviser 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, 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 Trusts
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. A
discussion regarding the basis for the approval of the investment advisory agreement by the Board
is available in the Trusts report to shareholders for the period ended December 31, 2010.
Potential Conflicts of Interest. Actual or apparent conflicts of interest may arise
because the Investment Adviser manages more than one account. For example, if a portfolio manager
identifies a limited investment opportunity which may be suitable for more than one fund or other
account, a fund may not be able to take full advantage of the opportunity due to an allocation of
filled purchase or sale orders across all eligible funds and other accounts. To deal with these
situations, the Investment Adviser has adopted procedures for allocating portfolio transactions
across multiple accounts. Under the procedures, investment opportunities are allocated in a fair
and equitable manner among the Trust and other funds and accounts managed by the Investment Adviser
in accordance with the Investment Advisers allocation procedures, but may not be allocated on a
strictly pro rata basis. Therefore, in certain instances the Trust may not be able to participate
in limited investment opportunities that are allocated to other funds or accounts (or may
participate on a more limited basis than would be the case if investments were allocated pro rata). Having separate transactions with
respect to a security may cause the Trust or other accounts to pay a higher price or sell at a
lower price than would be the case if trades were not aggregated.
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During periods in which the Trust is using leverage, the fees paid to the Investment
Adviser for investment advisory services and to the Administrator for administrative services will
be higher than if the Trust did not use leverage because the fees paid will be calculated on the
basis of the Trusts Managed Assets, which may create an incentive for the Investment Adviser to
leverage the Trust or to leverage using strategies that increase the Investment Advisers fee.
Furthermore, the Investment Adviser will also benefit to the extent that the Trusts Managed Assets
are derived from the reinvested collateral received on portfolio securities loaned.
In addition to the Advisory Fee of the Investment Adviser, 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 the Investment Adviser), 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 Trusts registration with the Commission and other
jurisdictions and taxes, if any.
Pursuant to the Trusts investment advisory agreement, the Trust has undertaken to
indemnify the Investment Adviser and its partners, officers, employees, agents, and controlling
persons for certain liabilities arising under the agreement, except liabilities arising from their
willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in
the conduct of his position. In accordance with the indemnification provision in the Trusts
Investment Advisory Agreement, the Trust has in the past indemnified the Investment Adviser from
time to time, and may continue to do so in the future.
CERTAIN LEGAL PROCEEDINGS
Matters
relating to investment in Broadstripe LLC.
WaveDivision Holdings, LLC
Litigation. The Trust, the Investment Adviser, other
accounts managed by the Investment Adviser, and an unaffiliated investment manager are defendants
in a lawsuit filed in Delaware Superior Court on November 17, 2008 (and subsequently amended to
include the Trust as a party) by WaveDivision Holdings, LLC and an affiliate, alleging causes of
action stemming from the plaintiffs 2006 agreements with Millennium Digital Media Systems, LLC
(Millennium) (now known as Broadstripe, LLC), pursuant to which Millennium had agreed, subject to
certain conditions, to sell certain cable television systems to the plaintiffs. As of December 31, 2010, the Trust attributed total value to the Trusts investment in
the Millennium revolving credit agreement and term loan, each of which is secured by a first lien,
of an aggregate of approximately $17.9 million. The complaint alleges that the Investment Adviser
and an unaffiliated investment manager for certain defendants caused Millennium to terminate the contracts to sell the
cable systems to the plaintiffs. The amended complaint seeks compensatory and punitive damages in
an unspecified amount to be presented at trial, thus, the Trust cannot predict the amount of a
judgment, if any. The Trust and other accounts managed by the Investment Adviser have filed a
motion for summary judgment seeking dismissal of the lawsuit.
The Trust first held Broadstripe, LLC securities following the
occurrence of the events that gave rise to this
lawsuit. The Investment Adviser believes that the Trust will be removed as a defendant in
this lawsuit. In the event that the Investment Adviser or other funds managed by the Investment
Adviser are eventually found to be liable in this lawsuit, the Investment Adviser believes that
the Trust would not be responsible for any share of such liability
because the Trust did not purchase Broadstripe, LLC securities until after the occurrence of the events that gave rise to
this lawsuit. However, it is possible that the Investment Advisers view may be incorrect. In addition, depending on
the circumstances, under the investment advisory agreement the Investment Adviser may be entitled to indemnification
from the Trust for its liabilities and expenses incurred in connection with this lawsuit. The Investment Adviser and
the Trust intend to continue to defend this action vigorously.
Bankruptcy
Matters. In addition, the Trust and other
funds managed by the Investment Adviser that held certain debt issued by Millennium are defendants in a complaint filed
on May 8, 2009 by the official committee of unsecured creditors of Millennium and its affiliated debtors (collectively,
the Debtors) in the United States Bankruptcy Court for the District of Delaware. The complaint alleges various causes
of action against the Trust, the Investment Adviser and certain other funds managed by the Investment Adviser and seeks
various relief, including recharacterization and equitable subordination of the debt held by the Trust and the other
funds and recovery of certain payments made by the Debtors to the Trust and the other funds.
On December 8, 2010, the
Trust and the other defendants entered into a settlement agreement. Among other things, the settlement provides for
the stay and dismissal of the claims asserted by the creditors committee. The settlement also creates a $3.3 million
creditors trust for the benefit of general unsecured creditors and provides for the payment of $500,000 in previously
incurred fees by counsel to the unsecured creditors committee. The settlement also establishes certain milestones
relating to the filing of a plan of reorganization or a motion to
sell all or substantially all the Debtors assets. In the event these milestones are not achieved by certain specified
dates, any party to the settlement may petition the United States Bankruptcy Court for the District of Delaware to
terminate the settlement for cause, in which case the litigation could recommence. If the settlement were terminated
and the creditors committee were to succeed in its causes of action,
all or a portion of the Trusts $17.9 million aggregate
investment amount in
Millennium may not be recoverable.
Matters
relating to UBS litigation.
The Investment Adviser and two affiliated unregistered
investment vehicles are defendants in a complaint filed on February 24, 2009 in the Supreme Court
of the State of New York, New York County, by UBS Securities LLC and UBS AG, London Branch. On
February 18, 2010, the original suit against the Investment Adviser was dismissed on its merits. On
June 28, 2010, UBS filed an amended complaint with the Court against the Investment Adviser and
certain affiliated registered and unregistered investment vehicles. The Trust is not party to this
action. The lawsuit relates to a warehouse facility formed for a proposed collateralized debt
obligation, or CDO, transaction that was not completed. Under the warehouse facility, the
plaintiffs acquired a portfolio of securities and instruments in anticipation of an offering to be
made by the proposed CDO of its debt and equity securities to be secured by those securities and
instruments. The plaintiffs seek monetary damages of approximately $687 million, plus certain
costs, fees and expenses based on alleged fraudulent inducement, breach of contract and fraudulent
conveyances. The Investment Adviser believes that it has meritorious defenses and intends to
continue to vigorously defend against the claims. Based on
its analysis of the case, the Investment Adviser believes that this matter is not likely to
have a material adverse effect upon its ability to perform its obligations under the Investment
Advisory Agreement with the Trust. However, the Investment Adviser cannot predict
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the ultimate outcome of the matter, and any substantial final disposition of the matter adverse to the
Investment Adviser would have a material adverse effect on the Investment Advisers ability to
perform its obligations under the Investment Advisory Agreement with the Trust, and potentially, on
the operations of the Trust.
The Investment Adviser is also a party to other litigation matters, none of which it believes
will have a material adverse effect on its ability to perform its obligations under the Investment
Advisory Agreement. Litigation and regulatory proceedings can be expensive, lengthy and disruptive
to the Trusts and the Investment Advisers normal investment activities.
ADMINISTRATOR/SUB-ADMINISTRATOR
Under an administration agreement dated June 29, 2006 and amended June 6, 2008, (the
Administration Agreement), the Investment Adviser provides administration services to the Trust,
provides executive and other personnel necessary to administer the Trust and furnishes office
space. Some of the administrative services provided by the Investment Adviser under the
Administration Agreement, include, but are not limited to:
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preparing and coordinating the Trusts state filings; |
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determining and overseeing publication of the Trusts NAV and distribution amounts; |
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overseeing and liaising with services providers, such as the custodian and transfer
agent; |
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monitoring leverage compliance; |
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coordinating the negotiation of credit agreements and other agreements with
counterparties; |
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investigating customer complaints; |
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determining and monitoring expense accruals; |
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authorizing expenditures and bill payments on behalf of the Trust; and |
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performing such additional administrative duties as requested by the Trust. |
The Investment Adviser will receive an annual fee, payable monthly, in an amount equal to
0.20% of the average weekly value of the Trusts Managed Assets. The Investment Adviser earned for
administration services $1,800,068, $984,464 and $1,193,860 in fees for the fiscal periods ended
December 31, 2008, December 31, 2009 and December 31, 2010, respectively. The accrued fees are
payable monthly as promptly as possible after the end of each month during which this Agreement is
in effect. The Investment Adviser may waive a portion of its fees. Under a separate
sub-administration agreement, dated June 29, 2006, the Investment Adviser has delegated certain
administrative functions to BNY Mellon Investment Servicing (US) Inc. (BNY), at an annual rate,
payable by the Investment Adviser, of 0.01% of the average weekly value of the Trusts Managed
Assets. Some of the administrative services delegated to BNY, include, but are not limited to,
preparing monthly security transaction listings; coordinating communications with other service
providers; coordinating printing of shareholder reports; monitoring compliance with various
regulatory schemes applicable to the Trust; assisting in preparation of proxy materials, fidelity
bond and insurance policies and with Commission examination and responses thereto; and coordinating
preparation of board materials.
AFFILIATED BROKERAGE
The Trust pays brokerage commissions to NexBank Securities, Inc., an affiliate of the
Investment Adviser, in connection with brokerage services provided. For more information regarding
brokerage commissions, please refer to Portfolio Transactions and Brokerage in the Trusts
Statement of Additional Information.
PORTFOLIO MANAGER
The Trusts portfolio manager is Greg Stuecheli. Mr. Stuecheli has managed the portfolio
since February 2011. His investment decisions are not subject to the oversight, approval or
ratification of a committee.
Mr. Stuecheli is a Partner and Senior Portfolio Manager of Retail Products at Highland Capital
Management, L.P. Previously, Mr. Stuecheli was a Portfolio Manager covering distressed and special
situation credit and equity investments. In addition, Mr. Stuecheli currently serves on the board
of directors of CCS Medical Holdings, Inc. and LLV Holdco, LLC (as Chairman). He is a
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former board
member of Safety-Kleen Holdco, Inc. Prior to joining Highland Capital Management, L.P. in June
2002, Mr. Stuecheli served as an analyst for Gryphon Management Partners, LP from 2000 to 2002. His
primary responsibilities included researching long and short investment ideas. In 1999 he was a
Summer Associate at Hicks, Muse, Tate & Furst. From 1995 to 1998, Mr. Stuecheli worked as a
chemical engineer at Jacobs Engineering Group and Cytec Industries. He received an MBA from
Southern Methodist University and a BS in Chemical Engineering from Rensselaer Polytechnic
Institute. He has earned the right to use the Chartered Financial Analyst designation.
The Statement of Additional Information provides additional information about the portfolio
managers compensation, other accounts managed by the portfolio manager and the portfolio managers
ownership of securities issued by the Trust.
Determination of Net Asset Value
The net asset value of the common shares of the Trust is computed based upon the value of the
Trusts investment portfolio securities and other assets. Net asset value per common share is
determined daily on each day that the NYSE is open for business as of the close of the regular
trading session on the NYSE, usually 4:00 p.m., Eastern time. The NYSE is open Monday through
Friday, but currently is scheduled to be closed on New Years Day, Dr. Martin Luther King, Jr. Day,
Presidents Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day or on the preceding Friday or subsequent Monday when a holiday falls on a Saturday or
Sunday, respectively.
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:
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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,
except that debt securities that are not credit-impaired and have remaining maturities of 60
days or less will be valued at amortized cost, a method of valuation that approximates
market value. 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 Trusts 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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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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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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The Trusts 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 Board. The
pricing of all assets that are fair valued in this manner will be subsequently reported to
and ratified by the Board. Pursuant to the Trusts pricing procedures, securities for which
market quotations are not readily available may include securities that are subject to legal
or contractual restrictions on resale, securities for which no or limited trading activity
has occurred for a period of time, or securities that are otherwise deemed to be illiquid
(i.e., securities that cannot be disposed of within seven days at approximately the price at
which the security is currently priced by the Trust).
Swaps and other derivatives would generally fall under this category. |
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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
arms-length transaction. 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
determinations are based upon all available factors that the Investment Adviser deems
relevant. 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
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result, fair value pricing may not 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.
DETERMINATIONS IN CONNECTION WITH OFFERINGS
In connection with any primary offering of the Trusts common shares, the Trust will need to
make the determination that it is not selling its common shares at a price below its then current
net asset value at the time at which the sale is made. To the extent that there is a possibility
that the Trust may (i) issue common shares at a price below the then current net asset value of its
common shares at the time at which the sale is made, or (ii) trigger the undertaking (which the
Trust provided to the Commission in the registration statement to which this prospectus is a part)
to suspend the offering of its common shares pursuant to this prospectus if the net asset value
fluctuates by certain amounts in certain circumstances until the prospectus is amended, the Trust
may elect, in the case of clause (i) above, to postpone the offering until such time that there is
no longer the possibility of the occurrence of such event and, in the case of clause (ii) above, to
comply with such undertaking or to undertake to determine net asset value to ensure that such
undertaking has not been triggered.
Distributions
Subject to market conditions, the Trust expects to declare dividends on the Trusts common
shares on a monthly basis. The Trust intends to pay any net capital gain distributions annually.
Various factors will affect the level of the Trusts current income and current gains, such as
its asset mix and the Trusts use of options and other derivative transactions. To permit the Trust
to maintain more stable monthly dividends and annual capital gain 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 Trusts net asset value, and,
correspondingly, distributions from previously undistributed income and gains, as well as from
capital, if any, will be deducted from the Trusts 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 Trusts Dividend Reinvestment Plan unless an election is made to receive cash. Each
participant in the Trusts 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 Trusts 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 BNY (the Plan Agent), agent for shareholders in administering the
Trusts 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 or other distributions (together, a dividend) 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 BNY,
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 BNY, 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. Some brokers may automatically elect to receive cash on your behalf
and may reinvest 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 shareholders shares are registered. Whenever the Trust declares 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
80
credited to each participants 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. The number of newly issued common shares to be credited to
each participants account will be determined by dividing the dollar amount of the uninvested
portion 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 uninvested portion 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 shareholders 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 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 U.S. 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 BNY Mellon
Investment Servicing (U.S.) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809; telephone (877)
665-1287.
Description of Capital Structure
This prospectus contains a summary of the common shares, preferred shares, and subscription
rights. These summaries are not meant to be a complete description of each security. However, this
prospectus and the accompanying prospectus supplement will contain the material terms and
conditions for each security.
Any of the securities described herein and in any prospectus supplement may be issued
separately or as part of a unit consisting of two or more securities
(for example, common shares and rights), which may or may not be
separable from one another. If such units are publicly offered, they
and their underlying securities will be registered under the Securities Act of 1933 prior to completion of the offering.
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COMMON SHARES
The Trust is a statutory trust organized under the laws of the State 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 such shareholders and/or by reducing the number
of common shares owned by such 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 securities
offered pursuant to this prospectus and common shares issued under the Trusts Dividend
Reinvestment Plan. Any additional offerings of shares will require approval by the Board. Any
additional offering of common shares will be subject to the requirements of the Investment Company
Act, which generally 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 Trusts common shareholders.
Any additional offerings of common shares would result in current shareholders owning a
smaller proportionate interest in the Trust than they owned prior to such offering to the extent
that shareholders do not purchase sufficient shares in such offering to maintain their percentage
interest. The Trusts net asset value would be reduced immediately following an offering of the
shares due to the costs of such offering, which will be borne entirely by the Trust. The sale of
shares by the Trust (or the perception that such sales may occur) may have an adverse effect on
prices of shares in the secondary market. An increase in the number of shares available may put
downward pressure on the market price for shares. If the Trust were unable to invest the proceeds
of an additional offering of shares as intended, the Trusts per share distribution may decrease
and the Trust may not participate in market advances to the same extent as if such proceeds were
fully invested as planned.
The Trusts 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 common shares
may not 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 Trusts outstanding shares as of December
31, 2010. The Trust does not currently hold any of its shares for its own account.
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Outstanding |
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Common Shares |
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Unlimited |
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63,829,353 |
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Pursuant to Section 3.8 of the Trusts Agreement and Declaration of Trust, the Board of Trustees of the Trust has the
power to cause each holder of common or preferred shares of the Trust to pay directly, in advance or arrears, for
charges of distribution, of the custodian or transfer, shareholder servicing or similar agent, a pro rata amount as
determined from time to time by the Board of Trustees of the Trust, by setting off such charges due from such
shareholder from declared but unpaid dividends or distributions owed such shareholder and/or by reducing the number
of shares in the account of such shareholder by that number of full and/or fractional shares which represents the
outstanding amount of such charges due from such shareholder. In the event the Trustees determine to cause each
shareholder to pay certain expenses directly by setting off such expenses due from a shareholder from dividends
payable to such shareholder, the shareholder generally will be deemed to receive, and incur U.S. federal income taxes
on, the full amount of the distribution paid to such shareholder, prior to its reduction by the expenses allocated to the
shareholder. Alternatively, to the extent the Trustees determine to cause each shareholder to pay certain expenses
directly by reducing the number of shares in the shareholders account by the amount of the expenses allocated to the shareholder, such
reduction in shares generally will constitute a redemption for U.S. federal income tax purposes,
giving rise to capital gain or loss on the shares redeemed. See
Tax Matters below for more information about the tax
treatment of distributions and redemptions from the Trust. In either case, the expenses directly charged to the
shareholder generally will be deductible by such shareholder for U.S. federal income tax purposes, but may be subject
to the 2% floor on miscellaneous itemized deductions and other significant limitations on itemized deductions set forth
in the Code.
For information concerning the U.S. federal income tax consequences of an investment in common
shares of the Trust, See Tax Matters below and Tax Matters in the Statement of Additional
Information.
PREFERRED SHARES
The Trusts Agreement and Declaration of Trust provides that the Board may authorize and issue
preferred shares with rights as determined by the Board, by action of the Board without the
approval of the holders of the common shares. Holders of common shares have no preemptive right to
purchase any preferred shares that might be issued. Whenever preferred shares are outstanding, the
Trust will not be permitted to declare any distributions from the Trust unless all accrued
dividends on preferred shares have been paid,
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unless asset coverage (as defined in the Investment
Company Act) with respect to preferred shares would be at least 200% after giving effect to the
distributions and unless certain other requirements imposed by any rating agencies rating the
preferred shares have been met.
The Trust may issue preferred shares as part of its leverage strategy. We cannot assure you,
however, that any preferred shares will be issued. Although the terms of any preferred shares,
including dividend rate, liquidation preference and redemption provisions, will be determined by
the Board, subject to applicable law and the Trusts Agreement and Declaration of Trust, it is
likely that the preferred shares will be structured to carry a relatively short-term dividend rate
reflecting interest rates on short-term bonds, by providing for the periodic redetermination of the
dividend rate at relatively short intervals through an auction, remarketing or other procedure. The
Trust also believes that it is likely that the liquidation preference, voting rights and redemption
provisions of the preferred shares will be similar to those stated below.
Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Trust, the holders of preferred shares will be entitled to receive a
preferential liquidating distribution, which is expected to equal the original purchase price per
preferred share plus accrued and unpaid dividends, whether or not declared, before any distribution
of assets is made to holders of common shares. After payment of the full amount of the liquidating
distribution to which they are entitled, the holders of preferred shares will not be entitled to
any further participation in any distribution of assets by the Trust.
Voting Rights. The Investment Company Act requires that the holders of any preferred shares,
voting separately as a single class, have the right to elect at least two trustees at all times.
The remaining trustees will be elected by holders of common shares and preferred shares, voting
together as a single class. In addition, subject to the prior rights, if any, of the holders of any
other class of senior securities outstanding, the holders of any preferred shares have the right to
elect a majority of the trustees of the Trust at any time two years dividends on any preferred
shares are unpaid. The Investment Company Act also requires that, in addition to any approval by
shareholders that might otherwise be required, the approval of the holders of a majority of any
outstanding preferred shares, voting separately as a class, would be required to (i) adopt any plan
of reorganization that would adversely affect the preferred shares, and (ii) take any action
requiring a vote of security holders under Section 13(a) of the Investment Company Act, including,
among other things, changes in the Trusts subclassification as a closed-end investment company or
changes in its fundamental investment restrictions. As a result of these voting rights, the Trusts
ability to take any such actions may be impeded to the extent that there are any preferred shares
outstanding. The Board presently intends that, except as otherwise indicated in this prospectus and
except as otherwise required by applicable law, holders of preferred shares will have equal voting
rights with holders of common shares (one vote per share, unless otherwise required by the
Investment Company Act) and will vote together with holders of common shares as a single class.
The affirmative vote of the holders of a majority of the outstanding preferred shares, voting
as a separate class, will be required to amend, alter or repeal any of the preferences, rights or
powers of holders of preferred shares that materially and adversely affect such preferences, rights
or powers, or to increase or decrease the authorized number of preferred shares. The class vote of
holders of preferred shares described above will in each case be in addition to any other vote
required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the Trust. The terms of the preferred
shares are expected to provide that (i) they are redeemable by the Trust in whole or in part at the
original purchase price per share plus accrued dividends per share, (ii) the Trust may tender for
or purchase preferred shares, and (iii) the Trust may subsequently resell any shares so tendered
for or purchased.
Any redemption or purchase of preferred shares by the Trust will reduce the leverage
applicable to the common shares, while any resale of shares by the Trust will increase that
leverage.
The discussion above describes the possible offering of preferred shares by the Trust. If the
Board determines to proceed with such an offering, the terms of the preferred shares may be the
same as, or different from, the terms described above, subject to applicable law and the Trusts
Agreement and Declaration of Trust. The Board, without the approval of the holders of common
shares, may authorize an offering of preferred shares or may determine not to authorize such an
offering and may fix the terms of the preferred shares to be offered.
The Trust has no present intention of offering any preferred shares in the next twelve months. If preferred shares are offered in the future, such shares will be registered under the Securities Act of 1933 prior to the offering.
SUBSCRIPTION RIGHTS
General
We may issue subscription rights to our shareholders to purchase common shares. Subscription
rights may be issued independently or together with any other offered security and may or may not
be transferable by the person purchasing or receiving the subscription
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rights. In connection with a
subscription rights offering to our shareholders, we would distribute certificates evidencing the
subscription rights and a prospectus supplement to our shareholders on the record date that we set
for receiving subscription rights in such subscription rights offering.
The applicable prospectus supplement would describe the following terms of subscription rights
in respect of which this prospectus is being delivered:
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the period of time the offering would remain open; |
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the title of such subscription rights; |
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the exercise price for such subscription rights (or method of calculation thereof); |
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the ratio of the offering; |
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the number of such subscription rights issued to each shareholder; |
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the extent to which such subscription
rights are transferable and the market on
which they may be traded if they are
transferable; |
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the date on which the right to
exercise such subscription rights shall
commence, and the date on which such right
shall expire (subject to any extension); |
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the extent to which such subscription
rights include an over-subscription
privilege with respect to unsubscribed
securities and the terms of such
over-subscription privilege; |
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any termination right we may have in connection with such subscription rights offering; and |
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any other terms of such subscription
rights, including exercise, settlement and
other procedures and limitations relating
to the transfer and exercise of such
subscription rights. |
Exercise of Subscription Rights
Each subscription right would entitle the holder of the subscription right to purchase for
cash such amount of shares of common shares at such exercise price as shall in each case be set
forth in, or be determinable as set forth in, the prospectus supplement relating to the
subscription rights offered thereby. Under the Investment Company Act, we may generally only offer
subscription rights that expire not later than 120 days after their issuance and are issued
exclusively and ratably to a class or classes of our security holders. Subscription rights may be
exercised at any time up to the close of business on the expiration date for such subscription
rights set forth in the prospectus supplement. After the close of business on the expiration date,
all unexercised subscription rights would become void.
Subscription rights may be exercised as set forth in the prospectus supplement relating to the
subscription rights offered thereby. Upon receipt of payment and the subscription rights
certificate properly completed and duly executed at the corporate trust office of the subscription
rights agent or any other office indicated in the prospectus supplement we will forward, as soon as
practicable, the common shares purchasable upon such exercise. To the extent permissible under
applicable law, we may determine to offer any unsubscribed offered securities directly to persons
other than shareholders, to or through agents, underwriters or dealers or through a combination of
such methods, as set forth in the applicable prospectus supplement. The Trusts common shareholders will indirectly bear all of the expenses of any subscription
rights offerings, regardless of whether the Trusts common shareholders exercise any subscription rights.
Dilutive
Effect
The Trust may effectuate one or more rights offering, as part of which the Trust will issue subscription rights. In any such event, shareholders who do not fully exercise their subscription rights should expect that they will, at the completion of a rights offering pursuant to this prospectus,
own a smaller proportional interest in the Trust than would otherwise be the case if they fully exercised their rights.
We cannot state precisely the amount of any such dilution in share ownership because we do not know at this time what
proportion of the shares will be purchased as a result of such rights offering. These shareholders will also experience
a disproportionately greater decrease in their participation in the
Trusts earnings and assets and their voting power
than the increase the Trust will experience in its assets, potential earning power and voting interests due to such offering. These shareholders may also experience a decline in the market price of their shares, which often reflects to some degree announced or potential increases and decreases in net asset value per share. This decrease could be more pronounced as the size of the offering and level of discounts increases. Further, if current shareholders do not purchase any shares to maintain their percentage interest, regardless of whether such offering is above or below the then current net asset value, their voting power will be diluted.
In addition, if the subscription price in any such offering is less than the net asset value per share of our
common shares, then shareholders would
experience an immediate dilution of the aggregate net asset value of their shares as a result of the offering.
The amount of any decrease in net asset value is not predictable because it is not known at this time what the
subscription price and net asset value
per share will be on the expiration date of a rights offering or what proportion of the shares will be purchased as a result of such rights offering. Any dilution could be substantial and may be compounded by any subsequent rights offering the Trust may undertake.
U.S. Federal Income Tax Consequences of an Issuance of Subscription Rights to Common
Shareholders
The following is a summary of the material U.S. federal income tax consequences of an issuance
of subscription rights to our common shareholders pursuant to this prospectus (for purposes of this
section, each such issuance is referred to as an offer and each subscription right, a right),
under the provisions of the Code, U.S. Treasury regulations promulgated under the Code (Treasury
regulations), and other applicable authority in effect as of the date of the prospectus that are
generally applicable to common shareholders and other holders of rights to purchase common shares
who are United States persons within the meaning of the Code. This summary does not address any
state, local, foreign or other tax consequences. These authorities may be changed, possibly with
retroactive effect, or subject to new legislative, administrative, or judicial action. Common
shareholders or other holders of rights should consult their tax advisors regarding the tax
consequences, including U.S. federal, state, or local, or foreign or other tax
consequences, relevant to their particular circumstances. This summary assumes that the
rights are issued separately by the Trust, and not part of a unit consisting of two or more
securities.
The Trust believes that the value of any right issued pursuant to an offer will not be
includible in the income of a common shareholder at the time the right is issued, and the Trust
will not report to the IRS that a common shareholder has income as a result of the issuance of the
right; however, depending on the specific terms of the offer, there may be no guidance directly on
point concerning certain aspects of the taxation of the offer. The remainder of this discussion
assumes that the receipt of the rights by common shareholders will not be a taxable event for U.S.
federal income tax purposes.
The basis of a right issued to a common shareholder will be zero and the basis of the common
share(s) with respect to which the right was issued (the Old Share(s)) will remain unchanged,
except that the shareholder must allocate the basis of the Old Share(s)
84
and the right in proportion
to their respective fair market values on the date of distribution if (i) 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(s) on that date, or (b) the shareholder affirmatively elects (in the manner set out
in Treasury regulations) to allocate to the right a portion of the basis of the Old Share(s) and
(ii) the right does not expire unexercised in the hands of the shareholder (i.e., the shareholder
either exercises or sells the right following its issuance).
No loss will be recognized by a common shareholder if a right distributed to such shareholder
expires unexercised in the hands of such shareholder. The basis of a right purchased in the market
generally will be its purchase price. If a right that has been purchased in the market expires
unexercised, the holder will recognize a loss equal to the basis of the right.
Any gain or loss on the sale of a right or, in the case of rights purchased in the market, any
loss from a right that expires unexercised, will be a capital gain or loss if the right is held as
a capital asset (which, in the case of rights issued to common shareholders, will normally depend
on whether the Old Shares are held as capital assets), and will be a long-term capital gain or loss
if the holding period of the right exceeds (or is deemed to exceed) one year. The deductibility of
capital losses is subject to limitation. The holding period of a right issued to a common
shareholder will include the holding period of the Old Share(s).
No gain or loss will be recognized by a holder upon the exercise of a right, and the basis of
any common 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. When a holder exercises a right, the
holders holding period in the New Share(s) does not include the time during which the holder held
the unexercised right; the holding period of the New Share(s) will begin no later than the date
following the date of exercise of the right.
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 may also be treated as distributed to the IRA depositor.
For more information relating to the U.S. federal income tax consequences of an investment in
the Trust, see Tax Matters below and Tax Matters in the Statement of Additional Information.
Previous Rights Offerings
On January 18, 2008, the Trust
offered subscription rights to its common shareholders. The net proceeds from this rights
offering was $143.6 million, and 85% of these proceeds were used to purchase loans, with the
remaining 15% used to purchase bonds. The Trust was able to fully invest the proceeds within
two months of the rights offering.
EMPLOYEE PLAN CONSIDERATIONS
Shareholders
whose common shares are held in employee benefit plans subject to the Employee
Retirement Income Security Act of 1974 (ERISA) or Section 4975 of the Code (including corporate
savings and 401(k) plans, Keogh or H.R. 10 plans of self-employed individuals and individual
retirement accounts) (each, a Plan) should be aware that additional contributions of cash to the
Plan (other than rollover contributions or trustee-to-trustee transfers from other Plans) in order
to exercise rights would be treated as contributions to such 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 Plans qualified under Section 401(a) of the Code and
certain other 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 a Plan.
ERISA contains fiduciary responsibility requirements, and ERISA and the Code contain prohibited
transaction rules that may affect the exercise or transfer of rights. Due to the complexity of
these rules and the penalties for noncompliance, fiduciaries of Plans and other retirement plans
should consult with their counsel and other advisers regarding the consequences of their exercise
or transfer of rights under ERISA and the Code. Additional special
issues may arise in the case of any Plan sponsored or maintained by
the Trust or any affiliate thereof.
CREDIT FACILITY AND NOTES
The Trust currently leverages through borrowings from a secured revolving credit facility and
secured notes. The Trust has entered into a secured Credit Agreement with SSB to borrow up to
$125,000,000. Such borrowings constitute financial leverage. The Credit Agreement contains
customary covenant, negative covenant and default provisions, including covenants that limit the
Trusts ability to: (i) pay dividends in certain circumstances, (ii) incur additional debt, or
(iii) consolidate or merge into or with any person, other than as permitted by the Credit
Agreement, or sell, lease or otherwise transfer, directly or indirectly, all or substantially all
of its assets. In addition, the Trust agreed not to purchase assets not contemplated by the
investment policies and restrictions in effect when
the Credit Agreement became effective. The prohibition on the payment of dividends might
impair the ability of the Trust to meet the RIC distribution requirements and to avoid Trust-level
U.S. federal income or excise taxes. Furthermore, the Trust may not incur additional debt from any
other party, except in limited circumstances (e.g., in the ordinary course of business).
Additionally, on April 16, 2010, the Trust issued notes with a term of five years to
Metropolitan Life Insurance and some of its affiliates in a total amount of $120,000,000, and
subsequently provided security for the notes. Such borrowings constitute financial leverage.
Under the terms of the note purchase agreement, the Trust may be restricted from paying dividends
under certain circumstances. Such a prohibition on the payment of dividends might impair the
ability of the Trust to meet the RIC distribution requirements and to avoid Trust-level U.S.
federal income or excise taxes.
85
Any senior security representing indebtedness, as defined in Section 18(g) of the Investment
Company Act, must have asset coverage of at least 400%. Debt incurred under the Credit Agreement
will be considered a senior security for this purpose.
Market and Net Asset Value Information
The Trusts common shares are listed on the NYSE under the symbol HCF. The Trusts common
shares commenced trading on the NYSE in June 2006. In the relatively short trading history of the
Trusts common shares, the Trusts common shares have traded at both a premium and a discount to
net asset value. 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 Trusts 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 Trusts common shares on the NYSE, the corresponding net asset value per share
on such dates and the corresponding premium/discount to net asset value per share on such dates.
See Net Asset Value for information as to how the Trusts net asset value is determined.
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Premium/ |
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(Discount) as a % |
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Market Price |
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Net Asset Value per Share |
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of Net Asset Value |
Quarter |
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High |
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Low |
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High |
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Low |
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High |
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Low |
1st Quarter 2009 |
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$ |
6.30 |
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$ |
4.27 |
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$ |
6.73 |
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$ |
6.15 |
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(6.4 |
)% |
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(30.7 |
)% |
2nd Quarter 2009 |
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$ |
5.20 |
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$ |
4.69 |
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$ |
6.11 |
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$ |
6.00 |
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(14.9 |
)% |
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(21.9 |
)% |
3rd Quarter 2009 |
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$ |
6.35 |
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$ |
4.95 |
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$ |
6.89 |
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$ |
6.28 |
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(7.8 |
)% |
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(21.2 |
)% |
4th Quarter 2009 |
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$ |
6.46 |
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$ |
6.01 |
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$ |
7.18 |
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$ |
7.05 |
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(10.1 |
)% |
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(14.8 |
)% |
1st Quarter 2010 |
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$ |
7.96 |
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$ |
6.37 |
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$ |
7.50 |
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$ |
7.21 |
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6.1 |
% |
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(11.7 |
)% |
2nd Quarter 2010 |
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$ |
8.20 |
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$ |
6.93 |
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$ |
7.64 |
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$ |
7.46 |
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7.3 |
% |
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(7.1 |
)% |
3rd Quarter 2010 |
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$ |
7.49 |
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$ |
6.91 |
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$ |
7.42 |
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$ |
7.29 |
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1.0 |
% |
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(5.2 |
)% |
4th Quarter 2010 |
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$ |
7.89 |
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$ |
6.91 |
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$ |
7.76 |
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$ |
7.59 |
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1.62 |
% |
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(2.5 |
)% |
The
Trusts net asset value per common share at the close of
business on July 22, 2011 (the
last trading date prior to the date of this prospectus on which the Trust determined its net asset
value) was $7.56, and the last reported sale price of a common share on the NYSE on that day was
$7.55, a discount to net asset value of 0.13%.
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. 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 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. 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 Trusts Agreement and Declaration of Trust requires the favorable vote of a
majority of the Board 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
86
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 Trusts 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 Trusts 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 and 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 believes, however, that the
closed-end structure is desirable in light of the Trusts investment objectives and policies.
Therefore, you should assume that it is not likely that the Board 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
Trusts 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 Trusts
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 Agreement and Declaration of Trust also provides that the Trust may be liquidated upon the
approval of 80% of the trustees.
The Board has determined that provisions with respect to the Board 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 Trusts Agreement and Declaration of Trust, on file with
the Commission, for the full text of these provisions, the material terms of which are summarized
in this prospectus.
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 funds 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 Board 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 Board 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 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; Discount
Shares of closed-end investment companies often trade at a discount to their net asset value,
and the Trusts 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
87
market price of the Trusts
common shares will be determined by such factors as relative demand for and supply of such common
shares in the market, the Trusts net asset value, general market and economic conditions and other
factors beyond the control of the Trust. See Net Asset Value. Although the Trusts 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. The Board 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 Trusts 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.
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 Trusts 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
Trusts 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. See the Trusts Statement of Additional Information for a
discussion of the U.S. federal income tax implications of a repurchase or tender offer by the
Trust.
Before deciding whether to take any action if the common shares trade below net asset value,
the Board would likely consider all relevant factors, including the extent and duration of the
discount, the liquidity of the Trusts 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
Trusts shares should trade at a discount, the Board may determine that, in the interest of the
Trust and its shareholders, no action should be taken.
Tax Matters
The following is a general summary of some of the important U.S. federal income tax considerations
affecting the Trust and its common shareholders that are United States persons within the meaning
of the Code, and does not address any state, local, foreign or other tax consequences. It reflects
provisions of the Code, existing Treasury regulations, and other applicable authority, as of the
date of this prospectus. These authorities may be changed, possibly with retroactive effect, or
subject to new legislative, administrative, or judicial interpretations. This summary does not
purport to be a complete description of the U.S. federal income tax considerations applicable to
common shareholders of the Trust. For example, we have not described certain tax considerations
that may be relevant to certain types of holders subject to special treatment under the U.S.
federal income tax laws, including shareholders subject to the U.S. federal alternative minimum
tax, insurance companies, tax-exempt organizations, pension plans and trusts, RICs, dealers in
securities, shareholders holding Trust shares through tax-advantaged accounts (such as 401(k) plans
or IRAs), financial institutions, and shareholders holding Trust shares as part of a hedge,
straddle, or conversion transaction. This summary assumes that investors hold Trust common shares
as capital assets (within the meaning of the Code). Your investment in the Trust may have other tax
implications. Please consult your tax advisor about U.S. federal, state, local, foreign or other
tax laws applicable to you, as tax matters are very complex and the tax consequences to an investor
in the Trusts common shares will depend on the facts of his, her or its particular situation. For
more information, including a summary of certain tax consequences of investing in the Trust for
non-U.S. persons, please see the Statement of Additional Information under Tax Matters.
This summary does not discuss the tax consequences of an investment in subscription rights of the
Trust, separately, or as part of a unit consisting of two or more securities. See Description of
Capital StructureSubscription Rights above for a discussion of the material U.S. federal income
tax consequences of the Trusts issuance of subscription rights to common shareholders.
The Trust has elected to be treated as a RIC under Subchapter M of the Code and intends each year
to qualify and to be eligible to be treated as such. In order to qualify for the special tax
treatment accorded RICs and their shareholders, the Trust must, among other things:
(i) derive at least 90% of its gross income for each taxable year from: (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) net income derived
from interests in qualified publicly traded partnerships;
88
(ii) diversify its holdings so that, at the end of each quarter of the Trusts taxable year, (a) at
least 50% of the market value of the Trusts total assets consists of cash and cash items, U.S.
government securities, the securities of other RICs and other securities limited, in respect of any
one issuer, to an amount not greater than 5% of the value of the Trusts 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 Trusts total assets is invested (x) in the securities (other than U.S. government
securities and the securities of other RICs) of any one issuer or of two or more issuers that the
Trust controls, as determined under applicable Code rules, and that are determined to be engaged in
the same business or similar or related trades or businesses, or (y) in the securities of one or
more qualified publicly traded partnerships; and
(iii) distribute to its shareholders with respect to each taxable year at least 90% of the sum of
its investment company taxable income (as that term is defined in the Code, without regard to the
deduction for dividends paidgenerally taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and any net tax-exempt interest income,
for such year.
In general, a RIC is not subject to tax at the corporate level on income and gains from investments
that are distributed to shareholders provided they comply with these ongoing requirements. However,
the Trusts failure to comply with one or more of these requirements would result in Trust-level
taxation and consequently a reduction in income available for distribution to shareholders.
Amounts not distributed on a timely basis in accordance with a calendar-year distribution
requirement are subject to a nondeductible 4% federal excise tax at the Trust level. To avoid the
tax, the Trust must distribute during each calendar year an amount at least equal to the sum of (i)
98% of its ordinary income (not taking into account any capital gains or losses) for the calendar
year, (ii) 98.2% of its capital gains in excess of its capital losses (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 Trusts taxable year) and (iii) any such undistributed income from
the prior year. For these purposes, the Trust will be treated as having distributed any amount on
which it has been subject to corporate income tax in the taxable year ending with the calendar
year. The Trust reserves the right to pay the excise tax when circumstances warrant.
Certain of the Trusts investment practices, including Derivative Transactions, short sales and
hedging activities generally, as well as the Trusts investments in certain types of securities,
including loans or other debt obligations issued or purchased at a discount and preferred stock,
may be subject to special and complex U.S. federal income tax provisions that may, among other
things: (i) disallow, suspend or otherwise limit the allowance of certain losses or deductions,
(ii) convert lower taxed long-term capital gain or qualified dividend income into higher taxed
short-term capital gain or ordinary income, (iii) accelerate the recognition of income, (iv)
convert short-term losses into long-term losses, (v) cause the Trust to recognize income or gain
without a corresponding receipt of cash, (vi) adversely affect the time a purchase or sale of stock
or other securities is deemed to occur, (vii) cause adjustments in the holding periods of the
Trusts securities, or (viii) otherwise adversely alter the characterization of certain complex
financial transactions. These U.S. federal income tax provisions could therefore affect the amount,
timing and/or character of distributions to shareholders. In particular, the Trust expects that a
substantial portion of the Trusts investments in loans and other debt obligations will be treated
as having market discount and/or original issue discount for U.S. federal income tax purposes,
which, in some cases, could be significant, and could cause the Trust to recognize income in
respect of these investments before, or without receiving, cash representing such income. The Trust
may be required to, among other things, dispose of securities, including at potentially
disadvantageous times or prices, to (i) mitigate the effect of these, as well as certain of the
other provisions described above, (ii) prevent the Trusts disqualification as a RIC, or (iii)
avoid incurring Trust-level U.S. federal income or excise taxes.
Investments in distressed debt obligations that are at risk of or are in default present
special tax issues for the Trust. Tax rules are not entirely clear about issues such as whether and
to what extent the Trust should recognize market discount on a distressed debt obligation, when the
Trust may cease to accrue interest, original issue discount or market discount, when and to what
extent the Trust may take deductions for bad debts or worthless securities and how the Trust should
allocate payments received on obligations in
default between principal and income. These and other related issues will be addressed by the
Trust as necessary, in order to seek to ensure that it distributes sufficient income to preserve
its status as a RIC and that it does not become subject to Trust-level U.S. federal income or
excise taxes.
Special tax rules may change the treatment of gains and losses recognized by the Trust when
the Trust invests in certain foreign debt securities or engages in foreign currency transactions.
The application of these special rules may accelerate or increase the Trusts recognition of
ordinary income or loss, and affect the timing, amount and/or character of distributions made by
the Trust. In addition, dividend, interest, capital gains 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, and therefore shareholders will not be entitled
to claim a credit or deduction for such taxes on their own tax returns. Foreign taxes paid by or
withheld from the Trust will reduce the return from the Trusts underlying investments.
89
Distributions paid to shareholders by the Trust from its net realized long-term capital gains
(that is, the excess of any net long-term capital gain over net short-term capital loss) that the
Trust reports (generally on an IRS Form 1099) as capital gain dividends (capital gain dividends)
are generally taxable to you as long-term capital gains, regardless of how long you have held your
shares. Long-term capital gain rates applicable to shareholders taxed at individual rates have been
temporarily reduced in general, to 15% with a 0% rate applying to taxpayers in the 10% and 15%
rate brackets for taxable years beginning before January 1, 2013. These reduced rates will
expire for taxable years beginning on or after January 1, 2013, unless Congress enacts legislation
providing otherwise. All other dividends paid to you by the Trust (including dividends from net
investment income and from short-term capital gains (that is, the excess of any net short-term
capital gain over any net long-term capital loss)) from its earnings and profits are generally
taxable to you as ordinary income. For taxable years beginning before January 1, 2013,
distributions of investment income reported (generally on an IRS Form 1099) by the Trust as derived
from qualified dividend income will be taxed in the hands of shareholders taxed at individual
rates at the rates applicable to long-term capital gains, provided holding periods and other
requirements are met at both the shareholder and Trust levels. This provision will expire for
taxable years beginning on or after January 1, 2013, unless Congress enacts legislation providing
otherwise. It is not generally expected that a significant portion of Trust distributions will
qualify for favorable tax treatment as qualified dividend income for shareholders taxed at
individual rates or as income eligible for the dividend-received deduction for corporate
shareholders.
If, for any taxable year, the Trusts total distributions exceed both current earnings and
profits and accumulated earnings and profits, the excess will generally be treated as a tax-free
return of capital up to the amount of your tax basis in the shares. The amount treated as a
tax-free return of capital will reduce your tax basis in the shares, thereby increasing your
potential gain or reducing your potential loss on the subsequent sale of the shares. Any amounts
distributed to you in excess of your tax basis in the shares will be taxable to you as capital
gain.
Dividends and other taxable distributions are taxable to you even if they are reinvested in
additional common shares of the Trust under the Trusts Dividend Reinvestment Plan. If your
dividends and other distributions are reinvested in common shares under the Dividend Reinvestment
Plan, you generally will be treated as having received a dividend equal to either (i) if common
shares are purchased on the open market on your behalf, the amount of cash allocated to you for the
purchase of such common shares, or (ii) if newly issued common shares are issued to you, generally,
the fair market value of such new common shares. 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 (generally on an IRS Form 1099) after the end of each year
setting forth the amount and tax status of any distributions paid to you by the Trust.
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. Any such gain or loss generally will
be long-term capital gain or loss if you have held (or are treated as having held) such shares for
more than one year at the time of sale. All or a portion of any loss you realize on a taxable sale
or exchange of your shares of the Trust will be disallowed if you acquire other shares of the Trust
(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 shares. In such
case, the basis of the shares acquired will be adjusted to reflect the disallowed loss. In
addition, any loss realized upon a taxable sale or exchange of Trust
shares held (or deemed held) by you for six months or less will be treated as long-term,
rather than short-term, to the extent of any capital gain dividends received (or deemed received)
by you with respect to those shares.
Rules enacted in March 2010 generally impose a new reporting and 30% withholding tax regime with respect to certain
U.S.-source income, including dividends and interest, and gross proceeds from the sale or other disposal of property
that can produce U.S.-source interest or dividends. The IRS has issued only preliminary guidance with respect to these
new rules. Very generally, beginning in 2014 or 2015, depending on the type of payments, these rules will require that
distributions to a common shareholder by the Trust, including the redemption of shares, be subject to the 30%
withholding tax, unless the common shareholder provides certain information, certifications, or other documentation, as
the Trust requires, to comply with the rules. For more information, see the Statement of Additional Information.
The Trust may be required to withhold, for U.S. federal backup withholding tax purposes,
currently at a rate of 28%, a portion of the dividends, distributions and redemption proceeds
payable to a non-corporate shareholder who fails to provide the Trust (or its agent)
90
with the
shareholders correct taxpayer identification number (in the case of an individual, generally, such
individuals 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. 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 is PFPC Trust Company (301 Bellevue Parkway,
Wilmington, DE 19809; telephone (877) 665-1287). The custodian performs custodial services for the
Trust. BNY Mellon Investment Servicing (US) Inc. (101 Sabin Street, Pawtucket, RI 02860; telephone
(877) 665-1287) serves as the Trusts transfer agent with respect to its common shares.
Legal Opinion
Certain legal matters in connection with the securities will be passed upon for the Trust by
Smith, Katzenstein & Jenkins, LLP, Wilmington, Delaware, special Delaware counsel to the Trust. If certain legal matters in connection with an offering
of securities are passed upon by counsel for the underwriters or sales agent of such offering, such
counsel will be named in a prospectus supplement.
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 Trusts 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.
No dealer, salesperson or any other person has been authorized to give any information or to
make any representations other than those contained in this prospectus in connection with the
Offering and, if given or made, such information or representations must not be relied upon as
having been authorized by the Trust, the Investment Adviser, or the Dealer Manager. This prospectus
does not constitute an offer to sell or the solicitation of any offer to buy any security other
than the common shares of the Trust offered by this prospectus, nor does it constitute an offer to
sell or a solicitation of any offer to buy the common shares of the Trust by anyone in any
jurisdiction in which such offer or solicitation is not authorized, or in which the person making
such offer or solicitation is not qualified to do so, or to any such person to whom it is unlawful
to make such offer or solicitation. Neither the delivery of this prospectus nor any sale made
hereunder shall, under any circumstances, create any implication that information contained herein
is correct as of any time subsequent to the date hereof. However, if any material change occurs
while this prospectus is required by law to be delivered, the prospectus will be amended or
supplemented accordingly.
Where You Can Find Additional Information
We have filed with the Commission a registration statement on Form N-2 together with all
amendments and related exhibits under the Securities Act. The registration statement contains
additional information about us and the securities being offered by this prospectus.
We file annual and semi-annual reports, proxy statements and other information with the
Commission. You can inspect any materials we file with the Commission, without charge, at the
Commissions Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the
Commission at 1-800-SEC-0330 for further information on the Public Reference Room. The information
we file with the Commission is available free of charge by contacting us at NexBank Tower, 13455
Noel Road, Suite 800, Dallas, Texas 75240 or by telephone at (877) 665-1287 or on our web site at
www.highlandfunds.com. The Commission also maintains a web site that contains reports, proxy
statements and other information regarding registrants, including us, that file such
91
information
electronically with the Commission. The address of the Commissions web site is www.sec.gov. Unless
specifically incorporated into this prospectus, documents contained on our web site or on the
Commissions web site about us are not incorporated into this prospectus and should not be
considered to be part of this prospectus.
92
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
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93
Highland Credit Strategies Fund
Common Shares
Subscription Rights
PRELIMINARY PROSPECTUS
[_____________], 2011
The information in this Prospectus Supplement 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 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 _______
PRELIMINARY PROSPECTUS SUPPLEMENT
(To Prospectus dated _______, 2011)
Highland Credit Strategies Fund
Common Shares
The date of this prospectus is ________
We are offering for sale _______ of our common shares. Our
common shares are traded on the New York Stock Exchange under the symbol HCF. The last reported
sale price for our common shares on _______, _______ was $_______ per share.
The net asset value of the Trusts common shares at the close of business on [ ] was $[ ] per
share.
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Per Share |
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The aggregate expenses of the offering are estimated to be
$_______, which represents approximately $_______ per share. |
The underwriters may also purchase up to an additional _______ common
shares from us at the public offering price, less underwriting discounts and commissions, to cover
over-allotments, if any, within 30 days after the date of this Prospectus Supplement. If the
over-allotment option is exercised in full, the total proceeds, before expenses, to the Trust would
be $_______ and the total underwriting discounts and commissions would be $_______. The common shares will be
ready for delivery on or about _____, _.
You should read this Prospectus Supplement and the accompanying Prospectus before deciding
whether to invest in our common shares and retain them for future reference. The Prospectus
Supplement and the accompanying Prospectus contain important information about us. Material that
has been incorporated by reference and other information about us can be obtained from us by
calling 1-877-665-1287 or by writing to the Trust at NexBank Tower, 13455 Noel Road, Suite 800,
Dallas, Texas 75240. The Trusts Statement of Additional Information relating to this offering and
annual and semi-annual reports are available, free of charge, on the Trusts web site
www.highlandfunds.com. You can obtain the same information, free of charge, from the Securities and
Exchange Commissions web site at www.sec.gov.
Investing in our securities involves a high degree of risk and may be considered speculative.
You should review the information set forth under Principal Risks of the Trust on page ___ of the
accompanying Prospectus before investing in our common shares.
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.
S-1
Table of Contents
Prospectus Supplement
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Prospectus
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S-2
ABOUT THIS PROSPECTUS SUPPLEMENT
You should rely only on the information contained or incorporated by reference in this
Prospectus Supplement and the accompanying Prospectus. Neither the Trust nor the underwriters have
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 making an offer
to sell these securities in any jurisdiction where the offer or sale is not permitted. The
information in this Prospectus Supplement and the accompanying Prospectus is accurate only as of
the date of this Prospectus Supplement or the Prospectus, as applicable, and under no circumstances
should the delivery of this Prospectus Supplement or the accompanying Prospectus or the sale of any
securities imply that the information in this Prospectus Supplement or the accompanying Prospectus
is accurate as of any later date or that the affairs of the Trust have not changed since the date
hereof or thereof. Our business, financial condition, results of operations and prospects may have
changed since then. We will update the information in these documents to reflect material changes
only as required by law.
This document has two parts. The first part is this Prospectus Supplement, which describes the
terms of this offering of common shares and also adds to and updates information contained in the
accompanying Prospectus. The second part is the accompanying Prospectus, which gives more general
information and disclosure. To the extent the information contained in this Prospectus Supplement
differs from or is additional to the information contained in the accompanying Prospectus, you
should rely only on the information contained in this Prospectus Supplement. You should read this
Prospectus Supplement and the accompanying Prospectus together with the additional information
described under the heading Where You Can Find Additional Information before investing in our
common shares.
Cautionary Notice Regarding Forward-Looking Statements
This Prospectus Supplement and the accompanying Prospectus contain forward-looking
statements. Forward-looking statements relate to future events or the Trusts future financial
performance. Forward-looking statements can generally be identified by terminology such as may,
will, should, expects, plans, anticipates, could, intends, target, projects,
contemplates, believes, estimates, predicts, potential or continue or the negative of
these terms or other similar words. Important assumptions in forward-looking statements include the
Trusts ability to acquire or originate new investments and to achieve certain margins and levels
of profitability. In light of these and other uncertainties, the inclusion of a projection or
forward-looking statement should not be regarded as a representation by the Trust that its plans or
objectives will be achieved.
There are a number of important risks and uncertainties that could cause the Trusts actual
results to differ materially from those indicated by such forward-looking statements. These risks
include, but are not limited to, the following:
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Changes in interest rates; |
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Risks associated with investing in high yield securities (also known as junk
securities), senior loans and other debt and equity securities; |
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Risks of investing in obligations of stressed, distressed and bankrupt issuers; |
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Risks associated with the Trusts use of leverage; |
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Derivatives and structured finance securities risk; and |
For a discussion of these and additional risks as well as other factors that could cause the
Trusts actual results to differ from forward-looking statements contained in this Prospectus
Supplement and the accompanying Prospectus, please see the discussion under Principal Risks of the
Trust in the accompanying Prospectus. You should not place undue reliance on these forward-looking
statements. The forward-looking statements made in this
Prospectus Supplement and the accompanying Prospectus relate only to events as of the date on
which the
S-3
statements are made. The Trust undertakes no obligation to update any forward-looking
statement to reflect events or circumstances occurring after the date of this Prospectus Supplement
and the accompanying Prospectus, as applicable, except as required by federal securities laws.
The forward-looking statements contained in this Prospectus Supplement and the accompanying
Prospectus are excluded from the safe harbor protection provided by Section 27A of the Securities
Act of 1933 and the forward looking statements contained in our periodic reports are excluded from
the safe harbor protection provided by Section 21E of the Securities Exchange Act of 1934.
S-4
SUMMARY OF TRUST FEES AND EXPENSES
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Shareholder Transaction Expenses |
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Sales load (as a percentage of offering price) |
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[ ] |
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Offering expenses borne by the holders of common shares
(as a percentage of offering price) |
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[ ] |
% |
Dividend reinvestment and cash purchase plan fees |
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Percentage of Net Assets |
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Borrowings(2)) |
Annual Expenses |
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Management fees |
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[ ] |
%(3) |
Other expenses |
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%(4) |
Interest payments on borrowed funds |
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%(5) |
Total annual expenses |
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[ ] |
% |
The purpose of this table is to assist the investor in understanding the various costs and
expenses that an investor in the Trust will bear directly or indirectly.
EXAMPLE
The following example illustrates the projected expenses that you would pay on a $1,000
investment in common shares of the Trust (including the total sales load of $[ ] and the other
estimated costs of this offering to be borne by the Trust of $[___]), assuming (1) that the Trusts
current net assets do not increase or decrease, (2) that the Trust maintains a leverage ratio of [
]% from all sources of leverage, (3) that the Trust incurs total annual expenses of [ ]% of net
assets attributable to common shares through year 10, and (4) a 5% annual return. The following
example also assumes all dividends and distributions are reinvested at net asset value. The
example should not be considered a representation of future expenses, and actual expenses
(including leverage and other expenses) may be greater or less than those shown.
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3 Years |
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5 Years |
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10 Years |
Total expenses incurred |
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[ ] |
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[ ] |
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[ ] |
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[ ] |
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Common shareholders will be charged a $[ ] service charge and pay a
brokerage commission of $[ ] per share sold if they direct the Plan
Agent (as defined in the accompanying Prospectus) to sell common
shares held in a dividend reinvestment account. Each participant in
the Trusts 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. See Dividend Reinvestment
Plan in the accompanying Prospectus. |
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(2) |
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Assumes leverage in the amount of [ ]% of net assets. The Trust
currently employs leverage in an amount equal to [ ]% of net assets.
The Trust may use leverage through borrowings and/or preferred shares.
The Trust currently borrows under secured, privately placed notes and
a secured revolving credit facility. See Principal Risks of the Trust
Leverage Risk in the accompanying Prospectus for a brief
description of the Trusts Notes with Metropolitan Life Insurance
Company and affiliates and the Credit Agreement with State Street Bank
and Trust Company. However, the Trust has no present intention to
issue preferred shares in the next twelve months. |
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(3) |
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Management fees are the investment advisory and administrative
services fees paid to the Investment Adviser, which are computed based
on Managed Assets. See Management of the Trust Investment Adviser
and Management of the Trust Administrator/Sub-Administrator in
the accompanying Prospectus. Such fees |
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S-5
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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
Trusts leverage of 20% of the Trusts total assets as of December 31,
2010). Because the base management fees of [ ]% are based on the
rusts gross assets, when the Trust uses leverage, the base management
fees as a percentage of net assets attributable to common shares will
increase because the Trusts common shareholders bear all of the fees
and expenses of the Trust. |
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(4) |
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Other Expenses, which is based on the Trusts estimated current
expenses, includes costs associated with the Trusts short sales on
securities, including dividend and interest expenses associated with
securities sold short. When a cash dividend is declared or interest is
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
issuers ex-dividend or ex-interest date). Other Expenses also
includes the dividend and interest expense that the Trust is expected
to incur during the current fiscal year. |
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(5) |
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Interest payments on borrowed funds is estimated based on the
interest rate currently in effect with respect to the Trusts credit
facility and includes the ongoing commitment fees payable under the
terms of the credit facility. |
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S-6
USE OF PROCEEDS
We estimate the total net proceeds of the offering to be $______ ($_____ if the over-allotment
option is exercised in full), based on the public offering price of $_____ per share and after deducting
underwriting discounts and commissions and estimated offering expenses payable by us.
The Trust will invest the net proceeds of any sales of common shares in accordance with the
Trusts investment objectives and policies as stated in the accompanying Prospectus, or use such
proceeds for other general corporate purposes. Assuming current market conditions, the Trust
estimates that the net proceeds of the offering will be substantially invested in accordance with
its investment objectives and policies within one to three months of the completion of the
offering. Pending such investment, it is anticipated that the proceeds of the offering will be
invested in short-term debt securities. These temporary investments are expected to provide a lower
net return than we hope to achieve from our targeted investments. The Trust does not expect to use
any part of the proceeds to repay any of its outstanding debt under the Credit Agreement. Following
the completion of the offering, the Trust may increase the amount of leverage outstanding. See Use
of Leverage in the accompanying Prospectus.
Although the Trust may issue debt securities or preferred shares in the future, it has no present intention to do so in the
twelve months following the offering.
FINANCIAL HIGHLIGHTS
[To be provided.]
PRICE RANGE OF COMMON SHARES
The following table sets forth for the quarters indicated, the high and low sale prices on the
New York Stock Exchange per share of our common shares and the net asset value and the premium or
discount from net asset value per share at which the common shares were trading, expressed as a
percentage of net asset value, at each of the high and low sale prices provided.
[To be provided.]
The last reported price for our common shares on _______, ____ was $_____ per share.
PLAN OF DISTRIBUTION
[To be provided.]
LEGAL OPINION
Certain legal matters will be passed on by Smith, Katzenstein & Jenkins, LLP, Wilmington,
Delaware, special Delaware counsel to the Trust in connection with the offering of the common shares. Certain legal
matters in connection with this offering will be passed upon for the underwriters by .
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission (the Commission) a registration
statement on Form N-2 together with all amendments and related exhibits under the Securities Act of
1933. The registration statement contains additional information about us and the securities being
offered by this Prospectus Supplement and the accompanying Prospectus.
We file annual and semi-annual reports, proxy statements and other information with the
Commission. You can inspect any materials we file with the Commission, without charge, at the
Commissions Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the
Commission at 1-800-SEC-0330 for further
information on the Public Reference Room. The information we file with the Commission is
available free of charge by contacting us at NexBank Tower, 13455 Noel Road, Suite 800, Dallas,
Texas 75240 or by telephone at
S-7
(877) 665-1287 or on our web site at www.highlandfunds.com. The
Commission also maintains a web site that contains reports, proxy statements and other information
regarding registrants, including us, that file such information electronically with the Commission.
The address of the Commissions web site is www.sec.gov. Unless specifically incorporated into this
Prospectus Supplement or the accompanying Prospectus, documents contained on our web site or on the
Commissions web site about us are not incorporated into this Prospectus Supplement or the
accompanying Prospectus and should not be considered to be part of this Prospectus Supplement or
the accompanying Prospectus.
S-8
The information in this Prospectus Supplement 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 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 ______
PRELIMINARY PROSPECTUS SUPPLEMENT
(To Prospectus dated _______, 2011)
Highland Credit Strategies Fund
__________ Rights for _______ Shares
Subscription Rights for Common Shares
The date of this prospectus is ________
We are issuing subscription rights (the Rights) to our common shareholders to
purchase additional shares of our common shares. Our common shares are traded on the New York Stock
Exchange under the symbol HCF. The last reported sale
price for our common shares on _______ ,
_______ was $_______ per share. The net asset value of the Trusts common shares
at the close of business on [ ] was $[ ] per share.
Investing in common shares through Rights involves certain risks that are described in the
Special Characteristics and Risks of the Rights Offering section beginning on page R-[ ] of the
Prospectus Supplement.
SHAREHOLDERS WHO DO NOT EXERCISE THEIR RIGHTS MAY, AT THE COMPLETION OF THE OFFERING, OWN A SMALLER
PROPORTIONAL INTEREST IN THE TRUST THAN IF THEY EXERCISED THEIR RIGHTS. AS A RESULT OF THE OFFERING
YOU MAY EXPERIENCE DILUTION OR ACCRETION OF THE AGGREGATE NET ASSET VALUE OF YOUR COMMON SHARES
DEPENDING UPON WHETHER THE TRUSTS NET ASSET VALUE PER SHARE OF COMMON SHARES IS ABOVE OR BELOW THE
SUBSCRIPTION PRICE ON THE EXPIRATION DATE.
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Per Share |
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(1) |
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The aggregate expenses of the offering are estimated to be $
_______, which represents approximately $_______ per share. |
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The common shares are expected to be ready for delivery in book-entry form through the
Depository Trust Company on or about _____. If the offer is extended, the common shares are
expected to be ready for delivery in book-entry form through the Depository Trust Company on or
about _____.
You should read this Prospectus Supplement and the accompanying Prospectus before deciding
whether to invest in our securities and retain them for future reference. The Prospectus Supplement
and the accompanying Prospectus contain important information about us. Material that has been
incorporated by reference and other information about us can be obtained from us by calling
1-877-665-1287 or by writing to the Trust at NexBank Tower, 13455 Noel Road, Suite 800, Dallas,
Texas 75240. The Trusts Statement of Additional Information relating to this offering and annual
and semi-annual reports are available, free of
charge, on the Trusts web site www.highlandfunds.com. You can obtain the same information, free of
charge, from the Securities and Exchange Commissions web site at www.sec.gov.
R-1
Investing in our securities involves a high degree of risk and may be considered speculative.
You should review the information set forth under Principal Risks of the Trust on page ___ of the
accompanying Prospectus before investing in our common shares.
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.
Table of Contents
Prospectus Supplement
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Plan of Distribution |
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Table of Contents
Prospectus
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Offerings |
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R-2
ABOUT THIS PROSPECTUS SUPPLEMENT
You should rely only on the information contained or incorporated by reference in this
Prospectus Supplement and the accompanying Prospectus. Neither the Trust nor the underwriters have
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 making an offer
to sell these securities in any jurisdiction where the offer or sale is not permitted. The
information in this Prospectus Supplement and the accompanying Prospectus is accurate only as of
the date of this Prospectus Supplement or the Prospectus, as applicable, and under no circumstances
should the delivery of this Prospectus Supplement or the accompanying Prospectus or the sale of any
securities imply that the information in this Prospectus Supplement or the accompanying Prospectus
is accurate as of any later date or that the affairs of the Trust have not changed since the date
hereof or thereof. Our business, financial condition, results of operations and prospects may have
changed since then. We will update the information in these documents to reflect material changes
only as required by law.
This document has two parts. The first part is this Prospectus Supplement, which describes the
terms of this offering of Rights and also adds to and updates information contained in the
accompanying Prospectus. The second part is the accompanying Prospectus, which gives more general
information and disclosure. To the extent the information contained in this Prospectus Supplement
differs from or is additional to the information contained in the accompanying Prospectus, you
should rely only on the information contained in this Prospectus Supplement. You should read this
Prospectus Supplement and the accompanying Prospectus together with the additional information
described under the heading Where You Can Find Additional Information before investing in our
common shares.
Cautionary Notice Regarding Forward-Looking Statements
This Prospectus Supplement and the accompanying Prospectus contain forward-looking
statements. Forward-looking statements relate to future events or the Trusts future financial
performance. Forward-looking statements can generally be identified by terminology such as may,
will, should, expects, plans, anticipates, could, intends, target, projects,
contemplates, believes, estimates, predicts, potential or continue or the negative of
these terms or other similar words. Important assumptions in forward-looking statements include the
Trusts ability to acquire or originate new investments and to achieve certain margins and levels
of profitability. In light of these and other uncertainties, the inclusion of a projection or
forward-looking statement should not be regarded as a representation by the Trust that its plans or
objectives will be achieved.
There are a number of important risks and uncertainties that could cause the Trusts actual
results to differ materially from those indicated by such forward-looking statements. These risks
include, but are not limited to, the following:
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Changes in interest rates; |
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Risks associated with investing in high yield securities (also known as junk
securities), senior loans and other debt and equity securities; |
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Risks of investing in obligations of stressed, distressed and bankrupt issuers; |
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Risks associated with the Trusts use of leverage; |
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Derivatives and structured finance securities risk; and |
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For a discussion of these and additional risks as well as other factors that could cause the
Trusts actual results to differ from forward-looking statements contained in this Prospectus
Supplement and the accompanying Prospectus, please see the discussion under Principal Risks of the
Trust in the accompanying Prospectus. You
should not place undue reliance on these forward-looking statements. The forward-looking
statements made in this
R-3
Prospectus Supplement and the accompanying Prospectus relate only to events
as of the date on which the statements are made. The Trust undertakes no obligation to update any
forward-looking statement to reflect events or circumstances occurring after the date of this
Prospectus Supplement and the accompanying Prospectus, as applicable, except as required by federal
securities laws.
The forward-looking statements contained in this Prospectus Supplement and the accompanying
Prospectus are excluded from the safe harbor protection provided by Section 27A of the Securities
Act of 1933 and the forward looking statements contained in our periodic reports are excluded from
the safe harbor protection provided by Section 21E of the Securities Exchange Act of 1934.
SUMMARY OF THE TERMS OF THE RIGHTS OFFERING
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Terms of the Offering
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[To be provided.] |
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Amount Available for
Primary Subscription
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$[ ] |
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Title
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Subscription Rights for Common Shares |
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Subscription Price
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Rights may be exercised at a price of
$_____ per share of Common Shares (the
Subscription Price). See Terms of the
Offering. |
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Record Date
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Rights will be issued to holders of record
of the Trusts Common Shares on ______,
2011 (the Record Date). See Terms of the
Offering. |
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Number of Rights Issued
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____ Rights will be issued in respect of
each share of Common Shares of the Trust
outstanding on the Record Date. See Terms
of the Offering. |
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Number of Rights Required to
Purchase One Common Share
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A holder of Rights may purchase _____ share
of Common Shares of the Trust for every
____ Rights exercised. The number of Rights
to be issued to a shareholder on the Record
Date will be rounded up to the nearest
number of Rights evenly divisible by ___.
See Terms of the Offering. |
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Over-Subscription Privilege
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[To be provided.] |
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Transfer of Rights
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[To be provided.] |
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Subscription Period
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The Rights may be exercised at any time
after issuance and prior to expiration of
the Rights, which will be 5:00 PM Eastern
Time on ______, 2011 (the Expiration
Date) (the Subscription Period). See
Terms of the Offering and Method of
Exercise of Rights. |
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Offering Expenses
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The expenses of the Offering are expected to
be approximately $[ ]. See Use of
Proceeds. |
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Sale of Rights
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[To be provided.] |
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Use of Proceeds
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The Trust estimates the net proceeds of the
Offering to be approximately $[ ].
This figure is based on the Subscription
Price per share of $_____ and assumes all
new shares of Common Shares offered are
sold and that the expenses related to the
Offering estimated at approximately $[
] are paid. |
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The Investment Adviser anticipates that
investment of the proceeds will be made in
accordance with the Trusts investment
objectives and policies as appropriate
investment opportunities are identified,
which is expected to be substantially |
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R-4
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completed in approximately one to three
months. Pending such investment, the
proceeds will be held in short-term debt
securities. See Use of Proceeds. |
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Taxation/ERISA
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See Taxation. |
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Rights Agent
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[To be provided.] |
DESCRIPTION OF THE RIGHTS OFFERING
[To be provided.]
R-5
SUMMARY OF TRUST FEES AND EXPENSES
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Shareholder Transaction Expenses |
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Sales load (as a percentage of offering price) |
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[ ] |
% |
Offering expenses borne by the holders of common shares
(as a percentage of offering price) |
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[ ] |
% |
Dividend reinvestment and cash purchase plan fees |
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None (1) |
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Percentage of Net Assets |
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Attributable to Common Shares |
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(Assumes Leverage Through |
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Borrowings(2)) |
Annual Expenses |
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Management fees |
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[ ] |
%(3) |
Other expenses |
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[ ] |
%(4) |
Interest payments on borrowed funds |
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[ ] |
%(5) |
Total annual expenses |
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[ ] |
% |
The purpose of this table is to assist the investor in understanding the various costs and
expenses that an investor in the Trust will bear directly or indirectly.
EXAMPLE
The following example illustrates the projected expenses that you would pay on a $1,000
investment in common shares of the Trust (including the total sales load of $[ ] and the other
estimated costs of this offering to be borne by the Trust of $[___]), assuming (1) that the Trusts
current net assets do not increase or decrease, (2) that the Trust maintains a leverage ratio of [
]% from all sources of leverage, (3) that the Trust incurs total annual expenses of [ ]% of net
assets attributable to common shares through year 10, and (4) a 5% annual return. The following
example also assumes all dividends and distributions are reinvested at net asset value. The
example should not be considered a representation of future expenses, and actual expenses
(including leverage and other expenses) may be greater or less than those shown.
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1 Year |
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3 Years |
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5 Years |
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10 Years |
Total expenses incurred |
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$ |
[ ] |
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$ |
[ ] |
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$ |
[ ] |
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$ |
[ ] |
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(1) |
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Common shareholders will be charged a $[ ] service charge and pay a
brokerage commission of $[ ] per share sold if they direct the Plan
Agent (as defined in the accompanying Prospectus) to sell common
shares held in a dividend reinvestment account. Each participant in
the Trusts 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. See Dividend Reinvestment
Plan in the accompanying Prospectus. |
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(2) |
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Assumes leverage in the amount of [ ]% of net assets. The Trust
currently employs leverage in an amount equal to [ ]% of net assets.
The Trust may use leverage through borrowings and/or preferred shares.
The Trust currently borrows under secured, privately placed notes and
a secured revolving credit facility. See Principal Risks of the Trust
Leverage Risk in the accompanying Prospectus for a brief
description of the Trusts Notes with Metropolitan Life Insurance
Company and affiliates and the Credit Agreement with State Street Bank
and Trust Company. However, the Trust has no present intention to
issue preferred shares in the next twelve months. |
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(3) |
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Management fees are the investment advisory and administrative
services fees paid to the Investment Adviser, which are computed based
on Managed Assets. See Management of the Trust Investment Adviser
and Management of the Trust Administrator/Sub-Administrator in
the accompanying Prospectus. Such fees |
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R-6
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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
Trusts leverage of 20% of the Trusts total assets as of December 31,
2010). Because the base management fees of [ ]% are based on the
rusts gross assets, when the Trust uses leverage, the base management
fees as a percentage of net assets attributable to common shares will
increase because the Trusts common shareholders bear all of the fees
and expenses of the Trust. |
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(4) |
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Other Expenses, which is based on the Trusts estimated current
expenses, includes costs associated with the Trusts short sales on
securities, including dividend and interest expenses associated with
securities sold short. When a cash dividend is declared or interest is
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
issuers ex-dividend or ex-interest date). Other Expenses also
includes the dividend and interest expense that the Trust is expected
to incur during the current fiscal year. |
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(5) |
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Interest payments on borrowed funds is estimated based on the
interest rate currently in effect with respect to the Trusts credit
facility and includes the ongoing commitment fees payable under the
terms of the credit facility. |
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R-7
USE OF PROCEEDS
We
estimate the net proceeds of the Offering to be $[ ], based on the Subscription Price per
share of $[ ], assuming all new shares of Common Shares offered are sold and that the expenses
related to the Offering estimated at approximately $[ ] are paid and after deduction of the
underwriting discounts and commissions.
The Trust will invest the net proceeds of any sales of common shares in accordance with the
Trusts investment objectives and policies as stated in the accompanying Prospectus, or use such
proceeds for other general corporate purposes. Assuming current market conditions, the Trust
estimates that the net proceeds of the offering will be substantially invested in accordance with
its investment objectives and policies within one to three months of the completion of the
offering. Pending such investment, it is anticipated that the proceeds of the offering will be
invested in short-term debt securities. These temporary investments are expected to provide a lower
net return than we hope to achieve from our targeted investments. The Trust does not expect to use
any part of the proceeds to repay any of its outstanding debt under the Credit Agreement. Following
the completion of the offering, the Trust may increase the amount of leverage outstanding. See Use
of Leverage in the accompanying Prospectus.
Although the Trust may issue debt securities or preferred shares in the future, it has no present intention to do so in the
twelve months following the offering.
FINANCIAL HIGHLIGHTS
[To be provided.]
PRICE RANGE OF COMMON SHARES
The following table sets forth for the quarters indicated, the high and low sale prices on the
New York Stock Exchange per share of our common shares and the net asset value and the premium or
discount from net asset value per share at which the common shares were trading, expressed as a
percentage of net asset value, at each of the high and low sale prices provided.
[To be provided.]
The last reported price for our common shares on _______, _____ was $_____ per share.
PLAN OF DISTRIBUTION
[To be provided.]
SPECIAL CHARACTERISTICS AND RISKS OF THE RIGHTS OFFERING
Risk is inherent in all investing. Therefore, before investing in the Rights and/or Common
Shares you should consider the risks associated with such an investment carefully. See Principal
Risks of the Trust in the accompanying Prospectus. The following summarizes some of the matters
that you should consider before investing in the Trust through the
Offering:
Dilution. Shareholders who do not exercise their Rights may, at the completion of the
Subscription Period, own a smaller proportional interest in the Trust than if they exercised their
Rights. As a result of the Offering, you may experience dilution in net asset value per share if the
subscription price is below the net asset value per share at the completion of the Subscription
Period. If the Subscription Price per share is below the net asset value per share of the Trusts
shares at the completion of the Subscription Period, you will experience an immediate dilution of
the aggregate net asset value of your shares if you do not
participate in the Offering and you will
experience a reduction in the net asset value per share of your shares whether or not you
participate in the Offering.
The Trust cannot state precisely the extent of this dilution if you do not exercise your
Rights because the Trust does not know what the net asset value per
share will be when the Offering
expires or what proportion of the Rights will be exercised. Assuming, for example, that all Rights
are exercised, the Subscription Price is $[ ] and the Trusts net asset value per share at the
expiration of the Offering is $[ ] (the Funds net asset value as of [ ]), the Trusts net asset
value per share (after payment of estimated offering expenses) would be reduced by approximately $[
] ([ ]%) per share.
R-8
If you do not wish to exercise your Rights, you should consider selling them as set forth in
this Prospectus. The Trust cannot give any assurance, however, that a market for the Rights will
develop or that the Rights will have any marketable value.
Leverage. 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. Following the
completion of the Offering, the
Trusts amount of leverage outstanding will decrease. The leverage of the Trust as of [] was []%.
Assuming no new leverage, after the completion of the Offering, the leverage of the Trust is expected to decrease to []%.
Such a decrease in leverage may only be temporary, and the Trust may subsequently increase the amount of its leverage
as described under Use of Leverage in the accompanying Prospectus.
The use of leverage for investment purposes creates opportunities for greater total returns but at the
same time increases risk. When leverage is employed, the net asset value, market price of the
Common Shares and the yield to holders of Common Shares may be more volatile. Any investment income
or gains earned with respect to the amounts borrowed in excess of the interest due on the borrowing
will augment the Trusts income. Conversely, if the investment performance with respect to the
amounts borrowed fails to cover the interest on such borrowings, the value of the Trusts common
shares may decrease more quickly than would otherwise be the case, and distributions on the Common
Shares would be reduced or eliminated. Interest payments and fees incurred in connection with such
borrowings will reduce the amount of net income available for distribution to common shareholders.
Because the fee paid to the Investment Adviser is calculated on the basis of the Trusts
average weekly net assets, which include the proceeds of leverage, the dollar amount of the
management fee paid by the Trust to the Investment Adviser will be higher (and the Investment
Adviser will be benefited to that extent) when leverage is utilized. The Investment Adviser will
utilize leverage only if it believes such action would result in a net benefit to the Trusts
shareholders after taking into account the higher fees and expenses associated with leverage
(including higher management fees).
The Trusts leveraging strategy may not be successful.
Increase
in Share Price Volatility; Decrease in Share Price. The Offering may result in an
increase in trading of the Common Shares, which may increase volatility in the market price of the
Common Shares. The Offering may result in an increase in the number of shareholders wishing to sell
their Common Shares, which would exert downward price pressure on the price of Common Shares.
Under-Subscription.
It is possible that the Offering will not be fully subscribed.
Under-subscription of the Offering could have an impact on the net
proceeds of the Offering and whether
the Trust achieves any benefits.
Expenses.
All expenses relating to the Rights Offering will be borne by the Trusts
existing shareholders, whether or not such shareholders participate
in the Rights Offering.
TAXATION
[To be provided.]
LEGAL OPINION
Certain legal matters will be passed on by Smith, Katzenstein & Jenkins, LLP, Wilmington,
Delaware, special Delaware counsel to the Trust in connection with the offering of the Rights. Certain legal matters
in connection with this offering will be passed upon for the underwriters by
.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission (the Commission) a registration
statement on Form N-2 together with all amendments and related exhibits under the Securities Act of
1933. The registration statement contains additional information about us and the securities being
offered by this Prospectus Supplement and the accompanying Prospectus.
We file annual and semi-annual reports, proxy statements and other information with the
Commission. You can inspect any materials we file with the Commission, without charge, at the
Commissions Public Reference Room at
100 F Street, N.E., Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for
further
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information on the Public Reference Room. The information we file with the Commission is
available free of charge by contacting us at NexBank Tower, 13455 Noel Road, Suite 800, Dallas,
Texas 75240 or by telephone at (877) 665-1287 or on our web site at www.highlandfunds.com. The
Commission also maintains a web site that contains reports, proxy statements and other information
regarding registrants, including us, that file such information electronically with the Commission.
The address of the Commissions web site is www.sec.gov. Unless specifically incorporated into this
Prospectus Supplement or the accompanying Prospectus, documents contained on our web site or on the
Commissions web site about us are not incorporated into this Prospectus Supplement or the
accompanying Prospectus and should not be considered to be part of this Prospectus Supplement or
the accompanying Prospectus.
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The information in this preliminary Statement of Additional Information 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 Statement of Additional
Information is not an offer to sell these securities and is not soliciting an offer to buy these
securities in any jurisdiction where the offer or sale is not permitted.
Subject
to Completion, Dated July 29, 2011
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 of 1940, as amended (the Investment
Company Act), with limited 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 [_____], which is incorporated by reference
into this Statement of Additional Information. 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 Commissions web site 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
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This Statement of Additional Information is dated [_________]
USE OF PROCEEDS
Pending investment in securities that meet the Trusts investment objectives and policies, the
net proceeds of the Offering 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 Trusts investment
objectives and policies within approximately one to three months after the completion of the
Offering.
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 common shares and 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;
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(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 Trusts 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 Trusts 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
Trusts 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 (excluding certain temporary borrowings).
The Trust will not engage in any secured borrowings constituting senior securities described
under investment restriction number 2 pursuant to which the lenders would be able to foreclose on
more than 33 1/3% of the Trusts total assets, measured at the date of the initial borrowing.
The Trust is also subject to the following non-fundamental restrictions and policies, which
may be changed by the Board of Trustees of the Trust (the Board) and without shareholder
approval. The Trust may not:
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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 Trusts total assets and the Trusts
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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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 companys 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. |
In addition, to comply with the federal tax requirements for qualification as a registered
investment company, the Trusts investments must meet certain diversification requirements. See
Tax Matters.
For purposes of this Statement of Additional Information, a majority of the outstanding
shares means (a) 67% or more of the Trusts outstanding voting securities present at a meeting, if
the holders of more than 50% of its outstanding voting securities are present or represented by
proxy, or (b) more than 50% of its outstanding voting securities, whichever is less.
The percentage limitations applicable to the Trusts 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.
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INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Trusts investment objectives,
policies and techniques that are described in the prospectus.
Short-Term Debt Securities
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 securities, as well as pooled investment
vehicles (for example, money market funds) that invest in these securities:
(1) 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 (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC), whose securities
had historically been supported by the discretionary authority of the U.S. government to purchase
certain obligations of the agencies or instrumentalities but which are now in U.S. government
receivership; 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, because 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. 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 Capital
Management, L.P., the Trusts investment adviser (the Investment Adviser) will consider the
financial condition of the corporation (e.g., earning power, cash flow and other liquidity ratios)
and will continually monitor the corporations ability to meet all of its financial obligations,
because the Trusts 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 stock, 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
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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 issuers
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 securitys investment value. Convertible securities rank
senior to common stock in a corporations 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 securitys 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 securitys 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 credit or securities market investments that are either issued by
entities domiciled outside of the U.S., or denominated in currencies other than the U.S. dollar, or
both (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.
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.
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
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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 Trusts portfolio
resulting from fluctuations in the securities markets and changes in interest rates, to protect the
Trusts 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 the Investment
Advisers 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.
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, including without
limitation the following:
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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 Trusts 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 the Investment Adviser 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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The Trust may also purchase forward currency contracts to enhance income when the
Investment Adviser 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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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 Trusts 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 Trusts 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 the Investment Adviser 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 |
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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. |
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 Trusts
contingent obligations on such puts are covered by assets consisting of cash or 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. 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
entered into for good faith risk management purposes, the Investment Adviser and the Trust 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 Trusts 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 securities having an aggregate net asset value at all times at least equal to the
accrued excess. The Trust will enter into interest rate swap, cap or floor transactions only with
counterparties that are judged by the Investment Adviser to present acceptable credit risk to the
Trust. 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.
Additional 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 Advisers 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 Trusts ability to pursue certain of these strategies may be limited
by applicable regulations of the CFTC. The Trusts Derivative
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Transactions may accelerate and/or increase the amount of taxes payable by shareholders. In
addition, the Trusts ability to engage in certain Derivative Transactions may be limited by tax
considerations. See Tax Matters below for more information.
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 Trusts 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 Trusts 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
7
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 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 Trusts 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 Board 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 on an ongoing basis cash, U.S. government securities, or other
liquid securities in an amount at least equal to the Trusts net 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 Trusts 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 use of Derivative Transactions for hedging purposes may reduce the risk of loss due to
a decline in the value of an underlying securities position, at the same time such use tends 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
Advisers 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 ongoing 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.
Portfolio Turnover
The Trusts annual portfolio turnover rate may vary greatly from year to year. Although the
Trust cannot accurately predict its annual portfolio turnover rate, it is not expected to exceed
100% under normal circumstances. For the fiscal year ended December 31, 2009, the portfolio
turnover rate was 88%, and for the fiscal year ended December 31, 2010 the portfolio turnover rate
was 91%. Portfolio turnover rate is not considered a limiting factor in the execution of investment
decisions for the Trust. There are no limits on the rate of portfolio turnover, and investments may
be sold without regard to length of time held when the Trusts investment strategy so dictates. A
higher portfolio turnover rate results in correspondingly greater brokerage commissions and other
transactional expenses that are borne by the Trust. High portfolio turnover may result in the
realization of net short-term capital gains by the Trust which, when distributed to common
shareholders, will be taxable as ordinary income. See Tax Matters.
OTHER INVESTMENT POLICIES AND TECHNIQUES
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
8
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 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 Securities
The Trust may invest in Pay-in-kind, or PIK securities. PIK securities are securities which
pay interest through the issuance of additional debt or equity securities. Similar to zero coupon
obligations, PIK securities also carry additional risk as holders of these types of securities
typically do not receive cash until the final payment date on the security unless such security is
sold. In addition, if the issuer defaults, the Trust may obtain no return at all on its investment.
The market price of PIK securities 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 U.S. federal income tax law requires the holder of certain PIK securities to
accrue interest income with respect to these securities prior to the actual receipt of cash
payments. In order to receive the special treatment accorded to regulated investment companies
(RICs) and their shareholders under Subchapter M of the Internal Revenue Code of 1986, as amended
(the Code), and to avoid liability for U.S. federal income or excise taxes at the Trust level,
the Trust may be required to distribute income accrued with respect to these securities prior to
the Trusts receipt of cash on these securities and thus may, among other things, dispose of
portfolio securities under potentially disadvantageous circumstances in order to generate cash to
satisfy these distribution requirements. See Tax Matters below.
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 Trusts 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 it 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 the Investment Adviser to be creditworthy. When the Trust
purchases Assignments from Lenders, the Trust will acquire direct rights against the borrower on
the Loan. However, because 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
public 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 Trusts ability to dispose of particular
Assignments or Participations when necessary to meet the Trusts 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
9
may make it more difficult for the Trust to assign a value to those securities for purposes of
valuing the Trusts portfolio and calculating its net asset value.
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. The Trust may also 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.
Current U.S. federal income tax law requires the holder of certain zero-coupon bonds or
deferred payment securities to accrue interest income with respect to these securities prior to the
actual receipt of cash payments by the holder. In order to receive the special treatment accorded
to RICs and their shareholders under the Code and to avoid liability for U.S. federal income or
excise taxes at the Trust level, the Trust may be required to distribute income accrued with
respect to these securities prior to the Trusts receipt of cash on these securities and thus may,
among other things, dispose of Trust securities under potentially disadvantageous circumstances in
order to generate cash to satisfy these distribution requirements. See Tax Matters below.
Real Estate Investment Trusts (REITs)
The Trust may invest in REITs. REITs are pooled investment vehicles that invest primarily in
income-producing real estate or real estate-related loans or interests. REITs are subject to risks
similar to those associated with direct ownership of real estate (including loss to casualty or
condemnation, increases in property taxes and operating expenses, zoning law amendments, changes in
interest rates, overbuilding and increased competition, variations in market value, adverse changes
in the real estate markets generally or in specific sectors of the real estate industry and
possible environmental liabilities), as well as additional risks discussed below.
REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and
mortgage REITs. Equity REITs invest the majority of their assets directly in real property and
derive income primarily from the collection of rents. Equity REITs can also realize capital gains
by selling properties that have appreciated in value. Mortgage REITs invest the majority of their
assets in real estate mortgages and derive income from the collection of interest payments. REITs
are not taxed on income distributed to shareholders provided they comply with the applicable
requirements of the Code. The Trust will indirectly bear its proportionate share of any management
and other expenses paid by REITs in which it invests in addition to the expenses paid by the Trust.
Debt securities issued by REITs are, for the most part, general and unsecured obligations and are
subject to risks associated with REITs.
Investing in REITs involves certain unique risks in addition to those risks associated with
investing in the real estate industry in general. An equity REIT may be affected by changes in the
value of the underlying properties owned by the REIT. A mortgage REIT may be affected by changes in
interest rates and the ability of the issuers of its portfolio mortgages to repay their
obligations. REITs are dependent upon the skills of their managers and are not diversified. REITs
are generally dependent upon maintaining cash flows to repay borrowings and to make distributions
to shareholders and are subject to the risk of default by lessees or borrowers. REITs whose
underlying assets are concentrated in properties used by a particular industry, such as health
care, are also subject to risks associated with such industry. REITs are often leveraged or invest
in properties that are themselves leveraged, exposing them to the risks of leverage generally.
Among other things, leverage will generally increase losses during periods of real estate market
declines.
REITs (especially mortgage REITs) are also subject to interest rate risks. When interest rates
decline, the value of a REITs investment in fixed rate obligations can be expected to rise.
Conversely, when interest rates rise, the value of a REITs investment in fixed rate obligations
can be expected to decline. If the REIT invests in adjustable rate mortgage loans the interest
rates on which are reset periodically, yields on a REITs investments in such loans will gradually
align themselves to reflect changes in market interest rates. This causes the value of such
investments to fluctuate less dramatically in response to interest rate fluctuations than would
investments in fixed rate obligations.
REITs may have limited financial resources, may trade less frequently and in a more limited
volume and may be subject to more abrupt or erratic price movements than larger company securities.
10
MANAGEMENT OF THE TRUST
Trustees
The Board provides broad oversight over the operations and affairs of the Trust and protects
the interests of shareholders. The Board 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 Trusts 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, the Investment Adviser and their Board members and officers is NexBank Tower, 13455 Noel
Road, Suite 800, Dallas, Texas 75240, unless otherwise specified below.
Information About Each Trustees Experience, Qualifications, Attributes, or Skills for Board
Membership
The following provides an overview of the considerations that led the Board to conclude that
each individual nominee for Trustee or each individual serving as a continuing Trustee of the Trust
should be nominated or so serve, as well as each nominees and Trustees name and certain
biographical information as reported by them to the Trust. Among the factors the Board considered
when concluding that an individual should be a nominee for Trustee or serve on the Board were the
following: (i) the individuals business and professional experience and accomplishments; (ii) the
individuals ability to work effectively with the other members of the Board; (iii) the
individuals prior experience, if any, serving on company boards (including public companies and,
where relevant, other investment companies) and the boards of other complex enterprises and
organizations; and (iv) how the individuals skills, experiences and attributes would contribute to
an appropriate mix of relevant skills and experience on the Board.
In respect of each nominee and continuing Trustee, the individuals professional
accomplishments and prior experience, including, in some cases, in fields related to the operations
of the Trust, were a significant factor in the determination that the individual should be a
nominee for Trustee or serve as a Trustee of the Trust. Each nominees and continuing Trustees
professional experience and additional considerations that contributed to the Boards conclusion
that an individual should serve on the Board are summarized in the table below.
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Number of |
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Experience, |
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Portfolios in |
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Qualifications, |
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Highland Fund |
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Other |
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Attributes, |
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Term of Office |
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Complex |
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Directorships/ |
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Skills for |
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Position |
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and Length of |
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Principal Occupation(s) |
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Overseen by |
|
Trusteeships |
|
Board |
Name and Age |
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with Trust |
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Time Served(1) |
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During Past Five Years |
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Trustee(2) |
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Held |
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Membership |
INDEPENDENT
TRUSTEES(3) |
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Timothy K. Hui
(Age 62)
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Trustee
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3 years; Trustee since inception in 2006
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Vice President since
February 2008, Dean of
Educational Resources
from July 2006 to
January 2008, and
Assistant Provost for
Graduate Education
from July 2004 to June
2006 at Philadelphia
Biblical University.
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23 |
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None
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Significant
experience on this
and/or other boards
of
directors/trustees;
administrative and
managerial
experience; legal
training and
practice. |
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Scott F. Kavanaugh
(Age 49)
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Trustee
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3 years;
Trustee since inception in 2006
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Vice-Chairman,
President and Chief
Operating Officer at
Keller Financial Group
since September 2007;
Chairman and Chief
Executive Officer at
First Foundation Bank
since September 2007;
Vice Chair, President
and Chief Operating
Officer of First
Foundation, Inc.
(holding company)
since September 2007;
and Private investor
since February 2004.
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23 |
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None
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Significant
experience on this
and/or other boards
of
directors/trustees;
significant
executive
experience
including current
and past service as
chairman and chief
executive officer
of a bank; other
financial industry
and banking
experience. |
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Number of |
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Experience, |
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Portfolios in |
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Qualifications, |
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Highland Fund |
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Other |
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Attributes, |
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Term of Office |
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Complex |
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Directorships/ |
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Skills for |
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Position |
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and Length of |
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Principal Occupation(s) |
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Overseen by |
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Trusteeships |
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Board |
Name and Age |
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with Trust |
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Time Served(1) |
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During Past Five Years |
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Trustee(2) |
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Held |
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Membership |
James F. Leary
(Age 80)
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Trustee
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3 years; Trustee since inception in 2006
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Managing Director,
Benefit Capital
Southwest, Inc. (a
financial consulting
firm) since January
1999.
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23 |
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Board Member of
Capstone Group of
Funds (7
portfolios)
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Significant
experience on this
and/or other boards
of
directors/trustees;
significant
executive
experience
including past
service as chief
financial officer
of an operating
company; audit
committee financial
expert. |
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Bryan A. Ward
(Age 55)
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Trustee
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3 years; Trustee since inception in 2006
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Senior Manager,
Accenture, LLP (a
consulting firm) since
January 2002.
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23 |
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None
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Significant
experience on this
and/or other boards
of
directors/trustees;
significant
managerial and
executive
experience;
significant
experience as a
management
consultant. |
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INTERESTED TRUSTEE |
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R. Joseph Dougherty(4)
(Age 41)
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Trustee and
Chairman of the
Board, President
and Chief Executive
Officer
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3 years; Trustee and Chairman of the
Board since inception in 2006.
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Team Leader of the
Investment Adviser
since 2000, Trustee of
the funds in the
Highland Fund Complex
since 2004 and
President and Chief
Executive Officer of
the funds in the
Highland Fund Complex
since December 2008;
Director of NexBank
Securities, Inc. since
June 2009; Senior Vice
President of Highland
Distressed
Opportunities, Inc.
from September 2006 to
June 2009; Senior Vice
President of the funds
in the Highland Fund
Complex from 2004 to
December 2008.
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23 |
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None
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Positions and
experience at the
Adviser; continuing
service as
President and Chief
Executive Officer
of the Trust;
significant
executive and
financial
experience |
OFFICERS
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Position with |
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Term of Office and |
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Name and Age |
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Trust |
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Length of Time Served |
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Principal Occupation(s) During Past Five Years |
R. Joseph Dougherty
(Age 41)
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Trustee and
Chairman of the
Board, President
and Chief Executive
Officer
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Indefinite Term;
Chairman of the
Board since
inception in 2006;
President and Chief
Executive Officer
since December 2008
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Team Leader of the Investment Adviser since
2000, Trustee of the funds in the Highland
Fund Complex since 2004 and President and
Chief Executive Officer of the funds in the
Highland Fund Complex since December 2008;
Director of NexBank Securities, Inc. since
June 2009; Senior Vice President of Highland
Distressed Opportunities, Inc. from September
2006 to June 2009; Senior Vice President of
the funds in the Highland Fund Complex from
2004 to December 2008. |
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Brian Mitts
(Age 40)
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Treasurer
(Principal
Accounting Officer
and Principal
Financial Officer)
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Indefinite Term;
Treasurer since
November 2010
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Senior Retail Fund Analyst of the Adviser
since 2007 and Principal Accounting Officer
and Treasurer of the funds in the Highland
Fund Complex since November 2010; Manager of
Financial Reporting at HBK Investments (a
hedge fund) from 2005 to 2007. |
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Ethan Powell
(Age 36)
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Secretary
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Indefinite Term;
Secretary since
November 2010
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Senior Retail Fund Analyst of the Adviser
since 2007 and Secretary of the funds in the
Highland Fund Complex since November 2010;
Manager in the Merger and Acquisitions
Division at Ernst & Young from 1999 to 2006. |
12
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|
|
|
|
|
|
Position with |
|
Term of Office and |
|
|
Name and Age |
|
Trust |
|
Length of Time Served |
|
Principal Occupation(s) During Past Five Years |
Matthew S. Okolita
(Age 29)
|
|
Chief Compliance
Officer
|
|
Indefinite Term;
Chief Compliance
Officer since May
2010
|
|
Chief Compliance Officer of the Adviser and
Cummings Bay Capital Management, L.P. since
May 2010; Chief Compliance Officer of
Highland Capital Management Europe, LTD (an
FSA registered adviser) and certain other
investment advisers affiliated with the
Adviser since June 2010; Compliance Manager
of the Adviser from March 2008 to May 2010;
Legal Associate at NewStar Financial Inc. (a
commercial finance company) from August 2006
to December 2007; Compliance Associate at
Commonwealth Financial Network (a registered
investment adviser/broker-dealer) from
January 2004 to August 2006. |
|
|
|
(1) |
|
After a Trustees 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 20010 and are expected to stand for re-election in 2013; Messrs.
Hui and Kavanaugh, as Class II Trustees, were re-elected in 2008 and are expected to stand for
re-election in 2011; and Mr. Dougherty, the sole Class III Trustee, was re-elected in 2009 and
is expected to stand for re-election in 2012. |
|
(2) |
|
The Highland Fund Complex consists of all of the registered investment companies advised by
the Investment Adviser as of the date of this Statement of Additional Information. |
|
(3) |
|
Independent Trustees are those who are not interested persons as that term is defined under
Section 2(a)(19) of the Investment Company Act. |
|
(4) |
|
Mr. Dougherty is deemed to be an interested person of the Trust under the Investment
Company Act because of his position with the Investment Adviser. |
Role of the Board of Trustees, Leadership Structure and Risk Oversight
The Role of the Board of Trustees
The Board oversees the management and operations of the Trust. Like most registered
investment companies, the day-to-day management and operation of the Trust is performed by various
service providers to the Trust, such as the Adviser, and the distributor, administrator, custodian,
and transfer agent. The Board has appointed senior employees of certain of these service providers
as officers of the Trust, with responsibility to monitor and report to the Board on the Trusts
operations. The Board receives regular reports from these officers and service providers regarding
the Trusts operations. For example, the Treasurer provides reports as to financial reporting
matters and investment personnel report on the performance of the Trusts portfolios. The Board has
appointed a Chief Compliance Officer who administers the Trusts compliance program and regularly
reports to the Board as to compliance matters. Some of these reports are provided as part of formal
in person Board meetings which are typically held quarterly, in person, and involve the Boards
review of, among other items, recent Trust operations. The Board also periodically holds telephonic
meetings as part of its review of the Trusts activities. From time to time one or more members of
the Board may also meet with management in less formal settings, between scheduled Board meetings,
to discuss various topics. In all cases, however, the role of the Board and of any individual
Trustee is one of oversight and not of management of the day-to-day affairs of the Trust and its
oversight role does not make the Board a guarantor of the Trusts investments, operations or
activities.
Board Structure and Leadership
The Board has structured itself in a manner that it believes allows it to perform its
oversight function effectively. The Board consists of five Trustees, four of whom are not
interested persons (as defined in the Investment Company Act) of the Trust (the Independent
Trustees). The Chairman of the Board, Mr. R. Joseph Dougherty, also serves as President and Chief
Executive Officer of the Trust, and as such he participates in the oversight of the Trusts
day-to-day business affairs. The Board believes that Mr. Dohertys role as both Chairman of the
Board and President and Chief Executive Officer of the Trust facilitates communications between the
Adviser and the Board and helps to enhance the remaining Trustees understanding of the operations
of the Adviser and the Trust. Mr. Dougherty is an interested person of the Trust (an Interested
Trustee) because of his position with the Adviser. The Trustees meet periodically throughout the
year in person and by telephone to oversee the Trusts activities, review contractual arrangements
with service providers for the Trust and review the Trusts performance. During the fiscal year
ending on December 31, 2010, the Board convened 17 times. Each Trustee attended at least 75% of the
aggregate of the total number of meetings of the Board and Committees on which he served. The Board
conducts much of its work through certain standing Committees, each of which is comprised
exclusively of all of the Independent Trustees and each of whose meetings are chaired by an
Independent Trustee. The Trust has four committees: (i) an Audit Committee, (ii) a Nominating
Committee, (iii) a Litigation Committee and (iv) a Qualified Legal Compliance Committee.
The Audit Committee. Pursuant to the Audit Committee Charter adopted by the Trusts Board,
the Trusts Audit Committee is responsible for (1) oversight of the Trusts accounting and
financial reporting processes and the audits of the Trusts financial statements and (2) providing
assistance to the Board in connection with its oversight of the integrity of the Trusts financial
statements, the Trusts compliance with legal and regulatory requirements, and the independent
auditors qualifications and independence, and the performance of the Trusts internal audit
function and independent auditors. The function of the Audit
13
Committee is oversight; it is managements responsibility to maintain appropriate systems for
accounting and internal control over financial reporting. In addition, the Audit Committee may
address questions arising with respect to the valuation of certain securities in the Trusts
portfolio. A current copy of the Trusts Audit Committee Charter is available on the Trusts web
site at www.highlandfunds.com. The Audit Committee met five times in fiscal year 2010. The members
of the Trusts Audit Committee are Messrs. Hui, Kavanaugh, Leary, and Ward, and the Board of the
Trust has determined that Mr. Leary is an audit committee financial expert, for purposes of the
federal securities laws. Mr. Kavanaugh acts as Chairman of the Audit Committee.
The Nominating Committee. The Trusts Nominating Committee is responsible for identifying
individuals qualified to serve as Trustees of the Trust and either selecting or recommending Board
nominees for election or appointment. A current copy of the Trusts Nominating Committee Charter is
available on the Trusts web site at www.highlandfunds.com.
The Nominating Committee will consider recommendations for nominees from shareholders
submitted to the Secretary of the Trust, NexBank Tower, Suite 800, 13455 Noel Road, Dallas, Texas
75240. Such shareholder recommendations must include information regarding the recommended nominee
as specified in the Nominating Committee Charter.
The Nominating Committee Charter describes the factors considered by the Nominating
Committee in selecting nominees. In evaluating potential nominees, including any nominees
recommended by shareholders, the Nominating Committee takes into consideration factors listed in
the Nominating Committee Charter, including experience, skills, expertise, education, knowledge,
diversity, personal and professional integrity, character, business judgment, time availability in
light of other commitments, dedication, the existence of any relationships that might give rise to
a conflict of interest and such other relevant factors that the Nominating Committee considers
appropriate in the context of the needs of the Board.
The Nominating Committee met one time in fiscal year 2010. The members of the Nominating
Committee are Messrs. Hui, Kavanaugh, Leary and Ward. The Nominating Committee does not have a
Chairman, although meetings of the Committee are chaired by an Independent Trustee.
The Litigation Committee. The Trust has established a Litigation Committee to seek to
address any potential conflicts of interest between the Trust and the Adviser in connection with
any potential or existing litigation or other legal proceeding relating to securities held by both
the Trust and the Adviser or another client of the Adviser. The Litigation Committee met eight
times in fiscal year 2010. The members of the Litigation Committee are Messrs. Hui, Kavanaugh,
Leary and Ward. The Litigation Committee does not have a Chairman, although meetings of the
Committee are chaired by an Independent Trustee.
The Qualified Legal Compliance Committee. The Qualified Legal Compliance Committee
(QLCC) is charged with compliance with Rules 205.2(k) and 205.3(c) of Title 17 of the Code of
Federal Regulations regarding alternative reporting procedures for attorneys representing the Trust
who appear and practice before the Securities and Exchange Commission (SEC) on behalf of the
Trust. The QLCC is comprised of Messrs. Hui, Kavanaugh, Leary and Ward. The QLCC did not meet
during the fiscal year 2010. The QLCC does not have a Chairman, although meetings of the Committee
are chaired by an Independent Trustee.
The Trust does not have a Compensation Committee.
The Trust does not have a lead Independent Trustee. The Boards leadership structure features
all of the Independent Trustees serving as members of each board committee. Inclusion of all
Independent Trustees in the committees allows them to participate in the full range of the Boards
oversight duties, including oversight of the risk management process. In addition, although the
Independent Trustees recognize that having a lead Independent Trustee may in some circumstances
help coordinate communications with management and otherwise assist a board in the exercise of its
oversight duties, the Independent Trustees believe that because of the relatively small size of the
Board, the ratio of Independent Trustees to Interested Trustees and the good working relationship
among the Board members, it has not been necessary to designate a lead Independent Trustee.
The Board periodically reviews its leadership structure, including the role of the Chairman.
The Board also completes an annual self-assessment during which it reviews its leadership and
committee structure and considers whether its structure remains appropriate in light of the Trusts
current operations. The Board believes that its leadership structure, including having an
Interested Chairman and the current percentage of the Board who are Independent Trustees, is
appropriate given its specific characteristics. These characteristics include: (i) the Advisers
role in the operation of the Trusts business; (ii) the extent to which the work of the Board is
conducted through the standing Committees, each of whose meetings are chaired by an Independent
Trustee and comprised of all Independent Trustees; (iii) the extent to which the Independent
Trustees meet as needed, together with their independent legal counsel, in the absence of members
of management and members of the Board who are interested persons of the Trust; and (iv) Mr.
Doughertys additional role with the Adviser, which enhances the Boards understanding of the
operations of the Adviser.
14
Board Oversight of Risk Management
The Boards role is one of oversight, rather than active management. This oversight extends to
the Trusts risk management processes. These processes are embedded in the responsibilities of
officers of, and service providers to, the Trust. For example, the Adviser and other service
providers are primarily responsible for the management of the Trusts investment risks. The Board
has not established a formal risk oversight committee. However, much of the regular work of the
Board and its standing Committees addresses aspects of risk oversight. For example, the Trustees
seek to understand the key risks facing the Trust, including those involving conflicts of interest;
how management identifies and monitors these risks on an ongoing basis; how management develops and
implements controls to mitigate these risks; and how management tests the effectiveness of those
controls.
In the course of providing that oversight, the Board receives a wide range of reports on the
Trusts activities from the Adviser and other service providers, including regarding the Trusts
investment portfolio, the compliance of the Trust with applicable laws, and the Trusts financial
accounting and reporting. The Board also meets periodically with the Trusts Chief Compliance
Officer to receive reports regarding the compliance of the Trust with the federal securities laws
and the Trusts internal compliance policies and procedures, and meets with the Trusts Chief
Compliance Officer periodically, including at least annually to review the Chief Compliance
Officers annual report, including the Chief Compliance Officers risk-based analysis for the
Trust. The Boards Audit Committee also meets regularly with the Treasurer and the Trusts
independent public accounting firm to discuss, among other things, the internal control structure
of the Trusts financial reporting function. The Board also meets periodically with the portfolio
managers of the Trust to receive reports regarding the management of the Trust, including its
investment risks.
The Board recognizes that not all risks that may affect the Trust can be identified, that it
may not be practical or cost-effective to eliminate or mitigate certain risks, that it may be
necessary to bear certain risks (such as investment-related risks) to achieve the Trusts goals,
that reports received by the Trustees with respect to risk management matters are typically
summaries of the relevant information, and that the processes, procedures and controls employed to
address risks may be limited in their effectiveness. As a result of the foregoing and other
factors, risk management oversight by the Board and by the Committees is subject to substantial
limitations.
Compensation of Trustees
The executive officers of the Trust and the trustees who are interested persons of the Trust
(as defined in the Investment Company Act) receive no direct remuneration from the Trust. Each
Independent Trustee receives an annual retainer of $150,000 payable in quarterly installments and
allocated among each portfolio in the Highland Fund Complex based upon relative net assets.
Independent Trustees are reimbursed for actual out-of-pocket expenses relating to attendance at
meetings. The Trustees do not have any pension or retirement plan.
The following table summarizes the compensation paid by the Trust to the Independent Trustees
and the aggregate compensation paid by the Highland Fund Complex to the Independent Trustees for
the fiscal year ended December 31, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Compensation |
|
|
|
Aggregate |
|
|
from the Trust and |
|
|
|
Compensation |
|
|
Highland Fund |
|
Name of Independent Trustees |
|
from the Trust |
|
|
Complex |
|
Timothy K. Hui |
|
$ |
40,134 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
Scott F. Kavanaugh |
|
$ |
40,134 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
James F. Leary |
|
$ |
40,134 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
Bryan A. Ward |
|
$ |
40,134 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
Share Ownership
The following table shows the dollar range of equity securities beneficially owned by the
Trusts trustees in the Trust and the aggregate dollar range of equity securities owned by the
Trusts trustees in all funds overseen by the trustee in the Highland Fund Complex as of
12/31/2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregate Dollar Range |
|
|
|
|
|
|
of Equity Securities |
|
|
Dollar Range of |
|
Overseen by Trustee in |
|
|
Equity Securities in |
|
the Family of Registered |
Name of Trustee |
|
the Trust |
|
Investment Companies |
Interested Trustee |
|
|
|
|
|
|
|
|
R. Joseph Dougherty |
|
Over $100,000 |
|
Over $100,000 |
Independent Trustees |
|
|
|
|
|
|
|
|
Timothy K. Hui |
|
$ |
1-$10,000 |
|
|
$ |
1-$10,000 |
|
Scott F. Kavanaugh |
|
$ |
10,001-50,000 |
|
|
$ |
10,001-50,000 |
|
James F. Leary |
|
$ |
10,001-50,000 |
|
|
$ |
10,001-50,000 |
|
Bryan A. Ward |
|
$ |
1-$10,000 |
|
|
$ |
1-$10,000 |
|
15
As of March 1, 2011, trustees and officers of the Trust, individually and as a group, owned
less than 1% of the outstanding shares of the Trust.
Proxy Voting Policies and Procedures
The Board has delegated the voting of proxies for Trust securities to the Investment Adviser
pursuant to the Investment Advisers proxy voting policies and procedures. Under these policies and
procedures, the Investment Adviser will vote proxies related to Trust securities in the best
interests of the Trust and its shareholders. A copy of the Investment Advisers proxy voting
policies and procedures is attached as Appendix B to this Statement of Additional Information. The
Trusts 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 Commissions 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 Commissions Public Reference Room in Washington, D.C. Information on the operation
of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. The codes
of ethics are available on the EDGAR Database on the Commissions 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 Commissions Public Reference
Section, Washington, D.C. 20549-0102.
Investment Adviser
For a description of the Investment Adviser, including a description of its controlling
persons, see Management of the TrustInvestment Adviser in the Trusts prospectus.
As described in more detail in the Trusts prospectus, 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 Trusts 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.
Pursuant to the investment advisory agreement, the Trust has paid the following amounts as
Advisory Fees, net of waivers, to the Investment Adviser for the past three fiscal years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 (1) |
|
2009 (1) |
|
2010 (1) |
Advisory Fees |
|
$ |
8,628,206 |
|
|
$ |
4,094,096 |
|
|
$ |
5,513,207 |
|
|
|
|
|
(1) |
|
The Advisory Fees reported in the table reflect certain fee waivers in effect during the
years ended December 31, 2008, 2009 and 2010, resulting in waivers in the amounts of $372,134,
$828,225, and $456,091, respectively. |
Administration Services
Pursuant to the Trusts administration services agreement, the Investment Adviser performs the
following services: (i) prepare monthly security transaction listings; (ii) supply various normal
and customary portfolio and Trust statistical data as requested on an ongoing basis; (iii) prepare
for execution and file the Trusts 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 Trusts annual and semi-annual
shareholder reports; (vi) prepare income and capital gain distributions; (vii) prepare the
semiannual and annual financial statements; (viii) monitor the Trusts compliance with Internal
Revenue Code, Commission and prospectus requirements; (ix) prepare, coordinate with the Trusts
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(h) 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 and coordinate preparation of proxy statements;
(xi) assist in obtaining the
16
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;
(xii) monitor the Trusts 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 mailing of Board materials; (xv) attend Board meetings and draft minutes
thereof; (xvi) maintain the Trusts corporate calendar to assure compliance with various filing and
Board approval deadlines; (xvii) assist the Trust in the handling of Commission examinations and
responses thereto; (xviii) assist the Trusts chief executive officer and chief financial officer
in making certifications required under the Commissions disclosure forms; (xix) prepare and
coordinate the Trusts state notice filings; (xx) furnish the Trust office space in the offices of
the Investment Adviser, or in such other place or places as may be agreed from time to time, and
all necessary office facilities, simple business equipment, supplies, utilities and telephone
service for managing the affairs of the Trust; (xxi) perform clerical, bookkeeping and other
administrative services not provided by the Trusts other service providers; (xxii) determine or
oversee the determination and publication of the Trusts net asset value in accordance with the
Trusts policies as adopted from time to time by the Board; (xxiii) oversee the maintenance by the
Trusts 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) such other books and records
required by law or for the proper operation of the Trust; (xxiv) determine the amounts available
for distribution as dividends and distributions to be paid by the Trust to its shareholders;
calculate, analyze and prepare a detailed income analysis and forecast future earnings for
presentation to the Board; prepare and arrange for the printing of dividend notices to
shareholders, as applicable, and provide the Trusts 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 Trusts dividend reinvestment plan; (xxv) serve as liaison
between the Trust and each of its service providers; (xxvi) assist in monitoring and tracking the
daily cash flows of the individual assets of the Trust, as well as security position data of
portfolio investments; assist in resolving any identified discrepancies with the appropriate third
party, including the Trusts custodian, administrative agents and other service providers, through
various means including researching available data via agent notices, financial news and data
services, and other sources; (xxvii) monitor compliance with leverage tests under the Trusts
credit facility, and communicate with leverage providers and rating agencies; (xxviii) coordinate
negotiation and renewal of credit agreements for presentation to the Board; (xxix) coordinate
negotiations of agreements with counterparties and the Trusts custodian for derivatives, short
sale and similar transactions, as applicable; (xxx) provide assistance with the settlement of
trades of portfolio securities; (xxxi) coordinate and oversee the provision of legal services to
the Trust; (xxxii) cooperate with the Trusts independent registered public accounting firm in
connection with audits and reviews of the Trusts financial statements, including interviews and
other meetings, and provide necessary information and coordinate confirmations of bank loans and
other assets for which custody is not through DTC, as necessary; (xxxiii) provide Secretary and any
Assistant Secretaries, Treasurer and any Assistant Treasurers and other officers for the Trust as
requested; (xxxiv) develop or assist in developing compliance guidelines and procedures; (xxxv)
investigate and research customer and other complaints to determine liability, facilitate
resolution and promote equitable treatment of all parties; (xxxvi) determine and monitor expense
accruals for the Trust; (xxxvii) authorize expenditures and approve bills for payment on behalf of
the Trust; (xxxviii) monitor the number of shares of the Trust registered and assist in the
registration of additional shares, as necessary; (xxxix) prepare such reports as the Board may
request from time to time; (xl) administer and oversee any securities lending program of the Trust;
and (xli) perform such additional administrative duties relating to the administration of the Trust
as may subsequently be agreed upon in writing between the Trust and the Investment Adviser. The
Investment Adviser 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 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 administration services agreement.
Accordingly, under a separate sub-administration services agreement, dated June 29, 2006, as
amended from time to time, the Investment Adviser has delegated certain administrative functions to
BNY Mellon Investment Servicing (US) Inc., at an annual rate, payable by the Investment Adviser, of
0.01% of the average weekly value of the Trusts Managed Assets.
Pursuant to the administration services agreement, the Trust has paid the following amounts as
Administration Fees to the Investment Adviser for the past three fiscal years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 (1) |
|
2009 (1) |
|
2010 (1) |
Administration Fees |
|
$ |
1,618,635 |
|
|
$ |
580,664 |
|
|
$ |
971,494 |
|
|
|
|
|
(1) |
|
The Administration Fees reported in the table reflect certain fee waivers in effect during
the years ended December 31, 2008, 2009 and 2010, resulting in waivers in the amounts of
$181,433, $403,800, and $222,366, respectively. |
Portfolio Manager
The portfolio manager of the Trust is Greg Stuecheli.
As of December 31, 2010, Mr. Stuecheli managed the following client accounts:
17
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|
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|
|
|
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|
|
|
|
|
Number of |
|
Assets Subject |
|
|
|
|
|
|
|
|
|
|
Accounts |
|
to a |
|
|
|
|
|
|
Assets of |
|
Subject to a |
|
Performance |
|
|
Number of |
|
Accounts |
|
Performance |
|
Fee |
Type of Account |
|
Accounts |
|
(in millions) |
|
Fee |
|
(in millions) |
Registered Investment Companies |
|
|
3 |
|
|
$ |
1,026 |
|
|
|
1 |
|
|
$ |
2.95 |
|
Other Pooled Investment Vehicles |
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
Other Accounts |
|
|
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|
|
Because the portfolio manager manages other accounts, including accounts that may pay higher
fees, potential conflicts of interest exist, including potential conflicts between the investment
strategy of the Trust and the investment strategy of the other accounts managed by the portfolio
manager and potential conflicts in the allocation of investment opportunities between the Trust and
the 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 Advisers (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.
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
Advisers 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 Advisers 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 guidance, the Trust may be prohibited from co-investing with certain
of its affiliates in some types of private placement transactions.
Compensation
The Investment Advisers 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
18
salary, a discretionary bonus, various retirement benefits and one or more of the incentive
compensation programs established by the Investment Adviser such as the Short Term Incentive 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. Base compensation is determined by taking into account
current industry norms and market data to ensure that the Investment Adviser pays a competitive
base compensation.
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 paid to recognize specific business
contributions and to ensure that the total level of compensation is competitive with the market, as
well as participation in incentive plans, including one or more of the following:
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Short Term Incentive 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 the
Investment Adviser in order to promote the success of the Investment Adviser. |
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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 the
Investment Adviser through the use of Long-Term Incentive Units. |
Because each persons compensation is based on his or her individual performance, the
Investment Adviser does not have a typical percentage split among base salary, bonus and other
compensation. 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 Investment Adviser. The Investment Adviser believes
it is in the best interest of shareholders to maintain stability of portfolio management personnel.
Conflicts of Interest
From time to time, potential and actual conflicts of interest may arise between the portfolio
managers management of the investments of the Trust, on the one hand, and the management of other
accounts, on the other. Potential and actual conflicts of interest may also arise as a result of
the Investment Advisers other business activities and the Investment Advisers possession of
material non-public information about an issuer. Other accounts managed by the portfolio manager
might have similar investment objectives or strategies as the Trust, or otherwise hold, purchase,
or sell securities that are eligible to be held, purchased or sold by the Trust. The other accounts
might also have different investment objectives or strategies than the Trust.
Knowledge and Timing of Trust Trades. A potential conflict of interest may arise as a result
of the portfolio managers day-to-day management of the Trust. Because of his position with the
Trust, the portfolio manager knows the size, timing and possible market impact of the Trusts
trades. It is theoretically possible that the portfolio manager could use this information to the
advantage of other accounts he manages and to the possible detriment of the Trust.
Investment Opportunities. A potential conflict of interest may arise as a result of the
portfolio managers management of a number of accounts with varying investment guidelines. Often,
an investment opportunity may be suitable for both the Trust and other accounts managed by the
portfolio manager, but may not be available in sufficient quantities for both the Trust and the
other accounts to participate fully. Similarly, there may be limited opportunity to sell an
investment held by the Trust and another account. The Investment Adviser has adopted policies and
procedures reasonably designed to allocate investment opportunities on a fair and equitable basis
over time.
Under the Investment Advisers allocation procedures, investment opportunities are allocated
among various investment strategies based on individual account investment guidelines and the
Investment Advisers investment outlook. The Investment Adviser has also adopted additional
procedures to complement the general trade allocation policy that are designed to address potential
conflicts of interest due to the side-by-side management of the Trust and certain pooled investment
vehicles, including investment opportunity allocation issues.
Conflicts potentially limiting the Trusts investment opportunities may also arise when the
Trust and other clients of the Investment Adviser invest in different parts of an issuers capital
structure, such as when the Trust owns senior debt obligations of an issuer and other clients own
junior tranches of the same issuer, or when the Trust owns debt securities of an issuer and other
clients own equity securities of the same issuer. In such circumstances, if the issuer experiences
financial or operational challenges, decisions over whether to trigger an event of default, over
the terms of any workout, or how to exit an investment may result in conflicts of interest
(including, for example, conflicts over proposed waivers and amendments to debt covenants). For
example, a debt holder may be better served by a liquidation of the issuer in which it may be paid
in full, whereas an equity holder might prefer a
19
reorganization that holds the potential to create value for the equity holders. In addition, the Investment
Adviser may also, in certain circumstances, pursue or enforce rights with respect to a particular
issuer jointly on behalf of one or more of its clients, or the Investment Advisers personnel may
work together to pursue or enforce such rights. Certain clients may be negatively impacted by the
Investment Advisers activities on behalf of its other clients, and transactions on behalf of some
clients may be impaired or effected at prices or terms that may be less favorable than would
otherwise have been the case. In order to minimize such conflicts, the portfolio manager may avoid
certain investment opportunities that would potentially give rise to conflicts with other clients
of the Investment Adviser or the Investment Adviser may enact internal procedures designed to
minimize such conflicts, which could have the effect of limiting the Trusts investment
opportunities.
Additionally, if the Investment Adviser acquires material non-public confidential information
in connection with its business activities for other clients, the portfolio manager may be
restricted from purchasing securities or selling securities for the Trust. When making investment
decisions where a conflict of interest may arise, the Investment Adviser will endeavor to act in a
fair and equitable manner as between the Trust and other clients; however, in certain instances the
resolution of the conflict may result in the Investment Adviser acting on behalf of another client
in a manner that may not be in the best interest, or may be opposed to the best interest, of the
Trust.
Performance Fees. The portfolio manager may advise certain accounts with respect to which the
advisory fee is based entirely or partially on performance. Performance fee arrangements may create
a conflict of interest for the portfolio manager in that the portfolio manager may have an
incentive to allocate the investment opportunities that he believes might be the most profitable to
such other accounts instead of allocating them to the Trust. The Investment Adviser has adopted
policies and procedures reasonably designed to allocate investment opportunities between the Trust
and such other accounts on a fair and equitable basis over time.
Securities Ownership of Portfolio Manager
The following table sets forth the dollar range of equity securities of the Trust beneficially
owned by the portfolio manager as of December 31, 2010.
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Dollar Range of |
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Equity Securities in |
Name of Portfolio Manager |
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the Trust |
Greg Stuecheli |
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$10,001 $50,000 |
PORTFOLIO TRANSACTIONS AND BROKERAGE
Selection of Broker-Dealers; Order Placement
Subject to the overall review of the Board, the Investment Adviser is responsible for
decisions to buy and sell securities and other portfolio holdings of the Trust, for selecting the
broker or dealer to be used, and for negotiating any commission rates paid. In underwritten
offerings, securities usually are purchased at a fixed price that includes an amount of
compensation to the underwriter, generally referred to as the underwriters concession or discount.
On occasion, certain money market instruments may be purchased directly from an issuer, in which
case no commissions or discounts are paid.
The Investment Adviser and its affiliates manage other accounts, including private funds and
individual accounts that invest in senior loans and Trust investments. Although investment
decisions for the Trust are made independently from those of such other accounts, investments of
the type the Trust may make also may be made on behalf of such other accounts. When the Trust and
one or more other accounts is prepared to invest in, or desires to dispose of, the same investment,
available investments or opportunities for each are allocated in a manner believed by the
Investment Adviser to be equitable over time. The Investment Adviser may (but is not obligated to)
aggregate orders, which may include orders for accounts in which the Investment Adviser or its
affiliates have an interest, to purchase and sell securities to obtain favorable execution or lower
brokerage commissions, to the extent permitted by applicable laws and regulations. Although the
Investment Adviser believes that, over time, the potential benefits of participating in volume
transactions and negotiating lower transaction costs should benefit all participating accounts, in
some cases these activities may adversely affect the price paid or received or the size of the
position obtained by or disposed of for the Trust. Where trades are aggregated, the investments or
proceeds, as well as the expenses incurred, will be allocated by the Investment Adviser in a manner
designed to be equitable and consistent with the Investment Advisers fiduciary duty to the Trust
and its other clients (including its duty to seek to obtain best execution of client trades).
Commission Rates; Brokerage and Research Services
In placing orders for the Trusts portfolio, the Investment Adviser is required to give
primary consideration to obtaining the most favorable price and efficient execution. This means
that the Investment Adviser will seek to execute each transaction at a price and commission, if
any, which provides the most favorable total cost or proceeds reasonably attainable in the
circumstances. In seeking the
20
most favorable price and execution, the Investment Adviser, having in mind the Trusts best
interests, will consider all factors it deems relevant, including, by way of illustration: price;
the size, type and difficulty of the transaction; the nature of the market for the security; the
amount of the commission; the timing of the transaction taking into account market prices and
trends; operational capabilities; the reputation, experience and financial stability of the
broker-dealer involved; and the quality of service rendered by the broker-dealer in other
transactions. Though the Investment Adviser generally seeks reasonably competitive commissions or
spreads, the Trust will not necessarily be paying the lowest commission or spread available. The
Investment Adviser may place portfolio transactions, to the extent permitted by law, with brokerage
firms participating in a distribution of the Trusts shares if it reasonably believes that the
quality of execution and the commission are comparable to that available from other qualified
firms.
The Investment Adviser seeks to obtain best execution considering the execution price and
overall commission costs paid and other factors. The Investment Adviser routes its orders to
various broker-dealers for execution at its discretion. Factors involved in selecting brokerage
firms include the size, type and difficulty of the transaction, the nature of the market for the
security, the reputation, experience and financial stability of the broker-dealer involved, the
quality of service, the quality of research and investment information provided and the firms risk
in positioning a block of securities. Within the framework of the policy of obtaining the most
favorable price and efficient execution, the Investment Adviser does consider brokerage and
research services (as defined in the Securities Exchange Act of 1934, as amended) provided by
brokers who effect portfolio transactions with the Investment Adviser or the Trust. Brokerage and
research services are services that brokerage houses customarily provide to institutional
investors and include statistical and economic data and research reports on particular issuers and
industries.
Affiliated Brokers; Regular Broker-Dealers
The Investment Adviser is currently affiliated with NexBank Securities, Inc. (NexBank), a
Financial Industry Regulatory Authority (FINRA) member broker-dealer that is indirectly
controlled by the principals of the Investment Adviser. Absent an exemption from the Commission or
other regulatory relief, the Trust is generally precluded from effecting certain principal
transactions with affiliated brokers. The Trust may utilize affiliated brokers for agency
transactions subject to compliance with policies and procedures adopted pursuant to Rule 17e-1
under the Investment Company Act. These policies and procedures are designed to provide that
commissions, fees or other remuneration received by any affiliated broker or its affiliates for
agency transactions are reasonable and fair compared to the remuneration received by other brokers
in comparable transactions.
During the fiscal year ended December 31, 2008, the Trust paid brokerage commissions of
$382,282, of which $20,123 was paid to NexBank.
During the fiscal year ended December 31, 2009, the Trust paid brokerage commissions of
$36,920, of which $0 was paid to NexBank.
During the fiscal year ended December 31, 2010, the Trust paid brokerage commissions of
$11,706, of which $0 was paid to NexBank. During the fiscal year ended December 31, 2010,
transactions in which the Trust used NexBank as broker comprised 0% of the aggregate dollar amount
of transactions involving the payment of commissions, and 0% of the aggregate brokerage commissions
paid by the Trust. 0% of the $11,706 paid to other brokers by the Trust during the fiscal year
ended December 31, 2010 (representing commissions on transactions involving approximately $0) was
directed to those brokers at least partially on the basis of research services they provided.
During the fiscal year ended December 31, 2010, the Trust did not acquire any securities of
its regular brokers or dealers. At that date, the Trust did not hold any securities of its regular
brokers or dealers. For these purposes, regular brokers or dealers are (a) the brokers or dealers
that received the greatest dollar amount of brokerage commissions by virtue of direct or indirect
participation in the Trusts portfolio transactions during the Trusts most recent fiscal year, (b)
the brokers or dealers that engaged as principal in the largest dollar amount of portfolio
transactions of the Trust during the Trusts most recent fiscal year, or (c) the brokers or dealers
that sold the largest dollar amount of securities of the Trust during the Trusts most recent
fiscal year.
PRINCIPAL HOLDERS OF SECURITIES
The following table sets forth the name, address and percentage of ownership of each person
who is known by the Trust to own, of record or beneficially, 5% or more of the Trusts outstanding
common shares as of July 29, 2011.
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NAME & ADDRESS |
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ON ACCOUNT |
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% OF SHARES |
Morgan Stanley (1)
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9.4% |
1585 Broadway |
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New York, NY 10036 |
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First Trust Portfolios L.P. (2)
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19.4% |
120 East Liberty Drive, Suite 400 |
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Wheaton, IL 60187 |
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(1) |
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Based on information contained in a Schedule 13G/A filed jointly by Morgan Stanley and Morgan
Stanley Smith Barney LLC on February 14, 2011. Reflects sole voting power with respect to
3,598,182 shares, shared voting power with respect to 2,215,067 shares and sole dispositive
power with respect to 5,975,947 shares. |
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(2) |
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Based on information contained in a Schedule 13G/A filed jointly by The Charger Corporation,
First Trust Portfolios L.P., and First Trust Advisors L.P. on July 8, 2011. Reflects sole
voting power with respect to 0 shares, shared voting power with respect to 0 shares and sole
dispositive power with respect to 12,384,078 shares. |
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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 Trusts 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 performance and 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 Board 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 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 Trusts 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 Trusts net income. Any share repurchase, tender offer or borrowing that
might be approved by the Board 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 at the time it considers such issue, it is the Boards present policy, which may
be changed by the Board, 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 Trusts status as a RIC under the Code
(which could cause the Trusts 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 Trusts investment objectives and
policies in order to repurchase shares; or (3) there is, in the Boards 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 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
Trusts shares trading at a price equal to their net asset value. Nevertheless, the fact that the
Trusts 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.
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Before deciding whether to take any action if the common shares trade below net asset value,
the Board would likely consider all relevant factors, including the extent and duration of the
discount, the liquidity of the Trusts 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
Trusts shares should trade at a discount, the Board may determine that, in the interest of the
Trust and its shareholders, no action should be taken.
If the Board determines to repurchase common shares in a private transaction or to make a
tender offer for the common shares, the terms of any such offer may require a selling or tendering
(as applicable) shareholder to sell or tender (and thus effectively sell) all of his or her or its
common shares held, or considered to be held under certain attribution rules of the Code, by such
shareholder. Shareholders who sell (in a private repurchase transaction) or successfully tender and
effectively sell (pursuant to a tender offer) to the Trust all common shares held or considered to
be held by them generally will be treated as having sold their shares and generally will realize a
capital gain or loss. If a shareholder sells or tenders and effectively sells, as applicable, fewer
than all of his or her common shares, such shareholder may be treated as having received a taxable
dividend upon the sale or tender of his or her common shares. In such a case, there is a risk that
remaining shareholders whose percentage share interests in the Trust increase as a result of such
sale or tender by the other shareholder will be treated as having received a taxable distribution
from the Trust. The extent of such risk will vary depending upon the particular circumstances of
the private repurchase or tender offer, in particular whether such offer is a single and isolated
event or is part of a plan for periodically redeeming the common shares of the Trust; if isolated,
any such risk is likely remote. If, instead, the Board determines to repurchase common shares on
the open market, such that a selling shareholder would have no specific knowledge that he or she or
it is selling his or her or its shares to the Trust, it is less likely that remaining shareholders
whose percentage share interests in the Trust increase as a result of any such open-market sales
will be treated as having received a taxable distribution from the Trust.
To the extent the Trust recognizes net gains on the liquidation of portfolio securities to
meet any such repurchase or tender, the Trust will be required to make additional distributions to
its common shareholders.
TAX MATTERS
The following discussion of U.S. federal income tax consequences of investment in common
shares of the Trust is based on the Code, U.S. Treasury regulations promulgated thereunder, and
other applicable authority, as of the date of this Statement of Additional Information. These
authorities may be changed, possibly with retroactive effect, or subject to new legislative,
administrative, or judicial interpretation. The following discussion is only a summary of some of
the important U.S. federal tax considerations generally applicable to investments in the Trust and
does not constitute tax advice. This summary does not purport to be a complete description of the
U.S. federal income tax considerations applicable to an investment in common shares of the Trust.
There may be other U.S. federal income tax consequences applicable to particular common
shareholders. For example, except as otherwise specifically noted herein, we have not described
certain tax considerations that may be relevant to certain types of holders subject to special
treatment under the U.S. federal income tax laws, including shareholders subject to the U.S.
federal alternative minimum tax, insurance companies, tax-exempt organizations, pension plans and
trusts, RICs, dealers in securities, shareholders holding Trust shares through tax-advantaged
accounts (such as 401(k) plans or individual retirement accounts), financial institutions,
shareholders holding Trust shares as part of a hedge, straddle, or conversion transaction, entities
that are not organized under the laws of the United States or a political subdivision thereof, and
persons who are neither citizens nor residents of the United States. This summary assumes that
investors hold Trust common shares as capital assets (within the meaning of the Code). Shareholders
should consult their own tax advisers regarding their particular situation and the possible
application of U.S. federal, state, local, foreign or other tax laws.
This summary does not discuss the tax consequences of an investment in subscription rights of
the Trust, separately, or as part of a unit consisting of two or more securities. See Description
of Capital StructureSubscription Rights in the prospectus for a discussion of the material U.S.
federal income tax consequences of the Trusts issuance of subscription rights to common
shareholders.
Taxation of the Trust
The Trust has elected to be treated as a RIC under Subchapter M of the Code and intends each
year to qualify and to be eligible to be treated as such. In order to qualify for the special tax
treatment accorded RICs and their shareholders, the Trust must, among other things:
(i) derive at least 90% of its gross income for each taxable year from: (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) net
income derived from interests in qualified publicly traded partnerships (as described below);
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(ii) diversify its holdings so that, at the end of each quarter of the Trusts taxable year,
(a) at least 50% of the market value of the Trusts total assets consists of cash and cash items,
U.S. government securities, the securities of other RICs and other securities limited, in respect
of any one issuer, to an amount not greater than 5% of the value of the Trusts 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 Trusts total assets is invested (x) in the securities (other than U.S. government
securities and the securities of other RICs) of any one issuer or of two or more issuers that the
Trust controls, as determined under applicable Code rules, and that are determined to be engaged in
the same business or similar or related trades or businesses, or (y) in the securities of one or
more qualified publicly traded partnerships (as described below); and
(iii) distribute to its shareholders with respect to each taxable year at least 90% of the sum
of its investment company taxable income (as that term is defined in the Code, without regard to
the deduction for dividends paidgenerally taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and any net tax-exempt interest income
(the excess of its gross tax-exempt interest over certain disallowed deductions), for such year.
In general, for purposes of the 90% gross income requirement described in (i) above, income
derived from a partnership will be treated as qualifying income only to the extent such income is
attributable to items of income of the partnership which would be qualifying income if realized
directly by the RIC. However, 100% of the net income derived from an interest in a qualified
publicly traded partnership (generally, a partnership (y) interests in which are traded on an
established securities market or readily tradable on a secondary market or the substantial
equivalent thereof and (z) that derives less than 90% of its income from the qualifying income
described in (i)(a) above) will be treated as qualifying income. In general, such entities will be
treated as partnerships for federal income tax purposes because they meet the passive income
requirement under Section 7704(c)(2) of the Code. In addition, although in general the passive loss
rules of the Code do not apply to RICs, such rules do apply to a RIC with respect to items
attributable to an interest in a qualified publicly traded partnership.
For purposes of meeting the diversification requirement described in (ii) above, the term
outstanding voting securities of such issuer will include the equity securities of a qualified
publicly traded partnership. Also, for purposes of the diversification test in (ii) above, the
identification of the issuer (or, in some cases, issuers) of a particular Trust investment can
depend on the terms and conditions of that investment. In some cases, identification of the issuer
(or issuers) is uncertain under current law, and an adverse determination or future guidance by the
Internal Revenue Service (IRS) with respect to issuer identification for a particular type of
investment may adversely affect the Trusts ability to meet the diversification test in (ii) above.
If the Trust qualifies as a RIC (i.e., satisfies the source of income and diversification
requirements described in (i) and (ii) above) and satisfies the annual distribution requirement
described in (iii) above, the Trust will not be subject to U.S. federal income tax on income
distributed in a timely manner to its shareholders in the form of dividends (including Capital Gain
Dividends, as defined below).
If, for any taxable year, the Trust were to fail to qualify as a RIC by failing to meet the
income or diversification requirements described in (i) and (ii) above, the Trust could in some
cases cure such failure, including by paying a Trust-level tax and, in the case of a
diversification test failure, disposing of certain assets. If the Trust were ineligible to or
otherwise did not cure any such failure for any year, or if the Trust were otherwise to fail to
qualify as a RIC accorded special tax treatment for such year (e.g., by failing to meet the annual
distribution requirement described in (iii) above), the Trust would be subject to tax on
its taxable income at corporate rates, and all distributions from earnings and profits, including
any distributions of net tax-exempt income and net long-term capital gains, would be taxable to
shareholders as ordinary income. Some portions of such distributions might be eligible for the
dividends-received deduction in the case of corporate shareholders and might be eligible to be
treated as qualified dividend income and thus taxable at the lower long-term capital gain rate in
the case of shareholders taxed at individual rates with respect to distributions received in
taxable years beginning before January 1, 2013, provided, in both cases, the shareholder meets
certain holding period and other requirements in respect of the Trusts shares (as described
below). In addition, the Trust may be required to recognize unrealized gains, pay substantial taxes
and interest and make substantial distributions before requalifying as a RIC.
The Trust intends to distribute at least annually to its shareholders all or substantially all
of its investment company taxable income (computed without regard to the dividends-paid deduction)
and its net capital gain. Any investment company taxable income retained by the Trust will be
subject to a Trust-level tax at regular corporate rates. The Trust may also retain for investment
its net capital gain. If the Trust retains any net capital gain, it will be subject to Trust-level
tax at regular corporate rates on the amount retained, but may designate the retained amount as
undistributed capital gains in a timely notice to its shareholders who would then, in turn, be (i)
required to include in income for U.S. federal income tax purposes, as long-term capital gain,
their shares of such undistributed amount, and (ii) entitled to credit their proportionate shares
of the tax paid by the Trust on such undistributed amount against their U.S. federal income tax
liabilities, if any, and to claim refunds on a properly-filed U.S. tax return to the extent the
credit exceeds such liabilities. If the Trust makes this designation, for U.S. federal income tax
purposes, the tax basis of shares owned by a shareholder of the Trust would be increased by an
amount equal under current law to the difference between the amount of undistributed capital gains
included in the shareholders gross income under clause (i) of the preceding sentence and the
tax deemed paid by the shareholder
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under clause (ii) of the preceding sentence. The Trust is not
required to, and there can be no assurance the Trust will, make this designation if it retains all
or a portion of its net capital gain in a taxable year.
In determining its net capital gain, including in connection with determining the amount
available to support a Capital Gain Dividend, its taxable income, and its earnings and profits, a
RIC generally may elect to treat part or all of any post-October capital loss (defined as the
greatest of net capital loss, net long-term capital loss, or net short-term capital loss, in each
case attributable to the portion of the taxable year after October 31) or late-year ordinary loss
(generally, (i) net ordinary loss from the sale, exchange or other taxable disposition of property,
attributable to the portion of the taxable year after October 31, plus (ii) other net ordinary loss
attributable to the portion of the taxable year after December 31) as if incurred in the succeeding
taxable year.
If the Trust fails to distribute in a calendar year at least an amount equal to the sum
of 98% of its ordinary income for such year and 98.2% of its capital gain net income (adjusted for
certain ordinary losses) for the one-year period ending on October 31 of such year (unless an
election is made to use the Trusts fiscal year), plus any such undistributed income from the prior
year, the Trust will be subject to a nondeductible 4% excise tax on the undistributed amounts.
For purposes of the required excise tax distribution, a RICs ordinary gains and losses from
the sale, exchange or other taxable disposition of property that would otherwise be taken into
account after October 31 of a calendar year generally are treated as arising on January 1 of the
following calendar year. Also, for these purposes, the Trust will be treated as having distributed
any amount on which it has been subject to corporate income tax in the taxable year ending with the
calendar year. The Trust reserves the right to pay the excise tax when circumstances warrant.
Capital losses in excess of capital gains (net capital losses) are not permitted to be
deducted against the Trusts net investment income. Instead, potentially subject to certain
limitations, the Trust may carry net capital losses from any taxable year forward to subsequent
taxable years to offset capital gains, if any, realized during such subsequent taxable year.
Capital loss carryforwards are reduced to the extent they offset current-year net realized capital
gains, whether the Trust retains or distributes such gains. If the Trust has incurred net capital
losses in a taxable year beginning on or before December 22, 2010 (pre-2011 losses), the Trust is
permitted to carry such losses forward for eight taxable years; in the year to which they are
carried forward, such losses are treated as short-term capital losses that first offset any
short-term capital gains, and then offset any long-term capital gains.
If the Trust incurs net capital losses in taxable years beginning after December 22, 2010,
those losses will be carried forward to one or more subsequent taxable years without expiration.
Any such carryforward losses will retain their character as short-term or long-term; this may well
result in larger distributions of short-term gains to shareholders (taxable to individual
shareholders as ordinary income) than would have resulted under the previous regime described
above. The Trust must use any such carryforwards, which will not expire, applying them first
against gains of the same character, before it uses any pre-2011 losses. This increases the
likelihood that pre-2011 losses will expire unused at the conclusion of the eight-year carryforward
period.
See the Trusts most recent annual shareholder report for the Trusts available capital loss
carryovers as of the end of its most recently ended fiscal year.
Trust Distributions
Distributions are taxable to shareholders even if they are paid from income or gains earned by
the Trust before a shareholder invested in the Trust (and thus were included in the price the
shareholder paid for its shares). Distributions are taxable whether shareholders receive them in
cash or reinvest them in additional shares through the Trusts Dividend Reinvestment Plan. A
shareholder whose distributions are reinvested in shares through the Trusts Dividend Reinvestment
Plan will be treated as having received a dividend equal to either (i) if new common shares are
issued to the shareholder, generally, the fair market value of the new shares issued to the
shareholder, or (ii) if the common shares are purchased on the open market on the shareholders
behalf, the amount of cash allocated to the shareholder for the purchase of such shares. See
Dividend Reinvestment Plan in the Trusts Prospectus for more information.
Dividends and other distributions paid by the Trust are generally treated under the Code as
received by shareholders at the time the dividend or distribution is made. However, a dividend paid
to shareholders in January of a year generally is deemed to have been paid by the Trust on December
31 of the preceding year, if the dividend was declared and payable to shareholders of record on a
date in October, November or December of that preceding year.
The Trust will send you information (generally on an IRS Form 1099) after the end of each year
setting forth the amount and tax status of any dividends or other distributions paid to you by the
Trust.
For U.S. federal income tax purposes, distributions of investment income are generally taxable
as ordinary income. Taxes on distributions of capital gains are determined by how long the Trust
has owned or is treated as having owned the investments that generated them, rather than how long a
shareholder has owned his or her shares. In general, the Trust will recognize long-term capital
gain or loss on investments it has owned (or is deemed to have owned) for more than one year,
and short-term capital gain or loss on
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investments it has owned (or is deemed to have owned) for
one year or less. Distributions of net capital gain (that is, the excess of net long-term capital
gain over net short-term capital loss) that are properly reported by the Trust (generally on an IRS
Form 1099) as capital gain dividends (Capital Gain Dividends) will generally be taxable to
shareholders as long-term capital gains. Distributions from capital gains are generally made after
applying any available capital loss carryovers. Long-term capital gain rates applicable to
shareholders taxed at individual rates have been temporarily reducedin general, to 15% with a 0%
rate applying to taxpayers in the 10% and 15% rate bracketsfor taxable years beginning before
January 1, 2013. These reduced rates will expire for taxable years beginning on or after January 1,
2013, unless Congress enacts legislation providing otherwise. Distributions of net
short-term capital gain (that is, the excess of net short-term capital gain over net long-term
capital loss) will generally be taxable to shareholders receiving such distributions as ordinary
income. For taxable years beginning before January 1, 2013, distributions of investment income
reported by the Trust as derived from qualified dividend income will be taxed in the hands of
individuals at the rates applicable to long-term capital gain, provided holding period and other
requirements are met at both the shareholder and Trust level. This provision will expire for
taxable years beginning on or after January 1, 2013, unless Congress enacts legislation providing
otherwise. The Trust does not expect a significant portion of Trust distributions to be
derived from qualified dividend income.
In order for some portion of the dividends received by a Trust shareholder to be qualified
dividend income, the Trust must meet holding period and other requirements with respect to some
portion of the dividend-paying stocks in its portfolio and the shareholder must meet holding period
and other requirements with respect to the Trusts shares. A dividend will not be treated as
qualified dividend income (at either the Trust or shareholder level) (1) if the dividend is
received with respect to any share of stock held for fewer than 61 days during the 121-day period
beginning on the date which is 60 days before the date on which such share becomes ex-dividend with
respect to such dividend (or, in the case of certain preferred stock, 91 days during the 181-day
period beginning 90 days before such date), (2) to the extent that the recipient is under an
obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to
positions in substantially similar or related property, (3) if the recipient elects to have the
dividend income treated as investment income for purposes of the limitation on deductibility of
investment interest, or (4) if the dividend is received from a foreign corporation that is (a) not
eligible for the benefits of a comprehensive income tax treaty with the United States (with the
exception of dividends paid on stock of such a foreign corporation readily tradable on an
established securities market in the United States) or (b) treated as a passive foreign investment
company.
In general, distributions of investment income designated by the Trust as derived from
qualified dividend income will be treated as qualified dividend income by a shareholder taxed at
individual rates, provided the shareholder meets the holding period and other requirements
described in the paragraph immediately above with respect to the Trusts shares.
In general, dividends of net investment income received by corporate shareholders of the Trust
will qualify for the 70% dividends-received deduction generally available to corporations to the
extent of the amount of eligible dividends received by the Trust from domestic corporations for the
taxable year. A dividend received by the Trust will not be treated as a qualifying dividend (i) if
it has been received with respect to any share of stock that the Trust has held for less than 46
days (91 days in the case of certain preferred stock) during the 91-day period beginning on the
date which is 45 days before the date on which such share becomes ex-dividend with respect to such
dividend (during the 181-day period beginning 90 days before such date in the case of certain
preferred stock) or (ii) to the extent that the Trust is under an obligation (pursuant to a short
sale or otherwise) to make related payments with respect to positions in substantially similar or
related property. Moreover, the dividends-received deduction may be disallowed or reduced (i) if
the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of
the Trust or (ii) by application of various provisions of the Code (for instance, the
dividends-received deduction is reduced in the case of a dividend received on debt-financed
portfolio stock (generally, stock acquired with borrowed funds)). The Trust does not expect a
significant portion of Trust distributions to be eligible for this corporate dividends-received
deduction.
Any distribution of income that is attributable to (i) income received by the Trust in lieu of
dividends with respect to securities on loan pursuant to a securities lending transaction or (ii)
dividend income received by the Trust on securities it temporarily purchased from a counterparty
pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan
by the Trust, such distribution will not constitute qualified dividend income to individual
shareholders and will not be eligible for the dividends-received deduction for corporate
shareholders.
Return of Capital Distributions
If the Trust makes a distribution to a shareholder in excess of the Trusts current and
accumulated earnings and profits in any taxable year, the excess distribution will be treated as a
return of capital to the extent of such shareholders tax basis in its shares, and thereafter as
capital gain. A return of capital is not taxable, but it reduces a shareholders tax basis in its
shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the
shareholder of its shares.
Distributions on the Trusts shares are generally subject to U.S. federal income tax as
described herein to the extent they do not exceed the Trusts realized income and gains, even
though such dividends and distributions may economically represent a return of a
26
particular
shareholders investment. Such distributions are likely to occur in respect of shares purchased at
a time when the Trusts net asset value reflects either unrealized gains, or realized but
undistributed income or gains, that were therefore included in the price the shareholder paid. Such
distributions may reduce the value of the Trusts shares below the shareholders cost basis in
those shares. As described above, the Trust is required to distribute realized income and gains
regardless of whether the Trusts net asset value also reflects unrealized losses.
Tax Implications of Certain Trust Investments
Some debt obligations with a fixed maturity date of more than one year from the date of
issuance that are acquired by the Trust in the secondary market may be treated as having market
discount. Very generally, market discount is the excess of the stated redemption price of a debt
obligation (or in the case of an obligation issued with OID (as defined below), its revised issue
price) over the purchase price of such obligation. Generally, any gain recognized on the
disposition of, and any partial payment of principal on, a debt obligation having market discount
is treated as ordinary income to the extent the gain, or principal payment, does not exceed the
accrued market discount on such debt obligation. Alternatively, a holder may elect to accrue
market discount currently. As of the date of this Statement of Additional Information, the Trust
has made this election, and as such, the Trust is required to include currently any accrued market
discount on such debt obligations in the Trusts taxable income (as ordinary income) and thus
distribute it over the terms of the obligations, even though payment of those amounts is not
received until a later time, upon partial or full repayment or disposition of the applicable debt
obligations. The Trust reserves the right to revoke this election at any time pursuant to
applicable IRS procedures. The rate at which market discount accrues, and thus is included in the
Trusts income, will depend upon which of the permitted accrual methods the Trust elects.
In addition, some debt obligations with a fixed maturity date of more than one year from the
date of issuance (and zero-coupon debt obligations with a fixed maturity date of more than one year
from the date of issuance) that are acquired by the Trust will be treated as debt obligations that
are issued originally at a discount. Generally, the amount of the original issue discount (OID)
is treated as interest income and is included in taxable income (and required to be distributed by
the Trust) over the term of the debt obligation, even though payment of that amount is not received
until a later time, upon partial or full repayment or disposition of the debt obligation. In
addition, PIK securities will give rise to income which is required to be distributed and is
taxable even though the Trust receives no interest payment in cash on the security during the year
in which the income was accrued
The Trust expects that a substantial portion of the Trusts investments in loans and other
debt obligations will be treated as having market discount and/or OID, which, in some cases, could
be significant.
Some debt obligations with a fixed maturity date of one year or less from the date of issuance
that are acquired by the Trust may be treated as having OID or, in certain cases, acquisition
discount (very generally, the excess of the stated redemption price over the purchase price).
Generally, the Trust will be required to include the OID or acquisition discount in income (as
ordinary income) over the term of the debt obligation and thus distribute it over the term of the
debt obligation, even though payment of that amount is not received until a later time, upon
partial or full repayment or disposition of the debt obligation. The rate at which OID or
acquisition discount accrues, and thus is included in the Trusts income, will depend upon which of
the permitted accrual methods the Trust elects.
Some preferred securities may include provisions that permit the issuer, at its discretion, to
defer the payment of distributions for a stated period without any adverse consequences to the
issuer. If the Trust owns a preferred security that is deferring the payment of its distributions,
the Trust may be required to report income for U.S. federal income tax purposes to the extent of
any such deferred distribution even though the Trust has not yet actually received the cash
distribution.
As a result of holding the foregoing kinds of securities, the Trust may be required to pay out
as an income distribution each year an amount which is greater than the total amount of cash
interest (or dividends in the case of preferred securities) the Trust actually received. Such
distributions may be made from, among other things, the cash assets of the Trust or cash generated
from the Trusts liquidation of portfolio securities. The Trust may realize gains or losses from
such liquidations. In the event the Trust realizes net long-term or short-term capital gains from
such transactions, its shareholders may receive a larger capital gain or ordinary dividend,
respectively, than they would in the absence of such transactions.
Investments in distressed debt obligations that are at risk of or in default present special
tax issues for the Trust. Tax rules are not entirely clear about issues such as whether and to what
extent the Trust should recognize market discount on these debt obligations, when the Trust may
cease to accrue interest, OID or market discount, when and to what extent the Trust may take
deductions for bad debts or worthless securities and how the Trust should allocate payments
received on obligations in default between principal and income. These and other related issues
will be addressed by the Trust when, as and if it invests in such securities, in order to seek to
ensure that it distributes sufficient income to preserve its status as a RIC and does not
become subject to U.S. federal income or excise tax.
27
A portion of the OID accrued on certain high-yield discount obligations owned by the Trust may
not be deductible to the issuer and will instead be treated as a dividend paid by the issuer for
purposes of the dividends-received deduction. In such cases, if the issuer of the obligation is a
domestic corporation, dividend payments by the Trust may be eligible for the dividends-received
deduction to the extent of the deemed dividend portion of such OID.
Any transactions by the Trust in foreign currencies, foreign currency-denominated debt
obligations and certain foreign currency options, futures contracts and forward contracts (and
similar instruments) may give rise to ordinary income or loss to the extent such income or loss
results from fluctuations in the value of the foreign currency concerned. Such ordinary income
treatment may accelerate Trust distributions to shareholders and increase the distributions taxed
to shareholders as ordinary income. Any net ordinary losses so created cannot be carried forward
by the Trust to offset income or gains earned in subsequent years.
Any equity investments by the Trust in certain passive foreign investment companies
(PFICs) could potentially subject the Trust to a U.S. federal income tax (including interest
charges) on distributions received from the company or on proceeds received from the disposition of
shares in the company. This tax cannot be eliminated by making distributions to Trust shareholders.
However, the Trust may elect to avoid the imposition of that tax. For example, the Trust may elect
to treat a PFIC as a qualified electing fund (i.e., make a QEF election), in which case the
Trust will be required to include its share of the companys income and net capital gains annually,
regardless of whether it receives any distribution from the company. The Trust also may make an
election to mark the gains (and to a limited extent losses) in such holdings to the market as
though it had sold and repurchased its holdings in those PFICs on the last day of the Trusts
taxable year. Such gains and losses are treated as ordinary income and loss. The QEF and
mark-to-market elections may accelerate the recognition of income (without the receipt of cash) and
increase the amount required to be distributed by the Trust to avoid taxation. Making either of
these elections therefore may require the Trust to liquidate other investments (including when it
is not advantageous to do so) to meet its distribution requirement, which also may accelerate the
recognition of gain and affect the Trusts total return. Dividends paid by PFICs will not be
eligible to be treated as qualified dividend income.
Because it is not always possible to identify a foreign corporation as a PFIC, the Trust may
incur the tax and interest charges described above in some instances.
Income received by the Trust from sources within foreign countries may be subject to
withholding and other taxes imposed by such countries. Tax treaties between certain countries and
the United States may reduce or eliminate such taxes. Shareholders generally will not be entitled
to claim a credit or deduction with respect to foreign taxes incurred by the Trust. This will
decrease the Trusts yield on securities subject to such taxes.
The Trusts Derivative Transactions, as well as any of its other hedging, short sale or
similar transactions, may be subject to one or more special tax rules (including, for instance,
notional principal contract, mark-to-market, constructive sale, straddle, wash sale and short-sale
rules). These rules may affect whether gains and losses recognized by the Trust are treated as
ordinary or capital and/or as short-term or long-term, accelerate the recognition of income or
gains to the Trust, defer losses, and cause adjustments in the holding periods of the Trusts
securities. The rules could therefore affect the amount, timing and/or character of distributions
to shareholders.
Because the tax rules applicable to derivative financial instruments are in some cases
uncertain under current law, an adverse determination or future guidance by the IRS with respect to
these rules (which determination or guidance could be retroactive) may affect whether the Trust has
made sufficient distributions, and otherwise satisfied the relevant requirements, to maintain its
qualification as a RIC and avoid a Trust-level tax.
Certain of the Trusts Derivative Transactions and investments in foreign currency-denominated
instruments, and any of the Trusts transactions in foreign currencies and hedging activities, are
likely to produce a difference between its book income and the sum of its taxable income and net
tax-exempt income (if any). If there are differences between the Trusts book income and the sum
of its taxable income and net tax-exempt income (if any), the Trust may be required to distribute
amounts in excess of its book income or a portion of Trust distributions may be treated as a return
of capital to shareholders. If the Trusts book income exceeds the sum of its taxable income and
net tax-exempt income (if any), the distribution (if any) of such excess generally will be treated
as (i) a dividend to the extent of the Trusts remaining earnings and profits (including earnings
and profits arising from any tax-exempt income), (ii) thereafter, as a return of capital to the
extent of the recipients basis in its shares, and (iii) thereafter, as gain from the sale or
exchange of a capital asset. If the Trusts book income is less than the sum of its taxable income
and net tax-exempt income (if any), the Trust could be required to make distributions exceeding
book income to qualify as a RIC that is accorded special tax treatment and to avoid a Trust-level
tax.
The Trusts investments in equity securities of REITs may result in the Trusts receipt of
cash in excess of the REITs earnings; if the Trust distributes these amounts, these distributions
could constitute a return of capital to Trust shareholders for U.S. federal
28
income tax purposes.
Investments by the Trust in REIT equity securities also may require the Trust to accrue and
distribute income not yet received. To generate sufficient cash to make the requisite
distributions, the Trust may be required to sell securities in its portfolio (including when it is
not advantageous to do so) that it otherwise would have continued to hold. Dividends received by
the Trust from a REIT generally will not constitute qualified dividend income.
Under a notice issued by the IRS in October 2006 and Treasury regulations that have yet to be
issued but may apply retroactively, a portion of a Trusts income (if any) (including income
allocated to the Trust from a REIT or other pass-through entity) that is attributable to a residual
interest in a real estate mortgage investment conduit (REMIC) (including by investing in residual
interests in collateralized mortgage obligations) or an equity interest in a taxable mortgage pool
(TMP) (referred to in the Code as an excess inclusion) will be subject to U.S. federal income
tax in all events. This notice also provides, and the regulations are expected to provide, that
excess inclusion income of a RIC will be allocated to shareholders of the RIC in proportion to the
dividends received by such shareholders, with the same consequences as if the shareholders held the
related interest directly. As a result, to the extent the Trust invests in any such interests, it
may not be a suitable investment for certain tax-exempt shareholders (as noted below in Tax-Exempt
Shareholders).
In general, excess inclusion income allocated to shareholders (i) cannot be offset by net
operating losses (subject to a limited exception for certain thrift institutions), (ii) will
constitute unrelated business taxable income (UBTI) to entities (including a qualified pension
plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity)
subject to tax on UBTI, thereby potentially requiring such an entity that is allocated excess
inclusion income, and otherwise might not be required to file a U.S. federal income tax return, to
file such a tax return and pay tax on such income, and (iii) in the case of a non-U.S. shareholder,
will not qualify for any reduction in U.S. federal withholding tax.
Backup Withholding
The Trust generally is required to withhold and remit to the U.S. Treasury a percentage of the
taxable distributions and redemption proceeds paid to any individual shareholder who fails to
properly furnish the Trust with a correct taxpayer identification number (TIN), who has
under-reported dividend or interest income, or who fails to certify to the Trust that he or she is
not subject to such withholding. The backup withholding tax rate is 28% for amounts paid through
2012. This rate will expire and the backup withholding rate will be 31% for amounts paid after
December 31, 2012, unless Congress enacts tax legislation providing otherwise.
Backup withholding is not an additional tax. Any amounts withheld may be credited against the
shareholders U.S. federal income tax liability, provided the appropriate information is furnished
to the IRS.
Sale or Exchange of Trust Shares
The sale or exchange of Trust shares may give rise to a gain or loss. In general, any gain or
loss realized upon a taxable disposition of shares will be treated as long-term capital gain or
loss if the shares have been held for more than 12 months. Otherwise, the gain or loss on the
taxable disposition of Trust shares will be treated as short-term capital gain or loss. However,
any loss realized upon a taxable disposition of shares held for six months or less will be treated
as long-term, rather than short-term, to the extent of any Capital Gain Dividends received (or
deemed received) by the shareholder with respect to the shares. All or a portion of any loss
realized upon a taxable disposition of Trust shares will be disallowed if other substantially
identical shares are purchased within 30 days before or after the disposition. In such a case, the
basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
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
advisers.
Tax Shelter Reporting Regulations
Under Treasury regulations, if a shareholder recognizes a loss with respect to common shares
of $2 million or more for an individual shareholder or $10 million or more for a corporate
shareholder, the shareholder must file with the IRS a disclosure statement on Form 8886. Direct
shareholders of portfolio securities are in many cases excepted from this reporting requirement,
but under current guidance, shareholders of a RIC are not excepted. Future guidance may extend the
current exception from this reporting requirement to shareholders of most or all RICs. The fact
that a loss is reportable under these regulations does not affect the legal determination of
whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax
advisers to determine the applicability of these regulations in light of their individual
circumstances.
29
Non-U.S. Shareholders
Distributions properly designated as Capital Gain Dividends generally will not be subject to
withholding of U.S. federal income tax. In general, dividends other than Capital Gain Dividends
paid by the Trust to a shareholder that is not a United States person within the meaning of the
Code (a foreign shareholder) are subject to withholding of U.S. federal income tax at a rate of
30% (or lower applicable treaty rate) even if they are funded by income or gains (such as portfolio
interest, short-term capital gains, or foreign-source dividend and interest income) that, if paid
to a foreign shareholder directly, would not be subject to withholding. However, effective for
taxable years of a RIC beginning before January 1, 2012, the Trust will not be required to withhold
any amounts (i) with respect to distributions (other than distributions to a foreign shareholder
(A) that has not provided a satisfactory statement that the beneficial owner is not a U.S. person,
(B) to the extent that a dividend paid is attributable to certain interest on an obligation if the
foreign shareholder is the issuer of such obligation or a 10% shareholder of the issuer, (C) that
is within certain foreign countries that have inadequate information exchange with the United
States, or (D) to the extent the dividend is attributable to interest paid by a person that is a
related person of the foreign shareholder and the foreign shareholder is a controlled foreign
corporation) from U.S.-source interest income of types similar to those not subject to U.S. federal
income tax if earned directly by an individual foreign shareholder, to the extent such
distributions are properly reported as such by the Trust in a written notice to shareholders
(interest-related dividends), and (ii) with respect to distributions (other than (A)
distributions to an individual foreign shareholder who is present in the United States for a period
or periods aggregating 183 days or more during the year of the distribution and (B) distributions
subject to special rules regarding the disposition of U.S. real property interests (USRPIs, as
described below)) of net short-term capital gains in excess of net long-term capital losses to the
extent such distributions are properly reported as such by the Trust in a written notice to
shareholders (short-term capital gain dividends). The Trust is permitted to report such part of
its dividends as interest-related or short-term capital gain dividends as are eligible, but is not
required to do so. Absent legislation extending these exemptions for taxable years beginning on or
after January 1, 2012, these special withholding exemptions for interest-related and short-term
capital gain dividends will expire and these dividends generally will be subject to withholding as
described above.
In the case of shares held through an intermediary, the intermediary may withhold even if the
Trust reports all or a portion of a payment as an interest-related or short-term capital gain
dividend to shareholders. Foreign shareholders should contact their intermediaries regarding the
application of these rules to their accounts.
A foreign shareholder is not, in general, subject to U.S. federal income tax on gains (and is
not allowed a deduction for losses) realized on the sale of shares of the Trust or on Capital Gain
Dividends unless (i) such gain or dividend is effectively connected with the conduct of a trade or
business carried on by such holder within the United States, (ii) in the case of an individual
holder, the holder is present in the United States for a period or periods aggregating 183 days or
more during the year of the sale or the receipt of the Capital Gain Dividend and certain other
conditions are met, or (iii) certain special rules relating to gain attributable to the sale or
exchange of USRPIs apply to the foreign shareholders sale of shares of the Trust or to the Capital
Gain Dividend the foreign person received.
Foreign shareholders with respect to whom income from the Trust is effectively connected with
a trade or business conducted by the foreign shareholder within the United States will in general
be subject to U.S. federal income tax on the income derived from the Trust at the graduated rates
applicable to U.S. citizens, residents or domestic corporations, whether such income is received in
cash or reinvested in additional shares of the Trust and, in the case of a foreign corporation, may
also be subject to a branch profits tax. If a foreign shareholder is eligible for the benefits of
a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal
income tax on a net basis only if it is also attributable to a permanent establishment maintained
by the shareholder in the United States. More generally, foreign shareholders who are residents of
a country with an income tax treaty with the United States may obtain different tax results than
those described herein, and are urged to consult their tax advisers.
Special rules apply to distributions to certain foreign shareholders from a RIC that is either
a United States real property holding corporation (USRPHC) or would be a USRPHC absent certain
exceptions to the definition thereof. Additionally, special rules apply to the sale of shares in a
RIC that is a USRPHC or former USRPHC. Very generally, a USRPHC is a domestic corporation that
holds USRPIs USRPIs are defined as any interest in U.S. real property or any equity interest in
a USRPHC or former USRPHC the fair market value of which, during specified testing periods,
equals or exceeds 50% of the sum of the fair market values of the corporations USRPIs, interests
in real property located outside the United States and other assets. The Trust has not been a
USRPHC and generally does not expect that it will become a USRPHC but for the operation of these
exceptions, and thus does not expect these special tax rules to apply.
In order to qualify for any exemption from withholding described above (to the extent
applicable) or for lower withholding tax rates under income tax treaties, or to establish an
exemption from backup withholding, a foreign shareholder must comply with
applicable certification and filing requirements relating to its non-U.S. status (including,
in general, furnishing an IRS Form W-8BEN or substitute form). Foreign shareholders should contact
their tax advisers in this regard.
30
Special rules (including withholding and reporting requirements) apply to foreign partnerships
and those holding Trust shares through foreign partnerships. Additional considerations may apply to
foreign trusts and estates. Investors holding Trust shares through foreign entities should consult
their tax advisers.
A foreign shareholder may be subject to state and local tax and to the U.S. federal estate tax
in addition to the U.S. federal tax on income referred to above.
Tax-Exempt Shareholders
Under current law, the Trust serves to block (that is, prevent the attribution to
shareholders of) UBTI from being realized by tax-exempt shareholders. Notwithstanding this
blocking effect, a tax-exempt shareholder could realize UBTI by virtue of its investment in the
Trust if shares in the Trust constitute debt-financed property in the hands of the tax-exempt
shareholder within the meaning of Section 514(b) of the Code.
A tax-exempt shareholder may also recognize UBTI if the Trust recognizes excess inclusion
income derived from direct or indirect investments in residual interests in REMICS or equity
interests in TMPs if the amount of such income recognized by the Trust exceeds the Trusts
investment company taxable income (after taking into account deductions for dividends paid by the
Trust).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that
invest in RICs that invest directly or indirectly in residual interests in REMICs or equity
interests in TMPs. Under legislation enacted in December 2006, a CRT (as defined in Section 664 of
the Code) that realizes any UBTI for a taxable year must pay an excise tax annually of an amount
equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI as a
result of investing in a RIC that recognizes excess inclusion income. Rather, if at any time during
any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the United States,
a state or political subdivision, or an agency or instrumentality thereof, and certain energy
cooperatives) is a record holder of a share in a RIC that recognizes excess inclusion income, then
the RIC will be subject to a tax on that portion of its excess inclusion income for the taxable
year that is allocable to such shareholders at the highest federal corporate income tax rate. The
extent to which this IRS guidance remains applicable in light of the December 2006 legislation is
unclear. To the extent permitted under the Investment Company Act, the Trust may elect to specially
allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such
shareholders distributions for the year by the amount of the tax that relates to such
shareholders interest in the Trust.
CRTs and other tax-exempt investors are urged to consult their tax advisers concerning the
consequences of investing in the Trust.
Shareholder Reporting Obligations With Respect to Foreign Bank and Financial Accounts and Other Foreign Financial Assets
Certain individuals (and, to the extent provided in future guidance, certain domestic entities) must disclose annually
their interests in specified foreign financial assets on IRS Form 8938, which must be attached to their U.S. federal
income tax returns for taxable years beginning after March 18, 2010. The IRS has not yet released a copy of the Form
8938 and has suspended the requirement to attach Form 8938 for any taxable year for which an income tax return is
filed before the release of Form 8938. Following Form 8938s release, individuals will be required to attach to their
next income tax return required to be filed with the IRS a Form 8938 for each taxable year for which the filing of Form
8938 was suspended. Until the IRS provides more details regarding this reporting requirement, including in Form 8938
itself and related Treasury regulations, it remains unclear under what circumstances, if any, a shareholders (indirect)
interest in the Trusts specified foreign financial
assets (if any) will be required to be reported on this Form 8938. In
addition, shareholders that are U.S. persons and own, directly or indirectly, more than 50% of the Trust could be
required to report annually their financial interest in
the Trusts foreign financial accounts, if any, on Treasury
Department Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Shareholders should consult
their tax advisers to determine the applicability to them of these reporting requirements.
Other Reporting and Withholding Requirements
Rules enacted in March 2010 require the reporting to the IRS
of direct and indirect ownership of foreign financial accounts and foreign entities by U.S. persons. Failure to provide
this required information could result in a 30% withholding tax on
certain payments (withholdable payments) beginning
in 2014 or 2015, depending on the type of payment. Specifically, withholdable payments subject to this 30% withholding tax
include payments of U.S.-source dividends and interest made on or after January 1, 2014, and payments of gross proceeds
from the sale or other disposal of property that can produce U.S.-source dividends or interest made on or after January
1, 2015.
The IRS has issued only preliminary guidance with respect to these new rules; their scope
remains unclear and potentially subject to material change. Very generally, it is possible that all or
a portion of distributions made by the Trust on or after the dates noted above(or such later dates as may be
provided in future guidance) to a shareholder, including a distribution in redemption of shares and a distribution
of income or gains otherwise exempt from withholding under the rules applicable to foreign shareholders described above
(e.g., Capital Gain Dividends and interest-related and short-term capital gain dividends), will be subject to the 30%
withholding requirement. Payments to a foreign shareholder that is a
foreign financial institution will generally be
subject to withholding, unless such shareholder enters into a timely agreement with the IRS. Payments to shareholders
that are U.S. persons or foreign individuals
31
will generally not be subject to withholding, so long as such shareholders provide the Trust with such certifications or
other documentation, including, to the extent required, with regard to their direct and indirect owners, as the Trust is
required to comply with these rules. Persons investing in the Trust through an intermediary should contact their
intermediary regarding the application of this reporting and withholding regime to their investments in the Trust.
Shareholders are urged to consult a tax adviser regarding this reporting and withholding regime, in light of their
particular circumstances.
Shares Purchased Through Tax Qualified Plans
Special tax rules apply to investments through defined contribution plans and other
tax-qualified plans. Shareholders should consult their tax advisers to determine the suitability of
shares of the Trust as an investment through such plans and the precise effect of an investment on
their particular tax situation.
General Considerations
The U.S. federal income tax discussion set forth above is for general information only.
Prospective investors should consult their tax advisers regarding the specific federal tax
consequences of purchasing, holding, and disposing of shares of the Trust, as well as the effects
of state, local and foreign tax law and any proposed tax law changes.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP, located at 2001 Ross Avenue, Suite 1800, Dallas, TX, 75201,
provides accounting and auditing services to the Trust.
CUSTODIAN
The custodian of the assets of the Trust is PFPC Trust Company (301 Bellevue Parkway,
Wilmington, DE 19809; telephone (877) 665-1287). The custodian performs custodial services for the
Trust.
ADDITIONAL INFORMATION
A registration statement on Form N-2, including amendments thereto, relating to the shares
offered hereby (the Registration Statement), has been filed by the Trust with the Commission. 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 securities 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 Commissions 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 Trusts audited financial statements appearing in the Trusts annual shareholder report
for the period ended December 31, 2010 are incorporated by reference in this Statement of
Additional Information and have been so incorporated in reliance upon the report of
PricewaterhouseCoopers LLP, independent registered public accounting firm for the Trust. The
Trusts annual shareholder report is available upon request and without charge by writing to the
Trust at NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 or by calling (877)
665-1287.
32
APPENDIX A
Standard & PoorsA brief description of the applicable rating symbols of Standard & Poors
and their meanings (as published by Standard & Poors) follows:
Issue Credit Rating Definitions
A Standard & Poors issue credit rating is a forward-looking opinion about 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 opinion reflects Standard & Poors view of
the obligors capacity and willingness to meet its financial commitments as they come due, and may
assess terms, such as collateral security and subordination, which could affect ultimate payment in
the event of default.
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. 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 Standard & Poors analysis of the
following considerations:
|
i) |
|
Likelihood of paymentcapacity and willingness of the obligor to meet its financial
commitment on an obligation in accordance with the terms of the obligation; |
|
|
ii) |
|
Nature of and provisions of the obligation; |
|
|
iii) |
|
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. |
Issue ratings are an assessment of default risk, but may incorporate an assessment of relative
seniority or ultimate recovery in the event of default. Junior obligations are typically rated
lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such
differentiation may apply when an entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company obligations.)
AAA
An obligation rated AAA has the highest rating assigned by Standard & Poors. The obligors
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 obligors 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
obligors capacity to meet its financial commitment on the obligation is still strong.
A-1
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.
BB
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 obligors 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 obligors 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 C rating is assigned to obligations that are currently highly vulnerable to nonpayment,
obligations that have payment arrearages allowed by the terms of the documents, or obligations of
an issuer that is the subject of a bankruptcy petition or similar action which have not experienced
a payment default. Among others, the C rating may be assigned to subordinated debt, preferred
stock or other obligations on which cash payments have been suspended in accordance with the
instruments terms or when preferred stock is the subject of a distressed exchange offer, whereby
some or all of the issue is either repurchased for an amount of cash or replaced by other
instruments having a total value that is less than par.
D
An obligation rated D is in payment default. The D rating category is used when payments
on an obligation, including a regulatory capital instrument, are not made on the date due even if
the applicable grace period has not expired, unless Standard & Poors 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.
An obligations rating is lowered to D upon completion of a distressed exchange offer, whereby
some or all of the issue is either repurchased for an amount of cash or replaced by other
instruments having a total value that is less than par.
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.
A-2
NR
This indicates that no rating has been requested, that there is insufficient information on
which to base a rating, or that Standard & Poors 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 & Poors. The
obligors 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
obligors 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 obligors 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 obligors
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, including a regulatory capital instrument, are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poors 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.
A-3
SPUR (Standard & Poors Underlying Rating)
This is a rating of a stand-alone capacity of an issue to pay debt service on a
credit-enhanced debt issue, without giving effect to the enhancement that applies to it. These
ratings are published only at the request of the debt issuer/obligor with the designation SPUR to
distinguish them from the credit-enhanced rating that applies to the debt issue. Standard & Poors
maintains surveillance of an issue with a published SPUR.
Municipal Short-Term Note Ratings Definitions
A Standard & Poors U.S. municipal note rating reflects Standard & Poors opinion about the
liquidity factors and market access risks unique to the notes. Notes due in three years or less
will likely receive a note rating. Notes with an original maturity of more than three years will
most likely receive a long-term debt rating. In determining which type of rating, if any, to
assign, Standard & Poors analysis will review the following considerations:
|
a. |
|
Amortization schedule the larger the final maturity relative to other maturities, the
more likely it will be treated as a note; and |
|
|
b. |
|
Source of payment the more dependent the issue is on the market for its refinancing, the
more likely it will be treated as a note. Note rating symbols are as follows: |
SP-1
Strong capacity to pay principal and interest. An issue determined to possess a very strong
capacity to pay debt service is given a plus (+) designation.
SP-2
Satisfactory capacity to pay principal and interest, with some vulnerability to adverse
financial and economic changes over the term of the notes.
SP-3
Speculative capacity to pay principal and interest.
Dual Ratings
Standard & Poors assigns dual ratings to all debt issues that have a put option or demand
feature as part of their structure. The first rating addresses the likelihood of repayment of
principal and interest as due, and the second rating addresses only the demand feature. The
long-term rating symbols are used for bonds to denote the long-term maturity and the short-term
rating symbols for the put option (for example, AAA/A-1+). With U.S. municipal short-term demand
debt, note rating symbols are used with the short-term issue credit rating symbols (for example,
SP-1+/A-1+).
The ratings and other credit related opinions of Standard & Poors and its affiliates are
statements of opinion as of the date they are expressed and not statements of fact or
recommendations to purchase, hold, or sell any securities or make any investment decisions.
Standard & Poors assumes no obligation to update any information following publication. Users of
ratings and credit related opinions should not rely on them in making any investment decision.
Standard &Poors opinions and analyses do not address the suitability of any security. Standard &
Poors Financial Services LLC does not act as a fiduciary or an investment advisor. While Standard
& Poors has obtained information from sources it believes to be reliable, Standard & Poors does
not perform an audit and undertakes no duty of due diligence or independent verification of any
information it receives. Ratings and credit related opinions may be changed, suspended, or
withdrawn at any time.
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
A-4
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 NRi
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 issuers published financial
information, as well as additional information in the public domain. They do not, however, reflect
in-depth meetings with an issuers 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 years financial statements, but may be reviewed on an interim basis if a
major event occurs that may affect the issuers 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.
|
i) |
|
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 & Poors of appropriate
documentation. Changes in the information provided to Standard & Poors could result in the
assignment of a different rating. In addition, Standard & Poors reserves the right not to
issue a final rating. |
|
|
ii) |
|
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 & Poors 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.
unsolicited
Unsolicited ratings are those credit ratings assigned at the initiative of Standard & Poors
and not at the request of the issuer or its agents.
Inactive Qualifiers (No longer applied or outstanding)
*
A-5
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 issuers 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 & Poors 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.
Moodys Investors Service, Inc.A brief description of the applicable Moodys Investors
Service, Inc. (Moodys) rating symbols and their meanings (as published by Moodys) follows:
Long-Term Obligation Ratings
Moodys 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.
Moodys 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.
A-6
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: Moodys 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
Moodys 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 pari
passu notes issued under the same program, at the programs relevant indicated rating, provided
such notes do not exhibit any of the characteristics listed below:
|
i) |
|
Notes containing features that link interest or principal to the credit performance of
any third party or parties (i.e., credit-linked notes); |
|
|
ii) |
|
Notes allowing for negative coupons, or negative principal; |
|
|
iii) |
|
Notes containing any provision that could obligate the investor to make any additional payments; |
|
|
iv) |
|
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, Moodys policy is to look through to the credit risk of the
underlying obligor. Moodys policy with respect to non-credit linked obligations is to rate the
issuers 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. Moodys encourages market participants to contact Moodys 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:
Moodys 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.
Moodys 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.
A-7
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.
A-8
APPENDIX B
PROXY VOTING POLICIES AND PROCEDURES
PROXY VOTING POLICY
1. |
|
Application; General Principles |
1.1 This proxy voting policy (the Policy) applies to securities held in Client accounts
(including registered investment companies and other pooled investment vehicles) as to which the
above-captioned investment adviser (the Company) has voting authority, directly or indirectly.
Indirect voting authority exists where the Companys 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 Clients best economic interests and without regard to the interests of the Company or any
other Client of the Company.
2.1 Monitoring. A member of the settlement group (the 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. The portfolio manager(s) may consult
a member of the settlement group as necessary.
2.2 Voting. Upon receipt of notice from the settlement designee, the portfolio
manager(s) of the fund(s) in which 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 accordance with the
Guidelines set forth below.
2.3 Guideline. 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. This Policy is designed
to be implemented in a manner reasonably expected to ensure that voting rights are exercised in the
best interests of the Companys clients. Each proxy is voted on a case-by-case basis taking into
consideration any relevant contractual obligations as well as other relevant facts and
circumstances. In general, the Company reviews and considers corporate governance issues related to
proxy matters and generally supports proposals that foster good corporate governance practices.
Portfolio manager(s) may vote proxies as recommended by the security issuers management on routine
matters related to the operation of the issuer and on matters not expected to have a significant
impact on the issuer and/or its shareholders, because the Company believes that recommendations by
the issuer are generally in shareholders best interests, and therefore in the best economic
interest of the Companys clients.
2.4 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 Companys compliance department prior
to causing the proxy to be voted.
2.4.1. For a security held by a an investment company, the Company shall disclose the
conflict and its reasoning for voting as it did to the Retail Funds Board of Trustees at the
next regularly scheduled quarterly meeting. In voting proxies for securities held by an
investment company, the Company may consider only the interests of the Fund. It is the
responsibility of the compliance department to document the basis for the decision and furnish
the documentation to the Board of Trustees. The Company may resolve the conflict of interest by
following the proxy voting recommendation of a disinterested third party (such as ISS, Glass
Lewis, or another institutional proxy research firm).
2.5 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 Clients 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
matters being voted upon are not material events affecting the securities and 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.
Highland Capital Management, L.P.
Proxy Voting Policy
B-1
2.6 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.
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, or of an affiliate, accounting for more than 5%
of the Companys or affiliates annual revenues.
3.1.2 The issuer is an entity that reasonably could be expected to pay the Company or its
affiliates more than $1 million through the end of the Companys next two full fiscal years.
3.1.3 The issuer is an entity in which a Covered Person (as defined in the Companys
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 (the 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(1)
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 Companys 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.
3.1.5 The matter under consideration could reasonably be expected to result in a material
financial benefit to the Company or its affiliates through the end of the Companys next two full
fiscal years (for example, a vote to increase an investment advisory fee for a 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 Clients
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 Companys 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 issuers outstanding voting securities, but only if: (i) such securities do not
represent one of the 10 largest holdings of such issuers outstanding voting securities and (ii)
such securities do not represent more than 2% of the Clients 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.
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(1) |
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For the purposes of this Policy, relative includes the following family members: spouse,
minor children or stepchildren or children or stepchildren sharing the persons home. |
B-2
4. |
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Recordkeeping, Retention and Compliance Oversight |
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 Companys 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 SECs 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 investment company
clients will be reported periodically, as requested, to the investment companys Board of Trustees
and, to the SEC on an annual basis pursuant to Form N-PX.
4.5 Compliance oversees the implementation of this procedure, including oversight over voting
and the retention of proxy ballots voted. The CCO may review proxy voting pursuant to the firms
compliance program.
Adopted by the Companys Compliance Committee: March 24, 2009, amended June 17, 2009
Approved by the Highland Funds Board of Trustees for all Funds (except Highland Long/Short Equity
Fund): June 5, 2009
B-3
Part C
Other Information
Item 25. Financial Statements and Exhibits
1. Financial Statements
Part A Financial Highlights.
Part B Audited financial statements for the period ended December 31, 2010 are incorporated by
reference herein to the Trusts annual report for the period ended December 31, 2010.
2. Exhibits
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(a)
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Agreement and Declaration of Trust (1) |
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(b)
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By-Laws (1) |
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(c)
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Not applicable |
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(d)(1)
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Provisions of instruments defining the rights of holders of securities are contained in the
Registrants Agreement and Declaration of Trust and By-Laws |
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(d)(2)
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Form of Subscription Certificate (7) |
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(e)
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Form of Dividend Reinvestment Plan (2) |
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(f)
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Not applicable |
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(g)(1)
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Form of Investment Advisory Agreement (2) |
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(h)(1)
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Form of Underwriting Agreement (7) |
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(h)(2)
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Form of Dealer Manager Agreement (7) |
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(i)
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Not applicable |
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(j)
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Form of Custodian Services Agreement (1) |
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(k)(1)
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Form of Transfer Agency Services Agreement (1) |
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(k)(2)
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Form of Administration Services Agreement (2) |
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(k)(3)
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Form of Amendment No. 1 to Administration Services Agreement (4) |
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(k)(4)
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Form of Sub-Administration Services Agreement (1) |
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(k)(5)
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Form of Accounting Services Agreement (1) |
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(k)(6)
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Form of Marketing and Structuring Fee Agreement (2) |
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(k)(7)
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Form of Subscription Agent
Agreement (7) |
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(k)(8)
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Credit Agreement, dated February 2, 2011, between the Trust and State Street Bank and Trust Company (5) |
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(k)(9)
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Note Purchase Agreement, dated April 16, 2010, between the Trust and Metropolitan Life Insurance
Company and affiliated companies (5) |
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(k)(10)
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First Amendment Agreement, dated as of January 31, 2011, to Note Purchase Agreement, dated April 16,
2010, between the Trust and Metropolitan Life Insurance Company and affiliated companies (5) |
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(l)
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Opinion and Consent of Special Delaware Counsel to the Trust (6) |
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(m)
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Not applicable |
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(n)
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Consent of Independent Registered
Public Accounting Firm (6) |
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(o)
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Not applicable |
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(p)
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Subscription Agreement (1) |
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(q)
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Not applicable |
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(r)(1)
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Code of Ethics of the Trust (1) |
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(r)(2)
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Code of Ethics of the Investment Adviser (1) |
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(s)
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Power of Attorney (5) |
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(1) |
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Incorporated by reference from Pre-Effective Amendment No. 4 to the Trusts Registration
Statement on Form N-2 (File No. 333-132436), filed on June 9, 2006. |
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(2) |
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Incorporated by reference from Pre-Effective Amendment No. 5 to the Trusts Registration
Statement on Form N-2 (File No. 333-132436), filed on June 21, 2006. |
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(3) |
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Incorporated by reference from Pre-Effective Amendment No. 1 to the Trusts Registration
Statement on Form N-14 (File No. 333-149424), filed on April 17, 2008. |
2
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(4) |
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Incorporated by reference from the Trusts Registration Statement on Form N-14 (File No.
333-156464), filed on December 24, 2008. |
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(5) |
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Incorporated by reference from the Trusts Registration
Statement on Form N-14 (File No. 333-173004), filed on March 23,
2011. |
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(6) |
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Filed herewith. |
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(7) |
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To be filed by amendment. |
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Item 26. Marketing Arrangements
Reference is made to the form of underwriting agreement and/or sales agreement for the Registrants
common shares to be filed in a post-effective amendment to the Registrants Registration Statement
and the section entitled Plan of Distribution contained in Registrants Prospectus, filed
herewith as Part A of Registrants Registration Statement.
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:
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Legal Fees |
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$ |
250,000 |
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Subscription Agent |
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50,000 |
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Information Agent |
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18,000 |
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Accounting Fees |
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100,000 |
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Printing and Mailing |
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50,000 |
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NYSE Listing Fee |
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50,000 |
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SEC Registration Fee |
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17,415 |
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FINRA Fee |
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20,000 |
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Other |
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10,000 |
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Total |
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$ |
565,415 |
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Note: All amounts are estimates.
Item 28. Persons Controlled by or Under Common Control with the Registrant
None.
Item 29. Number of Holders of Shares
As of July
14, 2011:
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Number of |
Title of Class |
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Record Holders |
Common Shares of Beneficial Interest
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2,741 |
Item 30. Indemnification
Article V of the Registrants 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
3
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 indemnitees 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
4
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
Trusts 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 7 of the Dealer
Manager Agreement, which will be filed as Exhibit (h) in a subsequent pre-effective amendment and
will discuss 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 Commissions web
site (File No. 801-54874) and is incorporated herein by reference.
Item 32. Location of Accounts and Records
The Trusts accounts, books and other documents are currently located at the offices of the
Registrant, c/o Highland Capital Management, L.P., NexBank Tower, 13455 Noel Road, Suite 800,
Dallas, Texas 75240 and at the offices of the Registrants Custodian, Sub-Administrator and
Transfer Agent.
Item 33. Management Services
Not Applicable.
Item 34. Undertakings
(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) The Registrant undertakes to file a post-effective amendment to the registration statement,
and to suspend any offers or sales pursuant to the registration statement until such
post-effective amendment has been declared effective under the Securities Act of 1933, in
the event the shares of the Registrant are trading below its net asset value and either (i) the
Registrant receives, or has been advised by its independent registered accounting firm that it
will receive, an audit report reflecting substantial doubt regarding the
registrants ability to
continue as a going concern; or (ii) the Registrant has concluded that a material adverse change has
occurred in its financial position or results of operations that has caused the financial
statements and other disclosures on the basis of which the offering would be made to be
materially misleading. |
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(3) The Registrant undertakes to file a post-effective amendment under Section 8(c) of
the Securities Act of 1933 if it intends to issue rights priced below the shares net
asset value. |
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If the securities being registered are to be offered to existing shareholders pursuant to
rights, and any securities not taken by shareholders are to be reoffered to the public, the
Registrant undertakes to supplement the prospectus, after the expiration of the subscription
period, to set forth the results of the subscription offer, the transactions by underwriters during
the subscription period, the amount of unsubscribed securities to be purchased by underwriters,
and the terms of any subsequent reoffering thereof. If any public offering by the underwriters of
the securities being registered is to be made on terms differing from those set forth on the cover
page of the prospectus, the Registrant further undertakes to file a post-effective amendment to set
forth the terms of such offering.
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(4) |
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The Registrant undertakes: |
(a) to file, during any period in which offers or sales are being made, a post-effective
amendment to this Registration Statement:
5
(1) to include any prospectus required by Section 10(a)(3) of the Securities Act of 1933;
(2) to reflect in the prospectus any facts or events arising after the effective date of the
registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in the registration statement; and
(3) to include any material information with respect to the plan of distribution not previously
disclosed in the registration statement or any material change to such information in the
registration statement;
(b) that, for the purpose of determining liability under the Securities Act of 1933, each such
post-effective amendment shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of those securities at that time shall be deemed to
be the initial bona fide offering thereof; and
(c) to remove from registration by means of a post-effective amendment any of the securities
being registered which remain unsold at the termination of the offering;
(d) that, for the purpose of determining liability under the Securities Act of 1933 to any
purchaser, if the Registrant is subject to Rule 430C; each prospectus filed pursuant to Rule
497(b), (c), (d) or (e) under the Securities Act of 1933, shall be deemed to be part of and
included in this registration statement as of the date it is first used after effectiveness.
Provided, however, that no statement made in this registration statement or prospectus that is
part of this registration statement or made in a document incorporated or deemed incorporated by
reference into this registration statement or prospectus that is art of this registration
statement will, as to a purchaser with a time of contract of sale prior to such first use,
supercede or modify any statement that was made in this registration statement or prospectus that
was part of this registration statement or made in any such document immediately prior to such
date of first use;
(e) that for the purpose of determining liability of the Registrant under the Securities Act of
1933 to any purchaser in the initial distribution of securities, the undersigned Registrant
undertakes that in a primary offering of securities of the undersigned Registrant pursuant to
this registration statement, regardless of the underwriting method used to sell the securities to
the purchaser, if the securities are offered or sold to such purchaser by means of any of the
following communications, the undersigned Registrant will be a seller to the purchaser and will
be considered to offer or sell such securities to the purchaser:
(1) any preliminary prospectus or prospectus of the undersigned Registrant relating to the
offering required to be filed pursuant to Rule 497 under the Securities Act of 1933;
(2) the portion of any advertisement pursuant to Rule 482 under the Securities Act of 1933
relating to the offering containing material information about the undersigned Registrant or its
securities provided by or on behalf of the undersigned Registrant; and
(3) any other communication that is an offer in the offering made by the undersigned Registrant
to the purchaser.
(5) The Registrant undertakes that:
(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.
(7) The Registrant undertakes to file a post-effective
amendment under Section 8(c) of the Securities Act of 1933 in connection with any one or more offerings of the
Registrants common
shares (including rights to purchase the common shares) below net asset value that will result in greater than 15%
dilution, in the aggregate, to existing net asset value per share.
6
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
29th day
of July, 2011.
|
|
|
|
|
|
|
/s/ R. Joseph Dougherty*
R. Joseph Dougherty
|
|
|
|
|
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
29th day
of July, 2011.
|
|
|
Name |
|
Title |
/s/ R. Joseph Dougherty*
R. Joseph Dougherty
|
|
Trustee, Chief Executive Officer and President |
|
|
|
/s/ Timothy K. Hui*
Timothy K. Hui
|
|
Trustee |
|
|
|
/s/ Scott F. Kavanaugh*
Scott F. Kavanaugh
|
|
Trustee |
|
|
|
/s/ James F. Leary*
James F. Leary
|
|
Trustee |
|
|
|
/s/ Bryan A. Ward*
Bryan A. Ward
|
|
Trustee |
|
|
|
/s/ Brian Mitts
Brian Mitts
|
|
Treasurer (Principal Accounting Officer and Principal Financial Officer) |
|
|
|
|
|
|
*By:
|
|
/s/ Brian Mitts
Brian Mitts
|
|
|
|
|
Attorney-in-Fact |
|
|
|
|
July 29, 2011 |
|
|
|
EXHIBIT INDEX
|
|
|
|
EXHIBIT |
|
|
NUMBER |
|
DESCRIPTION |
|
(l)
|
|
Opinion and Consent of Special Delaware Counsel to
the Trust |
|
(n)
|
|
Consent of Independent Registered
Public Accounting Firm |
|