highlandn2.htm
As
filed with the Securities and Exchange Commission on November 2,
2007
1933
Act File
No. 333-
1940
Act File No. 811-21869
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
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Registration
Statement under the Securities Act of
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Pre-Effective
Amendment No.
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Post-Effective
Amendment No.
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Registration
Statement under the Investment Company Act of
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Amendment
No. 10
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Highland
Credit Strategies Fund
(Exact
Name of Registrant as Specified in the Declaration of Trust)
Two
Galleria Tower
13455
Noel Road, Suite 800
Dallas,
Texas 75240
(Address
of Principal Executive Offices)
(877)
665-1287
(Registrant’s
telephone number, including area code)
James
D. Dondero, President
Highland
Credit Strategies Fund
Two
Galleria Tower
13455
Noel Road, Suite 800
Dallas,
Texas 75240
(Name
and Address of Agent for Service)
Copies
to:
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Charles
B. Taylor
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Leonard
Mackey
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Skadden
Arps Slate Meagher & Flom LLP
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Clifford
Chance US LLP
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333
West Wacker Drive
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31
West 52nd
Street
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Chicago,
Illinois 60606
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New
York, NY 10019
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Approximate
date of proposed public offering:
As
soon as practicable after the effective date of this Registration
Statement
________________________________
CALCULATION
OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
Title
of Securities Being Registered
|
Amount
Being
Registered
(1)
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Proposed
Maximum
Offering
Price
per Unit (1)
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Proposed
Maximum
Aggregate
Offering
Price (1)
|
Amount
of
Registration
Fee
|
Common
Shares, $0.001 par value
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100,000
shares
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$18.38
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$1,838,000
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$56.43
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(1) Estimated
solely for the purpose of calculating the registration fee as required by Rule
457(c) under the Securities Act of 1933, as amended, based upon the average
of
the high and low sales prices reported on the New York Stock Exchange
consolidated reporting system of $18.38 on November 1, 2007.
The
registrant hereby amends this registration statement on such date or dates
as
may be necessary to delay its effective date until the registrant shall file
a
further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said section 8(a), may determine.
The
information in this preliminary prospectus is not complete and may be changed.
We may not sell these securities until the Registration Statement filed with
the
Securities and Exchange Commission is effective. This
preliminary prospectus is not an offer to sell these securities and is not
soliciting an offer to buy these securities in any state where the offer or
sale
is not permitted.
Subject
to Completion, Dated November 2, 2007
PROSPECTUS
Highland
Credit Strategies Fund
[·]
Common Shares
Issuable
Upon Exercise of Rights to Subscribe for Such Shares
The
Highland Credit Strategies Fund
(the “Trust”) is issuing transferable rights (“Rights”) to its common
shareholders of record (“Record Date Shareholders”) as of the close of business
on [·], 2007 (the “Record Date”), entitling the holders of those Rights to
subscribe for up to an aggregate of [·]of the Trust’s common shares of
beneficial interest (the “Offer”). Record Date Shareholders will receive one
Right for each outstanding whole common share held on the Record Date. The
Rights entitle their holders to purchase one new common share for every [·]
Rights held (1-for-[·]). Record Date Shareholders who fully exercise their
Rights will be entitled to subscribe for additional common shares of the Fund
that may become available with respect to any unexercised Rights, subject to
certain limitations and subject to allotment. The Trust’s outstanding common
shares are listed and trade on the New York Stock Exchange (“NYSE”) under the
symbol “HCF,” as will the common shares offered for subscription in the Offer.
The Rights are transferable and will be listed for trading on the NYSE under
the
symbol “[·]” during the course of the Offer, which may afford non-subscribing
Record Date Shareholders the opportunity to sell their Rights for cash value.
See “The Offer” on page [·] of this prospectus for a complete discussion of the
terms of the Offer. The subscription price (the “Subscription Price”) will be
determined based upon a formula equal to [·]% of the average of the last
reported sale prices of the Trust’s common shares on the NYSE on the Expiration
Date (as defined below) and the four preceding trading days (the “Formula
Price”). If, however, the Formula Price is less than [·]% of the Trust’s net
asset value per share on the Expiration Date, then the Subscription Price will
be [·]% of the Trust’s net asset value per common share on that day. The
offer will expire at [·] p.m., Eastern time, on [·], 2007, unless extended as
described in this prospectus.
The
Trust’s net asset value per common
share at the close of business on [·], 2007 (the last trading date prior to the
date of this prospectus on which the Trust determined its net asset value)
was
$[·] and the last reported sale price of a common share on the NYSE on that day
was $[·].
Record
Date Shareholders who do not
fully exercise their Rights should expect that they will, upon completion of
the
Offer, own a smaller proportional interest in the Trust than they owned prior
to
the Offer. In addition, because the Subscription Price per common share may
be
less than the then current net asset value per common share, the completion
of
the Offer may result in an immediate dilution of the net asset value per common
share for all existing shareholders. Such dilution is not currently determinable
because it is not known how many shares will be subscribed for, what the net
asset value or market price of the common shares will be on the Expiration
Date
or what the Subscription Price will be. Such dilution could be substantial.
If
such dilution occurs, shareholders will experience a decrease in the net asset
value per common share held by them, irrespective of whether they exercise
all
or any portion of their Rights. The distribution to Record Date Shareholders
of
transferable Rights, which may themselves have intrinsic value, will afford
such
shareholders the potential of receiving cash payment upon the sale of the
Rights, receipt of which may be viewed as partial compensation for the economic
dilution of their interests. No assurance can be given that a market for the
Rights will develop, or as to the value, if any, that the Rights will have.
See
“The Offer—Investment Considerations.”
If
you have questions or need further
information about the Offer, please write [·], the Trust’s information agent for
the Offer, at [·] or call [·].
(continued
on inside front cover)
Before
buying the Trust’s common shares
through the exercise of your Rights in the Offer, you should read the discussion
of the material risks of investing in the Trust in “Principal Risks of the
Trust” beginning
on page [·]. Certain of these risks are summarized in “Prospectus
Summary—Principal Investment Risks” beginning on page
[·].
Neither
the
Securities and Exchange Commission nor any state securities commission has
approved or disapproved of these securities or determined that this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
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Per
Share
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Total(1)
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Estimated
subscription price(2)
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$[·]
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$[·]
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Estimated
sales load(2)(3)
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$[·]
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$[·]
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Proceeds,
before expenses, to the Trust(2)(4)
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$[·]
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$[·]
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(footnotes
on inside front cover) |
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The
Trust is a
non-diversified closed-end management investment company, which was organized
under the laws of Delaware on March 10, 2006. The Trust’s investment
objectives are to provide both current income and capital appreciation. The
Trust seeks to achieve its investment objectives by investing primarily in
the
following categories of securities and instruments of corporations and other
business entities: (i) secured and unsecured floating and fixed rate loans;
(ii)
bonds and other debt obligations; (iii) debt obligations of stressed, distressed
and bankrupt issuers; (iv) structured products, including but not limited to,
mortgage-backed and other asset-backed securities and collateralized debt
obligations; and (v) equities. The Trust seeks to achieve its capital
appreciation objective by investing in category (iii) and (v) obligations and
securities, and to a lesser extent, in category (i), (ii), and (iv)
obligations. Under normal market conditions, at least 80% of the
Trust’s assets are invested in one or more of these principal investment
categories. Subject only to this general guideline, Highland Capital Management,
L.P., the Trust’s investment adviser (“Highland” or the “Investment Adviser”),
has broad discretion to allocate the Trust’s assets among these investment
categories and to change allocations as conditions warrant. Within the
categories of obligations and securities in which the Trust invests, Highland
employs various trading strategies, including capital structure arbitrage,
pair
trades and shorting. The Trust may also invest in these categories of
obligations and securities through the use of derivatives. Highland has full
discretion regarding the capital markets from which it can access investment
opportunities in accordance with the investment limitations set forth in this
prospectus. A significant portion of the Trust’s assets may be invested in
securities rated below investment grade, which are commonly referred to as
“junk
securities.” Junk securities are subject to greater risk of loss of principal
and interest and may be less liquid than investment grade securities. Highland
does not anticipate a high correlation between the performance of the Trust’s
portfolio and the performance of the corporate bond and equity markets. The
Trust’s investment objectives may be changed without shareholder approval. There
can be no assurance that the Trust’s investment objectives will be achieved. See
“The Trust’s Investments—Investment Objectives and Policies.
You
should read this prospectus, which
contains important information about the Trust, before deciding whether to
invest and retain it for future reference. A Statement of Additional
Information, dated [·], 2007, containing additional information about the Trust,
has been filed with the Securities and Exchange Commission (the “Commission”)
and is incorporated by reference in its entirety into this prospectus. You
can
review the table of contents of the Statement of Additional Information on
page
[·] of this prospectus. You may request a free copy of the Statement of
Additional Information, request the Trust’s annual and semi-annual reports,
request information about the Trust and make shareholder inquiries by calling
1-877-665-1287 or by writing to the Trust at Two Galleria Tower, 13455 Noel
Road, Suite 800, Dallas, Texas 75240. You may also obtain a copy of the
Statement of Additional Information (and other information regarding the Trust)
from the Commission’s Public Reference Room in Washington, D.C. by calling
1-202-942-8090. The Commission charges a fee for copies. The Trust’s annual and
semi-annual reports are available, free of charge, on the Trust’s web site
(http://www.highlandfunds.com). You can obtain the same information, free of
charge, from the Commission’s web site (http://www.sec.gov).
The
Trust’s common shares do not
represent a deposit or obligation of, and are not guaranteed or endorsed by,
any
bank or other insured depository institution, and are not federally insured
by
the Federal Deposit Insurance Corporation, the Federal Reserve Board or any
other government agency.
________________________
(footnotes
from front cover)
(1)
Assumes that all Rights are exercised at the estimated Subscription
Price.
(2)
Estimated on the basis of [·]% of the last reported sale price of a share of the
Trust’s common shares on the NYSE on [·], 2007.
(3)
[·] will act as dealer manager for the Offer (the “Dealer Manager”). The Trust
has agreed to pay the Dealer Manager a fee
for
its financial structuring, marketing and soliciting services equal to [·]% of the Subscription
Price
per common share for each common share issued pursuant to the exercise of Rights
and the over-subscription privilege. The Dealer Manager will reallow a portion
of its fees to other broker-dealers who have assisted in soliciting the exercise
of Rights. The Trust and Highland Capital Management, L.P., the Trust’s
investment adviser (“Highland” or the “Investment Adviser”), have each agreed to
indemnify the Dealer Manager for or contribute to losses arising out of certain
liabilities, including liabilities under the Securities Act of 1933, as
amended.
(4)
Before deduction of offering expenses payable by the Trust, estimated at
$[·].
TABLE
OF CONTENTS
Prospectus
Summary
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1
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Summary
of Trust Expenses
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29
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Financial
Highlights
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31
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The
Offer
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32
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Use
of Proceeds
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43
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The
Trust
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43
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Investment
Objectives and Policies
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44
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Portfolio
Composition
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45
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Principal
Risks of the Trust
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60
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Management
of the Trust
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77
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Net
Asset Value
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79
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Distributions
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80
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Dividend
Reinvestment Plan
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80
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Description
of Capital Structure
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82
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Market
and Net Asset Value Information
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83
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Anti-Takeover
Provisions in the Agreement and Declaration of Trust
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84
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Closed-End
Fund Structure
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85
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Repurchase
of Common Shares
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86
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Tax
Matters
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86
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Custodian
and Transfer Agent
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87
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Legal
Opinions
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88
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Privacy
Principles of the Trust
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88
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Table
of
Contents for the Statement of Additional Information
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89
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You
should rely only on the information
contained or incorporated by reference in this prospectus. The Trust has not,
and the Dealer Manager has not, authorized any other person to provide you
with
different information. If anyone provides you with different or inconsistent
information, you should not rely on it. The Trust is not, and the Dealer Manager
is not, making an offer to sell these securities in any jurisdiction where
the
offer or sale is not permitted. The information contained in this prospectus
is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of common shares. The Trust will
amend this prospectus if, during the period that this prospectus is required
to
be delivered, there are any subsequent material
changes.
PROSPECTUS
SUMMARY
This
is only a summary. This summary
may not contain all of the information that you should consider before investing
in the Trust. You should review the more detailed information contained in
this
prospectus and in the Statement of Additional Information, especially the
information set forth under the heading “Principal Risks of the
Trust.”
The
Trust
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Highland
Credit Strategies Fund is a non-diversified, closed-end management
investment company. The Trust commenced operations on June 29, 2006,
following its initial public offering. Throughout this prospectus,
Highland Credit Strategies Fund is referred to simply as the
“Trust.” See “The Trust.”
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Purpose
of the Offer
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The
Board of Trustees of the Trust (the “Board”) and the Investment Adviser
have [determined that it would be in the best interests of the Trust
and
its shareholders to increase the assets of the Trust available for
investment, thereby enabling the Trust more fully to take advantage
of
current and prospective investment opportunities. The Board and the
Investment Adviser believe that the Offer is the most effective way
to
raise additional assets for the Trust while offering shareholders
the
opportunity to buy additional common shares at a discounted
price.]
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[The
Board and the Investment Adviser also believe that increasing the
Trust’s
assets available for investment may result in a modest reduction
of the
Trust’s expense ratio, as the Trust’s fixed costs would be spread over a
larger asset base.]
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There
is no assurance that the Offer will be successful, or that by increasing
the Trust’s assets available for investment its expense ratio will be
lowered. See “The Offer—Purpose of the Offer” on page
[·].
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Important
Terms of the Offer
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The
Trust is issuing transferable rights (“Rights”) to its common shareholders
of record (“Record Date Shareholders”) as of the close of business on [·],
2007 (the “Record Date”), entitling the holders of those Rights to
subscribe for up to an aggregate of [·] of the Trust’s common shares (the
“Shares”) (the “Offer”). Record Date Shareholders will receive one Right
for each whole common share of the Trust held on the Record Date.
These
Rights entitle the Record Date Shareholders to purchase one new Share
for
every [·]
Rights held (1-for-[·]).
Fractional Shares will not be issued upon the exercise of Rights;
accordingly, Rights may be exercised only in integer multiples of
[·],
except that any Record Date Shareholder who is issued fewer than
[·]
Rights may subscribe, at the Subscription Price (defined below),
for one
full Share. The Offer is not contingent upon any number of Rights
being
exercised. The subscription period commences on [·], 2007 and ends at 5:00
p.m., Eastern time, on [·], 2007, unless otherwise extended (the
“Expiration Date”). See “The Offer—Terms of the Offer” on page
[·].
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The
Trust will bear the expenses of the Offer, which will be paid from
the
proceeds of the Offer. These expenses include, but are not limited
to, the
expenses of preparing and printing the prospectus for the Offer and
the
expenses of Trust counsel and the Trust’s independent registered public
accounting firm in connection with the Offer.
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Subscription
Price
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The
subscription price (the “Subscription Price”) will be determined based on
a formula equal to [·]% of the average of the last reported sale prices of
the Trust’s common shares on the New York Stock Exchange (the “NYSE”) on
the Expiration Date and the four preceding trading days (the “Formula
Price”). If, however, the Formula Price is less than [·]%
of the net asset value per common share on the Expiration Date, then
the
Subscription Price will be
[·]%
of the Trust’s net asset value per common share on that day. See “The
Offer—The Subscription Price” on page [·].
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Over-Subscription
Privilege
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Record
Date Shareholders who exercise all the Rights issued to them (other
than
those Rights that cannot be exercised because they represent the
right to
acquire less than one Share) are entitled to subscribe for additional
Shares at the same Subscription Price pursuant to the over-subscription
privilege, subject to certain limitations and subject to allotment.
Investors who are not Record Date Shareholders, but who otherwise
acquire
Rights to purchase Shares pursuant to the Offer, are not entitled
to
subscribe for any Shares pursuant to the over-subscription privilege.
To
the extent sufficient Shares are not available to honor all
over-subscription requests, unsubscribed Shares will be allocated
pro rata
among those Record Date Shareholders who over-subscribe based on
the
number of common shares of the Trust they owned on the Record Date.
See
“The Offer—Over-Subscription Privilege” on page [·].
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Sale
and Transferability
of
Rights
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The
Rights will be listed for trading on the NYSE under the symbol “[·]”
during the course of the Offer. Trading in the Rights on the NYSE
may be
conducted until the close of trading on the NYSE on the last business
day
prior to the Expiration Date. The Trust and [·], the dealer manager of the
Offer (“[·]” or the “Dealer Manager”), will use their best efforts to
ensure that an adequate trading market for the Rights will exist,
although
there is no assurance that a market for the Rights will develop.
Assuming
a market exists for the Rights, the Rights may be purchased and sold
through usual brokerage channels or sold through the Subscription
Agent
(defined below).
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Record
Date Shareholders who do not wish to exercise any of the Rights issued
to
them pursuant to the Offer may instruct the Subscription Agent to
sell any
unexercised Rights through or to the Dealer Manager. Subscription
certificates representing the Rights to be sold through or to the
Dealer
Manager must be received by the Subscription Agent by 5:00 p.m.,
Eastern
time, [·], 2007 (or, if the subscription period is extended, by 5:00 p.m.,
Eastern time, two business days prior to the extended Expiration
Date).
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Alternatively,
the Rights evidenced by a subscription certificate may be transferred
until the Expiration Date in whole or in part by endorsing the
subscription certificate for transfer in accordance with the accompanying
instructions. See “The Offer—Sale and Transferability” on page
[·].
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Method
for Exercising Rights
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Rights
are evidenced by subscription certificates that will be mailed to
Record
Date Shareholders (except as described below under “Requirements for
Foreign Shareholders”) or, if their common shares are held by Cede &
Co. or any other depository or nominee, to Cede & Co. or such other
depository or nominee. Rights may be exercised by filling in and
signing
the subscription certificate and mailing it in the envelope provided,
or
otherwise delivering the completed and signed subscription certificate
to
the Subscription Agent, together with payment at the estimated
Subscription Price for the Shares. Completed subscription certificates
and
payments must be received by the Subscription Agent by 5:00 p.m.,
Eastern
time, on the Expiration Date at the offices of the Subscription Agent.
Rights also may be exercised by contacting your broker, banker or
trust
company, who can arrange, on your behalf, to guarantee delivery of
payment
and of a properly completed and executed subscription certificate.
A fee
may be charged for this service by your broker, banker or trust company.
See “The Offer—Exercise of Rights” on page [·] and “The Offer—Payment for
Shares” on page [·].
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Requirements
for Foreign
Shareholders
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Subscription
certificates will not be mailed to Record Date Shareholders whose
addresses are outside the United States (for these purposes, the
United
States includes the District of Columbia and the territories and
possessions of the United States) (“Foreign Shareholders”). The
Subscription Agent will send a letter via regular mail to Foreign
Shareholders to notify them of the Offer. The Rights of Foreign
Shareholders will be held by the Subscription Agent for their accounts
until instructions are received to exercise the Rights. If instructions
have not been received by 5:00 p.m., Eastern time, on [·], 2007, three
business days prior to the Expiration Date (or, if the subscription
period
is extended, on or before three business days prior to the extended
Expiration Date), the Rights of Foreign Shareholders will be transferred
by the Subscription Agent to the Dealer Manager, who will either
purchase
the Rights or use its best efforts to sell the Rights. The net proceeds,
if any, from sale of those Rights by or to the Dealer Manager will
be
remitted to these Foreign Shareholders.
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Important
Dates to
Remember
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Record
Date:
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[·],
2007
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Subscription
Period:
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[·]
to [·], 2007*
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Final
Date Rights Will Trade on NYSE:
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[·],
2007*
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Expiration
Date and Pricing Date:
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[·],
2007*
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Delivery
of Executed Subscription Certificates
and
Payment for Shares Due or Notices of
Guarantees
of Delivery Due:
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[·],
2007*
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Delivery
of Executed Subscription Certificates
and
Payment for Guarantees of Delivery Due:
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[·],
2007*
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Confirmation
Mailed to Participants:
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[·],
2007*
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Final
Payment for Shares Due:
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[·],
2007*†
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*
Unless the Offer is extended.
†
See “The Offer—Payment for Shares” on page [·].
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Distribution
Arrangements
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[·]
will act as Dealer Manager for this Offer. Under the terms and subject
to
the conditions contained in the Dealer Manager Agreement among [·], the
Trust and the Investment Adviser, the Dealer Manager will provide
financial structuring services and marketing assistance in connection
with
the Offer and will solicit the exercise of Rights and participation
in the
over-subscription privilege. The Trust has agreed to pay the Dealer
Manager a fee for its financial structuring, marketing and soliciting
services equal to [·]% of the aggregate Subscription Price for the Shares
issued pursuant to the exercise of Rights and the over-subscription
privilege. The Dealer Manager will reallow a part of its fees to
other
broker-dealers who have assisted in soliciting the exercise of Rights.
The
Trust and the Investment Adviser have each agreed to indemnify the
Dealer
Manager for or contribute to losses arising out of certain liabilities,
including liabilities under the Securities Act of 1933, as amended
(the
“Securities Act”).
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Prior
to the expiration of the Offer, the Dealer Manager may independently
offer
for sale Shares it has acquired through purchasing and exercising
the
Rights, at prices it sets. Although the Dealer Manager may realize
gains
and losses in connection with purchases and sales of Shares, such
offering
of Shares is intended by the Dealer Manager to facilitate the Offer
and
any such gains or losses are not expected to be material to the Dealer
Manager. The Dealer Manager’s fee for its financial structuring, marketing
and soliciting services is independent of any gains or losses that
may be
realized by the Dealer Manager through the purchase and exercise
of the
Rights and the sale of Shares. See “Distribution Arrangements” on page
[·].
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Subscription
Agent
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The
subscription agent for the Offer is [·] (“[·]” or the “Subscription
Agent”).
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Information
Agent
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The
information agent for the Offer is [·] (“[·]” or the “Information Agent”).
If you have questions or need further information about the Offer,
please
write the Information Agent at [·] or call [·].
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Listing
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The
Trust’s outstanding common shares are listed and trade on the NYSE under
the symbol “HCF,” as will the Shares offered for subscription in the
Offer. The Rights are transferable and will be listed for trading
on the
NYSE under the symbol “[·]” during the course of the
Offer.
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Use
of Proceeds
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The
net proceeds of the Offer will be invested in accordance with the
Trust’s
investment objectives and policies set forth below. Assuming current
market conditions, the Trust estimates that the net proceeds of the
Offer
will be substantially invested in accordance with its investment
objectives and policies within [·] to [·] months of the completion of the
Offer. Pending such investment, it is anticipated that the proceeds
of the
Offer will be invested in short-term debt securities. The Trust does
not
expect to use any part of the proceeds to repay some or all of its
outstanding debt under the Loan Agreement described below under “Use of
Leverage.”
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Investment
Objectives and
Policies
|
The
Trust’s investment objectives are to provide both current income and
capital appreciation. The Trust seeks to achieve its investment objectives
by investing primarily in the following categories of securities
and
instruments of corporations and other business entities: (i) secured
and
unsecured floating and fixed rate loans; (ii) bonds and other debt
obligations; (iii) debt obligations of stressed, distressed and bankrupt
issuers; (iv) structured products, including but not limited to,
mortgage-backed and other asset-backed securities and collateralized
debt
obligations; and (v) equities. The Trust seeks to achieve its capital
appreciation objective by investing in category (iii) and (v) obligations
and securities, and to a lesser extent, in category (i), (ii), and
(iv)
obligations. Under normal market conditions, at least 80% of
the Trust’s assets are invested in one or more of these principal
investment categories. Subject only to this general guideline, Highland
has broad discretion to allocate the Trust’s assets among these investment
categories and to change allocations as conditions warrant. Within
the
categories of obligations and securities in which the Trust invests,
Highland employs various trading strategies, including capital structure
arbitrage, pair trades and shorting. The Trust may also invest in
these
categories of obligations and securities through the use of derivatives.
A
significant portion of the Trust’s assets may be invested in securities
rated below investment grade, which are commonly referred to as “junk
securities.” Junk securities are subject to greater risk of loss of
principal and interest and may be less liquid than investment grade
securities. Highland does not
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anticipate
a high correlation between the performance of the Trust’s portfolio and
the performance of the corporate bond and equity markets. The Trust’s
investment objectives may be changed without shareholder approval.
There
can be no assurance that the Trust’s investment objectives will be
achieved. See “The Trust’s Investments—Investment Objectives and
Policies.”
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Investment
Strategies
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Under
normal market conditions, the Trust invests across various markets
in
which the Investment Adviser holds significant investment experience:
primarily the leveraged loan, high yield, structured products and
stressed
and distressed markets. Highland makes investment decisions based
on
quantitative analysis, which employs sophisticated, data-intensive
models
to drive the investment process. The Highland has full discretion
regarding the capital markets from which it can access investment
opportunities in accordance with the investment limitations set forth
in
this prospectus.
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Highland
uses trading strategies to exploit pricing inefficiencies across
the
credit markets, or debt markets, and within an individual issuer’s capital
structure. Highland varies the Trust’s investments by strategy, industry,
security type and credit market, but reserves the right to re-position
the
Trust’s portfolio among these criteria depending on market dynamics, and
thus the Trust may experience high portfolio turnover. Highland manages
interest rate, default, currency and systemic risks through a variety
of
trading methods and market tools, including derivative hedging
instruments, as it deems appropriate.
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This
multi-strategy investment program allows Highland to assess what
it
considers to be the best opportunities across multiple markets and
to
adjust quickly the Trust’s trading strategies and market focus to changing
conditions. The Investment Adviser focuses primarily on the U.S.
marketplace, but may pursue opportunities in the non-U.S. credit
or
securities markets by investing up to 20% of the Trust’s assets in
non-U.S. credit or securities market investments.
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The
Trust invests and trades in listed and unlisted, public and private,
rated
and unrated, debt and equity instruments and other obligations, including
structured debt and equity instruments as well as financial derivatives.
Investments may include investments in stressed and distressed positions,
which may include publicly-traded debt and equity securities, obligations
which were privately placed with banks, insurance companies and other
lending institutions, trade claims, accounts receivable and any other
form
of obligation recognized as a claim in a bankruptcy or workout
process.
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As
part of its investment program, the Trust may invest, from time to
time,
in debt or synthetic instruments that are sold in direct placement
transactions between their issuers and their purchasers and that
are
neither listed on an exchange, nor traded over the counter. The
Trust
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may
also receive equity or equity-related securities in connection with
a
workout transaction or may invest directly in equity
securities.
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The
Trust may employ currency hedges (either in the forward or options
markets) in certain circumstances to reduce currency risk and may
engage
in other derivative transactions for hedging purposes or to enhance
total
return. The Trust may also lend securities and engage in short sales
of
securities. In addition, the Trust may invest in the securities of
companies whose capital structures are highly
leveraged.
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From
time to time, the Investment Adviser may also invest a portion of
the
Trust’s assets in short-term U.S. Government obligations, certificates
of
deposit, commercial paper and other money market instruments, including
repurchase agreements with respect to such obligations to enable
the Trust
to make investments quickly and to serve as collateral with respect
to
certain of its investments. A greater percentage of Trust assets
may be
invested in such obligations if the Investment Adviser believes that
a
defensive position is appropriate because of the outlook for security
prices or in order to respond to adverse market, economic, business
or
political conditions. From time to time cash balances in the Trust’s
brokerage account may be placed in a money market fund. See “The Trust’s
Investments—Investment Strategies.”
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Use
of Leverage
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As
provided in the Investment Company Act of 1940 (the “Investment Company
Act”) and subject to certain exceptions, the Trust may issue debt or
preferred shares with the condition that immediately after issuance
the
value of its total assets, less certain ordinary course liabilities,
exceed 300% of the amount of the debt outstanding and exceed 200%
of the
sum of the amount of debt and preferred shares
outstanding.
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The
Trust, as of [·], 2007, is leveraged through borrowings from a credit
facility in the amount of $[·] or [·]% of the Trust’s total assets
(including the proceeds of such leverage). The total leverage of
the Trust
is expected to range between 20% and 50% of the Trust’s total
assets. The Trust seeks a leverage ratio where the rate of
return, net of applicable Trust expenses, on the Trust’s portfolio
investments purchased with leverage exceeds the costs associated
with such
leverage. The Trust’s asset coverage ratio as of [·], 2007 was
[·]%. See “Principal Risks of the Trust—Leverage Risk” for a
brief description of the Trust’s credit facility agreement with The Bank
of Nova Scotia.
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The
Trust may engage in additional borrowings and/or issue preferred
shares in
order to maintain the Trust’s desired leverage ratio. Leverage creates a
greater risk of loss, as well as a potential for more gain, for the
common
shares than if leverage were not used. Interest on borrowings
(or dividends on preferred shares) may be at a fixed or floating
rate and
generally will be based on short-term rates. So long as the
rate of return, net of applicable Trust expenses, on the Trust’s portfolio
investments purchased with leverage exceeds the costs associated
with such
leverage, the Trust will generate more return
or
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income
than will be needed to pay such costs. In this event, the excess
will be
available to pay higher dividends to holders of common
shares. Conversely, if the Trust’s return on such assets is
less than the cost of leverage and other Trust expenses, the return
to the
holders of the common shares will diminish. Where leverage is
employed, the net asset value and market price of the common shares
and
the yield to holders of common shares will be more volatile. The
Trust’s
leveraging strategy may not be successful. See “Principal Risks of the
Trust—Leverage Risk.”
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Principal
Risks of the Trust
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The
following is a summary of the principal risks associated with an
investment in the Trust’s common shares. Investors should also refer to
“Principal Risks of the Trust” in this prospectus for a more detailed
explanation of the risks associated with investing in the Trust’s common
shares.
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Investment
and Market Discount Risk. An investment in the Trust’s
common shares is subject to investment risk, including the possible
loss
of the entire amount that you invest. As with any stock, the price
of the
Trust’s shares will fluctuate with market conditions and other factors.
If
common shares are sold, the price received may be more or less than
the
original investment. Common shares are designed for long-term investors
and should not be treated as trading vehicles. Shares of closed-end
management investment companies frequently trade at a discount to
their
net asset value.
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Interest
Rate Risk. Interest rate risk is the risk that debt
securities, and the Trust’s net assets, may decline in value because of
changes in interest rates. Generally, debt securities will decrease
in
value when interest rates rise and increase in value when interest
rates
decline. This means that the net asset value of the common shares
will
fluctuate with interest rate changes and the corresponding changes
in the
value of the Trust’s debt security holdings.
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Prepayment
Risk. If interest rates fall, the principal on bonds held
by the Trust may be paid earlier than expected. If this happens,
the
proceeds from a prepaid security may be reinvested by the Trust in
securities bearing lower interest rates, resulting in a possible
decline
in the Trust’s income and distributions to shareholders. The Trust may
invest in pools of mortgages or other assets issued or guaranteed
by
private issuers or U.S. government agencies and instrumentalities.
Mortgage-related securities are especially sensitive to prepayment
risk
because borrowers often refinance their mortgages when interest rates
drop.
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Risks
of Investing in High-Yield Securities. A portion of the
Trust’s investments will consist of investments that may generally be
characterized as “high-yield securities” or “junk securities.” Such
securities are typically rated below investment grade by one or more
nationally recognized statistical rating organizations or are unrated
but
of comparable credit quality to obligations rated below
investment
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grade,
and have greater credit and liquidity risk than more highly rated
obligations. High-yield securities are generally unsecured and may
be
subordinate to other obligations of the obligor. The lower rating
of
high-yield securities reflects a greater possibility that adverse
changes
in the financial condition of the issuer or in general economic conditions
(including, for example, a substantial period of rising interest
rates or
declining earnings) or both may impair the ability of the issuer
to make
payment of principal and interest. Many issuers of high-yield securities
are highly leveraged, and their relatively high debt to equity ratios
create increased risks that their operations might not generate sufficient
cash flow to service their obligations. Overall declines in the below
investment grade bond and other markets may adversely affect such
issuers
by inhibiting their ability to refinance their obligations at
maturity.
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High-yield
securities are often issued in connection with leveraged acquisitions
or
recapitalizations in which the issuers incur a substantially higher
amount
of indebtedness than the level at which they had previously operated.
High-yield securities that are debt instruments have historically
experienced greater default rates than has been the case for investment
grade securities. The Trust may also invest in equity securities
issued by
entities whose obligations are unrated or are rated below investment
grade.
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The
Trust is authorized to invest in obligations of issuers which are
generally trading at significantly higher yields than had been
historically typical of the applicable issuer’s obligations. Such
investments may include debt obligations that have a heightened
probability of being in covenant or payment default in the future.
Such
investments generally are considered speculative. The repayment of
defaulted obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest
or other
payments. Typically such workout or bankruptcy proceedings result
in only
partial recovery of cash payments or an exchange of the defaulted
security
for other debt or equity securities of the issuer or its affiliates,
which
may in turn be illiquid or speculative.
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High-yield
securities purchased by the Trust are subject to certain additional
risks
to the extent that such obligations may be unsecured and subordinated
to
substantial amounts of senior indebtedness, all or a significant
portion
of which may be secured. Moreover, such obligations purchased by
the Trust
may not be protected by financial covenants or limitations upon additional
indebtedness and are unlikely to be secured by
collateral.
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Illiquidity
of Investments. The investments made by the Trust may be
very illiquid, and consequently, the Trust may not be able to sell
such
investments at prices that reflect the Investment Adviser’s assessment of
their fair value or the amount paid for such investments by
the
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Trust.
Illiquidity may result from the absence of an established market
for the
investments as well as legal, contractual or other restrictions on
their
resale by the Trust and other factors. Furthermore, the nature of
the
Trust’s investments, especially those in financially stressed and
distressed companies, may require a long holding period prior to
being
able to determine whether the investment will be profitable or not.
There
is no limit on the amount of the Trust’s portfolio that can be invested in
illiquid securities.
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Risks
of Investing in Senior Loans. Senior loans, such as bank
loans, are typically at the most senior level of the capital structure,
and are sometimes secured by specific collateral, including, but
not
limited to, trademarks, patents, accounts receivable, inventory,
equipment, buildings, real estate, franchises and common and preferred
stock of the obligor or its affiliates. A portion of the Trust’s
investments may consist of loans and participations therein originated
by
banks and other financial institutions, typically referred to as
“bank
loans.” The Trust’s investments may include loans of a type generally
incurred by borrowers in connection with highly leveraged transactions,
often to finance internal growth, acquisitions, mergers or stock
purchases, or for other reasons. As a result of the additional debt
incurred by the borrower in the course of the transaction, the borrower’s
creditworthiness is often judged by the rating agencies to be below
investment grade. Such loans are typically private corporate loans
which
are negotiated by one or more commercial banks or financial institutions
and syndicated among a group of commercial banks and financial
institutions. In order to induce the lenders to extend credit and
to offer
a favorable interest rate, the borrower often provides the lenders
with
extensive information about its business which is not generally available
to the public.
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Bank
loans often contain restrictive covenants designed to limit the activities
of the borrower in an effort to protect the right of lenders to receive
timely payments of principal and interest. Such covenants may include
restrictions on dividend payments, specific mandatory minimum financial
ratios, limits on total debt and other financial tests. Bank loans
usually
have shorter terms than subordinated obligations and may require
mandatory
prepayments from excess cash flow, asset dispositions and offerings
of
debt and/or equity securities. The bank loans and other debt obligations
to be acquired by the Trust are likely to be below investment
grade.
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The
Trust may acquire interests in bank loans and other debt obligations
either directly (by way of sale or assignment) or indirectly (by
way of
participation). The purchaser of an assignment typically succeeds
to all
the rights and obligations of the assigning institution and becomes
a
lender under the credit agreement with respect to the debt obligation;
however, its rights can be more restricted than those of the assigning
institution, and, in any event, the Trust may not be able unilaterally
to
enforce all rights and remedies under the loan and any associated
collateral. A participation interest in a portion of a
debt
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obligation
typically results in a contractual relationship only with the institution
participating out the interest, not with the borrower. In purchasing
participations, the Trust generally will have no right to enforce
compliance by the borrower with either the terms of the loan agreement
or
any rights of setoff against the borrower, and the Trust may not
directly
benefit from the collateral supporting the debt obligation in which
it has
purchased the participation. As a result, the Trust will be exposed
to the
credit risk of both the borrower and the institution selling the
participation.
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Purchasers
of bank loans are predominantly commercial banks, investment trusts
and
investment banks. As secondary market trading volumes increase, new
bank
loans frequently adopt standardized documentation to facilitate loan
trading which should improve market liquidity. There can be no assurance,
however, that future levels of supply and demand in bank loan trading
will
provide an adequate degree of liquidity or that the current level
of
liquidity will continue. Because of the provision to holders of such
loans
of confidential information relating to the borrower, the unique
and
customized nature of the loan agreement, the limited universe of
eligible
purchasers and the private syndication of the loan, bank loans are
not as
easily purchased or sold as a publicly traded security, and historically
the trading volume in the bank loan market has been small relative
to the
high-yield debt market.
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Second
Lien Loans Risk. Second lien loans are subject to the same
risks associated with investment in senior loans and non-investment
grade
securities. However, second lien loans are second in right of payment
to
senior loans and therefore are subject to additional risk that the
cash
flow of the borrower and any property securing the loan may be
insufficient to meet scheduled payments after giving effect to the
senior
secured obligations of the borrower. Second lien loans are expected
to
have greater price volatility than senior loans and may be less liquid.
There is also a possibility that originators will not be able to
sell
participations in second lien loans, which would create greater credit
risk exposure.
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Other
Secured Loans Risk. Secured loans other than senior loans
and second lien loans are subject to the same risks associated with
investment in senior loans, second lien loans and non-investment
grade
securities. However, such loans may rank lower in right of payment
than
any outstanding senior loans and second lien loans of the borrower
and
therefore are subject to additional risk that the cash flow of the
borrower and any property securing the loan may be insufficient to
meet
scheduled payments after giving effect to the higher ranking secured
obligations of the borrower. Lower ranking secured loans are expected
to
have greater price volatility than senior loans and second lien loans
and
may be less liquid. There is also a possibility that originators
will not
be able to sell participations in lower ranking secured loans, which
would
create greater credit risk
exposure.
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Unsecured
Loans Risk. Unsecured loans are subject to the same risks
associated with investment in senior loans, second lien loans, other
secured loans and non-investment grade securities. However, because
unsecured loans have lower priority in right of payment to any higher
ranking obligations of the borrower and are not backed by a security
interest in any specific collateral, they are subject to additional
risk
that the cash flow of the borrower and available assets may be
insufficient to meet scheduled payments after giving effect to any
higher
ranking obligations of the borrower. Unsecured loans are expected
to have
greater price volatility than senior loans, second lien loans and
other
secured loans and may be less liquid. There is also a possibility
that
originators will not be able to sell participations in unsecured
loans,
which would create greater credit risk exposure.
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Risks
of Investing in Obligations of Stressed, Distressed and Bankrupt
Issuers. The Trust is authorized to invest in the
securities and other obligations of stressed, distressed and bankrupt
issuers, including debt obligations that are in covenant or payment
default. There is no limit on the amount of the Trust’s portfolio that can
be invested in stressed, distressed or bankrupt issuers, and the
Trust may
invest for purposes of control. Such investments generally trade
significantly below par and are considered speculative. The repayment
of
defaulted obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest
or other
payments. Typically such workout or bankruptcy proceedings result
in only
partial recovery of cash payments or an exchange of the defaulted
obligation for other debt or equity securities of the issuer or its
affiliates, which may in turn be illiquid or
speculative.
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There
are a number of significant risks inherent in the bankruptcy process.
First, many events in a bankruptcy are the product of contested matters
and adversary proceedings and are beyond the control of the creditors.
While creditors are generally given an opportunity to object to
significant actions, there can be no assurance that a bankruptcy
court in
the exercise of its broad powers would not approve actions that would
be
contrary to the interests of the Trust. Second, a bankruptcy filing
by an
issuer may adversely and permanently affect the issuer. The issuer
may
lose its market position and key employees and otherwise become incapable
of restoring itself as a viable entity. If for this or any other
reason
the proceeding is converted to a liquidation, the value of the issuer
may
not equal the liquidation value that was believed to exist at the
time of
the investment. Third, the duration of a bankruptcy proceeding is
difficult to predict. A creditor’s return on investment can be adversely
affected by delays while the plan of reorganization is being negotiated,
approved by the creditors and confirmed by the bankruptcy court and
until
it ultimately becomes effective. Fourth, the administrative costs
in
connection with a bankruptcy proceeding are frequently high and would
be
paid out of the debtor’s estate prior to any return to creditors. For
example, if a proceeding involves protracted or difficult
litigation,
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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 Trust’s influence with respect to the class
of securities or other obligations it owns can be lost by increases
in the
number and amount of claims in that class or by different classification
and treatment. Sixth, in the early stages of the bankruptcy process
it is
often difficult to estimate the extent of, or even to identify, any
contingent claims that might be made. Seventh, especially in the
case of
investments made prior to the commencement of bankruptcy proceedings,
creditors can lose their ranking and priority if they exercise “domination
and control” over a debtor and other creditors can demonstrate that they
have been harmed by such actions. Eighth, certain claims that have
priority by law (for example, claims for taxes) may be
substantial.
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In
any investment involving stressed and distressed debt obligations,
there
exists the risk that the transaction involving such debt obligations
will
be unsuccessful, take considerable time or will result in a distribution
of cash or a new security or obligation in exchange for the stressed
and
distressed debt obligations, the value of which may be less than
the
Trust’s purchase price of such debt obligations. Furthermore, if an
anticipated transaction does not occur, the Trust may be required
to sell
its investment at a loss. Given the substantial uncertainties concerning
transactions involving stressed and distressed debt obligations in
which
the Trust invests, there is a potential risk of loss by the Trust
of its
entire investment in any particular investment.
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Investments
in companies operating in workout modes or under Chapter 11 of the
Bankruptcy Code are also, in certain circumstances, subject to certain
additional liabilities which may exceed the value of the Trust’s original
investment in a company. For example, under certain circumstances,
creditors who have inappropriately exercised control over the management
and policies of a debtor may have their claims subordinated or disallowed
or may be found liable for damages suffered by parties as a result
of such
actions. The Investment Adviser’s active management style may present a
greater risk in this area than would a more passive approach. In
addition,
under certain circumstances, payments to the Trust and distributions
by
the Trust or payments on the debt may be reclaimed if any such payment
is
later determined to have been a fraudulent conveyance or a preferential
payment.
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The
Investment Adviser on behalf of the Trust may participate on committees
formed by creditors to negotiate with the management of financially
troubled companies that may or may not be in bankruptcy or may negotiate
directly with debtors with respect to restructuring issues. If the
Trust
does choose to join a committee, the Trust would likely be only one
of
many participants, all of whom would
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interested
in obtaining an outcome that is in their individual best interests.
There
can be no assurance that the Trust would be successful in obtaining
results most favorable to it in such proceedings, although the Trust
may
incur significant legal and other expenses in attempting to do so.
As a
result of participation by the Trust on such committees, the Trust
may be
deemed to have duties to other creditors represented by the committees,
which might thereby expose the Trust to liability to such other creditors
who disagree with the Trust’s actions. Participation by the Trust on such
committees may cause the Trust to be subject to certain restrictions
on
its ability to trade in a particular investment and may also make
the
Trust an “insider” or an “underwriter” for purposes of the federal
securities laws. Either circumstance will restrict the Trust’s ability to
trade in or acquire additional positions in a particular investment
when
it might otherwise desire to do so.
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Insolvency
Considerations with Respect to Issuers of Debt
Obligations. Various laws enacted for the protection of
creditors may apply to the debt obligations held by the Trust. The
information in this paragraph is applicable with respect to U.S.
issuers
subject to United States bankruptcy laws. Insolvency considerations
may
differ with respect to other issuers. If a court in a lawsuit brought
by
an unpaid creditor or representative of creditors of an issuer of
a debt
obligation, such as a trustee in bankruptcy, were to find that the
issuer
did not receive fair consideration or reasonably equivalent value
for
incurring the indebtedness constituting the debt obligation and,
after
giving effect to such indebtedness, the issuer (i) was insolvent,
(ii) was
engaged in a business for which the remaining assets of such issuer
constituted unreasonably small capital or (iii) intended to incur,
or
believed that it would incur, debts beyond its ability to pay such
debts
as they mature, such court could determine to invalidate, in whole
or in
part, such indebtedness as a fraudulent conveyance, to subordinate
such
indebtedness to existing or future creditors of such issuer, or to
recover
amounts previously paid by such issuer in satisfaction of such
indebtedness.
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The
measure of insolvency for purposes of the foregoing will vary. Generally,
an issuer would be considered insolvent at a particular time if the
sum of
its debts were then greater than all of its property at a fair valuation,
or if the present fair saleable value of its assets was then less
than the
amount that would be required to pay its probable liabilities on
its
existing debts as they became absolute and matured. There can be
no
assurance as to what standard a court would apply in order to determine
whether the issuer was “insolvent” after giving effect to the incurrence
of the indebtedness constituting the debt obligation or that, regardless
of the method of valuation, a court would not determine that the
issuer
was “insolvent” upon giving effect to such incurrence. In addition, in the
event of the insolvency of an issuer of a debt obligation, payments
made
on such debt obligation could be subject to avoidance as a “preference” if
made within a certain period of time (which may be as long as one
year)
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insolvency.
Similarly, a court might apply the doctrine of equitable subordination
to
subordinate the claim of a lending institution against an issuer,
to
claims of other creditors of the borrower, when the lending institution,
another investor, or any of their transferees, is found to have engaged
in
unfair, inequitable, or fraudulent conduct. In general, if payments
on a
debt obligation are avoidable, whether as fraudulent conveyances
or
preferences, such payments can be recaptured either from the initial
recipient (such as the Trust) or from subsequent transferees of such
payments (such as the investors in the Trust). To the extent that
any such
payments are recaptured from the Trust the resulting loss will be
borne by
the investors. However, a court in a bankruptcy or insolvency proceeding
would be able to direct the recapture of any such payment from such
a
recipient or transferee only to the extent that such court has
jurisdiction over such recipient or transferee or its assets. Moreover,
it
is likely that avoidable payments could not be recaptured directly
from
any such recipient or transferee that has given value in exchange
for its
note, in good faith and without knowledge that the payments were
avoidable. Although the Investment Adviser will seek to avoid conduct
that
would form the basis for a successful cause of action based upon
fraudulent conveyance, preference or equitable subordination, these
determinations are made in hindsight, and, in any event, there can
be no
assurance as to whether any lending institution or other investor
from
which the Trust acquired the debt obligations engaged in any such
conduct
(or any other conduct that would subject the debt obligations and
the
issuer to insolvency laws) and, if it did, as to whether such creditor
claims could be asserted in a U.S. court (or in the courts of any
other
country) against the Trust.
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Leverage
Risk. The Trust currently leverages through borrowings
from a credit facility. The use of leverage, which can be described
as
exposure to changes in price at a ratio greater than the amount of
equity
invested, through borrowings, the issuance of preferred shares, or
other
forms of market exposure, magnifies both the favorable and unfavorable
effects of price movements in the investments made by the Trust.
Insofar
as the Trust continues to employ leverage in its investment operations,
the Trust will be subject to substantial risks of loss.
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The
Trust currently leverages through borrowings from a credit
facility. The Trust has entered into a revolving credit
agreement with The Bank of Nova Scotia (“Scotia”) to borrow up to
$300,000,000 (the “Loan Agreement”). Such borrowings constitute financial
leverage. The Loan Agreement contains covenants that may limit
the Trust’s ability to: (i) pay dividends in certain circumstances, (ii)
incur additional debt and (iii) change its fundamental investment
policies
and engage in certain transactions, including mergers and
consolidations. For instance, the Trust agreed not to purchase
assets not contemplated by the investment policies and restrictions
in
effect when the Loan Agreement became effective. Furthermore,
the Trust may not incur additional debt from any other party, except
for
in
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limited
circumstances (e.g., in the ordinary course of
business). In addition, the Loan Agreement contains a covenant
requiring asset coverage ratios that may be more stringent than those
required by the Investment Company Act. Any senior
security representing indebtedness, as defined in Section 18(g) of
the
Investment Company Act, must have asset coverage of at least 300%.
Debt
incurred under the Loan Agreement will be considered a senior security
for
this purpose.
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In
order to obtain and maintain the required ratings of loans made under
the
Loan Agreement from another credit facility, the Trust must comply
with
investment quality, diversification and other guidelines established
by
Moody’s and/or S&P or the credit facility,
respectively. The Trust does not anticipate that such
guidelines will have a material adverse effect on the Trust’s common
shareholders or its ability to achieve its investment objectives.
Moody’s
and S&P receive fees in connection with their ratings
issuances.
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Common
Stock Risk. The Trust will may exposure to common stocks.
Although common stocks have historically generated higher average
total
returns than fixed income securities over the long-term, common stocks
also have historically experienced significantly more volatility
in those
returns. Therefore, the Trust’s exposure to common stocks could result in
worse performance than would be the case had the Trust been invested
solely in debt securities. An adverse event, such as an unfavorable
earnings report, may depress the value of a particular common stock
held
by the Trust. Also, the price of common stock is sensitive to general
movements in the stock market and a drop in the stock market may
depress
the price of a common stock to which the Trust has exposure. Common
stock
prices fluctuate for several reasons, including changes in investors’
perceptions of the financial condition of an issuer or the general
condition of the relevant stock market, or when political or economic
events affecting the issuers occur. In addition, common stock prices
may
be particularly sensitive to rising interest rates, as the cost of
capital
rises and borrowing costs increase.
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Dividend
Risk. Dividends on common stock are not fixed but are
declared at the discretion of an issuer’s board of directors. There is no
guarantee that the issuers of the common stocks in which the Trust
invests
will declare dividends in the future or that, if declared, the dividends
will remain at current levels or increase over time
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Small
and Mid-Cap Securities Risk. The Trust may invest in
companies with small or medium-sized capitalizations. Securities
issued by
small and medium-sized companies can be more volatile than, and perform
differently from, larger company securities. There may be less trading
in
a small or medium company’s securities, which means that buy and sell
transactions in those securities could have a larger impact on the
security’s price than is the case with larger company securities. Small
and medium-sized companies may have
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fewer
business lines; changes in any one line of business, therefore, may
have a
greater impact on a small or medium-sized company’s security price than is
the case for a larger company. In addition, small or medium-sized
company
securities may not be well known to the investing
public.
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Non-U.S.
Securities Risk. The Trust may invest up to 20% of its
total assets in non-U.S. securities, including emerging market securities.
Investing in non-U.S. securities involves certain risks not involved
in
domestic investments, including, but not limited to: (i) fluctuations
in
foreign currency exchange rates; (ii) future foreign economic, financial,
political and social developments; (iii) different legal systems;
(iv) the
possible imposition of exchange controls or other foreign governmental
laws or restrictions; (v) lower trading volume; (vi) much greater
price
volatility and illiquidity of certain non-U.S. securities markets;
(vii)
different trading and settlement practices; (viii) less governmental
supervision; (ix) high and volatile rates of inflation; (x) fluctuating
interest rates; (xi) less publicly available information; and (xii)
different accounting, auditing and financial recordkeeping standards
and
requirements.
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Certain
countries in which the Trust may invest, especially emerging market
countries, historically have experienced, and may continue to experience,
high rates of inflation, high interest rates, exchange rate fluctuations,
large amounts of external debt, balance of payments and trade difficulties
and extreme poverty and unemployment. Many of these countries are
also
characterized by political uncertainty and instability. These risks
are
especially evident in the Middle East and West Africa. The cost of
servicing external debt will generally be adversely affected by rising
international interest rates because many external debt obligations
bear
interest at rates which are adjusted based upon international interest
rates. In addition, with respect to certain foreign countries, there
is a
risk of: (i) the possibility of expropriation or nationalization
of
assets; (ii) confiscatory taxation; (iii) difficulty in obtaining
or
enforcing a court judgment; (iv) economic, political or social
instability; and (v) diplomatic developments that could affect investments
in those countries. In addition, individual foreign economies may
differ
favorably or unfavorably from the U.S. economy in such respects as:
(i)
growth of gross domestic product; (ii) rates of inflation; (iii)
capital
reinvestment; (iv) resources; (v) self-sufficiency; and (vi) balance
of
payments position.
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As
a result of these potential risks, Highland may determine that,
notwithstanding otherwise favorable investment criteria, it may not
be
practicable or appropriate to invest in a particular country. The
Trust
may invest in countries in which foreign investors, including Highland,
have had no or limited prior experience.
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Emerging
Markets Risk. The Trust may invest up to 20% of its total
assets in securities of issuers based in emerging markets. Investing
in
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securities
of issuers based in emerging markets entails all of the risks of
investing
in securities of non-U.S. issuers to a heightened degree. Emerging
market
countries generally include every nation in the world except the
United
States, Canada, Japan, Australia, New Zealand and most countries
located
in Western Europe. These heightened risks include: (i) greater risks
of
expropriation, confiscatory taxation, nationalization, and less social,
political and economic stability; (ii) the smaller size of the markets
for
such securities and a lower volume of trading, resulting in lack
of
liquidity and in price volatility; and (iii) certain national policies
which may restrict the Trust’s investment opportunities including
restrictions on investing in issuers or industries deemed sensitive
to
relevant national interests.
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Foreign
Currency Risk. Because the Trust may invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes
in
foreign currency exchange rates may affect the value of securities
owned
by the Trust, the unrealized appreciation or depreciation of investments
and gains on and income from investments. Currencies of certain countries
may be volatile and therefore may affect the value of securities
denominated in such currencies, which means that the Trust’s net asset
value could decline as a result of changes in the exchange rates
between
foreign currencies and the U.S. dollar. These risks often are heightened
for investments in smaller, emerging capital markets. In addition,
the
Trust may enter into foreign currency transactions in an attempt
to
enhance total return which may further expose the Trust to the risks
of
foreign currency movements and other risks. The use of foreign currency
transactions can result in the Trust incurring losses as a result
of the
imposition of exchange controls, suspension of settlements or the
inability of the Trust to deliver or receive a specified
currency.
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Investments
in Unseasoned Companies. The Trust may invest in the
securities of less seasoned companies. These investments may present
greater opportunities for growth, but also involve greater risks
than
customarily are associated with investments in securities of more
established companies. Some of the companies in which the Trust may
invest
will be start-up companies which may have insubstantial operational
or
earnings history or may have limited products, markets, financial
resources or management depth. Some may also be emerging companies
at the
research and development stage with no products or technologies to
market
or approved for marketing. Securities of emerging companies may lack
an
active secondary market and may be subject to more abrupt or erratic
price
movements than securities of larger, more established companies or
stock
market averages in general. Competitors of certain companies may
have
substantially greater financial resources than many of the companies
in
which the Trust may invest.
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Initial
Public Offerings Risk. The Trust may invest in shares of
companies through initial public offerings (“IPOs”). IPOs and companies
that have recently gone public have the potential to produce substantial
gains for the Trust. However, there is no assurance that the Trust
will
have access to profitable IPOs. The investment performance of the
Trust
during periods when it is unable to invest significantly or at all
in IPOs
may be lower than during periods when the Trust is able to do so.
Securities issued in IPOs are subject to many of the same risks as
investing in companies with smaller market capitalizations. Securities
issued in IPOs have no trading history, and information about the
companies may be available for limited periods of time. In addition,
the
prices of securities sold in IPOs may be highly volatile or may decline
shortly after the IPO.
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Securities
Lending Risk. The Trust may lend its portfolio securities
(up to a maximum of one-third of its total assets) to banks or dealers
which meet the creditworthiness standards established by the board
of
trustees of the Trust. Securities lending is subject to the
risk that loaned securities may not be available to the Trust on
a timely
basis and the Trust may, therefore, lose the opportunity to sell
the
securities at a desirable price. Any loss in the market price of
securities loaned by the Trust that occurs during the term of the
loan
would be borne by the Trust and would adversely affect the Trust’s
performance. Also, there may be delays in recovery, or no recovery,
of
securities loaned or even a loss of rights in the collateral provided
by
the borrower should the borrower of the securities fail financially
while
the loan is outstanding. Although the Trust generally has the
ability to recall loaned securities pursuant to a securities lending
arrangement in the event that a shareholder vote is held, there is
a risk
that any delay in recovery of such security will result in the holder
of
such security being unable to vote. All of the aforementioned
risks may be greater for non-U.S. securities.
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Risks
Associated with Options on Securities. There are several
risks associated with transactions in options on securities. For
example,
there are significant differences between the securities and options
markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives.
A
decision as to whether, when and how to use options involves the
exercise
of skill and judgment, and even a well conceived transaction may
be
unsuccessful to some degree because of market behavior or unexpected
events.
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As
the writer of a covered call option, the Trust foregoes, during the
option’s life, the opportunity to profit from increases in the market
value of the security covering the call option above the sum of the
premium and the strike price of the call, but has retained the risk
of
loss should the price of the underlying security decline. As the
Trust
writes covered calls over more of its portfolio, its ability to benefit
from capital appreciation becomes more limited. The writer of
an
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option
has no control over the time when it may be required to fulfill its
obligation as a writer of the option. Once an option writer has received
an exercise notice, it cannot effect a closing purchase transaction
in
order to terminate its obligation under the option and must deliver
the
underlying security at the exercise price.
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When
the Trust writes covered put options, it bears the risk of loss if
the
value of the underlying stock declines below the exercise price minus
the
put premium. If the option is exercised, the Trust could incur a
loss if
it is required to purchase the stock underlying the put option at
a price
greater than the market price of the stock at the time of exercise
plus
the put premium the Trust received when it wrote the option. While
the
Trust’s potential gain in writing a covered put option is limited to
distributions earned on the liquid assets securing the put option
plus the
premium received from the purchaser of the put option, the Trust
risks a
loss equal to the entire exercise price of the option minus the put
premium.
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Exchange-Listed
Option Risks. There can be no assurance that a liquid
market will exist when the Trust seeks to close out an option position
on
an options exchange. Reasons for the absence of a liquid secondary
market
on an exchange include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may be imposed
by
an exchange on opening transactions or closing transactions or both;
(iii)
trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options; (iv) unusual
or
unforeseen circumstances may interrupt normal operations on an exchange;
(v) the facilities of an exchange or the Options Clearing Corporation
may
not at all times be adequate to handle current trading volume; or
(vi) one
or more exchanges could, for economic or other reasons, decide or
be
compelled at some future date to discontinue the trading of options
(or a
particular class or series of options). If trading were discontinued,
the
secondary market on that exchange (or in that class or series of
options)
would cease to exist. However, outstanding options on that exchange
that
had been issued by the Options Clearing Corporation as a result of
trades
on that exchange would continue to be exercisable in accordance with
their
terms. If the Trust were unable to close out a covered call option
that it
had written on a security, it would not be able to sell the underlying
security unless the option expired without exercise.
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The
hours of trading for options on an exchange may not conform to the
hours
during which the underlying securities are traded. To the extent
that the
options markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying
markets that cannot be reflected in the options markets. Call options
are
marked to market daily and their value will be affected by changes
in the
value and dividend rates of the underlying common stocks, an increase
in
interest rates, changes in the actual or perceived volatility of
the stock
market and the underlying common stocks and the remaining time to
the
options’
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expiration.
Additionally, the exercise price of an option may be adjusted downward
before the option’s expiration as a result of the occurrence of certain
corporate events affecting the underlying equity security, such as
extraordinary dividends, stock splits, merger or other extraordinary
distributions or events. A reduction in the exercise price of a call
option written by the Trust would reduce the Trust’s capital appreciation
potential on the underlying security.
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Over-the-Counter
Option Risk. The Trust may write (sell) unlisted (“OTC” or
“over-the-counter”) options. Options written by the Trust with respect to
non-U.S. securities, indices or sectors generally will be OTC options.
OTC
options differ from exchange-listed options in that they are two-party
contracts, with exercise price, premium and other terms negotiated
between
buyer and seller, and generally do not have as much market liquidity
as
exchange-listed options. The counterparties to these transactions
typically will be major international banks, broker-dealers and financial
institutions. The Trust may be required to treat as illiquid those
securities being used to cover certain written OTC options. The OTC
options written by the Trust will not be issued, guaranteed or cleared
by
the Options Clearing Corporation. In addition, the Trust’s ability to
terminate the OTC options may be more limited than with exchange-traded
options. Banks, broker-dealers or other financial institutions
participating in such transaction may fail to settle a transaction
in
accordance with the terms of the option as written. In the event
of
default or insolvency of the counterparty, the Trust may be unable
to
liquidate an OTC option position.
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Index
Option Risk. The Trust may sell index put and call options
from time to time. The purchaser of an index put option has the right
to
any depreciation in the value of the index below the exercise price
of the
option on or before the expiration date. The purchaser of an index
call
option has the right to any appreciation in the value of the index
over
the exercise price of the option on or before the expiration date.
Because
the exercise of an index option is settled in cash, sellers of index
call
options, such as the Trust, cannot provide in advance for their potential
settlement obligations by acquiring and holding the underlying securities.
The Trust will lose money if it is required to pay the purchaser
of an
index option the difference between the cash value of the index on
which
the option was written and the exercise price and such difference
is
greater than the premium received by the Trust for writing the option.
The
value of index options written by the Trust, which will be priced
daily,
will be affected by changes in the value and dividend rates of the
underlying common stocks in the respective index, changes in the
actual or
perceived volatility of the stock market and the remaining time to
the
options’ expiration. The value of the index options also may be adversely
affected if the market for the index options becomes less liquid
or
smaller. Distributions paid by the Trust on its common shares may
be
derived in part from the net index option premiums it receives from
selling index put and call options, less the cost of paying settlement
amounts
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to
purchasers of the options that exercise their options. Net index
option
premiums can vary widely over the short term and long
term.
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Asset-Backed
Securities Risk. Payment of interest and repayment of
principal on asset-backed securities may be largely dependent upon
the
cash flows generated by the assets backing the securities and, in
certain
cases, supported by letters of credit, surety bonds or other credit
enhancements. Asset-backed security values may also be affected by
the
creditworthiness of the servicing agent for the pool, the originator
of
the loans or receivables or the entities providing the credit enhancement.
In addition, the underlying assets are subject to prepayments that
shorten
the securities’ weighted average maturity and may lower their
return.
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Mortgage-Backed
Securities Risk. A mortgage-backed security, which
represents an interest in a pool of assets such as mortgage loans,
will
mature when all the mortgages in the pool mature or are prepaid.
Therefore, mortgage-backed securities do not have a fixed maturity,
and
their expected maturities may vary when interest rates rise or
fall.
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When
interest rates fall, homeowners are more likely to prepay their mortgage
loans. An increased rate of prepayments on the Trust’s mortgage-backed
securities will result in an unforeseen loss of interest income to
the
Trust as the Trust may be required to reinvest assets at a lower
interest
rate. Because prepayments increase when interest rates fall, the
price of
mortgage-backed securities does not increase as much as other fixed
income
securities when interest rates fall.
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When
interest rates rise, homeowners are less likely to prepay their mortgage
loans. A decreased rate of prepayments lengthens the expected maturity
of
a mortgage-backed security. Therefore, the prices of mortgage-backed
securities may decrease more than prices of other fixed income securities
when interest rates rise.
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Derivatives
Risk. The Trust may engage in derivative transactions for
hedging and speculative purposes or to enhance total return, including
options, futures, swaps, foreign currency transactions and forward
foreign
currency contracts, currency swaps or options on currency and currency
futures (“Derivative Transactions”). Derivative Transactions involve
risks, including the imperfect correlation between the value of such
instruments and the underlying assets, the possible default of the
other
party to the transaction or illiquidity of the derivative instruments.
The
ability to successfully use Derivative Transactions depends on the
Investment Adviser’s ability to predict pertinent market movements, which
cannot be assured. The use of Derivative Transactions may result
in losses
greater than if they had not been used, may require the Trust to
sell or
purchase portfolio securities at inopportune times or for prices
other
than current market values, may limit the amount of appreciation
the Trust
can realize on an investment or may cause the Trust to hold a security
that it might
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otherwise
sell. The use of foreign currency transactions can result in the
Trust’s
incurring losses as a result of the imposition of exchange controls,
suspension of settlements or the inability of the Trust to deliver
or
receive a specified currency. Additionally, amounts paid by the Trust
as
premiums and cash or other assets held in margin accounts with respect
to
Derivative Transactions are not otherwise available to the Trust
for
investment purposes.
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To
the extent that the Trust purchases options pursuant to a hedging
strategy, the Trust will be subject to the following additional risks.
If
a put or call option purchased by the Trust is not sold or exercised,
the
Trust will lose its entire investment in the option.
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Where
a put or call option on a particular security is purchased to hedge
against price movements in a related security, the price of the put
or
call option may move more or less than the price of the related security.
If restrictions on exercise were imposed, the Trust might be unable
to
exercise an option it had purchased. If the Trust were unable to
close out
an option that it had purchased on a security, it would have to exercise
the option in order to realize any profit or the option may expire
worthless.
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Market
Risk Generally. The profitability of a significant portion
of the Trust’s investment program depends to a great extent upon correctly
assessing the future course of the price movements of securities
and other
investments and the movements of interest rates. There can be no
assurance
that the Investment Adviser will be able to predict accurately these
price
and interest rate movements. With respect to certain investment strategies
the Trust utilizes, there is a high degree of market
risk.
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Reinvestment
Risk. The Trust reinvests the cash flows received from a
security. The additional income from such reinvestment, sometimes
called
interest-on-interest, is reliant on the prevailing interest rate
levels at
the time of reinvestment. There is a risk that the interest rate
at which
interim cash flows can be reinvested will fall. Reinvestment risk
is
greater for longer holding periods and for securities with large,
early
cash flows such as high-coupon bonds. Reinvestment risk also applies
generally to the reinvestment of the proceeds the Trust receives
upon the
maturity or sale of a portfolio security.
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Timing
Risk. Many agency, corporate and municipal bonds, and most
mortgage-backed securities, contain a provision that allows the issuer
to
“call” all or part of the issue before the bond’s maturity date, often
after five or ten years. The issuer usually retains the right to
refinance
the bond in the future if market interest rates decline below the
coupon
rate. There are three disadvantages to the call provision. First,
the cash
flow pattern of a callable bond is not known with certainty. Second,
because an issuer is more likely to call the bonds when interest
rates
have dropped, the Trust is exposed to reinvestment risk, i.e.,
the Trust may have to reinvest at lower interest rates the
proceeds
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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 Trust’s portfolio in the
manner necessary to employ successfully the Trust’s
strategy.
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Short
Sales Risk. Short selling involves selling securities
which may or may not be owned and borrowing the same securities for
delivery to the purchaser, with an obligation to replace the borrowed
securities at a later date. Short selling allows the Trust to profit
from
declines in market prices to the extent such decline exceeds the
transaction costs and the costs of borrowing the securities. However,
since the borrowed securities must be replaced by purchases at market
prices in order to close out the short position, any appreciation
in the
price of the borrowed securities would result in a loss. There can
be no
assurance that the securities necessary to cover a short position
will be
available for purchase. Purchasing securities to close out the short
position can itself cause the price of the securities to rise further,
thereby exacerbating the loss. The Trust may mitigate such losses
by
replacing the securities sold short before the market price has increased
significantly. Under adverse market conditions, the Trust might have
difficulty purchasing securities to meet its short sale delivery
obligations, and might have to sell portfolio securities to raise
the
capital necessary to meet its short sale obligations at a time when
fundamental investment considerations would not favor such sales.
Short
sales by the Trust that are not made “against the box” theoretically
involve unlimited loss potential since the market price of securities
sold
short may continuously increase.
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Risks
of Investing in Structured Finance Securities. A portion
of the Trust’s investments may consist of equipment trust certificates,
collateralized mortgage obligations, collateralized bond obligations,
collateralized loan obligations or similar instruments. Structured
finance
securities may present risks similar to those of the other types
of debt
obligations in which the Trust may invest and, in fact, such risks
may be
of greater significance in the case of structured finance securities.
Moreover, investing in structured finance securities may entail a
variety
of unique risks. Among other risks, structured finance securities
may be
subject to prepayment risk. In addition, the performance of a structured
finance security will be affected by a variety of factors, including
the
security’s priority in the capital structure of the issuer thereof, the
availability of any credit enhancement, the level and timing of payments
and recoveries on and the characteristics of the underlying receivables,
loans or other assets that are being securitized, remoteness of those
assets from the originator or transferor, the adequacy of and ability
to
realize upon any related collateral and the capability of the servicer
of
the securitized assets.
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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 its distributions, the Trust may be required to report
income
for tax purposes although it has not yet received such
income.
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Subordination. Preferred
securities are subordinated to bonds and other debt instruments in
a
company’s capital structure in terms of priority to corporate income and
liquidation payments, and therefore will be subject to greater credit
risk
than more senior debt instruments.
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Liquidity. Preferred
securities may be substantially less liquid than many other securities,
such as common stock or U.S. government securities.
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Limited
Voting Rights. Generally, preferred security holders have
no voting rights with respect to the issuing company unless preferred
dividends have been in arrears for a specified number of periods,
at which
time the preferred security holders may elect a number of directors
to the
issuer’s board. Generally, once all the arrearages have been paid, the
preferred security holders no longer have voting
rights.
|
|
|
|
|
Risks
of Investing in Synthetic Securities. With respect to
synthetic securities, the Trust will usually have a contractual
relationship only with the counterparty of such synthetic securities,
and
not the
|
|
Reference
Obligor (as defined below) on the Reference Obligation (as defined
below).
The Trust generally will have no right to directly enforce compliance
by
the Reference Obligor with the terms of the Reference Obligation
nor any
rights of set-off against the Reference Obligor, nor have any voting
rights with respect to the Reference Obligation. The Trust will not
benefit directly from any collateral supporting the Reference Obligation
or have the benefit of the remedies on default that would normally
be
available to a holder of such Reference Obligation. In addition,
in the
event of insolvency of its counterparty, the Trust will be treated
as a
general creditor of such counterparty and will not have any claim
with
respect to the credit risk of the counterparty as well as that of
the
Reference Obligor. As a result, an overabundance of synthetic securities
with any one counterparty subjects the investment to an additional
degree
of risk with respect to defaults by such counterparty as well as
by the
Reference Obligor. The Investment Adviser may not perform independent
credit analyses of the counterparties or any entities guaranteeing
such
counterparties, individually or in the aggregate. A “Reference Obligation”
is the debt security or other obligation upon which the synthetic
security
is based. A “Reference Obligor” is the obligor on a Reference Obligation.
There is no maximum amount of Trust’s assets that may be invested in
synthetic securities.
|
|
|
|
Valuation
Risk. Fair value is defined as
the amount for which assets could be sold in an orderly disposition
over a
reasonable period of time, taking into account the nature of the
asset.
Fair value pricing, however, involves judgments that are inherently
subjective and inexact, since fair valuation procedures are used
only when
it is not possible to be sure what value should be attributed to
a
particular asset or when an event will affect the market price of
an asset
and to what extent. As a result, there can be no assurance that fair
value
pricing will reflect actual market value, and it is possible that
the fair
value determined for a security will be materially different from
the
value that actually could be or is realized upon the sale of that
asset.
|
|
|
|
Risks
of Non-Diversification and Other Focused Strategies. While
the Investment Adviser invests in a number of fixed-income and equity
instruments issued by different issuers and employs multiple investment
strategies with respect to the Trust’s portfolio, it is possible that a
significant amount of the Trust’s investments could be invested in the
instruments of only a few companies or other issuers or that at any
particular point in time one investment strategy could be more heavily
weighted than the others. The focus of the Trust’s portfolio in any one
issuer would subject the Trust to a greater degree of risk with respect
to
defaults by such issuer or other adverse events affecting that issuer,
and
the focus of the portfolio in any one industry or group of industries
(but
not to exceed 25% of the Trust’s total assets) would subject the Trust to
a greater degree of risk with respect to economic downturns relating
to
such industry or industries. The focus of the Trust’s portfolio in any one
investment strategy would subject the Trust to a greater degree of
risk
than if the Trust’s
|
|
portfolio
were varied in its investments with respect to several investment
strategies.
|
|
|
|
Market
Disruption and Geopolitical Risk. The aftermath of the war
in Iraq and the continuing occupation of Iraq, instability in the
Middle
East and terrorist attacks in the United States and around the world
may
result in market volatility and may have long-term effects on the
U.S. and
worldwide financial markets and may cause further economic uncertainties
in the United States and worldwide. The Investment Adviser does not
know
how long the securities markets may be affected by these events and
cannot
predict the effects of the occupation or similar events in the future
on
the U.S. economy and securities markets.
|
|
|
|
Risks
of Investing in a Trust with Anti-Takeover Provisions. The
Trust’s Agreement and Declaration of Trust includes provisions that could
limit the ability of other entities or persons to acquire control
of the
Trust or convert the Trust to open-end status. These provisions could
deprive the holders of common shares of opportunities to sell their
common
shares at a premium over the then current market price of the common
shares or at net asset value.
|
|
|
|
Key
Adviser Personnel Risk. The Trust’s ability to identify
and invest in attractive opportunities is dependent upon Highland,
its
investment adviser. If one or more key individuals leaves Highland,
Highland may not be able to hire qualified replacements or may require
an
extended time to do so. This situation could prevent the Trust from
achieving its investment objectives.
|
|
|
|
Given
the risks described above, an investment in the common shares may
not be
appropriate for all investors. You should carefully consider your
ability
to assume these risks before making an investment in the
Trust.
|
|
|
Investment
Adviser and
Administrator
|
Highland
is the investment adviser and administrator of the Trust. As of [·], 2007,
Highland managed approximately $[·] billion in assets on behalf of
investors around the world. In return for its advisory services,
Highland
receives an annual fee, payable monthly, in an amount equal to 1.00%
of
the average weekly value of the Trust’s Managed Assets. In return for its
administrative services, Highland receives an annual fee, payable
monthly,
in an amount equal to 0.20% of the average weekly value of the Trust’s
Managed Assets. “Managed Assets” means the total assets of the Trust,
including any form of investment leverage, minus all accrued expenses
incurred in the normal course of operations, but not excluding any
liabilities or obligations attributable to investment leverage obtained
through (i) indebtedness of any type (including, without limitation,
borrowing through a credit facility or the issuance of debt securities),
(ii) the issuance of preferred shares or other similar preference
securities, (iii) the reinvestment of collateral received for securities
loaned in
|
|
accordance
with the Trust’s investment objectives and policies, and/or (iv) any other
means. Highland, at its own expense, has the authority to engage
both a
sub-adviser and a sub-administrator, each of which may be an affiliate
of
Highland. See “Management of the Trust—Investment Adviser” and “Management
of the Trust—Administrator/Sub-Administrator.”
|
|
|
|
Potential
Conflicts of Interest. The Trust currently employs
investment leverage in the form of borrowings through a credit facility.
If the Trust continues to employ leverage, the Investment Adviser
will
benefit because the Trust’s Managed Assets will increase with leverage.
The Investment Adviser will also benefit to the extent that the Trust’s
Managed Assets increase with reinvested collateral received on portfolio
securities loaned. See “Management of the Trust — Investment
Adviser.”
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|
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|
SUMMARY
OF TRUST EXPENSES
The
following table is intended to
assist investors in understanding the fees and expenses (annualized) that an
investor in the Trust would bear, directly or indirectly, as a result of the
Offer being fully subscribed and the receipt of net proceeds from the Offer
of
approximately $[·] million.
|
|
Percentage
of
Subscription
Price
|
Shareholder
Transaction Expenses
|
|
|
Sales
load
|
|
[·]%(1)
|
Dividend
reinvestment and cash purchase plan fees
|
|
None(2)
|
|
|
Percentage
of Net Assets
Attributable
to
Common
Shares
(assumes
leverage
through
borrowings)(3)
|
Annual
Expenses
|
|
|
Management
fees
|
|
|
[·]%(4)
|
Other
expenses
|
|
|
[·]%(5)
|
Interest
payments on borrowed funds
|
|
|
[·]%
|
Total
annual expenses
|
|
|
[·]%
|
____________________________
(1)
|
The
Dealer Manager will receive a fee for its financial structuring,
marketing
and soliciting services equal to [·] of the aggregate Subscription Price
for Shares issued pursuant to the Offer. The Dealer Manager will
reallow
to broker-dealers in the selling group to be formed and managed by
the
Dealer Manager selling fees equal to [·] of the Subscription Price per
Share for each Share issued pursuant to the Offer as a result of
their
selling efforts. In addition, the Dealer Manager will reallow to
other
broker-dealers that have executed and delivered a soliciting dealer
agreement and have solicited the exercise of Rights solicitation
fees
equal to [·]% of the Subscription Price per Share for each Share issued
pursuant to the exercise of Rights as a result of their soliciting
efforts, subject to a maximum fee based on the number of Shares held
by
each broker-dealer through The Depository Trust Company (“DTC”) on the
Record Date. These fees and expenses will be borne by the Trust and
indirectly by all of its shareholders, including those who do not
exercise
their Rights.
|
(2)
|
Common
shareholders will be charged a $2.50 service charge and pay a brokerage
commission of $0.05 per share sold if they direct the Plan Agent
(as
defined below) to sell common shares held in a dividend reinvestment
account. Each participant in the Trust’s Dividend Reinvestment Plan will
pay a pro rata share of brokerage commissions incurred when dividend
reinvestment occurs in open-market purchases because the Trust will
purchase its shares in the open market when the net asset value per
common
share is greater than the market value per common
share.
|
(3)
|
The
table above estimates the Trust’s annual expenses, assuming leverage
through borrowings at the Trust’s current level of approximately [·]% of
its total assets (including assets acquired with leverage). Assuming
no
leverage, the Trust’s annual expenses would be estimated to be as
follows:
|
|
|
Percentage
of Net Assets Attributable to
|
|
|
Common
Share (assumes no leverage)
|
|
Annual
Expenses
|
|
|
|
|
|
|
|
Management
fees
|
|
1.20%(4)
|
|
Interest
payments on borrowed funds
|
|
None
|
|
Other
expenses
|
|
[·]%(5)
|
|
|
Total
annual expenses
|
[·]%
|
|
(4)
|
Management
fees are the investment advisory and administrative services fees
paid to
Highland which are computed based on Managed Assets. Such fees have
been
converted to net assets for purposes of the fee table presentation
as
follows: management fees, assuming no leverage, divided by (one minus
the
current leverage of [·]% of the Trust’s total
assets).
|
(5)
|
“Other
Expenses” includes costs associated with the Trust’s short sales on
securities, including dividend expenses in securities sold short.
When a
cash dividend is declared on a security for which the Trust holds
a short
position, the Trust incurs the obligation to pay an amount equal
to that
dividend to the lender of the shorted security. Thus, the estimate
for
dividend expenses paid is also based on the dividend yields of stocks
that
would be sold short as part of anticipated trading practices (which
may
involve avoiding dividend expenses with respect to certain short
sale
transactions by closing out the position prior to the underlying
issuer’s
ex-dividend date). The Trust did not have any actual dividend expenses
with respect to short sale transactions in the past fiscal year,
but may
incur such expenses in the current fiscal year. “Other
Expenses” includes the dividend expense that the Trust is expected to
incur during the current fiscal
year.
|
EXAMPLE
The
following example illustrates the expenses that you would pay on a $1,000
investment in common shares of the Trust (including the total sales load of
$[·]
and the other estimated costs of this offering to be borne by the Trust, which
correspond to $[·]), assuming (1) that the Offer is fully subscribed and the
Trust receives net proceeds from the Offer of approximately $[·] million, (2)
that the Trust’s current net assets do not increase or decrease, (3) that the
Trust borrows approximately $[·] million under its credit facility, (3) that the
Trust incurs total annual expenses of [·]% of net assets attributable to common
shares and (4) a 5% annual return:
|
|
1
Year
|
|
3
Years
|
|
5
Years
|
|
10
Years
|
|
|
|
|
|
|
|
|
|
Total
expenses incurred
|
|
$[·]
|
|
$[·]
|
|
$[·]
|
|
$[·]
|
FINANCIAL
HIGHLIGHTS
Except
when noted, the information in
this table is derived from the Trust’s financial statements audited by [·], whose
report on such financial statements is contained in the Trust’s 2006 Annual
Report and incorporated by reference into the Statement of Additional
Information.
Per
Share Operating Performance
|
Six
Months Ended
June
30, 2007
(unaudited)
|
|
Period
Ended
December
30, 2006(a)
|
Net
Asset Value, Beginning of Period
|
$20.08
|
|
$19.06
|
Income
from Investment Operations
|
|
|
|
Net
investment income
|
0.84
|
|
0.71
|
Net
realized and unrealized gain on investments
|
0.43
|
|
0.91
|
Total
from investment operations applicable to common
shareholders
|
1.27
|
|
1.62
|
Less
Distributions Declared to Common Shareholders
|
|
|
|
From
net investment income
|
(0.90)
|
|
(0.60)
|
Net
Asset Value End of Period
|
$20.45
|
|
$20.08
|
Market
Value, End of Period
|
$19.80
|
|
$21.16
|
Market
Value Total Return(b)
|
6.65%(c)
|
|
9.06%(c)
|
Ratios
to Average Net Assets/Supplemental Data
|
|
|
|
Common
Share Information at End of Period:
|
|
|
|
Ratios
based on average net assets
|
|
|
|
Net
assets, end of period (in 000’s)
|
$705,903
|
|
$692,964
|
Net
operating expenses
|
1.81%
|
|
1.53%
|
Interest
expenses
|
2.07%
|
|
1.03%
|
Dividend
income from short positions
|
0.16%
|
|
N/A
|
Net
expenses
|
4.04%
|
|
2.56%
|
Net
investment income
|
8.28%
|
|
7.64%
|
Ratios
based on average Managed Assets
|
|
|
|
Net
assets, end of period (in 000’s)
|
$705,903
|
|
$692,964
|
Net
operating expenses
|
1.33%
|
|
1.31%
|
Interest
expenses
|
1.52%
|
|
0.89%
|
Dividend
income from short positions
|
0.11%
|
|
N/A
|
Net
expenses
|
2.96%
|
|
2.20%
|
Net
investment income
|
6.07%
|
|
6.33%
|
Portfolio
turnover rate
|
52.49%(c)
|
|
45.95%(c)
|
(a)
|
The
Trust commenced investment operations on June 29,
2006.
|
(b)
|
Based
on market value per share. Dividends and distributions, if any, are
assumed for purposes of this calculation to be reinvested at prices
obtained under the Trust’s dividend reinvestment
plan.
|
THE
OFFER
Purpose
of the Offer
[The
Board of
Trustees of the Trust (the “Board”) and the Investment Adviser have determined
that it would be in the best interests of the Trust and its shareholders to
increase the assets of the Trust available for investment, thereby enabling
the
Trust more fully to take advantage of current and prospective investment
opportunities. The Board and the Investment Adviser believe that the Offer
is
the most effective way to raise additional assets for the Trust while offering
shareholders the opportunity to buy additional common shares at a discounted
price.
The
Board and the Investment Adviser
also believe that increasing the Trust’s assets available for investment may
result in a modest reduction of the Trust’s expense ratio, as the Trust’s fixed
costs would be spread over a larger asset base.] There is no assurance that
the
Offer will be successful, or that by increasing the Trust’s assets available for
investment its expense ratio will be lowered.
The
Offer provides Record Date
Shareholders the opportunity to purchase additional shares of the Trust’s common
shares at a price below the market price. The distribution to Record Date
Shareholders of transferable Rights may afford non-participating Record Date
Shareholders the opportunity to sell their Rights for some cash value, receipt
of which may be viewed as partial compensation for any economic dilution of
their interests resulting from the Offer.
Important
Terms of the Offer
The
Trust is issuing transferable
rights (“Rights”) to its common shareholders of record (“Record Date
Shareholders”) as of the close of business on [·], 2007 (the “Record Date”),
entitling the holders of those Rights to subscribe for up to an aggregate of
[·]
the Trust’s common shares (the “Shares”) (the “Offer”). Record Date Shareholders
will receive one Right for each whole common share of the Trust held on the
Record Date. These Rights entitle the Record Date Shareholders to purchase
one
new Share for every [·]
Rights
held (1-for-[·]).
Fractional Shares will not be issued upon the exercise of Rights; accordingly,
Rights may be exercised only in integer multiples of [·],
except
that any Record Date Shareholder who is issued fewer than [·]
Rights
may subscribe, at the Subscription Price (defined below), for one full Share.
Record
Date Shareholders who exercise
all of the Rights issued to them (other than those Rights that cannot be
exercised because they represent the right to acquire less than one Share)
are
entitled to subscribe for additional Shares at the same Subscription Price
pursuant to the over-subscription privilege, subject to certain limitations
and
subject to allotment. Investors who are not shareholders on the Record Date,
but
who otherwise acquire Rights to purchase common shares pursuant to the Offer,
are not entitled to subscribe for any common shares pursuant to the
over-subscription privilege. See “Over-Subscription Privilege”
below.
The
subscription period commences on
[·], 2007 and ends at 5:00 p.m., Eastern time, on [·], 2007, unless otherwise
extended (the “Expiration Date”).
For
purposes of determining the maximum
number of shares of the Trust’s common stock a shareholder may acquire pursuant
to the Offer, broker-dealers, trust companies, banks or others whose shares
are
held of record by Cede & Co., the nominee for the Depository Trust Company
(“DTC”), or by any other depository or nominee will be deemed to be the holders
of the Rights that are held by [·] or such other depository or nominee on their
behalf.
The
Rights are transferable and will be
listed for trading on the NYSE under the symbol “[·]” during the course of the
Offer. Trading in the Rights on the NYSE is expected to be conducted until
the
close of trading on the NYSE on [·], 2007 (or if the Offer is extended, until
the last business day prior to the extended Expiration Date). See “Sale and
Transferability of Rights.” The Shares, once issued, will be listed on the NYSE
under the symbol “HCF.” The Rights will be evidenced by subscription
certificates which will be mailed to Record Date Shareholders, except as
discussed below under “Requirements for Foreign Shareholders.”
Rights
may be exercised by completing a
subscription certificate and delivering it, together with payment of the
estimated Subscription Price, to the Subscription Agent. A Rights holder will
have no right to rescind a purchase after the Subscription Agent has received
a
completed subscription certificate together with payment for the Shares offered
pursuant to the Offer, except as provided under “Notice of Net Asset Value
Decline.” Rights holders who exercise their Rights will not know at the time of
exercise the Subscription Price of the Shares being acquired and will be
required initially to pay for both the Shares subscribed for during the
subscription period and, if eligible, any additional Shares subscribed for
pursuant to the over-subscription privilege at the estimated Subscription Price
of $[·] per Share. For a discussion of the method by which Rights may be
exercised and Shares paid for, see “Exercise of Rights” and “Payment for
Shares.”
The
Board retained [·] to provide the
Trust with financial structuring, marketing and soliciting services relating
to
the Offer, including advice with respect to the structure, timing and terms
of
the Offer. In determining the structure of the Offer, the Board considered,
among other things, [using a fixed-pricing versus a variable pricing mechanism,
the benefits and drawbacks of conducting a non-transferable versus a
transferable rights offering, the effect on the Trust and its existing
shareholders if the Offer is not fully subscribed, the dilutive effects on
the
Trust and its existing shareholder of the Offer and the experience of [·] in
conducting rights offerings. The Board also considered that the Investment
Adviser would benefit from the Offer because the investment advisory fee paid
by
the Trust to the Investment Adviser pursuant to the Investment Advisory
Agreement is based on the Trust’s Managed Assets, which would increase as a
result of the Offer.] See “Certain Effects of the Offer” on page
[·].
Subscription
Price
The
subscription price (the
“Subscription Price”) will be determined based on a formula equal to [·]% of the
average of the last reported sale prices of the Trust’s common shares on the New
York Stock Exchange (the “NYSE”) on the Expiration Date and the four preceding
trading days (the “Formula Price”). If, however, the Formula Price is less than
[·]%
of the net asset value per common share on the Expiration Date, then the
Subscription Price will be [·]%
of the
Trust’s net asset value per common share on that day.
Because
the Expiration Date of the
subscription period will be [·], 2007 (unless we extend the subscription
period), Rights holders will not know the Subscription Price at the time of
exercise and will be required initially to pay for both the Shares subscribed
for pursuant to the primary subscription and, if eligible, any additional Shares
subscribed for pursuant to the over-subscription privilege at the estimated
Subscription Price of $[·] per share. See “Payment for Shares.” Rights holders
who exercise their Rights will have no right to rescind a purchase after receipt
of their completed subscription certificates together with payment for Shares
by
the Subscription Agent, except as provided under “Notice of Net Asset Value
Decline.” The Trust does not have the right to withdraw the Rights or cancel the
Offer after the Rights have been distributed.
The
net asset value per share of the
Trust’s common stock at the close of business on [·], 2007 (the last trading
date prior to the date of this prospectus on which the Trust determined its
net
asset value) was $[·] and the last reported sale price of a share on the NYSE on
that day was $[·].
Over-Subscription
Privilege
Record
Date Shareholders who exercise
all the Rights issued to them (other than those Rights that cannot be exercised
because they represent the right to acquire less than one Share) are entitled
to
subscribe for additional Shares at the same Subscription Price pursuant to
the
over-subscription privilege, subject to certain limitations and subject to
allotment. Investors who are not Record Date Shareholders, but who otherwise
acquire Rights to purchase Shares pursuant to the Offer, are not entitled to
subscribe for any Shares pursuant to the over-subscription privilege. To the
extent sufficient Shares are not available to honor all over-subscription
requests, unsubscribed Shares will be allocated pro rata among those Record
Date
Shareholders who over-subscribe based on the number of common shares of the
Trust they owned on the Record Date. The allocation process may involve a series
of allocations in order to assure that the total number of shares of common
stock available for over-subscriptions is distributed on a pro rata
basis.
Record
Date Shareholders who are fully
exercising their Rights during the subscription period should indicate, on
the
subscription certificate which they submit with respect to the exercise of
the
Rights issued to them, how many Shares they desire to acquire pursuant to the
over-subscription privilege.
Banks,
broker-dealers, trustees and
other nominee holders of Rights will be required to certify to the Subscription
Agent, before any over-subscription privilege may be exercised with respect
to
any particular beneficial owner, as to the aggregate number of Rights exercised
during the subscription period and the number of Shares subscribed for pursuant
to the over-subscription privilege by such beneficial owner and that such
beneficial owner’s primary subscription was exercised in full. Nominee holder
over-subscription forms will be distributed to banks, brokers, trustees and
other nominee holders of Rights with the subscription certificates.
The
Trust will not offer or sell any
Shares of its common stock that are not subscribed for during the subscription
period or pursuant to the over-subscription privilege.
The
Trust has been advised that the
Investment Adviser and each of the Trust’s trustees will exercise all of the
Rights initially issued to them and may request additional Shares pursuant
to
the over-subscription privilege. Rule 144 under the Securities Act (“Rule 144”)
generally provides that an “affiliate” of the Trust (which, for purposes of Rule
144, may include, among other persons, the Investment Adviser and the Trust’s
trustees) is entitled to sell, within any three-month period, a number of Shares
that does not exceed the greater of 1% of the then outstanding Shares or the
average weekly reported trading volume of the Shares during the four calendar
weeks preceding the sale. Sales under Rule 144 by covered persons are also
subject to certain restrictions on the manner of sale, to notice requirements
and to the availability of current public information about the Trust. In
addition, any profit resulting from a trustee’s or the Investment Adviser’s sale
of Shares within a period of less than six months from the purchases may have
to
be returned to the Trust .
Sale
and Transferability of Rights
The
Rights will be listed for trading
on the NYSE under the symbol “[·]” during the course of the Offer. Trading in
the Rights on the NYSE may be conducted until the close of trading on the NYSE
on the last business day prior to the Expiration Date. The Trust and [·], the
Dealer Manager will use their best efforts to ensure that an adequate trading
market for the Rights will exist, although there is no
assurance
that
a
market for the Rights will develop. Assuming a market exists for the Rights,
the
Rights may be purchased and sold through usual brokerage channels or sold
through the Subscription Agent (defined below).
Sales
through the
Subscription Agent and the Dealer Manager. Record Date Shareholders
who do not wish to exercise any of the Rights issued to them pursuant to the
Offer may instruct the Subscription Agent to sell any unexercised Rights through
or to the Dealer Manager. Subscription certificates representing the Rights
to
be sold through or to the Dealer Manager must be received by the Subscription
Agent by 5:00 p.m., Eastern time, on [·], 2007 (or, if the subscription period
is extended, by 5:00 p.m., Eastern time, two business days prior to the extended
Expiration Date). Upon the timely receipt by the Subscription Agent of
appropriate instructions to sell Rights, the Subscription Agent will ask the
Dealer Manager either to purchase them or to use its best efforts to complete
their sale, and the Subscription Agent will remit the proceeds of the sale
to
the selling shareholder. If the Rights are sold, sales of those Rights will
be
deemed to have been effected at the weighted average price received by the
Dealer Manager on the day those Rights are sold. The sale price of any Rights
sold to the Dealer Manager will be based upon the then-current market price
for
the Rights. The Dealer Manager will also attempt to sell all Rights which remain
unclaimed as a result of subscription certificates being returned by the postal
authorities to the Subscription Agent as undeliverable as of the fourth business
day prior to the Expiration Date. The Subscription Agent will hold the proceeds
from those sales for the benefit of those nonclaiming shareholders until the
proceeds are either claimed or revert to the State of Delaware. There can be
no
assurance that the Dealer Manager will purchase or be able to complete the
sale
of any of those Rights, and neither the Trust nor the Dealer Manager have
guaranteed any minimum sale price for the Rights. If a Record Date Shareholder
does not utilize the services of the Subscription Agent and chooses to use
another broker-dealer or other financial institution to sell Rights issued
to
that shareholder pursuant to the Offer, then the other broker-dealer or
financial institution may charge a fee to sell the Rights.
Other
Transfers.
The Rights evidenced by a subscription certificate may be
transferred in whole by endorsing the subscription certificate for transfer
in
accordance with the instructions accompanying the subscription certificate.
A
portion of the Rights evidenced by a single subscription certificate (but not
fractional Rights) may be transferred by delivering to the Subscription Agent
a
subscription certificate properly endorsed for transfer, with instructions
to
register such portion of the Rights evidenced thereby in the name of the
transferee and to issue a new subscription certificate to the transferee
evidencing the transferred Rights. If this occurs, a new subscription
certificate evidencing the balance of the Rights, if any, will be issued to
the
Record Date Shareholder or, if the Record Date Shareholder so instructs, to
an
additional transferee. The signature on the subscription certificate must
correspond with the name as written upon the face of the subscription
certificate in every particular, without alteration or enlargement, or any
change. A signature guarantee must be provided by an eligible financial
institution as defined in Rule 17Ad-15 of the Securities Exchange Act of 1934
(the “Exchange Act”), subject to the standards and procedures adopted by the
Trust.
Record
Date Shareholders wishing to
transfer all or a portion of their Rights should allow at least five business
days prior to the Expiration Date for: (i) the transfer instructions to be
received and processed by the Subscription Agent; (ii) a new subscription
certificate to be issued and transmitted to the transferee or transferees with
respect to transferred Rights and to the transferor with respect to retained
Rights, if any; and (iii) the Rights evidenced by the new subscription
certificate to be exercised or sold by the recipients of the subscription
certificate. Neither the Trust nor the Subscription Agent or the Dealer Manager
shall have any liability to a transferee or transferor of Rights if subscription
certificates are not received in time for exercise or sale prior to the
Expiration Date.
Except
for the fees charged by the
Information Agent, Subscription Agent and Dealer Manager (which are expected
to
be paid from the proceeds of the Offer by the Trust), all commissions, fees
and
other
expenses (including brokerage commissions and transfer taxes) incurred or
charged in connection with the purchase, sale or transfer of rights will be
for
the account of the transferor of the Rights, and none of these commissions,
fees
or expenses will be paid by the Trust, the Information Agent, the Subscription
Agent or the Dealer Manager. Shareholders who wish to purchase, sell, exercise
or transfer Rights through a broker, bank or other party should first inquire
about any fees and expenses that the shareholder will incur in connection with
the transactions.
The
Trust anticipates that the Rights
will be eligible for transfer through, and that the exercise of the primary
subscription and the over-subscription may be effected through, the facilities
of DTC or the Subscription Agent until 5:00 p.m., Eastern time, on the
Expiration Date.
Method
for Exercising Rights
Rights
are evidenced by subscription
certificates that will be mailed to Record Date Shareholders (except as
described under “Requirements for Foreign Shareholders” below) or, if a
shareholder’s shares are held by Cede & Co. or any other depository or
nominee on their behalf, to Cede & Co. or the other depository or nominee.
Rights may be exercised by completing and signing the subscription certificate
and mailing it in the envelope provided, or otherwise delivering the completed
and signed subscription certificate to the Subscription Agent, together with
payment in full at the estimated Subscription Price for the shares by the
Expiration Date as described under “Payment For Shares.” Rights may also be
exercised by contacting your broker, banker or trust company, which can arrange,
on your behalf, to guarantee by the Expiration Date, delivery of payment and
of
a properly completed and executed subscription certificate pursuant to a notice
of guaranteed delivery by the close of business on the third business day after
the Expiration Date. A fee may be charged for this service. Completed
subscription certificates and payments must be received by the Subscription
Agent by 5:00 p.m., Eastern time, on the Expiration Date (unless delivery of
subscription certificate and payment is effected by means of a notice of
guaranteed delivery as described below under “Payment for Shares”) at the
offices of the Subscription Agent at the addresses set forth above under
“Subscription Agent.” Fractional Shares will not be issued upon exercise of
Rights.
Shareholders
Who
are Record Owners. Shareholders who are record owners can choose
between either option set forth below under “Payment For Shares.” If time is of
the essence, option (2) will permit delivery of the subscription certificate
and
payment after the Expiration Date.
Investors
Whose
Shares are Held by a Nominee. Shareholders whose shares are held by
a nominee, such as a broker or trustee, must contact that nominee to exercise
their Rights. In that case, the nominee will complete the subscription
certificate on behalf of the investor and arrange for proper payment by one
of
the methods set forth below under “Payment For Shares.”
Nominees.
Nominees, such as brokers, trustees or depositories for securities,
who hold shares of the Trust’s common stock for the account of others should
notify the respective beneficial owners of such shares as soon as possible
to
ascertain those beneficial owners’ intentions and to obtain instructions with
respect to the Rights. If the beneficial owner so instructs, the nominee should
complete the subscription certificate and submit it to the Subscription Agent
with the proper payment as described below under “Payment For
Shares.”
Banks,
brokers, trustees and other
nominee holders of Rights will be required to certify to the Subscription Agent,
before any over-subscription privilege may be exercised with respect to any
particular beneficial owner on the Record Date, as to the aggregate number
of
Rights exercised during the subscription period and the number of Shares
subscribed for pursuant to the over-subscription privilege by
the
beneficial owner and that the beneficial owner exercised all the Rights issued
to it pursuant to the Offer.
Requirements
for Foreign Shareholders
Subscription
certificates will not be
mailed to Record Date Shareholders whose addresses are outside the United States
(for these purposes, the United States includes the District of Columbia and
the
territories and possessions of the United States) (“Foreign Shareholders”). The
Subscription Agent will send a letter via regular mail to Foreign Shareholders
to notify them of the Offer. The Rights of Foreign Shareholders will be held
by
the Subscription Agent for their accounts until instructions are received to
exercise the Rights. If instructions have not been received by 5:00 p.m.,
Eastern time, on [·], 2007, three business days prior to the Expiration Date
(or, if the subscription period is extended, on or before three business days
prior to the extended Expiration Date), the Rights of Foreign Shareholders
will
be transferred by the Subscription Agent to the Dealer Manager, who will either
purchase the Rights or use its best efforts to sell the Rights. The net
proceeds, if any, from sale of those Rights by or to the Dealer Manager will
be
remitted to these Foreign Shareholders.
Important
Dates to Remember
Record
Date
|
.[·],
2007
|
Subscription
Period
|
.[·],
2007 to [·], 2007*
|
Final
Day Rights Will Trade on NYSE
|
[·],
2007*
|
Expiration
Date and Pricing Date
|
[·],
2007*
|
Delivery
of Executed Subscription Certificates
|
|
and
Payment for Shares Due or Notices of Guarantees of Delivery
Due
|
[·],
2007*
|
Delivery
of Executed Subscription Certificates and Payment for Guarantees
of
Delivery Due
|
[·],
2007*
|
Confirmation
Mailed to Participants
|
[·],
2007*
|
Final
Payment for Shares Due
|
.[·],
2007*†
|
*
Unless the Offer is
extended.
†
See
“The
Offer—Payment for
Shares.”
Distribution
Arrangements
[·]
will act as Dealer Manager for this
Offer. Under the terms and subject to the conditions contained in the Dealer
Manager Agreement among [·], the Trust and the Investment Adviser, the Dealer
Manager will provide financial structuring services and marketing assistance
in
connection with the Offer and will solicit the exercise of Rights and
participation in the over-subscription privilege. The Trust has agreed to pay
the Dealer Manager a fee for its financial structuring, marketing and soliciting
services equal to [·]% of the aggregate Subscription Price for the Shares issued
pursuant to the exercise of Rights and the over-subscription privilege. The
Dealer Manager will reallow a part of its fees to other broker-dealers who
have
assisted in soliciting the exercise of Rights.
The
Dealer Manager will reallow to
broker-dealers included in the selling group to be formed and managed by the
Dealer Manager selling fees equal to [·]%
of the
Subscription Price per share for each Share issued pursuant to the Offer as
a
result of their selling efforts. In addition, the Dealer Manager will reallow
to
other broker-dealers that have executed and delivered a soliciting dealer
agreement and have solicited the exercise of Rights solicitation fees equal
to
[·]%
of the Subscription Price per share for each Share issued pursuant to exercise
of Rights as a result of their soliciting efforts, subject to a maximum fee
based on the number of Shares held by each broker-dealer through DTC on the
Record Date. Fees will be paid
to the broker-dealer designated on the applicable portion of the subscription
certificates or, in the absence of such designation, to the Dealer
Manager.
The
Trust and the Investment Adviser
have each agreed to indemnify the Dealer Manager for, or contribute to losses
arising out of, certain liabilities, including liabilities under the Securities
Act. The Dealer Manager Agreement also provides that the Dealer Manager will
not
be subject to any liability to the Trust in rendering the services contemplated
by the Dealer Manager Agreement except for any act of bad faith, willful
misconduct or gross negligence of the Dealer Manager or reckless disregard
by
the Dealer Manager of its obligations and duties under the Dealer Manager
Agreement.
Prior
to the expiration of the Offer,
the Dealer Manager may independently offer for sale Shares acquired through
purchasing and exercising Rights, at prices it sets. Although the Dealer Manager
may realize gains and losses in connection with such purchases and sales, such
offering of Shares is intended by the Dealer Manager to facilitate the Offer
and
any such gains or losses are not expected to be material to the Dealer Manager.
The Dealer Manager’s fee for its financial structuring, marketing and soliciting
services is independent of any gains or losses that may be realized by the
Dealer Manager through the purchase and exercise of Rights.
In
the ordinary course of their
businesses, the Dealer Manager and/or its affiliates may engage in investment
banking or financial transactions with the Trust, the Investment Adviser and
their affiliates.
The
principal business address of [·]
is [·].
Subscription
Agent
[·]
is the Subscription Agent for the
Offer. The Subscription Agent will receive for its administrative, processing,
invoicing and other services a fee estimated to be approximately $[ ], plus
reimbursement for all out-of-pocket expenses related to the Offer. Questions
regarding the subscription certificates should be directed by mail to [·],
Attention: [Corporate Actions], [·]. Shareholders
may
also subscribe for the Offer by contacting their broker dealer, trust company,
bank or other nominee.
Completed
subscription certificates
must be sent together with proper payment of the estimated Subscription Price
for all Shares subscribed for in the primary subscription and the
over-subscription privilege (for Record Date Shareholders) to the Subscription
Agent by one of the methods described below. Alternatively, shareholders may
arrange for their financial institutions to send notices of guaranteed delivery
by facsimile to DTC to be received by the Subscription Agent prior to 5:00
p.m.,
Eastern time, on the Expiration Date. Facsimiles should be confirmed by
telephone at DTC. The Trust will accept only properly completed and executed
subscription certificates actually received at any of the addresses listed
below, prior to 5:00 p.m., New York City time, on the Expiration Date or by
the
close of business on the third business day after the Expiration Date following
timely receipt of a notice of guaranteed delivery. See “Payment for Shares”
below.
Subscription
Certificate Delivery Method
|
Address/Number
|
By
Notice of Guaranteed Delivery:
|
Contact
your broker-dealer, trust company, bank, or other nominee to notify
the
Trust of your intent to exercise the Rights.
|
By
First Class Mail Only: (No Overnight /Express Mail):
|
[·]
|
By
Hand:
|
[·]
|
By
Express Mail or Overnight Courier:
|
[·]
|
The
Trust will honor only subscription certificates received by the Subscription
Agent on or prior to the Expiration Date at one of the addresses listed above.
Delivery to an address other than those listed above will not constitute good
delivery.
Information
Agent
The
Information Agent for the Offer is
[·]. If you have questions or need further information about the Offer, please
write the Information Agent at [·]or call [·]. Any questions or requests for
assistance concerning the method of subscribing for Shares or additional copies
of this prospectus or subscription certificates should be directed to the
Information Agent. Shareholders may also contact their brokers or
nominees for information with respect to the Offer.
The
Information Agent will receive a
fee estimated to be approximately $[·] for its services, plus reimbursement for
all out-of-pocket expenses related to the Offer.
Expiration
of the Offer
The
offer will expire at 5:00 p.m.,
Eastern time, on [·], 2007, unless the Trust extends the Expiration Date. Rights
will expire on the Expiration Date and may not be exercised after this date.
If
the Trust extends the Expiration Date, the Trust will make an announcement
as
promptly as practicable. This announcement will be issued no later than 9:00
a.m., Eastern time, on the next business day following the previously scheduled
Expiration Date. Without limiting the manner in which the Trust may choose
to
make this announcement, the Trust will not, unless otherwise required by law,
have any obligation to publish, advertise or otherwise communicate this
announcement other than by making a release to the Dow Jones News Service or
any
other means of public announcement as the Trust may deem proper.
Payment
for Shares
Rights
holders who wish to acquire
Shares pursuant to the Offer may choose between the following methods of
payment:
(1)
A Rights holder can send the
subscription certificate together with payment for the shares of common stock
subscribed for during the subscription period and, if eligible, for any
additional shares subscribed for pursuant to the over-subscription privilege
to
the Subscription Agent based upon an estimated Subscription Price of $[·]
per
share. Subscription will be accepted when payment, together with the executed
subscription certificate, is received by the Subscription Agent at one of the
addresses set forth above; the payment and subscription certificate must be
received by the Subscription Agent by 5:00 p.m., Eastern time, on the Expiration
Date. The Subscription Agent will deposit all checks received by it for the
purchase of shares into a segregated interest-bearing account of the Trust
(the
interest from which will belong to the Trust) pending proration and distribution
of shares of the Trust’s common stock. A payment pursuant to this method must be
in U.S. dollars by money order or check drawn on a bank located in the United
States, must be payable to “Highland Credit
Strategies Fund” and
must accompany a properly completed and executed subscription certificate for
such subscription to be accepted.
(2)
Alternatively, a subscription will
be accepted by the Subscription Agent if, by 5:00 p.m., Eastern time, on the
Expiration Date, the Subscription Agent has received a notice of guaranteed
delivery
by
facsimile (telecopy) or otherwise from a bank, a trust company or NYSE member
guaranteeing delivery of (i) payment of the full Subscription Price for the
shares of the Trust’s common stock subscribed for during the subscription period
and, if eligible, any additional shares subscribed for pursuant to the
over-subscription privilege and (ii) a properly completed and executed
subscription certificate. The Subscription Agent will not honor a notice of
guaranteed delivery unless a properly completed and executed subscription
certificate and full payment for the shares of the Trust’s common stock at the
established subscription price are received by the Subscription Agent by the
close of business on the third business day after the Expiration
Date.
On
the confirmation date, which will be
five business days following the Expiration Date, a confirmation will be sent
by
the Subscription Agent to each Rights holder exercising its Rights (or, if
shares of the Trust’s common shares are held by DTC or any other depository or
nominee, to DTC and that other depository or nominee) showing (i) the number
of
Shares of the Trust acquired during the subscription period, (ii) the number
of
Shares, if any, acquired pursuant to the over-subscription privilege, (iii)
the
per share and total purchase price for the Shares and (iv) any additional amount
payable to the Trust by the Rights holder or any excess to be refunded by the
Trust to the Rights holder, in each case based on the Subscription Price as
determined on the Expiration Date. If any Record Date Shareholder exercises
its
right to acquire Shares of the Trust pursuant to the over-subscription
privilege, any excess payment which would otherwise be refunded to the Record
Date Shareholder will be applied by the Trust toward payment for Shares acquired
pursuant to exercise of the oversubscription privilege. Any additional payment
required from a Rights holder must be received by the Subscription Agent within
ten business days after the confirmation date ([·], 2007, unless the Expiration
Date is extended). Any excess payment to be refunded by the Trust to a Rights
holder will be mailed by the Subscription Agent to such Rights holder as
promptly as practicable. All payments by a Rights holder must be in U.S. dollars
by money order or check drawn on a bank located in the United States and payable
to“Highland
Credit
Strategies Fund.”
Whichever
of the two methods described
above is used, issuance and delivery of certificates for the Shares subscribed
for are contingent upon actual payment for such Shares.
Rights
holders who have exercised their
Rights will have no right to rescind their subscription after receipt of the
completed subscription certificate together with payment for Shares by the
Subscription Agent, except as described under “— Notice of Net Asset Value
Decline” below.
If
a Rights holder who acquires Shares
during the subscription period or pursuant to the over-subscription privilege
(for Record Date Shareholders) does not make payment of any amounts due by
the
Expiration Date or the date payment is due under a notice of guaranteed
delivery, the Trust reserves the right to take any or all of the following
actions through all appropriate means: (i) find other Record Date Shareholders
for the subscribed and unpaid for Shares; (ii) apply any payment actually
received by the Trust toward the purchase of the greatest whole number of Shares
which could be acquired by the Rights holder upon exercise of such Rights
acquired during the subscription period or pursuant to the over-subscription
privilege; and/or (iii) exercise any and all other rights or remedies to which
the Trust may be entitled, including, without limitation, the right to set
off
against payments actually received by it with respect to such subscribed
Shares.
The
method of delivery of completed
subscription certificates and payment of the Subscription Price to the
Subscription Agent will be at the election and risk of exercising Rights
holders, but if sent by mail it is recommended that such forms and payments
be
sent by registered mail, properly insured, with return receipt requested, and
that a sufficient number of days be allowed to ensure delivery to the
Subscription Agent and clearance of payment by 5:00 p.m., Eastern time, on
the
Expiration
Date.
Because uncertified personal checks may take at least five business days to
clear, exercising Rights holders are strongly urged to pay, or arrange for
payment, by means of certified or cashier’s check or money order.
All
questions concerning the
timeliness, validity, form and eligibility of any exercise of Rights will be
determined by the Trust, which determinations will be final and binding. The
Trust, in its sole discretion, may waive any defect or irregularity, or permit
a
defect or irregularity to be corrected within such time as it may determine,
or
reject the purported exercise of any Right. Subscriptions will not be deemed
to
have been received or accepted until substantially all irregularities have
been
waived or cured within such time as the Trust determines in its sole discretion.
The Trust will not be under any duty to give notification of any defect or
irregularity in connection with the submission of subscription certificates
or
incur any liability for failure to give such notification.
Notice
of Net Asset Value Decline
The
Trust has, pursuant to the SEC’s
regulatory requirements, undertaken to suspend the Offer until the Trust amends
this prospectus if subsequent to [·], 2007, the effective date of the Trust’s
Registration Statement, the Trust’s net asset value declines more than 10% from
the Trust’s net asset value as of that date. In that event, the Expiration Date
will be extended and the Trust will notify Record Date Shareholders of any
such
decline and permit Rights holders to cancel their exercise of
Rights.
Delivery
of Stock Certificates
Participants
in the Trust’s dividend
reinvestment plan (the “Plan”) will have any Shares acquired pursuant to the
Offer credited to their shareholder dividend reinvestment accounts in the Plan.
Shareholders whose shares are held of record by DTC or by any other depository
or nominee on their behalf or their broker-dealers’ behalf will have any Shares
acquired during the subscription period credited to the account of DTC or other
depository or nominee. Shares acquired pursuant to the over-subscription
privilege will be certificated and share certificates representing these Shares
will be sent directly to DTC or other depository or nominee. With respect to
all
other shareholders, share certificates for all Shares acquired pursuant to
the
Offer will be mailed promptly after payment for the shares subscribed for has
cleared.
U.S.
Federal Income Tax Consequences
The
following is a general summary of
the material U.S. federal income tax consequences of the Offer under the
provisions of the Internal Revenue Code of 1986, as amended (the “Code”), and
Treasury regulations in effect as of the date of the prospectus that are
generally applicable to Record Date Shareholders who are United States persons
within the meaning of the Code, and does not address any foreign, state or
local
tax consequences. The Code and Treasury regulations are subject to change or
differing interpretations by legislative or administrative action, which may
be
retroactive. Record Date Shareholders and exercising Rights holders should
consult their tax advisors regarding the tax consequences, including U.S.
federal, state, local or foreign tax consequences, relevant to their particular
circumstances.
The
value of a Right will not be
includible in the income of a Record Date Shareholder at the time the Right
is
issued.
The
basis of a Right issued to a Record
Date Shareholder will be zero, and the basis of the share with respect to which
the Right was issued (the old share) will remain unchanged, unless either (a)
the fair market value of the Right on the date of distribution is at least
15%
of the fair market value of the old share, or (b) such shareholder affirmatively
elects (in the manner set out in Treasury regulations under the
Code)
to allocate to the Right a portion of the basis of the old share. If either
(a)
or (b) applies, such shareholder must allocate basis between the old share
and
the Right in proportion to their fair market values on the date of
distribution.
The
basis of a Right purchased in the
market will generally be its purchase price.
The
holding period of a Right issued to
a Record Date Shareholder will include the holding period of the old
share.
No
loss will be recognized by a Record
Date Shareholder if a Right distributed to such shareholder expires unexercised
because the basis of the old share may be allocated to a Right only if the
Right
is exercised. If a Right that has been purchased in the market expires
unexercised, there will be a recognized loss equal to the basis of the
Right.
Any
gain or loss on the sale of a Right
will be a capital gain or loss if the Right is held as a capital asset (which
in
the case of Rights issued to Record Date Shareholders will depend on whether
the
old share is held as a capital asset), and will be a long-term capital gain
or
loss if the holding period is deemed to exceed one year.
No
gain or loss will be recognized by a
shareholder upon the exercise of a Right, and the basis of any Share acquired
upon exercise (the new Share) will equal the sum of the basis, if any, of the
Right and the Subscription Price for the new Share. The holding period for
the
new share will begin on the date when the Right is exercised.
Employee
Plan Considerations
Shareholders
whose shares are in
employee benefit plans subject to the Employee Retirement Income Security Act
of
1974, as amended (“ERISA”) (including corporate savings and 401(k) plans), Keogh
or H.R. 10 plans of self-employed individuals and individual retirement accounts
should be aware that additional contributions of cash to the employee retirement
plan (other than rollover contributions or trustee-to-trustee transfers from
other employee retirement plans) in order to exercise Rights would be treated
as
contributions to the employee retirement plan and, when taken together with
contributions previously made, may result in, among other things, excise taxes
for excess or nondeductible contributions. In the case of employee retirement
plan qualified under Section 401(a) of the Code and certain other employee
retirement plans, additional cash contributions could cause the maximum
contribution limitations of Section 415 of the Code or other qualification
rules
to be violated. In addition, there may be other adverse tax and ERISA
consequences if Rights are sold or transferred by an employee retirement
plan.
Employee
retirement plans and other tax
exempt entities, including governmental plans, should also be aware that if
they
borrow in order to finance their exercise of Rights, they may become subject
to
the tax on unrelated business taxable income (“UBTI”) under Section 511 of the
Code. If any portion of an individual retirement account (“IRA”) is used as
security for a loan, the portion so used is also treated as distributed to
the
IRA depositor.
ERISA
contains fiduciary responsibility
requirements, and ERISA and the Code contain prohibited transaction rules that
may affect the exercise of Rights. Due to the complexity of these rules and
the
penalties for noncompliance, employee retirement plans should consult with
their
counsel and other advisers regarding the consequences of their exercise of
Rights under ERISA and the Code.
Certain
Effects of the Offer
The
Investment Adviser will benefit
from the Offer because the investment advisory fee is based on the Trust’s
average weekly Managed Assets. It is not possible to state precisely the amount
of additional compensation the Investment Adviser will receive as a result
of
the Offer because it is not known how many Shares of the Trust will be
subscribed for and because the proceeds of the Offer will be invested in
additional portfolio securities which will fluctuate in value. However, assuming
(i) all Rights are exercised, (ii) the Trust’s average weekly net asset value
during 2007 is $[·] per share (the net asset value per share on [·], 2007) and
(iii) the Subscription Price is $[·] per share ([·]% of the last reported sale
price of the Trust’s common shares on [·], 2007), and after giving effect to
Dealer Manager fees and other offering expenses, the Investment Adviser would
have received additional advisory fees of approximately $[·] for
2007.
Investment
Considerations
Upon
completion of the Offer,
shareholders who do not exercise their Rights fully will own a smaller
proportional interest in the Trust than would be the case if the Offer had
not
been made. In addition, because the Subscription Price per Share will be less
than the then Trust’s net asset value per share, the Offer will result in a
dilution of the Trust’s net asset value per share for all shareholders,
irrespective of whether they exercise all or any portion of their Rights.
Although it is not possible to state precisely the amount of such a decrease
in
value, because it is not known at this time what the Subscription Price will
be,
what the net asset value per share will be at the Expiration Date or what
proportion of Shares will be subscribed for, the dilution could be substantial.
For example, assuming that all Rights are exercised, that the Trust’s net asset
value on the Expiration Date is $[·] per share (the net asset value per share on
[·], 2007), and that the Subscription Price is $[·] per share ([·]% of the last
reported sale price of the Trust’s common shares on [·], 2007), the Trust’s net
asset value per share on this date would be reduced by approximately $[·] per
share, after giving affect to Dealer Manager fees and other offering expenses,
estimated at $[·], payable by the Trust. Record Date Shareholders will
experience a decrease in the net asset value per share held by them,
irrespective of whether they exercise all or any portion of their Rights. The
distribution of transferable Rights, which may themselves have value, will
afford non-participating shareholders the potential of receiving a cash payment
upon the sale of the Rights, receipt of which may be viewed as partial
compensation for the economic dilution of their interests.
USE
OF PROCEEDS
The
Trust will
invest the net proceeds of any sales of securities in accordance with the
Trust’s investment objectives and policies as stated below. Assuming
current market conditions, the Trust estimates that the net proceeds of the
Offer will be substantially invested in accordance with its investment
objectives and policies within [·] to [·] months of the completion of the Offer.
Pending such investment, it is anticipated that the proceeds of the Offer will
be invested in short-term debt securities.
THE
TRUST
The
Trust is a non-diversified,
closed-end management investment company. The Trust was organized as a Delaware
statutory trust on March 10, 2006, pursuant to an Agreement and Declaration
of
Trust governed by the laws of the State of Delaware. The Trust commenced
operations on June 29, 2006, following its initial public offering. The Trust’s
principal office is located at Two Galleria Tower, 13455 Noel Road, Suite 800,
Dallas, Texas 75240 and its telephone number is (877) 665-1287.
INVESTMENT
OBJECTIVES AND POLICIES
Investment
Objectives and Policies
The
Trust’s investment objectives are
to provide both current income and capital appreciation. The Trust seeks to
achieve its investment objectives by investing primarily in the following
categories of securities and instruments of corporations and other business
entities: (i) secured and unsecured floating and fixed rate loans; (ii) bonds
and other debt obligations; (iii) debt obligations of stressed, distressed
and
bankrupt issuers; (iv) structured products, including but not limited to,
mortgage-backed and other asset-backed securities and collateralized debt
obligations; and (v) equities. Highland will seek to achieve its capital
appreciation objective by investing in category (iii) and (v) obligations and
securities, and to a lesser extent, in category (i), (ii), and (iv)
obligations. Under normal market conditions, at least 80% of the
Trust’s assets are invested in one or more of these principal investment
categories. Subject only to this general guideline, Highland has broad
discretion to allocate the Trust’s assets among these investment categories and
to change allocations as conditions warrant. In order to pursue most effectively
its opportunistic investment strategy, the Trust will not maintain fixed
duration, maturity or credit quality policies. The Trust may invest in debt
obligations of any credit quality. The Trust may invest without limitation
in
securities and obligations of domestic issuers, but may invest only up to 20%
of
the assets in non-U.S. obligors or issuers.
Within
the categories of obligations
and securities in which the Trust invests, Highland also employs various trading
strategies, including capital structure arbitrage, pair trades and shorting.
The
Trust may also invest in these categories of obligations and securities through
the use of derivatives. A significant portion of the Trust’s assets may be
invested in securities rated below investment grade, which are commonly referred
to as “junk securities.” Junk securities are subject to greater risk of loss of
principal and interest and may be less liquid than investment grade securities.
Highland does not anticipate a high correlation between the performance of
the
Trust’s portfolio and the performance of the corporate bond and equity
markets.
The
Trust’s investment objectives may
be changed without shareholder approval. There can be no assurance that the
Trust’s investment objectives will be achieved.
Investment
Strategies
Under
normal market conditions, the
Trust invests across various markets in which Highland holds significant
investment experience: primarily the leveraged loan, high yield, structured
products and stressed and distressed markets. Highland makes investment
decisions based on quantitative analysis, which employs sophisticated,
data-intensive models to drive the investment process. Highland has full
discretion regarding the capital markets from which it can access investment
opportunities in accordance with the investment limitations set forth in this
prospectus.
The
Investment Adviser uses trading
strategies to exploit pricing inefficiencies across the credit markets, or
debt
markets, and within an individual issuer’s capital structure. Highland varies
its investments by strategy, industry, security type and credit market, but
reserves the right to re-position its portfolio among these criteria depending
on market dynamics, and thus the Trust may experience high portfolio turnover.
The Investment Adviser manages interest rate, default, currency and systemic
risks through a variety of trading methods and market tools, including
derivative hedging instruments, as it deems appropriate. This
multi-strategy investment program allows the Investment Adviser to assess what
it considers to be the best opportunities across multiple markets and to adjust
quickly the Trust’s trading strategies and market focus to changing conditions.
The Investment Adviser focuses primarily on the U.S.
marketplace,
but may pursue opportunities in the non-U.S. credit or securities markets by
investing up to 20% of the Trust’s assets in non-U.S. credit or securities
market investments.
The
Investment Adviser may select
investments from a wide range of trading strategies and credit markets in order
to vary the Trust’s investments and to optimize the risk-reward parameters of
the Trust. Highland does not intend to invest the Trust’s assets according to
pre-determined allocations. The investment team and other Highland personnel
uses a wide range of resources to identify attractive individual investments
and
promising investment strategies for consideration in connection with investments
by the Trust. The following is a description of the general types of securities
in which the Trust may invest. This description is merely a summary, and the
Investment Adviser has discretion to cause the Trust to invest in other types
of
securities and to follow other investment criteria and guidelines as described
herein.
The
Trust invests and trades in listed
and unlisted, public and private, rated and unrated, debt and equity instruments
and other obligations, including structured debt and equity instruments as
well
as financial derivatives. Investments may include investments in stressed and
distressed positions, which may include publicly-traded debt and equity
securities, obligations which were privately placed with banks, insurance
companies and other lending institutions, trade claims, accounts receivable
and
any other form of obligation recognized as a claim in a bankruptcy or workout
process. The Trust may invest in securities traded in foreign countries and
denominated in foreign currencies.
As
part of its investment program, the
Trust may invest, from time to time, in debt or synthetic instruments that
are
sold in direct placement transactions between their issuers and their purchasers
and that are neither listed on an exchange, nor traded over the counter. The
Trust may also receive equity or equity-related securities in connection with
a
workout transaction or may invest directly in equity securities.
The
Trust may employ currency hedges
(either in the forward or options markets) in certain circumstances to reduce
currency risk and may engage in other derivative transactions for hedging
purposes or to enhance total return. The Trust may also lend securities and
engage in short sales of securities. The Trust is currently leveraged through
the use of a credit facility and may continue to use leverage in the future
through borrowings or the issuance of preferred shares. In addition,
the Trust may invest in the securities of companies whose capital structures
are
highly leveraged.
From
time to time, the Investment
Adviser may also invest a portion of the Trust’s assets in short-term U.S.
Government obligations, certificates of deposit, commercial paper and other
money market instruments, including repurchase agreements with respect to such
obligations to enable the Trust to make investments quickly and to serve as
collateral with respect to certain of its investments. A greater percentage
of
Trust assets may be invested in such obligations if the Investment Adviser
believes that a defensive position is appropriate because of the outlook for
security prices or in order to respond to adverse market, economic business
or
political conditions. From time to time cash balances in the Trust’s brokerage
account may be placed in a money market fund.
For
a more complete discussion of the
Trust’s portfolio composition, see “Portfolio Composition” below.
PORTFOLIO
COMPOSITION
The
Trust’s portfolio will be
composed principally of the following investments. Additional information
relating to the Trust’s investment policies and restrictions and the Trust’s
portfolio investments is contained in the Statement of Additional
Information.
Senior
Loans. Senior loans hold the most senior position in the capital
structure of a business entity, are typically secured with specific collateral
and have a claim on the general assets of the borrower that is senior to that
held by subordinated debtholders and stockholders of the borrower. The proceeds
of senior loans primarily are used to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock repurchases, and, to a lesser
extent, to finance internal growth and for other corporate purposes. Senior
loans typically have rates of interest which are redetermined either daily,
monthly, quarterly or semi-annually by reference to a base lending rate, plus
a
premium. These base lending rates generally are the London Interbank Offered
Rate (“LIBOR”), the prime rate offered by one or more major United States banks
(“Prime Rate”) or the certificate of deposit (“CD”) rate or other base lending
rates used by commercial lenders.
Loans
and other corporate debt
obligations are subject to the risk of non-payment of scheduled interest or
principal. Such non-payment would result in a reduction of income to the Trust,
a reduction in the value of the investment and a potential decrease in the
net
asset value of the Trust. There can be no assurance that the liquidation of
any
collateral securing a senior loan would satisfy a borrower’s obligation in the
event of non-payment of scheduled interest or principal payments, or that such
collateral could be readily liquidated. In the event of bankruptcy of a
borrower, the Trust could experience delays or limitations with respect to
its
ability to realize the benefits of the collateral securing a senior loan. To
the
extent that a senior loan is collateralized by stock in the borrower or its
subsidiaries, such a stock may lose all or substantially all of its value in
the
event of the bankruptcy of a borrower. Some senior loans are subject to the
risk
that a court, pursuant to fraudulent conveyance or other similar laws, could
subordinate senior loans to presently existing or future indebtedness of the
borrower or take other action detrimental to the holders of senior loans
including, in certain circumstances, invalidating such senior loans or causing
interest previously paid to be refunded to the borrower. If interest were
required to be refunded, it could negatively affect the Trust’s performance. To
the extent a senior loan is subordinated in the capital structure, it will
have
characteristics similar to other subordinated debtholders, including a greater
risk of nonpayment of interest or principal.
Many
loans in which the Trust
invests, and the issuers of such loan, are not rated by a rating agency, not
registered with the Commission or any state securities commission and not listed
on any national securities exchange. The amount of public information available
with respect to issuers of senior loans will generally be less extensive than
that available for issuers of registered or exchange listed securities. In
evaluating the creditworthiness of borrowers, the Investment Adviser will
consider, and may rely in part, on analyses performed by others. The Investment
Adviser does not view ratings as the determinative factor in its investment
decisions and relies more upon its credit analysis abilities than upon ratings.
Borrowers may have outstanding debt obligations that are rated below investment
grade by a rating agency. A high percentage of senior loans held by the Trust
may be rated, if at all, below investment grade by independent rating agencies.
In the event senior loans are not rated, they are likely to be the equivalent
of
below investment grade quality. Debt securities which are unsecured and rated
below investment grade (i.e., Ba and below by Moody’s Investors Service, Inc.
(“Moody’s”) or BB and below by Standard & Poor’s Ratings Group, a division
of The McGraw-Hill Companies, Inc. (“S&P”)) and comparable unrated bonds,
are viewed by the rating agencies as having speculative characteristics and
are
commonly known as “junk bonds.” A description of the ratings of corporate bonds
by Moody’s and S&P included as Appendix A to the Statement of Additional
Information. Because senior loans are senior in a borrower’s capital structure
and are often secured by specific collateral, the Investment Adviser believes
that senior loans have more favorable loss recovery rates as compared to most
other types of below investment grade debt obligations. However, there can
be no
assurance that the Trust’s actual loss recovery experience will be consistent
with the Investment Adviser’s prior experience or that the Trust’s senior loans
will achieve any specific loss recovery rates.
No
active trading market may exist
for many senior loans, and some senior loans may be subject to restrictions
on
resale. The Trust is not limited in the percentage of its assets that may be
invested in senior loans and other securities deemed to be illiquid. A secondary
market may be subject to irregular trading activity, wide bid/ask spreads and
extended trade settlement periods, which may impair the ability to realize
full
value on the disposition of an illiquid senior loan, and cause a material
decline in the Trust’s net asset value.
Senior
loans generally are arranged
through private negotiations between a borrower and a group of financial
institutions initially represented by an agent who is usually one of the
originating lenders. In larger transactions, it is common to have several
agents. Generally, however, only one such agent has primary responsibility
for
ongoing administration of a senior loan. Agents are typically paid fees by
the
borrower for their services. The agent is primarily responsible for negotiating
the credit agreement which establishes the terms and conditions of the senior
loan and the rights of the borrower and the lenders. The agent is also
responsible for monitoring collateral and for exercising remedies available
to
the lenders such as foreclosure upon collateral.
Credit
agreements may provide for the
termination of the agent’s status in the event that it fails to act as required
under the relevant credit agreement, becomes insolvent, enters FDIC receivership
or, if not FDIC insured, enters into bankruptcy. Should such an agent, lender
or
assignor with respect to an assignment inter-positioned between the Trust and
the borrower become insolvent or enter FDIC receivership or bankruptcy, any
interest in the senior loan of such person and any loan payment held by such
person for the benefit of the Trust should not be included in such person’s or
entity’s bankruptcy estate. If, however, any such amount were included in such
person’s or entity’s bankruptcy estate, the Trust would incur certain costs and
delays in realizing payment or could suffer a loss of principal or interest.
In
this event, the Trust could experience a decrease in net asset
value.
The
Trust’s investments in senior
loans may take one of several forms, including acting as one of the group of
lenders originating a senior loan, purchasing an assignment of a portion of
a
senior loan from a third party or acquiring a participation in a senior loan.
When the Trust is a member of the originating syndicate for a senior loan,
it
may share in a fee paid to the syndicate. When the Trust acquires a
participation in, or an assignment of, a senior loan, it may pay a fee to,
or
forego a portion of interest payments from, the lender selling the participation
or assignment. The Trust will act as lender, or purchase an assignment or
participation, with respect to a senior loan only if the agent is determined
by
the Investment Adviser to be creditworthy.
When
the Trust is one of the original
lenders, it will have a direct contractual relationship with the borrower and
can enforce compliance by the borrower with terms of the credit agreement.
It
also may have negotiated rights with respect to any funds acquired by other
lenders through set-off. Original lenders also negotiate voting and consent
rights under the credit agreement. Actions subject to lender vote or consent
generally require the vote or consent of the majority of the holders of some
specified percentage of the outstanding principal amount of the senior loan.
Certain decisions, such as reducing the interest rate, or extending the maturity
of a senior loan, or releasing collateral securing a senior loan, among others,
frequently require the unanimous vote or consent of all lenders
affected.
When
the Trust is a purchaser of an
assignment, it typically succeeds to all the rights and obligations under the
credit agreement of the assigning lender and becomes a lender under the credit
agreement with the same rights and obligations as the assigning lender.
Assignments are, however, arranged through private negotiations between
potential assignees and potential assignors, and the rights and obligations
acquired by the purchaser of an assignment may be more limited than those held
by the assigning lender.
The
Trust may also invest in
participations in senior loans. The rights of the Trust when it acquires a
participation are likely to be more limited than the rights of an original
lender or an investor who acquired an assignment. Participation by the Trust
in
a lender’s portion of a senior loan typically means that the Trust has only a
contractual relationship with the lender, not with the borrower. This means
that
the Trust has the right to receive payments of principal, interest and any
fees
to which it is entitled only from the lender selling the participation and
only
upon receipt by the lender of payments from the borrower.
With
a participation, the Trust will
have no rights to enforce compliance by the borrower with the terms of the
credit agreement or any rights with respect to any funds acquired by other
lenders through setoff against the borrower. In addition, the Trust may not
directly benefit from the collateral supporting the senior loan because it
may
be treated as a general creditor of the lender instead of a senior secured
creditor of the borrower. As a result, the Trust may be subject to delays,
expenses and risks that are greater than those that exist when the Trust is
the
original lender or holds an assignment. This means the Trust must assume the
credit risk of both the borrower and the lender selling the participation.
The
Trust will consider a purchase of participations only in those situations where
the Investment Adviser considers the participating lender to be
creditworthy.
In
the event of a bankruptcy or
insolvency of a borrower, the obligation of the borrower to repay the senior
loan may be subject to certain defenses that can be asserted by such borrower
against the Trust as a result of improper conduct of the lender selling the
participation. A participation in a senior loan will be deemed to be a senior
loan for the purposes of the Trust’s investment objectives and
policies.
Investing
in senior loans involves
investment risk. Some borrowers default on their senior loan payments. The
Trust
attempts to manage this credit risk through multiple different investments
within the portfolio and ongoing analysis and monitoring of borrowers. The
Trust
also is subject to market, liquidity, interest rate and other risks. See
“Principal Risks of the Trust.”
Second
Lien
Loans. Second lien loans are loans made by public and private
corporations and other non-governmental entities and issuers for a variety
of
purposes. Second lien loans are second in right of payment to one or more senior
loans of the related borrower. Second lien loans typically are secured by a
second priority security interest or lien to or on specified collateral securing
the borrower’s obligation under the loan and typically have similar protections
and rights as senior loans. Second lien loans are not (and by their terms
cannot) become subordinate in right of payment to any obligation of the related
borrower other than senior loans of such borrower. Second lien loans, like
senior loans, typically have adjustable floating rate interest payments. Because
second lien loans are second to senior loans, they present a greater degree
of
investment risk but often pay interest at higher rates reflecting this
additional risk. Such investments generally are of below investment grade
quality. Other than their subordinated status, second lien loans have many
characteristics and risks similar to senior loans discussed above. In addition,
second lien loans of below investment grade quality share many of the risk
characteristics of non-investment grade securities. As in the case of senior
loans, the Trust may purchase interests in second lien loans through assignments
or participations.
Second
lien loans are subject to the
same risks associated with investment in senior loans and non-investment grade
securities. Because second lien loans are second in right of payment to one
or
more senior loans of the related borrower, they therefore are subject to
additional risk that the cash flow of the borrower and any property securing
the
loan may be insufficient to meet scheduled payments after giving effect to
the
senior secured obligations of the borrower. Second lien loans are also expected
to have greater price volatility than senior loans and may be less liquid.
There
is also a possibility that originators will not be able to sell participations
in second lien loans, which would create greater credit risk
exposure.
Other
Secured
Loans. Secured loans other than senior loans and second lien
loans are made to public and private corporations and other non-governmental
entities and issuers for a variety of purposes. Such secured loans may rank
lower in right of payment to one or more senior loans and second lien loans
of
the borrower. Such secured loans typically are secured by a lower priority
security interest or lien to or on specified collateral securing the borrower’s
obligation under the loan, and typically have more subordinated protections
and
rights than senior loans and second lien loans. Secured loans may become
subordinated in right of payment to more senior obligations of the borrower
issued in the future. Such secured loans may have fixed or adjustable floating
rate interest payments. Because such secured loans may rank lower as to right
of
payment than senior loans and second lien loans of the borrower, they may
present a greater degree of investment risk than senior loans and second lien
loans but often pay interest at higher rates reflecting this additional risk.
Such investments generally are of below investment grade quality. Other than
their more subordinated status, such investments have many characteristics
and
risks similar to senior loans and second lien loans discussed above. In
addition, secured loans of below investment grade quality share many of the
risk
characteristics of non-investment grade securities. As in the case of senior
loans and second lien loans, the Trust may purchase interests in other secured
loans through assignments or participations. Other secured loans are subject
to
the same risks associated with investment in senior loans, second lien loans
and
non-investment grade securities. Because such loans, however, may rank lower
in
right of payment to senior loans and second lien loans of the borrower, they
may
be subject to additional risk that the cash flow of the borrower and any
property securing the loan may be insufficient to repay the scheduled payments
after giving effect to more senior secured obligations of the borrower. Such
secured loans are also expected to have greater price volatility than senior
loans and second lien loans and may be less liquid. There is also a possibility
that originators will not be able to sell participations in other secured loans,
which would create greater credit risk exposure.
Unsecured
Loans. Unsecured loans are loans made to public and private
corporations and other non-governmental entities and issuers for a variety
of
purposes. Unsecured loans generally have lower priority in right of payment
compared to holders of secured debt of the borrower. Unsecured loans are not
secured by a security interest or lien to or on specified collateral securing
the borrower’s obligation under the loan. Unsecured loans by their terms may be
or may become subordinate in right of payment to other obligations of the
borrower, including senior loans, second lien loans and other secured loans.
Unsecured loans may have fixed or adjustable floating rate interest payments.
Because unsecured loans are subordinate to the secured debt of the borrower,
they present a greater degree of investment risk but often pay interest at
higher rates reflecting this additional risk. Such investments generally are
of
non-investment grade quality. Other than their subordinated and unsecured
status, such investments have many characteristics and risks similar to senior
loans, second lien loans and other secured loans discussed above. In addition,
unsecured loans of non-investment grade quality share many of the risk
characteristics of non-investment grade securities. As in the case of secured
loans, the Trust may purchase interests in unsecured loans through assignments
or participations.
Unsecured
loans are subject to the
same risks associated with investment in senior loans, second lien loans, other
secured loans and non-investment grade securities. However, because unsecured
loans rank lower in right of payment to any secured obligations of the borrower,
they may be subject to additional risk that the cash flow of the borrower and
available assets may be insufficient to meet scheduled payments after giving
effect to the secured obligations of the borrower. Unsecured loans are also
expected to have greater price volatility than secured loans and may be less
liquid. There is also a possibility that loan originators will not be able
to
sell participations in unsecured loans, which would create greater credit risk
exposure.
Investment
Grade
Securities. The Trust may invest in a wide variety of bonds that
are rated or determined by the Investment Adviser to be of investment grade
quality of varying maturities issued by U.S. corporations and other business
entities. Bonds are fixed or variable rate debt obligations,
including
bills,
notes, debentures, money market instruments and similar instruments and
securities. Bonds generally are used by corporations and other issuers to borrow
money from investors for a variety of business purposes. The issuer pays the
investor a fixed or variable rate of interest and normally must repay the amount
borrowed on or before maturity. Certain bonds are “perpetual” in that they have
no maturity date. Some investment grade securities, such as zero coupon bonds,
do not pay current interest, but are sold at a discount from their face values.
Although more creditworthy and generally less risky than non-investment grade
securities, investment grade securities are still subject to market and credit
risk. Market risk relates to changes in a security’s value as a result of
interest rate changes generally. Investment grade securities have varying levels
of sensitivity to changes in interest rates and varying degrees of credit
quality. In general, bond prices rise when interest rates fall, and fall when
interest rates rise. Longer-term bonds and zero coupon bonds are generally
more
sensitive to interest rate changes. Credit risk relates to the ability of the
issuer to make payments of principal and interest. The values of investment
grade securities like those of other debt securities may be affected by changes
in the credit rating or financial condition of an issuer. Investment grade
securities are generally considered medium-and high-quality securities. Some,
however, may possess speculative characteristics, and may be more sensitive
to
economic changes and to changes in the financial condition of issuers. The
market prices of investment grade securities in the lowest investment grade
categories may fluctuate more than higher-quality securities and may decline
significantly in periods of general or regional economic difficulty. Like
non-investment grade securities, such investment grade securities in the lowest
investment grade categories may be thinly traded, making them difficult to
sell
promptly at an acceptable price.
Other
Fixed Income
Securities. The Trust also may purchase unsecured loans, other
floating rate or fixed rate debt securities such as notes, bonds and
asset-backed securities (such as securities issued by special purpose funds
investing in bank loans), investment grade and below investment grade fixed
income debt obligations and money market instruments, such as commercial paper.
The high yield securities in which the Trust invests are rated Ba or lower
by
Moody’s or BB or lower by S&P or are unrated but determined by the
Investment Adviser to be of comparable quality. Debt securities rated below
investment grade are commonly referred to as “junk securities” and are
considered speculative with respect to the issuer’s capacity to pay interest and
repay principal. Below investment grade debt securities involve greater risk
of
loss, are subject to greater price volatility and are less liquid, especially
during periods of economic uncertainty or change, than higher rated debt
securities. The Trust’s fixed-income securities may have fixed or variable
principal payments and all types of interest rate and dividend payment and
reset
terms, including fixed rate, adjustable rate, zero coupon, contingent, deferred,
payment in kind and auction rate features. The Trust may invest in fixed-income
securities with a broad range of maturities.
The
Trust may invest in zero coupon
bonds, deferred interest bonds and bonds or preferred stock on which the
interest is payable-in-kind (PIK bonds). To the extent the Trust invests in
such
instruments, they will not contribute to the Trust’s goal of current income.
Zero coupon and deferred interest bonds are debt obligations which are issued
at
a significant discount from face value. While zero coupon bonds do not require
the periodic payment of interest, deferred interest bonds provide for a period
of delay before the regular payment of interest begins. PIK bonds are debt
obligations that provide that the issuer thereof may, at its option, pay
interest on such bonds in cash or in the form of additional debt obligations.
Such investments may experience greater volatility in market value due to
changes in interest rates. The Trust may be required to accrue income on these
investments for federal income tax purposes and is required to distribute its
net income each year in order to qualify for the favorable federal income tax
treatment potentially available to regulated investment companies. The Trust
may
be required to sell securities to obtain cash needed for income
distributions.
Non-Investment
Grade
Securities. The Trust invest a significant portion of its assets
in securities rated below investment grade, such as those rated Ba or lower
by
Moody’s and BB or lower by S&P or
securities
comparably rated by other rating agencies or in unrated securities determined
by
Highland to be of comparable quality. Securities rated Ba by Moody’s are judged
to have speculative elements, their future cannot be considered as well assured
and often the protection of interest and principal payments may be very
moderate. Securities rated BB by S&P are regarded as having predominantly
speculative characteristics and, while such obligations have less near-term
vulnerability to default than other speculative grade debt, they face major
ongoing uncertainties or exposure to adverse business, financial or economic
conditions which could lead to inadequate capacity to meet timely interest
and
principal payments. Securities rated C are regarded as having extremely poor
prospects of ever attaining any real investment standing. Securities rated
D are
in default and the payment of interest and/or repayment of principal is in
arrears. The Trust may purchase securities rated as low as D or unrated
securities deemed by Highland to be of comparable quality. When Highland
believes it to be in the best interests of the Trust’s shareholders, the Trust
will reduce its investment in lower grade securities.
Lower
grade securities, though high
yielding, are characterized by high risk. They may be subject to certain risks
with respect to the issuing entity and to greater market fluctuations than
certain lower yielding, higher rated securities. The secondary market for lower
grade securities may be less liquid than that of higher rated securities.
Adverse conditions could make it difficult at times for the Trust to sell
certain securities or could result in lower prices than those used in
calculating the Trust’s net asset value.
The
prices of debt securities
generally are inversely related to interest rate changes; however, the price
volatility caused by fluctuating interest rates of securities also is inversely
related to the coupon of such securities. Accordingly, lower grade securities
may be relatively less sensitive to interest rate changes than higher quality
securities of comparable maturity, because of their higher coupon. This higher
coupon is what the investor receives in return for bearing greater credit risk.
The higher credit risk associated with lower grade securities potentially can
have a greater effect on the value of such securities than may be the case
with
higher quality issues of comparable maturity, and will be a substantial factor
in the Trust’s relative share price volatility.
Lower
grade securities may be
particularly susceptible to economic downturns. It is likely that an economic
recession could disrupt severely the market for such securities and may have
an
adverse impact on the value of such securities. In addition, it is likely that
any such economic downturn could adversely affect the ability of the issuers
of
such securities to repay principal and pay interest thereon and increase the
incidence of default for such securities.
The
ratings of Moody’s and S&P
and the other rating agencies represent their opinions as to the quality of
the
obligations which they undertake to rate. Ratings are relative and subjective
and, although ratings may be useful in evaluating the safety of interest and
principal payments, they do not evaluate the market value risk of such
obligations. Although these ratings may be an initial criterion for selection
of
portfolio investments, Highland also will independently evaluate these
securities and the ability of the issuers of such securities to pay interest
and
principal. To the extent that the Trust invests in lower grade securities that
have not been rated by a rating agency, the Trust’s ability to achieve its
investment objectives will be more dependent on Highland’s credit analysis than
would be the case when the Trust invests in rated securities.
Asset-Backed
Securities. The Trust may invest a portion of its assets in
asset-backed securities. Asset-backed securities are generally issued as
pass-through certificates, which represent undivided fractional ownership
interests in an underlying pool of assets, or as debt instruments, which are
also known as collateralized obligations, and are generally issued as the debt
of a special purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Asset-backed securities are often backed by a
pool
of assets representing the obligations of a number of different parties. Credit
card receivables are generally unsecured, and the debtors are entitled to the
protection of a number of state and
federal
consumer credit laws which give debtors the right to set off certain amounts
owed on the credit cards, thereby reducing the balance due. Most issuers of
automobile receivables permit the servicers to retain possession of the
underlying obligations. If the servicer were to sell these obligations to
another party, there is a risk that the purchaser would acquire an interest
superior to that of the holders of the related automobile receivables. In
addition, because of the large number of vehicles involved in a typical issuance
and technical requirements under state laws, the trustee for the holders of
the
automobile receivables may not have an effective security interest in all of
the
obligations backing such receivables. Therefore, there is a possibility that
recoveries on repossessed collateral may not, in some cases, be able to support
payments on these securities.
Collateralized
Loan Obligations
and Bond Obligations. The Trust may invest in certain
asset-backed securities that are securitizing certain financial assets by
issuing securities in the form of negotiable paper that are issued by a
financing company (generally called a Special Purpose Vehicle or “SPV”). These
securitized assets are, as a rule, corporate financial assets brought into
a
pool according to specific diversification rules. The SPV is a company founded
solely for the purpose of securitizing these claims and its only asset is the
diversified asset pool. On this basis, marketable securities are issued which,
due to the diversification of the underlying risk, generally represent a lower
level of risk than the original assets. The redemption of the securities issued
by the SPV takes place at maturity out of the cash flow generated by the
collected claims.
A
collateralized loan obligation
(“CLO”) is a structured debt security issued by an SPV that was created to
reapportion the risk and return characteristics of a pool of assets. The assets,
typically senior loans, are used as collateral supporting the various debt
tranches issued by the SPV. The key feature of the CLO structure is the
prioritization of the cash flows from a pool of debt securities among the
several classes of securities issued by a CLO.
The
Trust may also invest in
collateralized bond obligations (“CBOs”), which are structured debt securities
backed by a diversified pool of high yield, public or private fixed income
securities. These may be fixed pools or may be “market value” (or managed) pools
of collateral. The CBO issues debt securities that are typically separated
into
tranches representing different degrees of credit quality. The top tranche
of
securities has the greatest collateralization and pays the lowest interest
rate.
Lower CBO tranches have a lesser degree of collateralization quality and pay
higher interest rates intended to compensate for the attendant risks. The bottom
tranche specifically receives the residual interest payments (i.e., money that
is left over after the higher tranches have been paid) rather than a fixed
interest rate. The return on the lower tranches of CBOs is especially sensitive
to the rate of defaults in the collateral pool. Under normal market conditions,
the Trust expects to invest in the lower tranches of CBOs.
Distressed
Debt. The Trust is authorized to invest in the securities and
other obligations of distressed and bankrupt issuers, including debt obligations
that are in covenant or payment default. Such investments generally trade
significantly below par and are considered speculative. The repayment of
defaulted obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest or other
payments. Typically such workout or bankruptcy proceedings result in only
partial recovery of cash payments or an exchange of the defaulted obligation
for
other debt or equity securities of the issuer or its affiliates, which may
in
turn be illiquid or speculative. The Trust may invest in securities of a company
for purposes of gaining control.
Stressed
Debt. The Trust is authorized to invest in securities and other
obligations of stressed issuers. Stressed issuers are issuers that are not
yet
deemed distressed or bankrupt and whose debt securities are trading at a
discount to par, but not yet at distressed levels. An example would be an issuer
that
is in technical default of its credit agreement, or undergoing strategic or
operational changes, which results in market pricing
uncertainty.
Credit
Default
Swaps. To the extent consistent with Subchapter M of the
Internal Revenue Code of 1986, as amended (the “Code”), the Trust may enter into
credit default swap agreements. The “buyer” in a credit default contract is
obligated to pay the “seller” a periodic stream of payments over the term of the
contract provided that no event of default on an underlying reference obligation
has occurred. If an event of default occurs, the seller must pay the buyer
the
“par value” (full notional value) of the reference obligation in exchange for
the reference obligation. The Trust may be either the buyer or seller in the
transaction. If the Trust is a buyer and no event of default occurs, the Trust
loses its investment and recovers nothing. However, if an event of default
occurs, the buyer receives full notional value for a reference obligation that
may have little or no value. As a seller, the Trust receives income throughout
the term of the contract, which typically is between six months and three years,
provided that there is no default event.
Credit
default swaps involve greater
risks than if the Trust had invested in the reference obligation directly.
In
addition to general market risks, credit default swaps are subject to
illiquidity risk, counterparty risk and credit risks. The Trust will enter
into
swap agreements only with counterparties that are rated investment grade quality
by at least one nationally recognized statistical rating organization at the
time of entering into such transaction or whose creditworthiness is believed
by
the Investment Adviser to be equivalent to such rating. A buyer also will lose
its investment and recover nothing should no event of default occur. If an
event
of default were to occur, the value of the reference obligation received by
the
seller, coupled with the periodic payments previously received, may be less
than
the full notional value it pays to the buyer, resulting in a loss of value
to
the seller. When the Trust acts as a seller of a credit default swap agreement
it is exposed to many of the same risks of leverage described under “Principal
Risks of the Trust — Leverage Risk” in this prospectus since if an event of
default occurs the seller must pay the buyer the full notional value of the
reference obligation.
Senior
Loan Based
Derivatives. The Trust may obtain exposure to senior loans and
baskets of senior loans through the use of derivative instruments. Such
derivative instruments have recently become increasingly available. The
Investment Adviser reserves the right to utilize these instruments and similar
instruments that may be available in the future. For example, the Trust may
invest in a derivative instrument known as the Select Aggregate Market Index
(“SAMI”), which provides investors with exposure to a reference basket of senior
loans. SAMIs are structured as floating rate instruments. SAMIs consist of
a
basket of credit default swaps whose underlying reference securities are senior
loans. While investing in SAMIs will increase the universe of floating rate
debt
securities to which the Trust is exposed, such investments entail risks that
are
not typically associated with investments in other floating rate debt
securities. The liquidity of the market for SAMIs will be subject to liquidity
in the secured loan and credit derivatives markets. Investment in SAMIs involves
many of the risks associated with investments in derivative instruments
discussed generally below. The Trust may also be subject to the risk that the
counterparty in a derivative transaction will default on its obligations.
Derivative transactions generally involve the risk of loss due to unanticipated
adverse changes in securities prices, interest rates, the inability to close
out
a position, imperfect correlation between a position and the desired hedge,
tax
constraints on closing out positions and portfolio management constraints on
securities subject to such transactions. The potential loss on derivative
instruments may be substantially greater than the initial investment
therein.
Credit-Linked
Notes. The Trust may invest in credit-linked notes (“CLNs”) for
risk management purposes and to vary its portfolio. A CLN is a derivative
instrument. It is a synthetic obligation between two or more parties where
the
payment of principal and/or interest is based on the performance of some obligation
(a reference obligation). In addition to credit risk of the reference
obligations and interest rate risk, the buyer/seller of the CLN is subject
to
counterparty risk.
Common
Stocks. The Trust may acquire an interest in common stocks in
various ways, including upon the default of a senior loan secured by such common
stock or by acquiring common stock for investment. The Trust may also acquire
warrants or other rights to purchase a borrower’s common stock in connection
with the making of a senior loan. Common stocks of a corporation or other entity
that entitle the holder to a pro rata share of the profits, if any, of the
corporation without preference over any other shareholder or class of
shareholders, including holders of such entity’s preferred stocks and other
senior equity securities. Common stock usually carries with it the right to
vote
and frequently an exclusive right to do so. In selecting common stocks for
investment, the Trust generally expects to focus primarily on the security’s
dividend paying capacity rather than on its potential for capital
appreciation.
Preferred
Stocks. The Trust may invest in preferred stocks. Preferred
stocks are equity securities, but they have many characteristics of fixed income
securities, such as a fixed dividend payment rate and/or a liquidity preference
over the issuer’s common shares. However, because preferred stocks are equity
securities, they may be more susceptible to risks traditionally associated
with
equity investments than the Trust’s fixed income securities.
Fixed
rate preferred stocks have
fixed dividend rates. They can be perpetual, with no mandatory redemption date,
or issued with a fixed mandatory redemption date. Certain issues of preferred
stocks are convertible into other equity securities. Perpetual preferred stocks
provide a fixed dividend throughout the life of the issue, with no mandatory
retirement provisions, but may be callable. Sinking fund preferred stocks
provide for the redemption of a portion of the issue on a regularly scheduled
basis with, in most cases, the entire issue being retired at a future date.
The
value of fixed rate preferred stocks can be expected to vary inversely with
interest rates.
Adjustable
rate preferred stocks have
a variable dividend rate which is determined periodically, typically quarterly,
according to a formula based on a specified premium or discount to the yield
on
particular U.S. Treasury securities, typically the highest base-rate yield
of
one of three U.S. Treasury securities: the 90-day Treasury bill; the 10-year
Treasury note; and either the 20-year or 30-year Treasury bond or other index.
The premium or discount to be added to or subtracted from this base-rate yield
is fixed at the time of issuance and cannot be changed without the approval
of
the holders of the adjustable rate preferred stock. Some adjustable rate
preferred stocks have a maximum and a minimum rate and in some cases are
convertible into common stocks.
Auction
rate preferred stocks pay
dividends that adjust based on periodic auctions. Such preferred stocks are
similar to short-term corporate money market instruments in that an auction
rate
preferred stockholder has the opportunity to sell the preferred stock at par
in
an auction, normally conducted at least every 49 days, through which buyers
set
the dividend rate in a bidding process for the next period. The dividend rate
set in the auction depends on market conditions and the credit quality of the
particular issuer. Typically, the auction rate preferred stock’s dividend rate
is limited to a specified maximum percentage of an external commercial paper
index as of the auction date. Further, the terms of the auction rate preferred
stocks generally provide that they are redeemable by the issuer at certain
times
or under certain conditions.
Convertible
Securities. The Trust’s investment in fixed income securities
may include bonds and preferred stocks that are convertible into the equity
securities of the issuer or a related company. Depending on the relationship
of
the conversion price to the market value of the underlying securities,
convertible securities may trade more like equity securities than debt
instruments.
Money
Market
Instruments. Money market instruments include short-term U.S.
government securities, U.S. dollar-denominated, high quality commercial paper
(unsecured promissory notes issued by corporations to finance their short-term
credit needs), certificates of deposit, bankers’ acceptances and repurchase
agreements relating to any of the foregoing. U.S. government securities include
Treasury notes, bonds and bills, which are direct obligations of the U.S.
government backed by the full faith and credit of the United States and
securities issued by agencies and instrumentalities of the U.S. government,
which may be guaranteed by the U.S. Treasury, may be supported by the issuer’s
right to borrow from the U.S. Treasury or may be backed only by the credit
of
the federal agency or instrumentality itself.
U.S.
Government
Securities. U.S. government securities in which the Trust
invests include debt obligations of varying maturities issued by the U.S.
Treasury or issued or guaranteed by an agency or instrumentality of the U.S.
government, including the Federal Housing Administration, Federal Financing
Bank, Farmers Home Administration, Export-Import Bank of the United States,
Small Business Administration, Government National Mortgage Association (GNMA),
General Services Administration, Central Bank for Cooperatives, Federal Farm
Credit Banks, Federal Home Loan Banks, Federal Home Loan Mortgage Corporation
(FHLMC), Federal National Mortgage Association (FNMA), Maritime Administration,
Tennessee Valley Authority, District of Columbia Armory Board, Student Loan
Marketing Association, Resolution Trust Corporation and various institutions
that previously were or currently are part of the Farm Credit System (which
has
been undergoing reorganization since 1987). Some U.S. government securities,
such as U.S. Treasury bills, Treasury notes and Treasury bonds, which differ
only in their interest rates, maturities and times of issuance, are supported
by
the full faith and credit of the United States government. Others are supported
by (i) the right of the issuer to borrow from the U.S. Treasury, such as
securities of the Federal Home Loan Banks; (ii) the discretionary authority
of
the U.S. government to purchase the agency’s obligations, such as securities of
the FNMA; or (iii) only the credit of the issuer. No assurance can be given
that
the U.S. government will provide financial support in the future to U.S.
government agencies, authorities or instrumentalities that are not supported
by
the full faith and credit of the United States. Securities guaranteed as to
principal and interest by the U.S. government, its agencies, authorities or
instrumentalities include (i) securities for which the payment of principal
and
interest is backed by an irrevocable letter of credit issued by the U.S.
government or any of its agencies, authorities or instrumentalities; and (ii)
participations in loans made to non-U.S. governments or other entities that
are
so guaranteed. The secondary market for certain of these participations is
limited and therefore may be regarded as illiquid.
Other
Investment
Companies. The Trust may invest in the securities of other
investment companies to the extent that such investments are consistent with
the
Trust’s investment objectives and principal investment strategies and
permissible under the Investment Company Act. Under one provision of the
Investment Company Act, the Trust may not acquire the securities of other
investment companies if, as a result, (i) more than 10% of the Trust’s total
assets would be invested in securities of other investment companies, (ii)
such
purchase would result in more than 3% of the total outstanding voting securities
of any one investment company being held by the Trust or (iii) more than 5%
of
the Trust’s total assets would be invested in any one investment company. Other
provisions of the Investment Company Act are less restrictive provided that
the
Trust is able to meet certain conditions. These limitations do not apply to
the
acquisition of shares of any investment company in connection with a merger,
consolidation, reorganization or acquisition of substantially all of the assets
of another investment company.
The
Trust, as a holder of the
securities of other investment companies, will bear its pro rata portion of
the
other investment companies’ expenses, including advisory fees. These expenses
will be in addition to the direct expenses incurred by the
Trust.
Exchange
Traded
Funds. Subject to the limitations on investment in other
investment companies, the Trust may invest in exchange traded funds (“ETFs”).
ETFs, such as SPDRs, NASDAQ 100 Index Trading Stock (QQQs), iShares and various
country index funds, are funds whose shares are traded on a national exchange.
ETFs may be based on underlying equity or fixed income securities. SPDRs, for
example, seek to provide investment results that generally correspond to the
performance of the component common stocks of the S&P 500. ETFs do not sell
individual shares directly to investors and only issue their shares in large
blocks known as “creation units.” The investor purchasing a creation unit may
sell the individual shares on a secondary market. Therefore, the liquidity
of
ETFs depends on the adequacy of the secondary market. There can be no assurance
that an ETF’s investment objective will be achieved. ETFs based on an index may
not replicate and maintain exactly the composition and relative weightings
of
securities in the index. ETFs are subject to the risks of investing in the
underlying securities. The Trust, as a holder of the securities of the ETF,
will
bear its pro rata portion of the ETF’s expenses, including advisory fees. These
expenses are in addition to the direct expenses of the Trust’s own
operations.
Zero
Coupon
Securities. The securities in which the Trust invests may
include zero coupon securities, which are debt obligations that are issued
or
purchased at a significant discount from face value. The discount approximates
the total amount of interest the security will accrue and compound over the
period until maturity or the particular interest payment date at a rate of
interest reflecting the market rate of the security at the time of issuance.
Zero coupon securities do not require the periodic payment of interest. These
investments benefit the issuer by mitigating its need for cash to meet debt
service but generally require a higher rate of return to attract investors
who
are willing to defer receipt of cash. These investments may experience greater
volatility in market value than securities that make regular payments of
interest. The Trust accrues income on these investments for tax and accounting
purposes, which is distributable to shareholders and which, because no cash
is
received at the time of accrual, may require the liquidation of other portfolio
securities to satisfy the Trust’s distribution obligations, in which case the
Trust will forego the purchase of additional income producing assets with these
funds.
Derivative
Transactions. In addition to the credit default swaps and senior
loan bond derivatives discussed above the Trust may, but is not required to,
use
various Derivative Transactions described below to earn income, facilitate
portfolio management and mitigate risks. Such Derivative Transactions are
generally accepted under modern portfolio management and are regularly used
by
many mutual funds and other institutional investors. Although the Investment
Adviser seeks to use the practices to further the Trust’s investment objectives,
no assurance can be given that these practices will achieve this result. While
the Trust reserves the ability to use these Derivative Transactions, the
Investment Adviser does not anticipate that Derivative Transactions other than
senior loan bond derivatives will initially be a significant part of the Trust’s
investment approach. With changes in the market or the Investment Adviser’s
strategy, it is possible that these instruments may be a more significant part
of the Trust’s investment approach in the future.
The
Trust may purchase and sell
derivative instruments such as exchange-listed and over-the-counter put and
call
options on securities, financial futures, equity, fixed-income and interest
rate
indices, and other financial instruments, purchase and sell financial futures
contracts and options thereon, enter into various interest rate transactions
such as swaps, caps, floors or collars and enter into various currency
transactions such as currency forward contracts, currency futures contracts,
currency swaps or options on currency or currency futures or credit transactions
and credit default swaps. The Trust also may purchase derivative instruments
that combine features of these instruments. The Trust generally seeks to use
Derivative Transactions as a portfolio management or hedging technique to seek
to protect against possible adverse changes in the market value of senior loans
or other securities held in or to be purchased for the Trust’s portfolio,
protect the value of the Trust’s portfolio, facilitate the sale of certain
securities for investment purposes, manage the effective interest rate exposure
of the Trust, protect against changes
in
currency exchange rates, manage the effective maturity or duration of the
Trust’s portfolio, or establish positions in the derivatives markets as a
temporary substitute for purchasing or selling particular
securities.
Derivative
Transactions have risks,
including the imperfect correlation between the value of such instruments and
the underlying assets, the possible default of the other party to the
transaction or illiquidity of the derivative instruments. Furthermore, the
ability to use successfully Derivative Transactions depends on the Investment
Adviser’s ability to predict pertinent market movements, which cannot be
assured. Thus, the use of Derivative Transactions may result in losses greater
than if they had not been used, may require the Trust to sell or purchase
portfolio securities at inopportune times or for prices other than current
market values, may limit the amount of appreciation the Trust can realize on
an
investment, or may cause the Trust to hold a security that it might otherwise
sell. The use of currency transactions can result in the Trust incurring losses
as a result of the imposition of exchange controls, suspension of settlements
or
the inability of the Trust to deliver or receive a specified currency.
Additionally, amounts paid by the Trust as premiums and cash or other assets
held in margin accounts with respect to Derivative Transactions are not
otherwise available to the Trust for investment purposes.
A
more complete discussion of
Derivative Transactions and their risks is contained in the Statement of
Additional Information.
Swaps. Swap
contracts may be purchased or sold to obtain investment exposure and/or to
hedge
against fluctuations in securities prices, currencies, interest rates or market
conditions, to change the duration of the overall portfolio or to mitigate
default risk. In a standard “swap” transaction, two parties agree to exchange
the returns (or differentials in rates of return) on different currencies,
securities, baskets of currencies or securities, indices or other instruments,
which returns are calculated with respect to a “notional value,” i.e., the
designated reference amount of exposure to the underlying instruments. The
Trust
intends to enter into swaps primarily on a net basis, i.e., the two payment
streams are netted out, with the Trust receiving or paying, as the case may
be,
only the net amount of the two payments. If the other party to a swap contract
defaults, the Trust’s risk of loss will consist of the net amount of payments
that the Trust is contractually entitled to receive. The net amount of the
excess, if any, of the Trust’s obligations over its entitlements will be
maintained in a segregated account by the Trust’s custodian. The Trust will not
enter into a swap agreement unless the claims-paying ability of the other party
thereto is considered to be investment grade by the Investment Adviser. If
there
is a default by the other party to such a transaction, the Trust will have
contractual remedies pursuant to the agreements related to the transaction.
Swap
instruments are not exchange-listed securities and may be traded only in the
over-the-counter market.
Interest
Rate
Swaps. Interest rate swaps involve the exchange by the Trust
with another party of their respective commitments to pay or receive interest
(e.g., an exchange of fixed rate payments for floating rate payments). The
Trust
may use interest rate swaps for risk management purposes and as a speculative
investment.
Total
Return
Swaps. Total return swaps are contracts in which one party
agrees to make payments of the total return from the designated underlying
asset(s), which may include securities, baskets of securities, or securities
indices, during the specified period, in return for receiving payments equal
to
a fixed or floating rate of interest or the total return from the other
designated underlying asset(s). The Trust may use total return swaps for risk
management purposes and as a speculative investment.
Currency
Swaps. Currency swaps involve the exchange of the two parties’
respective commitments to pay or receive fluctuations with respect to
a notional
amount of two different currencies (e.g., an exchange of payments with respect
to fluctuations in the value of the U.S. dollar relative to the Japanese
yen). The Trust may enter into currency swap contracts and baskets thereof
for
risk management purposes and as a speculative
investment.
Short
Sales. The
Trust intends to attempt to limit exposure to a possible market decline in
the
value of its portfolio securities through short sales of securities that
Highland believes possess volatility characteristics similar to those being
hedged. In addition, the Trust intends to use short sales for non-hedging
purposes to pursue its investment objectives. Subject to the requirements of
the
Investment Company Act and the Code, the Trust will not make a short sale if,
after giving effect to such sale, the market value of all securities sold short
by the Trust exceeds 25% of the value of its total assets.
A
short sale is a transaction in
which the Trust sells a security it does not own in anticipation that the market
price of that security will decline. When the Trust makes a short sale, it
must
borrow the security sold short from a broker-dealer and deliver it to the buyer
upon conclusion of the sale. The Trust may have to pay a fee to borrow
particular securities and is often obligated to pay over any payments received
on such borrowed securities.
The
Trust’s obligation to replace the
borrowed security will be secured by collateral deposited with the
broker-dealer, usually cash, U.S. government securities or other liquid
securities. The Trust will also be required to designate on its books and
records similar collateral with its custodian to the extent, if any, necessary
so that the aggregate collateral value is at all times at least equal to the
current market value of the security sold short. Depending on arrangements
made
with the broker-dealer from which it borrowed the security regarding payment
over of any payments received by the Trust on such security, the Trust may
not
receive any payments (including interest) on its collateral deposited with
such
broker-dealer.
If
the price of the security sold
short increases between the time of the short sale and the time the Trust
replaces the borrowed security, the Trust will incur a loss; conversely, if
the
price declines, the Trust will realize a gain. Any gain will be decreased,
and
any loss increased, by the transaction costs described above. Although the
Trust’s gain is limited to the price at which it sold the security short, its
potential loss is unlimited.
The
Trust may also sell a security
short if it owns at least an equal amount of the security sold short or another
security convertible or exchangeable for an equal amount of the security sold
short without payment of further compensation (a short sale against-the-box).
In
a short sale against-the-box, the short seller is exposed to the risk of being
forced to deliver stocks that it holds to close the position if the borrowed
stock is called in by the lender, which would cause gain or loss to be
recognized on the delivered stock. The Trust expects normally to close its
short
sales against-the-box by delivering newly acquired stock.
Purchasing
securities to close out
the short position can itself cause the price of the securities to rise further,
thereby exacerbating the loss. Short-selling exposes the Trust to unlimited
risk
with respect to that security due to the lack of an upper limit on the price
to
which an instrument can rise. Although the Trust reserves the right to utilize
short sales, and currently intends to utilize short sales, Highland is under
no
obligation to utilize short sales at all.
Repurchase
Agreements. The Trust may invest up to 33 1/3% of its assets in
repurchase agreements. It may enter into repurchase agreements with
broker-dealers, member banks of the Federal Reserve System and other financial
institutions. Repurchase agreements are loans or arrangements under which the
Trust purchases securities and the seller agrees to repurchase the securities
within a specific time and at a specific price. The repurchase price is
generally higher than the Trust’s purchase price, with the difference being
income to the Trust. Under the direction of the board of trustees, the
Investment
Adviser
reviews and monitors the creditworthiness of any institution which enters into
a
repurchase agreement with the Trust. The counterparty’s obligations under the
repurchase agreement are collateralized with U.S. Treasury and/or agency
obligations with a market value of not less than 100% of the obligations, valued
daily. Collateral is held by the Trust’s custodian in a segregated, safekeeping
account for the benefit of the Trust. Repurchase agreements afford the Trust
an
opportunity to earn income on temporarily available cash at low risk. In the
event of commencement of bankruptcy or insolvency proceedings with respect
to
the seller of the security before repurchase of the security under a repurchase
agreement, the Trust may encounter delay and incur costs before being able
to
sell the security. Such a delay may involve loss of interest or a decline in
price of the security. If the court characterizes the transaction as a loan
and
the Trust has not perfected a security interest in the security, the Trust
may
be required to return the security to the seller’s estate and be treated as an
unsecured creditor of the seller. As an unsecured creditor, the Trust would
be
at risk of losing some or all of the principal and interest involved in the
transaction.
Lending
of
Assets. The Trust may lend up to 33 1/3% of its assets. It may
lend assets to registered broker-dealers or other institutional investors deemed
by the Investment Adviser to be of good standing under agreements which require
that the loans be secured continuously by collateral in cash, cash equivalents
or U.S. Treasury bills maintained on a current basis at an amount at least
equal
to the market value of the securities loaned. The Trust continues to receive
the
equivalent of the interest or dividends paid by the issuer on the securities
loaned as well as the benefit of an increase and the detriment of any decrease
in the market value of the securities loaned and would also receive compensation
based on investment of the collateral. The Trust would not, however, have the
right to vote any securities having voting rights during the existence of the
loan, but would call the loan in anticipation of an important vote to be taken
among holders of the securities or of the giving or withholding of consent
on a
material matter affecting the investment.
As
with other extensions of credit, there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. The Trust will lend portfolio securities only to firms that have
been approved in advance by the board of trustees, which will monitor the
creditworthiness of any such firms.
Non-U.S.
Securities. The Trust may invest up to 20% of its total assets
in non-U.S. securities, which may include securities denominated in U.S. dollars
or in non-U.S. currencies or multinational currency units. The Trust may invest
in non-U.S. securities of so-called emerging market issuers. For purposes of
the
Trust, a company is deemed to be a non-U.S. company if it meets the following
tests: (i) such company was not organized in the United States; (ii) such
company’s primary business office is not in the United States; (iii) the
principal trading market for such company’s securities is not located in the
United States; (iv) less than 50% of such company’s assets are located in the
United States; or (v) 50% or more of such issuer’s revenues are derived from
outside the United States. Non-U.S. securities markets generally are not as
developed or efficient as those in the United States. Securities of some
non-U.S. issuers are less liquid and more volatile than securities of comparable
U.S. issuers. Similarly, volume and liquidity in most non-U.S. securities
markets are less than in the United States and, at times, volatility of price
can be greater than in the United States.
Because
evidences of ownership of
such securities usually are held outside the United States, the Trust would
be
subject to additional risks if it invested in non-U.S. securities, which include
possible adverse political and economic developments, seizure or nationalization
of foreign deposits and adoption of governmental restrictions which might
adversely affect or restrict the payment of principal and interest on the
non-U.S. securities to investors located outside the country of the issuer,
whether from currency blockage or otherwise.
Since
non-U.S. securities may be
purchased with and payable in foreign currencies, the value of these assets
as
measured in U.S. dollars may be affected favorably or unfavorably by changes
in
currency rates and exchange control regulations.
Options. An
option on a security is a contract that gives the holder of the option, in
return for a premium, the right to buy from (in the case of a call) or sell
to
(in the case of a put) the writer of the option the security underlying the
option at a specified exercise or “strike” price. The writer of an option on a
security has the obligation upon exercise of the option to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Certain options, known as
“American style” options may be exercised at any time during the term of the
option. Other options, known as “European style” options, may be exercised only
on the expiration date of the option.
If
an option written by the Trust
expires unexercised, the Trust realizes on the expiration date a capital gain
equal to the premium received by the Trust at the time the option was written.
If an option purchased by the Trust expires unexercised, the Trust realizes
a
capital loss equal to the premium paid. Prior to the earlier of exercise or
expiration, an exchange-traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type, underlying security,
exercise price and expiration). There can be no assurance, however, that a
closing purchase or sale transaction can be effected when the Trust desires.
The
Trust may sell put or call options it has previously purchased, which could
result in a net gain or loss depending on whether the amount realized on the
sale is more or less than the premium and other transaction costs paid on the
put or call option when purchased. The Trust will realize a capital gain from
a
closing purchase transaction if the cost of the closing option is less than
the
premium received from writing the option, or, if it is more, the Trust will
realize a capital loss. If the premium received from a closing sale transaction
is more than the premium paid to purchase the option, the Trust will realize
a
capital gain or, if it is less, the Trust will realize a capital
loss.
Short-Term
Debt Securities;
Temporary Defensive Position; Invest-Up Period. During the
period in which the net proceeds of this offering of common shares are being
invested, during periods in which Highland determines that it is temporarily
unable to follow the Trust’s investment strategy or that it is impractical to do
so or pending re-investment of proceeds received in connection with the sale
of
a security, the Trust may deviate from its investment strategy and invest all
or
any portion of its assets in cash or cash equivalents. Highland’s determination
that it is temporarily unable to follow the Trust’s investment strategy or that
it is impractical to do so will generally occur only in situations in which
a
market disruption event has occurred and where trading in the securities
selected through application of the Trust’s investment strategy is extremely
limited or absent. In such a case, shares of the Trust may be adversely affected
and the Trust may not pursue or achieve its investment objectives.
PRINCIPAL
RISKS OF THE TRUST
Investment
and Market Discount Risk
An
investment in the Trust’s common
shares is subject to investment risk, including the possible loss of the entire
amount that you invest. As with any stock, the price of the Trust’s shares will
fluctuate with market conditions and other factors. If common shares are sold,
the price received may be more or less than the original investment. Shares
of
closed-end management investment companies frequently trade at a discount to
their net asset value. The Trust’s shares may trade at a price that is less than
the initial offering price. This risk may be greater for investors who sell
their shares in a relatively short period of time after completion of the
initial offering. Common shares are designed for long-term investors and should
not be treated as trading vehicles.
Interest
Rate Risk
Interest
rate risk is the risk that
debt securities, and the Trust’s net assets, may decline in value because of
changes in interest rates. Generally, debt securities will decrease in value
when interest rates rise and increase in value when interest rates decline.
This
means that the net asset value of the common shares will fluctuate with interest
rate changes and the corresponding changes in the value of the Trust’s debt
security holdings.
Prepayment
Risk
If
interest rates fall, the principal
on bonds held by the Trust may be paid earlier than expected. If this happens,
the proceeds from a prepaid security may be reinvested by the Trust in
securities bearing lower interest rates, resulting in a possible decline in
the
Trust’s income and distributions to shareholders. The Trust may invest in pools
of mortgages or other assets issued or guaranteed by private issuers or U.S.
government agencies and instrumentalities. Mortgage-related securities are
especially sensitive to prepayment risk because borrowers often refinance their
mortgages when interest rates drop.
Risks
of Investing in High-Yield Securities
A
portion of the Trust’s investments
will consist of investments that may generally be characterized as “high-yield
securities” or “junk securities.” Such securities are typically rated below
investment grade by one or more nationally recognized statistical rating
organizations or are unrated but of comparable credit quality to obligations
rated below investment grade, and have greater credit and liquidity risk than
more highly rated obligations. High-yield securities are generally unsecured
and
may be subordinate to other obligations of the obligor. The lower rating of
high-yield securities reflects a greater possibility that adverse changes in
the
financial condition of the issuer or in general economic conditions (including,
for example, a substantial period of rising interest rates or declining
earnings) or both may impair the ability of the issuer to make payment of
principal and interest. Many issuers of high-yield securities are highly
leveraged, and their relatively high debt to equity ratios create increased
risks that their operations might not generate sufficient cash flow to service
their obligations. Overall declines in the below investment grade bond and
other
markets may adversely affect such issuers by inhibiting their ability to
refinance their obligations at maturity.
High-yield
securities are often issued
in connection with leveraged acquisitions or recapitalizations in which the
issuers incur a substantially higher amount of indebtedness than the level
at
which they had previously operated. High-yield securities that are debt
instruments have historically experienced greater default rates than has been
the case for investment grade securities. The Trust may also invest in equity
securities issued by entities whose obligations are unrated or are rated below
investment grade.
The
Trust is authorized to invest in
obligations of issuers which are generally trading at significantly higher
yields than had been historically typical of the applicable issuer’s
obligations. Such investments may include debt obligations that have a
heightened probability of being in covenant or payment default in the future.
Such investments generally are considered speculative. The repayment of
defaulted obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest or other
payments. Typically such workout or bankruptcy proceedings result in only
partial recovery of cash payments or an exchange of the defaulted security
for
other debt or equity securities of the issuer or its affiliates, which may
in
turn be illiquid or speculative.
High-yield
securities purchased by
the Trust are subject to certain additional risks to the extent that such
obligations may be unsecured and subordinated to substantial amounts of senior
indebtedness, all or a significant portion of which may be secured. Moreover,
such obligations purchased by the Trust may not be protected by financial
covenants or limitations upon additional indebtedness and are unlikely to be
secured by collateral.
Illiquidity
of Investments
The
investments made by the Trust may
be very illiquid, and consequently, the Trust may not be able to sell such
investments at prices that reflect the Investment Adviser’s assessment of their
fair value or the amount paid for such investments by the Trust. Illiquidity
may
result from the absence of an established market for the investments as well
as
legal, contractual or other restrictions on their resale by the Trust and other
factors. Furthermore, the nature of the Trust’s investments, especially those in
financially stressed and distressed companies, may require a long holding period
prior to being able to determine whether the investment will be profitable
or
not. There is no limit on the amount of the Trust’s portfolio that can be
invested in illiquid securities.
Risks
of Investing in Senior Loans
Senior
loans are typically at the most
senior level of the capital structure, and are sometimes secured by specific
collateral, including, but not limited to, trademarks, patents, accounts
receivable, inventory, equipment, buildings, real estate, franchises and common
and preferred stock of the obligor or its affiliates. A portion of the Trust’s
investments may consist of loans and participations therein originated by banks
and other financial institutions, typically referred to as “bank loans.” The
Trust’s investments may include loans of a type generally incurred by borrowers
in connection with highly leveraged transactions, often to finance internal
growth, acquisitions, mergers or stock purchases, or for other reasons. As
a
result of the additional debt incurred by the borrower in the course of the
transaction, the borrower’s creditworthiness is often judged by the rating
agencies to be below investment grade. Such loans are typically private
corporate loans which are negotiated by one or more commercial banks or
financial institutions and syndicated among a group of commercial banks and
financial institutions. In order to induce the lenders to extend credit and
to
offer a favorable interest rate, the borrower often provides the lenders with
extensive information about its business which is not generally available to
the
public.
Bank
loans often contain restrictive
covenants designed to limit the activities of the borrower in an effort to
protect the right of lenders to receive timely payments of principal and
interest. Such covenants may include restrictions on dividend payments, specific
mandatory minimum financial ratios, limits on total debt and other financial
tests. Bank loans usually have shorter terms than subordinated obligations
and
may require mandatory prepayments from excess cash flow, asset dispositions
and
offerings of debt and/or equity securities. The bank loans and other debt
obligations to be acquired by the Trust are likely to be below investment grade.
For a discussion of the risks associated with below investment grade
investments, see “Risks of Investing in High Yield Securities”
below.
The
Trust may acquire interests in bank
loans and other debt obligations either directly (by way of sale or assignment)
or indirectly (by way of participation). The purchaser of an assignment
typically succeeds to all the rights and obligations of the assigning
institution and becomes a lender under the credit agreement with respect to
the
debt obligation; however, its rights can be more restricted than those of the
assigning institution, and, in any event, the Trust may not be able unilaterally
to enforce all rights and remedies under the loan and any associated collateral.
A participation interest in a portion of a debt obligation typically results
in
a contractual relationship only with the institution participating out the
interest, not with the borrower. In purchasing participations, the Trust
generally will have no right to
enforce
compliance by the borrower with neither the terms of the loan agreement nor
any
rights of setoff against the borrower, and the Trust may not directly benefit
from the collateral supporting the debt obligation in which it has purchased
the
participation. As a result, the Trust will be exposed to the credit risk of
both
the borrower and the institution selling the participation.
Purchasers
of bank loans are
predominantly commercial banks, investment funds and investment banks. As
secondary market trading volumes increase, new bank loans frequently adopt
standardized documentation to facilitate loan trading which should improve
market liquidity. There can be no assurance, however, that future levels of
supply and demand in bank loan trading will provide an adequate degree of
liquidity or that the current level of liquidity will continue. Because of
the
provision to holders of such loans of confidential information relating to
the
borrower, the unique and customized nature of the loan agreement, the limited
universe of eligible purchasers and the private syndication of the loan, bank
loans are not as easily purchased or sold as a publicly traded security, and
historically the trading volume in the bank loan market has been small relative
to the high-yield debt market.
Second
Lien Loans Risk
Second
lien loans are subject to the
same risks associated with investment in senior loans and non-investment grade
securities. However, second lien loans are second in right of payment to senior
loans and therefore are subject to additional risk that the cash flow of the
borrower and any property securing the loan may be insufficient to meet
scheduled payments after giving effect to the senior secured obligations of
the
borrower. Second lien loans are expected to have greater price volatility than
senior loans and may be less liquid. There is also a possibility that
originators will not be able to sell participations in second lien loans, which
would create greater credit risk exposure.
Other
Secured Loans Risk
Secured
loans other than senior loans
and second lien loans are subject to the same risks associated with investment
in senior loans, second lien loans and non-investment grade securities. However,
such loans may rank lower in right of payment than any outstanding senior loans
and second lien loans of the borrower and therefore are subject to additional
risk that the cash flow of the borrower and any property securing the loan
may
be insufficient to meet scheduled payments after giving effect to the higher
ranking secured obligations of the borrower. Lower ranking secured loans are
expected to have greater price volatility than senior loans and second lien
loans and may be less liquid. There is also a possibility that originators
will
not be able to sell participations in lower ranking secured loans, which would
create greater credit risk exposure.
Unsecured
Loans Risk
Unsecured
loans are subject to the
same risks associated with investment in senior loans, second lien loans, other
secured loans and non-investment grade securities. However, because unsecured
loans have lower priority in right of payment to any higher ranking obligations
of the borrower and are not backed by a security interest in any specific
collateral, they are subject to additional risk that the cash flow of the
borrower and available assets may be insufficient to meet scheduled payments
after giving effect to any higher ranking obligations of the borrower. Unsecured
loans are expected to have greater price volatility than senior loans, second
lien loans and other secured loans and may be less liquid. There is also a
possibility that originators will not be able to sell participations in
unsecured loans, which would create greater credit risk
exposure.
Risks
of Investing in Obligations of Stressed, Distressed and Bankrupt
Issuers
The
Trust is authorized to invest in
the securities and other obligations of stressed, distressed and bankrupt
issuers, including debt obligations that are in covenant or payment default.
There is no limit on the amount of the Trust’s portfolio that can be invested in
stressed, distressed or bankrupt issuers, and the Trust may invest for purposes
of control. Such investments generally trade significantly below par and are
considered speculative. The repayment of defaulted obligations is subject to
significant uncertainties. Defaulted obligations might be repaid only after
lengthy workout or bankruptcy proceedings, during which the issuer might not
make any interest or other payments. Typically such workout or bankruptcy
proceedings result in only partial recovery of cash payments or an exchange
of
the defaulted obligation for other debt or equity securities of the issuer
or
its affiliates, which may in turn be illiquid or speculative.
There
are a number of significant risks
inherent in the bankruptcy process. First, many events in a bankruptcy are
the
product of contested matters and adversary proceedings and are beyond the
control of the creditors. While creditors are generally given an opportunity
to
object to significant actions, there can be no assurance that a bankruptcy
court
in the exercise of its broad powers would not approve actions that would be
contrary to the interests of the Trust. Second, a bankruptcy filing by an issuer
may adversely and permanently affect the issuer. The issuer may lose its market
position and key employees and otherwise become incapable of restoring itself
as
a viable entity. If for this or any other reason the proceeding is converted
to
a liquidation, the value of the issuer may not equal the liquidation value
that
was believed to exist at the time of the investment. Third, the duration of
a
bankruptcy proceeding is difficult to predict. A creditor’s return on investment
can be adversely affected by delays while the plan of reorganization is being
negotiated, approved by the creditors and confirmed by the bankruptcy court
and
until it ultimately becomes effective. Fourth, the administrative costs in
connection with a bankruptcy proceeding are frequently high and would be paid
out of the debtor’s estate prior to any return to creditors. For example, if a
proceeding involves protracted or difficult litigation, or turns into a
liquidation, substantial assets may be devoted to administrative costs. Fifth,
bankruptcy law permits the classification of “substantially similar” claims in
determining the classification of claims in a reorganization. Because the
standard for classification is vague, there exists the risk that the Trust’s
influence with respect to the class of securities or other obligations it owns
can be lost by increases in the number and amount of claims in that class or
by
different classification and treatment. Sixth, in the early stages of the
bankruptcy process it is often difficult to estimate the extent of, or even
to
identify, any contingent claims that might be made. Seventh, especially in
the
case of investments made prior to the commencement of bankruptcy proceedings,
creditors can lose their ranking and priority if they exercise “domination and
control” over a debtor and other creditors can demonstrate that they have been
harmed by such actions. Eighth, certain claims that have priority by law (for
example, claims for taxes) may be substantial.
In
any investment involving stressed
and distressed debt obligations, there exists the risk that the transaction
involving such debt obligations will be unsuccessful, take considerable time
or
will result in a distribution of cash or a new security or obligation in
exchange for the stressed and distressed debt obligations, the value of which
may be less than the Trust’s purchase price of such debt obligations.
Furthermore, if an anticipated transaction does not occur, the Trust may be
required to sell its investment at a loss. Given the substantial uncertainties
concerning transactions involving stressed and distressed debt obligations
in
which the Trust invests, there is a potential risk of loss by the Trust of
its
entire investment in any particular investment.
Investments
in companies operating in
workout modes or under Chapter 11 of the Bankruptcy Code are also, in certain
circumstances, subject to certain additional liabilities which may exceed the
value of the Trust’s original investment in a company. For example, under
certain circumstances, creditors who have inappropriately exercised control
over
the management and policies of a debtor may have their claims subordinated
or
disallowed or may be found liable for damages
suffered
by parties as a result of such actions. The Investment Adviser’s active
management style may present a greater risk in this area than would a more
passive approach. In addition, under certain circumstances, payments to the
Trust and distributions by the Trust or payments on the debt may be reclaimed
if
any such payment is later determined to have been a fraudulent conveyance or
a
preferential payment.
The
Investment Adviser on behalf of the
Trust may participate on committees formed by creditors to negotiate with the
management of financially troubled companies that may or may not be in
bankruptcy or may negotiate directly with debtors with respect to restructuring
issues. If the Trust does choose to join a committee, the Trust would likely
be
only one of many participants, all of whom would be interested in obtaining
an
outcome that is in their individual best interests. There can be no assurance
that the Trust would be successful in obtaining results most favorable to it
in
such proceedings, although the Trust may incur significant legal and other
expenses in attempting to do so. As a result of participation by the Trust
on
such committees, the Trust may be deemed to have duties to other creditors
represented by the committees, which might thereby expose the Trust to liability
to such other creditors who disagree with the Trust’s actions. Participation by
the Trust on such committees may cause the Trust to be subject to certain
restrictions on its ability to trade in a particular investment and may also
make the Trust an “insider” or an “underwriter” for purposes of the federal
securities laws. Either circumstance will restrict the Trust’s ability to trade
in or acquire additional positions in a particular investment when it might
otherwise desire to do so.
Insolvency
Considerations with Respect to Issuers of Debt Obligations
Various
laws enacted for the protection
of creditors may apply to the debt obligations held by the Trust. The
information in this paragraph is applicable with respect to U.S. issuers subject
to United States bankruptcy laws. Insolvency considerations may differ with
respect to other issuers. If a court in a lawsuit brought by an unpaid creditor
or representative of creditors of an issuer of a debt obligation, such as a
trustee in bankruptcy, were to find that the issuer did not receive fair
consideration or reasonably equivalent value for incurring the indebtedness
constituting the debt obligation and, after giving effect to such indebtedness,
the issuer (i) was insolvent, (ii) was engaged in a business for which the
remaining assets of such issuer constituted unreasonably small capital or (iii)
intended to incur, or believed that it would incur, debts beyond its ability
to
pay such debts as they mature, such court could determine to invalidate, in
whole or in part, such indebtedness as a fraudulent conveyance, to subordinate
such indebtedness to existing or future creditors of such issuer, or to recover
amounts previously paid by such issuer in satisfaction of such
indebtedness.
The
measure of insolvency for purposes
of the foregoing will vary. Generally, an issuer would be considered insolvent
at a particular time if the sum of its debts were then greater than all of
its
property at a fair valuation, or if the present fair saleable value of its
assets was then less than the amount that would be required to pay its probable
liabilities on its existing debts as they became absolute and matured. There
can
be no assurance as to what standard a court would apply in order to determine
whether the issuer was “insolvent” after giving effect to the incurrence of the
indebtedness constituting the debt obligation or that, regardless of the method
of valuation, a court would not determine that the issuer was “insolvent” upon
giving effect to such incurrence. In addition, in the event of the insolvency
of
an issuer of a debt obligation, payments made on such debt obligation could
be
subject to avoidance as a “preference” if made within a certain period of time
(which may be as long as one year) before insolvency. Similarly, a court might
apply the doctrine of equitable subordination to subordinate the claim of a
lending institution against an issuer, to claims of other creditors of the
borrower, when the lending institution, another investor, or any of their
transferees, is found to have engaged in unfair, inequitable, or fraudulent
conduct. In general, if payments on a debt obligation are avoidable, whether
as
fraudulent conveyances or preferences, such payments can be recaptured either
from the initial recipient (such as the Trust) or from subsequent transferees
of
such payments (such as the investors in the Trust). To the extent that any
such
payments
are recaptured from the Trust the resulting loss will be borne by the investors.
However, a court in a bankruptcy or insolvency proceeding would be able to
direct the recapture of any such payment from such a recipient or transferee
only to the extent that such court has jurisdiction over such recipient or
transferee or its assets. Moreover, it is likely that avoidable payments could
not be recaptured directly from any such recipient or transferee that has given
value in exchange for its note, in good faith and without knowledge that the
payments were avoidable. Although the Investment Adviser will seek to avoid
conduct that would form the basis for a successful cause of action based upon
fraudulent conveyance, preference or equitable subordination, these
determinations are made in hindsight, and, in any event, there can be no
assurance as to whether any lending institution or other investor from which
the
Trust acquired the debt obligations engaged in any such conduct (or any other
conduct that would subject the debt obligations and the issuer to insolvency
laws) and, if it did, as to whether such creditor claims could be asserted
in a
U.S. court (or in the courts of any other country) against the
Trust.
Leverage
Risk
The
Trust currently leverages through
borrowings from a credit facility. The use of leverage, which can be
described as exposure to changes in price at a ratio greater than the amount
of
equity invested, either through the issuance of preferred shares, borrowings
or
other forms of market exposure, magnifies both the favorable and unfavorable
effects of price movements in the investments made by the Trust. Insofar as
the
Trust continues to employ leverage in its investment operations, the Trust
will
be subject to substantial risks of loss.
The
Trust currently leverages through
borrowings from a credit facility. The Trust has entered into a
revolving credit agreement with The Bank of Nova Scotia (“Scotia”) to borrow up
to $300,000,000 (the “Loan Agreement”). Such borrowings constitute financial
leverage. The Loan Agreement contains covenants that may limit the
Trust’s ability to: (i) pay dividends in certain circumstances, (ii) incur
additional debt and (iii) change its fundamental investment policies and engage
in certain transactions, including mergers and consolidations. For
instance, the Trust agreed not to purchase assets not contemplated by the
investment policies and restrictions in effect when the Loan Agreement became
effective. Furthermore, the Trust may not incur additional debt from
any other party, except for in limited circumstances (e.g., in the
ordinary course of business). In addition, the Loan Agreement
contains a covenant requiring asset coverage ratios that may be more stringent
than those required by the Investment Company Act. Any senior security
representing indebtedness, as defined in Section 18(g) of the Investment Company
Act, must have asset coverage of at least 300%.
In
order to obtain and maintain the
required ratings of loans from a credit facility, the Trust must comply with
investment quality, diversification and other guidelines established by Moody’s
and/or S&P or the credit facility, respectively. The Trust does
not anticipate that such guidelines will have a material adverse effect on
the
Trust’s of common shareholders or its ability to achieve its investment
objectives. Moody’s and S&P receive fees in connection with their ratings
issuances.
Successful
use of a leveraging strategy
may depend on the Investment Adviser’s ability to predict correctly interest
rates and market movements, and there is no assurance that a leveraging strategy
will be successful during any period in which it is employed.
Assuming
the utilization of leverage
in the amount of [·]% of the Trust’s total assets and an annual interest rate of
[·]% payable on such leverage based on market rates as of the date of this
prospectus, the additional income that the Trust must earn (net of expenses)
in
order to cover such leverage is [·]%. Actual costs of leverage may be higher or
lower than that assumed in the previous example.
The
following table is designed to
illustrate the effect on the return to a holder of the Trust’s common shares of
leverage in the amount of approximately [·]% of the Trust’s total assets,
assuming hypothetical annual returns of the Trust’s portfolio of minus 10% to
plus 10%. As the table shows, leverage generally increases the return to holders
of common shares when portfolio return is positive and greater than the cost
of
leverage and decreases the return when the portfolio return is negative or
less
than the cost of leverage. The figures appearing in the table are hypothetical
and actual returns may be greater or less than those appearing in the
table.
Assumed
portfolio return (net of expenses)
|
(10)%
|
(5)%
|
0%
|
5%
|
10%
|
Corresponding
common share return assuming [•]% leverage
|
|
|
|
|
|
Common
Stock Risk
The
Trust will have exposure to common
stock. Although common stock have historically generated higher average total
returns than fixed income securities over the long-term, common stock also
have
experienced significantly more volatility in those returns. Therefore, the
Trust’s exposure to 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 common stock held by the Trust. Also, the price of common stock
is
sensitive to general movements in the stock market and a drop in the stock
market may depress the price of common stock to which the Trust has exposure.
Common stock prices fluctuate for several reasons, including changes in
investors’ perceptions of the financial condition of an issuer or the general
condition of the relevant stock market, or when political or economic events
affecting the issuers occur. In addition, common stock prices may be
particularly sensitive to rising interest rates, as the cost of capital rises
and borrowing costs increase.
Dividend
Risk
Dividends
on common stock are not fixed
but are declared at the discretion of an issuer’s board of directors. There is
no guarantee that the issuers of the common stock in which the Trust invests
will declare dividends in the future or that, if declared, the dividends will
remain at current levels or increase over time
Small
and Mid-Cap Securities Risk
The
Trust may invest in companies with
small or medium-sized capitalizations. Securities issued by small and
medium-sized companies can be more volatile than, and perform differently from,
larger company securities. There may be less trading in a small or medium
company’s securities, which means that buy and sell transactions in those
securities could have a larger impact on the security’s price than is the case
with larger company securities. Small and medium-sized companies may have fewer
business lines; changes in any one line of business, therefore, may have a
greater impact on a small or medium-sized company’s security price than is the
case for a larger company. In addition, small or medium-sized company securities
may not be well known to the investing public.
Non-U.S.
Securities Risk
The
Trust may invest up to 20% of its
total assets in non-U.S. securities, including emerging market securities.
Investing in non-U.S. securities involves certain risks not involved in domestic
investments, including, but not limited to: (i) fluctuations in foreign currency
exchange rates; (ii) future foreign economic, financial, political and social
developments; (iii) different legal systems; (iv) the possible imposition of
exchange controls or other foreign governmental laws or restrictions; (v)
lower
trading
volume; (vi) much greater price volatility and illiquidity of certain non-U.S.
securities markets; (vii) different trading and settlement practices; (viii)
less governmental supervision; (ix) high and volatile rates of inflation; (x)
fluctuating interest rates; (xi) less publicly available information; and (xii)
different accounting, auditing and financial recordkeeping standards and
requirements.
Certain
countries in which the Trust
may invest, especially emerging market countries, historically have experienced,
and may continue to experience, high rates of inflation, high interest rates,
exchange rate fluctuations, large amounts of external debt, balance of payments
and trade difficulties and extreme poverty and unemployment. Many of these
countries are also characterized by political uncertainty and instability.
These
risks are especially evident in the Middle East and West Africa. The cost of
servicing external debt will generally be adversely affected by rising
international interest rates because many external debt obligations bear
interest at rates which are adjusted based upon international interest rates.
In
addition, with respect to certain foreign countries, there is a risk of: (i)
the
possibility of expropriation or nationalization of assets; (ii) confiscatory
taxation; (iii) difficulty in obtaining or enforcing a court judgment; (iv)
economic, political or social instability; and (v) diplomatic developments
that
could affect investments in those countries. In addition, individual foreign
economies may differ favorably or unfavorably from the U.S. economy in such
respects as: (i) growth of gross domestic product; (ii) rates of inflation;
(iii) capital reinvestment; (iv) resources; (v) self-sufficiency; and (vi)
balance of payments position.
As
a result of these potential risks,
Highland may determine that, notwithstanding otherwise favorable investment
criteria, it may not be practicable or appropriate to invest in a particular
country. The Trust may invest in countries in which foreign investors, including
Highland, have had no or limited prior experience.
Emerging
Markets Risk
The
Trust may invest up to 20% of its
total assets in securities of issuers based in emerging markets. Investing
in
securities of issuers based in underdeveloped emerging markets entails all
of
the risks of investing in securities of non-U.S. issuers to a heightened degree.
Emerging market countries generally include every nation in the world except
the
United States, Canada, Japan, Australia, New Zealand and most countries located
in Western Europe. These heightened risks include: (i) greater risks of
expropriation, confiscatory taxation, nationalization, and less social,
political and economic stability; (ii) the smaller size of the markets for
such
securities and a lower volume of trading, resulting in lack of liquidity and
in
price volatility; and (iii) certain national policies which may restrict the
Trust’s investment opportunities including restrictions on investing in issuers
or industries deemed sensitive to relevant national interests.
Foreign
Currency Risk
Because
the Trust may invest in
securities denominated or quoted in currencies other than the U.S. dollar,
changes in foreign currency exchange rates may affect the value of securities
owned by the Trust, the unrealized appreciation or depreciation of investments
and gains on and income from investments. Currencies of certain countries may
be
volatile and therefore may affect the value of securities denominated in such
currencies, which means that the Trust’s net asset value could decline as a
result of changes in the exchange rates between foreign currencies and the
U.S.
dollar. These risks often are heightened for investments in smaller, emerging
capital markets. In addition, the Trust may enter into foreign currency
transactions in an attempt to enhance total return which may further expose
the
Trust to the risks of foreign currency movements and other risks. The use of
foreign currency transactions can result in the Trust incurring losses as a
result of the imposition of exchange controls, suspension of settlements or
the
inability of the Trust to deliver or receive a specified
currency.
Investments
in Unseasoned Companies
The
Trust may invest in the securities
of less seasoned companies. These investments may present greater opportunities
for growth, but also involve greater risks than customarily are associated
with
investments in securities of more established companies. Some of the companies
in which the Trust may invest will be start-up companies which may have
insubstantial operational or earnings history or may have limited products,
markets, financial resources or management depth. Some may also be emerging
companies at the research and development stage with no products or technologies
to market or approved for marketing. Securities of emerging companies may lack
an active secondary market and may be subject to more abrupt or erratic price
movements than securities of larger, more established companies or stock market
averages in general. Competitors of certain companies may have substantially
greater financial resources than many of the companies in which the Trust may
invest.
Initial
Public Offerings Risk
The
Trust may invest in shares of
companies through initial public offerings (“IPOs”). IPOs and companies that
have recently gone public have the potential to produce substantial gains for
the Trust. However, there is no assurance that the Trust will have access to
profitable IPOs. The investment performance of the Trust during periods when
it
is unable to invest significantly or at all in IPOs may be lower than during
periods when the Trust is able to do so. Securities issued in IPOs are subject
to many of the same risks as investing in companies with smaller market
capitalizations. Securities issued in IPOs have no trading history, and
information about the companies may be available for limited periods of time.
In
addition, the prices of securities sold in IPOs may be highly volatile or may
decline shortly after the IPO.
Securities
Lending Risk
The
Trust may lend its portfolio
securities (up to a maximum of one-third of its total assets) to banks or
dealers which meet the creditworthiness standards established by the board
of
trustees of the Trust. Securities lending is subject to the risk that
loaned securities may not be available to the Trust on a timely basis and the
Trust may, therefore, lose the opportunity to sell the securities at a desirable
price. Any loss in the market price of securities loaned by the Trust that
occurs during the term of the loan would be borne by the Trust and would
adversely affect the Trust’s performance. Also, there may be delays in recovery,
or no recovery, of securities loaned or even a loss of rights in the collateral
should the borrower of the securities fail financially while the loan is
outstanding. Although the Trust generally has the ability to recall
loaned securities pursuant to a securities lending arrangement in the event
that
a shareholder vote is held, there is a risk that any delay in recovery of such
security will result in the holder of such security being unable to
vote. All of the aforementioned risks may be greater for non-U.S.
securities.
Risks
Associated with Options on Securities
There
are several risks associated with
transactions in options on securities. For example, there are significant
differences between the securities and options markets that could result in
an
imperfect correlation between these markets, causing a given transaction not
to
achieve its objectives. A decision as to whether, when and how to use options
involves the exercise of skill and judgment, and even a well conceived
transaction may be unsuccessful to some degree because of market behavior or
unexpected events.
As
the writer of a covered call
option, the Trust foregoes, during the option’s life, the opportunity to profit
from increases in the market value of the security covering the call option
above the sum of the
premium
and the strike price of the call, but has retained the risk of loss should
the
price of the underlying security decline. As the Trust writes covered calls
over
more of its portfolio, its ability to benefit from capital appreciation becomes
more limited. The writer of an option has no control over the time when it
may
be required to fulfill its obligation as a writer of the option. Once an option
writer has received an exercise notice, it cannot effect a closing purchase
transaction in order to terminate its obligation under the option and must
deliver the underlying security at the exercise price.
When
the Trust writes covered put
options, it bears the risk of loss if the value of the underlying stock declines
below the exercise price minus the put premium. If the option is exercised,
the
Trust could incur a loss if it is required to purchase the stock underlying
the
put option at a price greater than the market price of the stock at the time
of
exercise plus the put premium the Trust received when it wrote the option.
While
the Trust’s potential gain in writing a covered put option is limited to
distributions earned on the liquid assets securing the put option plus the
premium received from the purchaser of the put option, the Trust risks a loss
equal to the entire exercise price of the option minus the put
premium.
Exchange-Listed
Option Risks
There
can be no assurance that a liquid
market will exist when the Trust seeks to close out an option position on an
options exchange. Reasons for the absence of a liquid secondary market on an
exchange include the following: (i) there may be insufficient trading interest
in certain options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts, suspensions
or other restrictions may be imposed with respect to particular classes or
series of options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or the Options
Clearing Corporation may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of options
(or a particular class or series of options). If trading were discontinued,
the
secondary market on that exchange (or in that class or series of options) would
cease to exist. However, outstanding options on that exchange that had been
issued by the Options Clearing Corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their terms. If
the
Trust were unable to close out a covered call option that it had written on
a
security, it would not be able to sell the underlying security unless the option
expired without exercise.
The
hours of trading for options on an
exchange may not conform to the hours during which the underlying securities
are
traded. To the extent that the options markets close before the markets for
the
underlying securities, significant price and rate movements can take place
in
the underlying markets that cannot be reflected in the options markets. Call
options are marked to market daily and their value will be affected by changes
in the value and dividend rates of the underlying common shares, an increase
in
interest rates, changes in the actual or perceived volatility of the stock
market and the underlying common shares and the remaining time to the options’
expiration. Additionally, the exercise price of an option may be adjusted
downward before the option’s expiration as a result of the occurrence of certain
corporate events affecting the underlying equity security, such as extraordinary
dividends, stock splits, merger or other extraordinary distributions or events.
A reduction in the exercise price of an option would reduce the Trust’s capital
appreciation potential on the underlying security.
Over-the-Counter
Option Risk
The
Trust may write (sell) unlisted
(“OTC” or “over-the-counter”) options. Options written by the Trust with respect
to non-U.S. securities, indices or sectors generally will be OTC options. OTC
options differ from exchange-listed options in that they are two-party
contracts, with exercise price, premium and other terms negotiated between
buyer
and seller, and generally do not have as much market liquidity
as
exchange-listed
options. The counterparties to these transactions typically will be major
international banks, broker-dealers and financial institutions. The Trust may
be
required to treat as illiquid those securities being used to cover certain
written OTC options. The OTC options written by the Trust will not be issued,
guaranteed or cleared by the Options Clearing Corporation. In addition, the
Trust’s ability to terminate the OTC options may be more limited than with
exchange-traded options. Banks, broker-dealers or other financial institutions
participating in such transaction may fail to settle a transaction in accordance
with the terms of the option as written. In the event of default or insolvency
of the counterparty, the Trust may be unable to liquidate an OTC option
position.
Index
Option Risk
The
Trust may sell index put and call
options from time to time. The purchaser of an index put option has the right
to
any depreciation in the value of the index below the exercise price of the
option on or before the expiration date. The purchaser of an index call option
has the right to any appreciation in the value of the index over the exercise
price of the option on or before the expiration date. Because the exercise
of an
index option is settled in cash, sellers of index call options, such as the
Trust, cannot provide in advance for their potential settlement obligations
by
acquiring and holding the underlying securities. The Trust will lose money
if it
is required to pay the purchaser of an index option the difference between
the
cash value of the index on which the option was written and the exercise price
and such difference is greater than the premium received by the Trust for
writing the option. The value of index options written by the Trust, which
will
be priced daily, will be affected by changes in the value and dividend rates
of
the underlying common shares in the respective index, changes in the actual
or
perceived volatility of the stock market and the remaining time to the options’
expiration. The value of the index options also may be adversely affected if
the
market for the index options becomes less liquid or smaller. Distributions
paid
by the Trust on its common shares may be derived in part from the net index
option premiums it receives from selling index put and call options, less the
cost of paying settlement amounts to purchasers of the options that exercise
their options. Net index option premiums can vary widely over the short term
and
long term.
Asset-Backed
Securities Risk
Payment
of interest and repayment of
principal on asset-backed securities may be largely dependent upon the cash
flows generated by the assets backing the securities and, in certain cases,
supported by letters of credit, surety bonds or other credit enhancements.
Asset-backed security values may also be affected by the creditworthiness of
the
servicing agent for the pool, the originator of the loans or receivables or
the
entities providing the credit enhancement. In addition, the underlying assets
are subject to prepayments that shorten the securities’ weighted average
maturity and may lower their return.
Mortgage-Backed
Securities Risk
A
mortgage-backed security, which
represents an interest in a pool of assets such as mortgage loans, will mature
when all the mortgages in the pool mature or are prepaid. Therefore,
mortgage-backed securities do not have a fixed maturity, and their expected
maturities may vary when interest rates rise or fall.
When
interest rates fall, homeowners
are more likely to prepay their mortgage loans. An increased rate of prepayments
on the Trust’s mortgage-backed securities will result in an unforeseen loss of
interest income to the Trust as the Trust may be required to reinvest assets
at
a lower interest rate. Because prepayments increase when interest rates fall,
the price of mortgage-backed securities does not increase as much as other
fixed
income securities when interest rates fall.
When
interest rates rise, homeowners
are less likely to prepay their mortgage loans. A decreased rate of prepayments
lengthens the expected maturity of a mortgage-backed security. Therefore, the
prices of mortgage-backed securities may decrease more than prices of other
fixed income securities when interest rates rise.
Derivatives
Risk
The
Trust may engage in derivative
transactions for hedging and speculative purposes or to enhance total return,
including options, futures, swaps, foreign currency transactions and forward
foreign currency contracts, currency swaps or options on currency and currency
futures (“Derivative Transactions”). Derivatives allow an investor to hedge or
speculate upon the price movements of a particular security, financial benchmark
currency or index at a fraction of the cost of investing in the underlying
asset. The value of a derivative depends largely upon price movements in the
underlying asset. Therefore, many of the risks applicable to trading the
underlying asset are also applicable to derivatives of such asset. However,
there are a number of other risks associated with derivatives trading, including
the imperfect correlation between the value of such instruments and the
underlying assets, the possible default of the other party to the transaction
or
illiquidity of the derivative instruments. The ability to successfully use
Derivative Transactions depends on the Investment Adviser’s ability to predict
pertinent market movements, which cannot be assured. Because many derivatives
are “leveraged,” and thus provide significantly more market exposure than the
money paid or deposited when the transaction is entered into, a relatively
small
adverse market movement can not only result in the loss of the entire
investment, but may also expose the Trust to the possibility of a loss exceeding
the original amount invested. The use of Derivative Transactions may result
in
losses greater than if they had not been used, may require the Trust to sell
or
purchase portfolio securities at inopportune times or for prices other than
current market values, may limit the amount of appreciation the Trust can
realize on an investment or may cause the Trust to hold a security that it
might
otherwise sell. The use of foreign currency transactions can result in the
Trust
incurring losses as a result of the imposition of exchange controls, suspension
of settlements or the inability of the Trust to deliver or receive a specified
currency. Additionally, amounts paid by the Trust as premiums and cash or other
assets held in margin accounts with respect to Derivative Transactions are
not
otherwise available to the Trust for investment purposes.
To
the extent that the Trust purchases
options pursuant to a hedging strategy, the Trust will be subject to the
following additional risks. If a put or call option purchased by the Trust
is
not sold when it has remaining value, and if the market price of the underlying
security remains equal to or greater than the exercise price (in the case of
a
put), or remains less than or equal to the exercise price (in the case of a
call), the Trust will lose its entire investment in the option.
Where
a put or call option on a
particular security is purchased to hedge against price movements in a related
security, the price of the put or call option may move more or less than the
price of the related security. If restrictions on exercise were imposed, the
Trust might be unable to exercise an option it had purchased. If the Trust
were
unable to close out an option that it had purchased on a security, it would
have
to exercise the option in order to realize any profit or the option may expire
worthless.
Market
Risk Generally
The
profitability of a significant
portion of the Trust’s investment program depends to a great extent upon
correctly assessing the future course of the price movements of securities
and
other investments and the movements of interest rates. There can be no assurance
that the Investment Adviser will be able to predict accurately these price
and
interest rate movements. With respect to certain investment strategies the
Trust
utilizes, there is a high degree of market risk.
Reinvestment
Risk
The
Trust reinvests the cash flows
received from a security. The additional income from such reinvestment,
sometimes called interest-on-interest, is reliant on the prevailing interest
rate levels at the time of reinvestment. There is a risk that the interest
rate
at which interim cash flows can be reinvested will fall. Reinvestment risk
is
greater for longer holding periods and for securities with large, early cash
flows such as high-coupon bonds. Reinvestment risk also applies generally to
the
reinvestment of the proceeds the Trust receives upon the maturity or sale of
a
portfolio security.
Timing
Risk
Many
agency, corporate and municipal
bonds, and most mortgage-backed securities, contain a provision that allows
the
issuer to “call” all or part of the issue before the bond’s maturity date often
after 5 or 10 years. The issuer usually retains the right to refinance the
bond
in the future if market interest rates decline below the coupon rate. There
are
three disadvantages to the call provision. First, the cash flow pattern of
a
callable bond is not known with certainty. Second, because an issuer is more
likely to call the bonds when interest rates have dropped, the Trust is exposed
to reinvestment risk, i.e., the Trust may have to reinvest at lower
interest rates the proceeds received when the bond is called. Finally, the
capital appreciation potential of a bond will be reduced because the price
of a
callable bond may not rise much above the price at which the issuer may call
the
bond.
Inflation
Risk
Inflation
risk results from the
variation in the value of cash flows from a security due to inflation, as
measured in terms of purchasing power. For example, if the Trust purchases
a
bond in which it can realize a coupon rate of 5%, but the rate of inflation
increases from 2% to 6%, then the purchasing power of the cash flow has
declined. For all but adjustable bonds or floating rate bonds, the Trust is
exposed to inflation risk because the interest rate the issuer promises to
make
is fixed for the life of the security. To the extent that interest rates reflect
the expected inflation rate, floating rate bonds have a lower level of inflation
risk. In addition, during any periods of rising inflation, dividend
rates of any variable rate preferred share issued by the Trust would likely
increase, which would tend to further reduce returns to common
shareholders.
Arbitrage
Risks
The
Trust engages in capital structure
arbitrage and other arbitrage strategies. Arbitrage strategies entail various
risks, including the risk that external events, regulatory approvals and other
factors will impact the consummation of announced corporate events and/or the
prices of certain positions. In addition, hedging is an important feature of
capital structure arbitrage. There is no guarantee that the Investment Adviser
will be able to hedge the Trust’s portfolio in the manner necessary to employ
successfully the Trust’s strategy.
Short
Sales Risk
Short
selling involves selling
securities which may or may not be owned and borrowing the same securities
for
delivery to the purchaser, with an obligation to replace the borrowed securities
at a later date. Short selling allows the Trust to profit from declines in
market prices to the extent such decline exceeds the transaction costs and
the
costs of borrowing the securities. However, since the borrowed securities must
be replaced by purchases at market prices in order to close out the short
position, any appreciation in the price of the borrowed securities would result
in a loss. There can be no assurance that the securities necessary to cover
a
short position will be available for purchase. Purchasing securities to close
out the
short
position can itself cause the price of the securities to rise further, thereby
exacerbating the loss. The Trust may mitigate such losses by replacing the
securities sold short before the market price has increased significantly.
Under
adverse market conditions, the Trust might have difficulty purchasing securities
to meet its short sale delivery obligations, and might have to sell portfolio
securities to raise the capital necessary to meet its short sale obligations
at
a time when fundamental investment considerations would not favor such sales.
Short sales by the Trust that are not made “against the box” theoretically
involve unlimited loss potential since the market price of securities sold
short
may continuously increase.
Risks
of Investing in Structured Finance Securities
A
portion of the Trust’s investments
may consist of equipment trust certificates, collateralized mortgage
obligations, collateralized bond obligations, collateralized loan obligations
or
similar instruments. Structured finance securities may present risks similar
to
those of the other types of debt obligations in which the Trust may invest
and,
in fact, such risks may be of greater significance in the case of structured
finance securities. Moreover, investing in structured finance securities may
entail a variety of unique risks. Among other risks, structured finance
securities may be subject to prepayment risk. In addition, the performance
of a
structured finance security will be affected by a variety of factors, including
its priority in the capital structure of the issuer thereof, the availability
of
any credit enhancement, the level and timing of payments and recoveries on
and
the characteristics of the underlying receivables, loans or other assets that
are being securitized, remoteness of those assets from the originator or
transferor, the adequacy of and ability to realize upon any related collateral
and the capability of the servicer of the securitized assets.
Risks
of Investing in Preferred Securities.
There
are special risks associated with
investing in preferred securities, including:
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Deferral. Preferred
securities may include provisions that permit the issuer, at its
discretion, to defer distributions for a stated period without any
adverse
consequences to the issuer. If the Trust owns a preferred security
that is
deferring its distributions, the Trust may be required to report
income
for tax purposes although it has not yet received such
income.
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Subordination. Preferred
securities are subordinated to bonds and other debt instruments in
a
company’s capital structure in terms of priority to corporate income and
liquidation payments, and therefore will be subject to greater credit
risk
than more senior debt instruments.
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Liquidity. Preferred
securities may be substantially less liquid than many other securities,
such as common stock or U.S. government
securities.
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Limited
Voting Rights. Generally, preferred security holders have
no voting rights with respect to the issuing company unless preferred
dividends have been in arrears for a specified number of periods,
at which
time the preferred security holders may elect a number of trustees
to the
issuer’s board. Generally, once all the arrearages have been paid, the
preferred security holders no longer have voting
rights.
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Risks
of Investing in Swaps
Investments
in swaps involve the exchange with another party of their respective
commitments. Use of swaps subjects the Trust to risk of default by the
counterparty. If there is a default by the counterparty to such a transaction,
there may be contractual remedies pursuant to the agreements related to the
transaction although contractual remedies may not be sufficient in the event
the
counterparty is insolvent. However, the swap market has grown substantially
in
recent years with a large number of banks and investment banking firms acting
both as principals and agents utilizing standardized swap documentation. As
a
result, the swap market has become relatively liquid in comparison with the
markets for other similar instruments which are traded in the interbank market.
The Trust may enter into credit default swaps, currency swaps or other swaps
which may be surrogates for other instruments such as currency forwards or
options.
Risks
of Investing in Synthetic Securities
With
respect to synthetic securities
the Trust will usually have a contractual relationship only with the
counterparty of such synthetic securities, and not the Reference Obligor (as
defined below) on the Reference Obligation (as defined below). The Trust
generally will have no right to directly enforce compliance by the Reference
Obligor with the terms of the Reference Obligation nor any rights of set-off
against the Reference Obligor, nor have any voting rights with respect to the
Reference Obligation. The Trust will not benefit directly from any collateral
supporting the Reference Obligation or have the benefit of the remedies on
default that would normally be available to a holder of such Reference
Obligation. In addition, in the event of insolvency of its counterparty, the
Trust will be treated as a general creditor of such counterparty and will not
have any claim with respect to the credit risk of the counterparty as well
as
that of the Reference Obligor. As a result, an overabundance of synthetic
securities with any one counterparty subjects the notes to an additional degree
of risk with respect to defaults by such counterparty as well as by the
Reference Obligor. The Investment Adviser may not perform independent credit
analyses of the counterparties or any entities guaranteeing such counterparties,
individually or in the aggregate. A “Reference Obligation” is the debt security
or other obligation upon which the synthetic security is based. A “Reference
Obligor” is the obligor on a Reference Obligation. There is no maximum amount of
Trust’s assets that may be invested in synthetic securities.
Tax
Risk
The
Trust may invest in derivative instruments, such as swaps, and other
instruments, in order to obtain investment exposure to its principal investment
categories or for other purposes. The Trust intends only to invest in such
instruments to an extent and in a manner consistent with the Trust’s
qualification as a regulated investment company for federal income tax purposes.
If the Trust were to fail to qualify as a regulated investment company in any
year, then the Trust would be subject to federal (and state) income tax on
its
net income and capital gains at regular corporate income tax rates (without
a
deduction for distributions to shareholders). Trust income distributed to common
shareholders would also be taxable to shareholders as ordinary dividend income
to the extent attributable to the Trust’s earnings and profits. Accordingly, in
such event, the Trust’s ability to achieve its investment objectives would be
adversely affected, and common shareholders would be subject to the risk of
diminished investment returns.
Valuation
Risk
Fair
value is defined as the amount for
which assets could be sold in an orderly disposition over a reasonable period
of
time, taking into account the nature of the asset. Fair value pricing, however,
involves judgments that are inherently subjective and inexact, since fair
valuation procedures are used only when it is not possible to be sure what
value
should be attributed to a particular asset or when an event will affect the
market price of an asset and to what extent. As a result, there can be no
assurance that fair value pricing will reflect actual market value, and it
is
possible that the fair value determined for a security will be materially
different from the value that actually could be or is realized upon the sale
of
that asset.
Risks
of Non-Diversification and Other Focused Strategies
While
the Investment Adviser invests
in a number of fixed-income and equity instruments issued by different issuers
and employs multiple investment strategies with respect to the Trust’s
portfolio, it is possible that a significant amount of the Trust’s investments
could be invested in the instruments of only a few companies or other issuers
or
that at any particular point in time one investment strategy could be more
heavily weighted than the others. The focus of the Trust’s portfolio in any one
issuer would subject the Trust to a greater degree of risk with respect to
defaults by such issuer or other adverse events affecting that issuer, and
the
focus of the portfolio in any one industry or group of industries (but not
to
the extent of 25% of the Trust’s total assets) would subject the Trust to a
greater degree of risk with respect to economic downturns relating to such
industry. The focus of the Trust’s portfolio in any one investment strategy
would subject the Trust to a greater degree of risk than if the Trust’s
portfolio were varied in its investments with respect to several investment
strategies.
Market
Disruption and Geopolitical Risk
The
aftermath of the war in Iraq and
the continuing occupation of Iraq, instability in the Middle East and terrorist
attacks in the United States and around the world may result in market
volatility and may have long-term effects on the U.S. and worldwide financial
markets and may cause further economic uncertainties in the United States and
worldwide. The Investment Adviser does not know how long the securities markets
may be affected by these events and cannot predict the effects of the occupation
or similar events in the future on the U.S. economy and securities
markets.
Risks
of Investing in a Trust with Anti-Takeover Provisions
The
Trust’s Agreement and Declaration
of Trust includes provisions that could limit the ability of other entities
or
persons to acquire control of the Trust or convert the Trust to open-end status.
These provisions could deprive the holders of common shares of opportunities
to
sell their common shares at a premium over the then current market price of
the
common shares or at net asset value.
Key
Adviser Personnel Risk
The
Trust’s ability to identify and
invest in attractive opportunities is dependent upon Highland, its investment
adviser. If one or more key individuals leaves Highland, Highland may not be
able to hire qualified replacements or may require an extended time to do so.
This situation could prevent the Trust from achieving its investment
objectives.
Given
the risks described above, an
investment in the common shares may not be appropriate for all investors. You
should carefully consider your ability to assume these risks before making
an
investment in the Trust.
MANAGEMENT
OF THE TRUST
Trustees
and Officers
The
board of trustees is responsible
for the overall management of the Trust, including supervision of the duties
performed by Highland. There are five trustees of the Trust. Four of the
trustees are not “interested persons” (as defined in the Investment Company Act)
of the Trust. The name and business address of the trustees and officers of
the
Trust and their principal occupations and other affiliations during the past
five years are set forth under “Management of the Trust” in the Statement of
Additional Information.
Investment
Adviser
Highland
acts as the Trust’s
investment adviser. Highland is located at Two Galleria Tower, 13455 Noel Road,
Suite 800, Dallas, Texas 75240. As of [·], 2007, the Investment Adviser managed
approximately $[·] billion in assets on behalf of investors around the world.
Highland is controlled by James Dondero and Mark Okada, by virtue of their
respective share ownership, and its general partner, Strand Advisors, Inc.
(“Strand”), of which Mr. Dondero is the sole stockholder. Messrs. Dondero and
Okada have managed portfolios together since 1990.
Responsibilities. The
Investment Adviser provides the following services to the Trust: (i) furnishes
an investment program for the Trust; (ii) determines, subject to the overall
supervision and review of the board of trustees, the investments to be
purchased, held, sold or exchanged by the Trust and the portion, if any, of
the
assets of the Trust to be held uninvested; (iii) makes changes in the
investments of the Trust; and (iv) votes, exercises consents and exercises
all
other rights pertaining to such investments. Subject to the foregoing, the
Investment Adviser, at its own expense, will have the authority to engage one
or
more sub-advisers in connection with the portfolio management of the Trust,
which sub-advisers may be affiliates of the Investment Adviser; provided,
however, that the Investment Adviser shall remain responsible to the Trust
with
respect to its duties and obligations set forth in the investment advisory
agreement.
Compensation. In
return for its advisory services, the Investment Adviser receives an annual
fee,
payable monthly, in an amount equal to 1.00% of the average weekly value of
the
Trust’s Managed Assets (the “Advisory Fee”). The accrued fees are payable
monthly as promptly as possible after the end of each month during which the
investment advisory agreement is in effect. The Investment Adviser may waive
a
portion of its fees. A discussion regarding the basis for the approval of the
investment advisory agreement by the Trust’s board is available in the Trust’s
report to shareholders for the period ending June 30, 2006.
Potential
Conflicts of
Interest. Since the Trust employs leverage, the Investment
Adviser will benefit because the Trust’s Managed Assets will increase with
leverage. Furthermore, the Investment Adviser will also benefit to the extent
that the Trust’s Managed Assets are derived from the reinvested collateral
received on portfolio securities loaned.
In
addition to the Advisory Fee of
Highland, the Trust pays all other costs and expenses of its operations,
including, but not limited to, compensation of its trustees (other than those
affiliated with Highland), custodian, transfer and dividend disbursing agent
expenses, legal fees, listing fees and expenses, expenses of independent
auditors, expenses of preparing, printing and distributing shareholder reports,
notices, proxy statements and reports to governmental agencies, and
reimbursement of actual expenses of the Investment Adviser or others for
registration and maintenance of the Trust’s registrations with the Commission
and other jurisdictions and taxes, if any.
Administrator/Sub-Administrator
Under
an administration agreement
dated May 19, 2006, Highland provides administration services to the Trust,
provides executive and other personnel necessary to administer the Trust and
furnishes office space. Highland receives an annual fee, payable monthly, in
an
amount equal to 0.20% of the average weekly value of the Trust’s Managed Assets.
The accrued fees are payable monthly as promptly as possible after the end
of
each month during which this Agreement is in effect. Highland may waive a
portion of its fees. Under a separate sub-administration agreement, dated May
19, 2006, Highland has delegated certain administrative functions to PFPC,
Inc.,
at an annual rate, payable by Highland, of 0.01% of the average weekly value
of
the Trust’s Managed Assets.
Portfolio
Managers
The
Trust’s portfolio managers are
Kurtis Plumer, James Dondero and Mark Okada. Their investment decisions are
not
subject to the oversight, approval or ratification of a committee.
Kurtis
Plumer, CFA. Mr.
Plumer is a Senior Portfolio Manager and co-head of the Distressed Group at
Highland where he is responsible for managing the sourcing, investing and
monitoring process. He has over 14 years of experience in distressed, high
yield
bond and leveraged loan products. Prior to joining Highland in 1999, Mr. Plumer
was a distressed high yield bond trader at Lehman Brothers in New York, where
he
managed a $250 million portfolio invested in global distressed securities.
While
at Lehman, he also traded emerging market sovereign bonds. Prior to joining
Lehman Brothers, Mr. Plumer was a corporate finance banker at NationsBanc
Capital Markets, Inc. (now Bank of America Capital Markets, Inc.) where he
focused on M&A and financing transactions for the bank’s clients. Mr. Plumer
earned a BBA in Economics and Finance from Baylor University and an MBA in
Strategy and Finance from the Kellogg School at Northwestern University. Mr.
Plumer is a Chartered Financial Analyst.
James
Dondero, CFA, CPA,
CMA. Mr. Dondero is a founder and President of Highland. Formerly, Mr. Dondero
served as Chief Investment Officer of Protective Life’s GIC subsidiary and
helped grow the business from concept to over $2 billion between 1989 and 1993.
His portfolio management experience includes mortgage-backed securities,
investment grade corporates, leveraged bank loans, emerging markets,
derivatives, preferred stocks and common stocks. From 1985 to 1989, he managed
approximately $1 billion in fixed income funds for American Express. Prior
to
American Express, he completed his financial training at Morgan Guaranty Trust
Company. Mr. Dondero is a Beta Gamma Sigma graduate of the University of
Virginia, 1984 with degrees in Accounting and Finance. Mr. Dondero is a
Certified Public Accountant, Chartered Financial Analyst and a Certified
Management Accountant.
Mark
Okada, CFA. Mr. Okada
is Executive Vice President of Strand and the funds in the Highland Fund
Complex. Mr. Okada is a founder and Chief Investment Officer of Highland and
has
served as Chief Investment Officer since 2000. From 1993 to 2000, Mr. Okada
served as Executive Vice President of Highland. He is responsible for overseeing
Highland’s investment activities for its various funds and has over 19 years of
experience in the leveraged finance market. Formerly, Mr. Okada served as
Manager of Fixed Income for Protective Life’s GIC subsidiary from 1990 to 1993.
He was primarily responsible for the bank loan portfolio and other risk assets.
Protective was one of the first non-bank entrants into the syndicated loan
market. From 1986 to 1990, he served as Vice President for Hibernia National
Bank, managing over $1 billion of high-yield bank loans. Mr. Okada is an honors
graduate of the University of California Los Angeles with degrees in Economics
and Psychology. He completed his credit training at Mitsui and is a Chartered
Financial Analyst. Mr. Okada is also Chairman of the Board of Directors of
Common Grace Ministries Inc.
The
Statement of Additional
Information provides additional information about the portfolio managers’
compensation, other accounts managed by the portfolio managers and the portfolio
managers’ ownership of securities issued by the Trust.
NET
ASSET VALUE
The
net asset value of the common
shares of the Trust is computed based upon the value of the Trust’s portfolio
securities and other assets. Net asset value per common share is determined
daily on each day that the New York Stock Exchange is open for business as
of
the close of the regular trading session on the New York Stock Exchange. The
Trust calculates net asset value per common share by subtracting liabilities
(including accrued expenses or dividends) from the total assets of the Trust
(the value of the securities plus cash or other assets, including interest
accrued but not yet received) and dividing the result by the total number of
outstanding common shares of the Trust.
Valuations
The
Trust uses the following
valuation methods to determine either current market value for investments
for
which market quotations are available, or if not available, the fair value,
as
determined in good faith pursuant to policies and procedures approved by the
board of trustees:
|
(i)
|
The
market value of each security listed or traded on any recognized
securities exchange or automated quotation system will be the last
reported sale price at the relevant valuation date on the composite
tape
or on the principal exchange on which such security is traded. If
no sale
is reported on that date, the Investment Adviser utilizes, when available,
pricing quotations from principal market makers. Such quotations
may be
obtained from third-party pricing services or directly from investment
brokers and dealers in the secondary market. Generally, the Trust’s loan
and bond positions are not traded on exchanges and consequently are
valued
based on market prices received from third-party pricing services
or
broker-dealer sources.
|
|
(ii) |
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.
|
|
(iii) |
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.
|
|
(iv) |
The
Trust’s non-marketable investments will generally be valued in such manner
as the Investment Adviser determines in good faith to reflect their
fair
values under procedures established by, and under the general supervision
and responsibility of, the Trust’s board of trustees. The pricing of all
assets that are fair valued in this manner will be subsequently reported
to and ratified by the Trust’s board of
trustees.
|
When
determining the fair value of an
asset, the Investment Adviser seeks to determine the price that the Trust might
reasonably expect to receive from the current sale of that asset in an
arm’s-length transaction. Fair value determinations are based upon all available
factors that the Investment Adviser deems relevant.
DISTRIBUTIONS
Subject
to market conditions, the
Trust expects to declare dividend on the Trust’s common shares on a monthly
basis. The Trust intends to pay any capital gain distributions
annually.
Various
factors will affect the level
of the Trust’s current income and current gains, such as its asset mix and the
Trust’s use of options. To permit the Trust to maintain more stable monthly
dividends and annual distributions, the Trust may from time to time distribute
less than the entire amount of income and gains earned in the relevant month
or
year, respectively. The undistributed income and gains would be available to
supplement future distributions. As a result, the distributions paid by the
Trust for any particular period may be more or less than the amount of income
and gains actually earned by the Trust during the applicable period.
Undistributed income and gains will add to the Trust’s net asset value and,
correspondingly, distributions from undistributed income and gains and from
capital, if any, will be deducted from the Trust’s net asset value. Shareholders
will automatically have all dividends and distributions reinvested in common
shares issued by the Trust or common shares of the Trust purchased in the open
market in accordance with the Trust’s Dividend Reinvestment Plan unless an
election is made to receive cash. Each participant in the Trust’s Dividend
Reinvestment Plan will pay a pro rata portion of brokerage commissions incurred
in connection with open market purchases, and participants requesting a sale
of
securities through the plan agent of the Trust’s Dividend Reinvestment Plan are
subject to a sales fee and a brokerage commission. See “Dividend Reinvestment
Plan.”
DIVIDEND
REINVESTMENT PLAN
Unless
the registered owner of common
shares elects to receive cash by contacting the Plan Agent, all dividends
declared for the common shares of the Trust will be automatically paid in the
form of or, reinvested by PFPC Inc. (the “Plan Agent”), agent for shareholders
in administering the Trust’s Dividend Reinvestment Plan (the “Plan”) in
additional common shares of the Trust. If you are a registered owner of common
shares and elect not to participate in the Plan, you will receive all dividends
in cash paid by check mailed directly to you (or, if the shares are held in
street or other nominee name, then to such nominee) by PFPC, Inc., as dividend
disbursing agent. You may elect not to participate in the Plan and to receive
all dividends in cash by sending written instructions or by contacting PFPC,
Inc., as dividend disbursing agent, at the address set forth below.
Participation in the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by contacting the Plan Agent before the
dividend record date; otherwise such termination or resumption will be effective
with respect to any subsequently declared dividend or other distribution. Some
brokers may automatically elect to receive cash on your behalf and may re-invest
that cash in additional shares of the Trust for you.
The
Plan Agent will open an account
for each shareholder under the Plan in the same name in which such shareholder’s
shares are registered. Whenever the Trust declares a dividend or other
distribution (together, a “dividend”) payable in cash, non-participants in the
Plan will receive cash and participants in the Plan will receive the equivalent
in common shares. The common shares will be acquired by the Plan Agent for
the
participants’ accounts, depending upon the circumstances described below, either
(i) through receipt of additional unissued but authorized shares from the Trust
(“newly issued shares”) or (ii) by purchase of outstanding common shares on the
open market (“open-market purchases”) on the New York Stock Exchange or
elsewhere.
If,
on the payment date for any
dividend, the market price per common share plus estimated brokerage commissions
is greater than the net asset value per common share (such condition being
referred to herein as “market premium”), the Trust will issue common shares,
including fractions, to the participants in the amount of the dividend. The
number of newly issued common shares to be credited to each participant’s
account will be determined by dividing the dollar amount of the dividend
by
the net asset value per common share on the payment date; provided that, if
the
net asset value per common share is less than 95% of the market price per common
share on the payment date, the dollar amount of the dividend will be divided
by
95% of the market price per common share on the payment date.
If,
on the payment date for any
dividend, the net asset value per common share is greater than the market value
per common share plus estimated brokerage commissions (such condition being
referred to herein as “market discount”), the Plan Agent will invest the
dividend amount in common shares acquired on behalf of the participants in
open-market purchases.
In
the event of a market discount on
the payment date for any dividend, the Plan Agent will have until the last
business day before the next date on which the common shares trade on an
“ex-dividend” basis or 120 days after the payment date for such dividend,
whichever is sooner (the “last purchase date”), to invest the dividend amount in
common shares acquired in open-market purchases. It is contemplated that the
Trust will pay monthly dividends. Therefore, the period during which open-market
purchases can be made will exist only from the payment date of each dividend
through the date before the “ex-dividend” date of the third month of the
quarter. If, before the Plan Agent has completed its open-market purchases,
the
market price of a common share exceeds the net asset value per common share,
the
average per common share purchase price paid by the Plan Agent may exceed the
net asset value of the common shares, resulting in the acquisition of fewer
common shares than if the dividend had been paid in newly issued common shares
on the dividend payment date. Because of the foregoing difficulty with respect
to open market purchases, if the Plan Agent is unable to invest the full
dividend amount in open market purchases during the purchase period or if the
market discount shifts to a market premium during the purchase period, the
Plan
Agent may cease making open-market purchases and may invest the uninvested
portion of the dividend amount in newly issued common shares at the net asset
value per common share at the close of business on the last purchase date;
provided that, if the net asset value per common share is less than 95% of
the
market price per common share on the payment date, the dollar amount of the
dividend will be divided by 95% of the market price per common share on the
payment date.
The
Plan Agent maintains all
shareholders’ accounts in the Plan and furnishes written confirmation of all
transactions in the accounts, including information needed by shareholders
for
tax records. Common shares in the account of each Plan participant will be
held
by the Plan Agent on behalf of the Plan participant, and each shareholder proxy
will include those shares purchased or received pursuant to the Plan. The Plan
Agent will forward all proxy solicitation materials to participants and vote
proxies for shares held under the Plan in accordance with the instructions
of
the participants.
In
the case of shareholders such as
banks, brokers or nominees which hold shares for others who are the beneficial
owners, the Plan Agent will administer the Plan on the basis of the number
of
common shares certified from time to time by the record shareholder’s name and
held for the account of beneficial owners who participate in the
Plan.
There
will be no brokerage charges
with respect to common shares issued directly by the Trust. However, each
participant will pay a pro rata share of brokerage commissions incurred in
connection with open-market purchases. The automatic reinvestment of dividends
will not relieve participants of any federal, state or local income tax that
may
be payable (or required to be withheld) on such dividends. Accordingly, any
taxable dividend received by a participant that is reinvested in additional
common shares will be subject to federal (and possibly state and local) income
tax even though such participant will not receive a corresponding amount of
cash
with which to pay such taxes. See “Tax Matters.” Participants who request a sale
of shares through the Plan Agent are subject to a $2.50 sales fee and pay a
brokerage commission of $0.05 per share sold.
The
Trust reserves the right to amend
or terminate the Plan. There is no direct service charge to participants in
the
Plan; however, the Trust reserves the right to amend the Plan to include a
service charge payable by the participants.
All
correspondence concerning the
Plan should be directed to the Plan Agent at PFPC, Inc., 301 Bellevue Parkway,
Wilmington, Delaware 19809; telephone (877) 665-1287.
DESCRIPTION
OF CAPITAL STRUCTURE
Common
Shares
The
Trust is a statutory trust
organized under the laws of Delaware pursuant to an Agreement and Declaration
of
Trust dated as of March 10, 2006. The Trust is authorized to issue an unlimited
number of common shares of beneficial interest, par value $0.001 per share.
Each
common share has one vote and, when issued and paid for in accordance with
the
terms of this offering, will be fully paid and non-assessable, except that
the
trustees shall have the power to cause shareholders to pay expenses of the
Trust
by setting off charges due from shareholders from declared but unpaid dividends
or distributions owed the shareholders and/or by reducing the number of common
shares owned by each respective shareholder. The Trust currently is not aware
of
any expenses that will be paid pursuant to this provision, except to the extent
fees payable under its Dividend Reinvestment Plan are deemed to be paid pursuant
to this provision.
The
Trust intends to hold annual
meetings of shareholders so long as the common shares are listed on a national
securities exchange and such meetings are required as a condition to such
listing. All common shares are equal as to dividends, assets and voting
privileges and have no conversion, preemptive or other subscription rights.
The
Trust will send annual and semi-annual reports, including financial statements,
to all holders of its shares.
The
Trust has no present intention of
offering any additional shares other than the Shares and common shares issued
under the Trust’s Dividend Reinvestment Plan. Any additional offerings of shares
will require approval by the Trust’s board of trustees. Any additional offering
of common shares will be subject to the requirements of the Investment Company
Act, which provides that shares may not be issued at a price below the then
current net asset value, exclusive of sales load, except in connection with
an
offering to existing holders of common shares or with the consent of a majority
of the Trust’s outstanding voting securities.
The
Trust’s common shares are listed
on the New York Stock Exchange under the symbol “HCF.” Unlike
open-end funds, closed-end funds like the Trust do not continuously offer shares
and do not provide daily redemptions. Rather, if a shareholder determines to
buy
additional common shares or sell shares already held, the shareholder may do
so
by trading through a broker on the New York Stock Exchange or otherwise. Shares
of closed-end investment companies frequently trade on an exchange at prices
lower than net asset value. Because the market value of the common shares may
be
influenced by such factors as dividend levels (which are in turn affected by
expenses), dividend stability, net asset value, relative demand for and supply
of such shares in the market, general market and economic conditions and other
factors beyond the control of the Trust, the Trust cannot assure you that common
shares will trade at a price equal to or higher than net asset value in the
future. The common shares are designed primarily for long-term investors and
you
should not purchase the common shares if you intend to sell them soon after
purchase. See the Statement of Additional Information under “Repurchase of
Common Shares.”
The
following table provides
information about the Trust’s outstanding shares as of [·], 2007.
Title
of Class
|
Amount
Authorized
|
Amount
Outstanding
|
Common
Shares
|
Unlimited
|
[·]
|
Other
Shares
The
board of trustees (subject to
applicable law and the Trust’s Agreement and Declaration of Trust) may authorize
an offering, without the approval of the holders of common shares, of other
classes of shares, or other classes or series of shares, as they determine
to be
necessary, desirable or appropriate, having such terms, rights, preferences,
privileges, limitations and restrictions as the board of trustees see fit.
The
Trust currently does not expect to issue any other classes of shares, or series
of shares, except for the common shares.
Credit
Facility
The
Trust is currently using leverage
through borrowings from a credit facility. The Trust has entered into
a Loan Agreement with Scotia to borrow up to $300,000,000. Such borrowings
constitute financial leverage. The Loan Agreement contains covenants
that may limit the Trust’s ability to: (i) pay dividends in certain
circumstances, (ii) incur additional debt and (iii) change its fundamental
investment policies and engage in certain transactions, including mergers and
consolidations. For instance, the Trust agreed not to purchase assets
not contemplated by the Investment Policies and Restrictions in the Prospectus
in effect when the Loan Agreement became effective. Furthermore, the Trust
may
not incur additional debt from any other party, except for in limited
circumstances (e.g., in the ordinary course of business). In addition,
the Loan Agreement contains a covenant requiring asset coverage ratios that
may
be more stringent than those required by the Investment Company Act. Any senior
security representing indebtedness, as defined in Section 18(g) of the
Investment Company Act, such as the loan under the Loan Agreement, must have
asset coverage of at least 300%.
MARKET
AND NET ASSET VALUE INFORMATION
Our
common stock is listed on the
NYSE under the symbol “HCF.” Shares of our common stock commenced trading on the
NYSE in June 2006. Our common stock has a limited trading history. We cannot
predict whether our shares will trade in the future at a premium or discount
to
net asset value. The provisions of the Investment Company Act generally require
that the public offering price of common stock and exclusive of any underwriting
commissions and discounts must equal or exceed the net asset value per share
of
the company’s common stock (calculated within 48 hours of
pricing). Issuance of common stock may have an adverse effect on
prices in the secondary market for our common stock by increasing the number
of
shares of common stock available, which may put downward pressure on the market
price for our common stock.
The
following table sets forth for
each of the periods indicated the high and low closing market prices for our
shares of common stock on the NYSE, the net asset value per share and the
premium/discount to net asset value per share at which our shares of common
stock were trading. Net asset value is generally determined on the last business
day of each calendar month. See “Net Asset Value” for information as to the
determination of our net asset value.
Quarter
|
Market
price(1)
|
|
Net
asset value per share (2)
|
|
Premium/(Discount)
as
a
% of net asset value
|
|
High
|
Low
|
|
High
|
Low
|
|
High
|
Low
|
2nd
Quarter 2006
|
20.60
|
20.18
|
|
19.07
|
19.06
|
|
8.02%
|
5.87%
|
3rd
Quarter 2006
|
21.30
|
19.82
|
|
20.58
|
20.60
|
|
11.40%
|
3.62%
|
4th
Quarter 2006
|
21.48
|
20.10
|
|
21.16
|
20.18
|
|
7.28%
|
3.12%
|
1st
Quarter
2007
|
21.69
|
20.37
|
|
20.87
|
21.10
|
|
6.63%
|
0.18%
|
2nd
Quarter 2007
|
|
|
|
|
|
|
|
|
3rd
Quarter 2007
|
|
|
|
|
|
|
|
|
|
(1) Based
on high and low closing market price for the respective
quarter.
|
|
(2) Based
on the net asset value calculated on the close of business of each
day.
|
ANTI-TAKEOVER
PROVISIONS IN THE AGREEMENT AND DECLARATION OF TRUST
The
Agreement and Declaration of
Trust includes provisions that could have the effect of limiting the ability
of
other entities or persons to acquire control of the Trust or to change the
composition of its board of trustees. This could have the effect of depriving
shareholders of an opportunity to sell their shares at a premium over prevailing
market prices by discouraging a third party from seeking to obtain control
over
the Trust. Such attempts could have the effect of increasing the expenses of
the
Trust and disrupting the normal operation of the Trust. The board of trustees
is
divided into three classes, with the terms of one class expiring at each annual
meeting of shareholders. At each annual meeting, one class of trustees is
elected to a three-year term. This provision could delay for up to two years
the
replacement of a majority of the board of trustees. A trustee may be removed
from office (for cause, and not without cause) by the action of a majority
of
the remaining trustees followed by a vote of the holders of at least 75% of
the
shares then entitled to vote for the election of the respective
trustee.
In
addition, the Trust’s Agreement
and Declaration of Trust requires the favorable vote of a majority of the
Trust’s board of trustees followed by the favorable vote of the holders of at
least 75% of the outstanding shares of each affected class or series of the
Trust, voting separately as a class or series, to approve, adopt or authorize
certain transactions with 5% or greater holders of a class or series of shares
and their associates, unless the transaction has been approved by at least
80%
of the trustees, in which case “a majority of the outstanding voting securities”
(as defined in the Investment Company Act) of the Trust shall be required.
For
purposes of these provisions, a 5% or greater holder of a class or series of
shares (a “Principal Shareholder”) refers to any person who, whether directly or
indirectly and whether alone or together with its affiliates and associates,
beneficially owns 5% or more of the outstanding shares of all outstanding
classes or series of shares of beneficial interest of the Trust.
The
5% holder transactions subject to
these special approval requirements are: the merger or consolidation of the
Trust or any subsidiary of the Trust with or into any Principal Shareholder;
the
issuance of any securities of the Trust to any Principal Shareholder for cash,
except pursuant to any automatic dividend reinvestment plan; the sale, lease
or
exchange of all or any substantial part of the assets of the Trust to any
Principal Shareholder, except assets having an aggregate fair market value
of
less than 2% of the total assets of the Trust, aggregating for the purpose
of
such computation all assets sold, leased or exchanged in any series of similar
transactions within a twelve-month period; or the sale, lease or exchange to
the
Trust or any subsidiary of the Trust, in exchange for securities of the Trust,
of any assets of any Principal Shareholder, except assets having an aggregate
fair market value of less than 2% of the total assets of the Trust, aggregating
for purposes of such computation all assets sold, leased or exchanged in any
series of similar transactions within a twelve-month period.
To
convert the Trust to an open-end
investment company, the Trust’s Agreement and Declaration of Trust requires the
favorable vote of a majority of the board of the trustees followed by the
favorable vote of the holders of at least 75% of the outstanding shares of
each
affected class or series of shares of the Trust, voting separately as a class
or
series, unless such amendment has been approved by at least 80% of the trustees,
in which case “a majority of the outstanding voting securities” (as defined in
the Investment Company Act) of the Trust shall be required. The foregoing vote
would satisfy a separate requirement in the Investment Company Act that any
conversion of the Trust to an open-end investment company be approved by the
shareholders. If approved in the foregoing manner, conversion of the Trust
to an
open-end investment company could not occur until 90 days after the
shareholders’ meeting at which such conversion was approved and would also
require at least 30 days’ prior notice to all shareholders. Following any such
conversion, it is possible that certain of the Trust’s investment policies and
strategies would have to be modified to assure sufficient portfolio liquidity.
In the event of conversion, the common shares would cease to be listed on the
New York Stock Exchange or other national securities exchanges or market
systems. Shareholders of an open-end investment company may require the company
to redeem their shares at any time, except in certain circumstances as
authorized by or under the Investment Company Act, at their net asset value,
less such redemption charge, if any, as might be in effect at the time of a
redemption. The Trust expects to pay all such redemption requests in cash,
but
reserves the right to pay redemption requests in a combination of cash or
securities. If such partial payment in securities were made, investors may
incur
brokerage costs in converting such securities to cash. If the Trust were
converted to an open-end fund, it is likely that new shares would be sold at
net
asset value plus a sales load. The board of trustees believes, however, that
the
closed-end structure is desirable in light of the Trust’s investment objectives
and policies. Therefore, you should assume that it is not likely that the board
of trustees would vote to convert the Trust to an open-end fund.
For
the purposes of calculating “a
majority of the outstanding voting securities” under the Trust’s Agreement and
Declaration of Trust, each class and series of the Trust shall vote together
as
a single class, except to the extent required by the Investment Company Act
or
the Trust’s Agreement and Declaration of Trust, with respect to any class or
series of shares. If a separate class vote is required, the applicable
proportion of shares of the class or series, voting as a separate class or
series, also will be required.
The
Declaration of Trust also
provides that the Trust may be liquidated upon the approval of 80% of the
trustees.
The
board of trustees has determined
that provisions with respect to the board of trustees and the shareholder voting
requirements described above, which voting requirements are greater than the
minimum requirements under Delaware law or the Investment Company Act, are
in
the best interest of shareholders generally. Reference should be made to the
Trust’s Agreement and Declaration of Trust, on file with the Commission for the
full text of these provisions.
CLOSED-END
FUND STRUCTURE
The
Trust is a non-diversified,
closed-end management investment company (commonly referred to as a closed-end
fund). Closed-end funds differ from open-end funds (which are generally referred
to as mutual funds) in that closed-end funds generally list their shares for
trading on a stock exchange and do not redeem their shares at the request of
the
shareholder. This means that if you wish to sell your shares of a closed-end
fund you must trade them on the market like any other stock at the prevailing
market price at that time. In a mutual fund, if the shareholder wishes to sell
shares of the fund, the mutual fund will redeem or buy back the shares at “net
asset value” (less a redemption fee, if applicable, or contingent deferred sales
charge, if applicable). Also, mutual funds generally offer new shares on a
continuous basis to new investors, and closed-end funds generally do not. The
continuous inflows and outflows of assets in a mutual fund can make it difficult
to manage a mutual fund’s
investments.
By comparison, closed-end funds are generally able to stay more fully invested
in securities that are consistent with their investment objective and also
have
greater flexibility to make certain types of investments and to use certain
investment strategies, such as financial leverage and investments in illiquid
securities.
Shares
of closed-end funds frequently
trade at a discount to their net asset value. Because of this possibility and
the recognition that any such discount may not be in the interest of
shareholders, the Trust’s board of trustees might consider from time to time
engaging in open-market repurchases, tender offers for shares or other programs
intended to reduce the discount. We cannot guarantee or assure, however, that
the Trust’s board of trustees will decide to engage in any of these actions. Nor
is there any guarantee or assurance that such actions, if undertaken, would
result in the shares trading at a price equal or close to net asset value per
share. The board of trustees might also consider converting the Trust to an
open-end mutual fund, which would also require a vote of the shareholders of
the
Trust.
REPURCHASE
OF COMMON SHARES
Shares
of closed-end investment
companies often trade at a discount to their net asset value, and the Trust’s
common shares may also trade at a discount to their net asset value, although
it
is possible that they may trade at a premium above net asset value. The market
price of the Trust’s common shares will be determined by such factors as
relative demand for and supply of such common shares in the market, the Trust’s
net asset value, general market and economic conditions and other factors beyond
the control of the Trust. See “Net Asset Value.” Although the Trust’s common
shareholders will not have the right to redeem their common shares, the Trust
may take action to repurchase common shares in the open market or make tender
offers for its common shares. This may have the effect of reducing any market
discount from net asset value.
There
is no assurance that, if action
is undertaken to repurchase or tender for common shares, such action will result
in the common shares trading at a price which approximates their net asset
value. Although share repurchases and tenders could have a favorable effect
on
the market price of the Trust’s common shares, you should be aware that the
acquisition of common shares by the Trust will decrease the capital of the
Trust
and, therefore, may have the effect of increasing the Trust’s expense ratio and
decreasing the asset coverage with respect to any borrowings. Any share
repurchases or tender offers will be made in accordance with requirements of
the
Securities Exchange Act of 1934, as amended, the Investment Company Act and
the
principal stock exchange on which the common shares are traded.
TAX
MATTERS
The
following discussion summarizes
certain U.S. federal income tax considerations affecting the Trust and its
shareholders that are U.S. persons as defined for U.S. federal income tax
purposes. For more information, please see the Statement of Additional
Information under “Tax Matters.” Because each shareholder’s tax situation is
unique, ask your tax professional about the tax consequences to you of an
investment in the Trust.
The
Trust intends to qualify annually
as a regulated investment company under the Code. Accordingly, the Trust
generally will not be subject to U.S. federal income tax on its net investment
income and net realized capital gains that the Trust distributes to its
shareholders. The Trust expects to pay its shareholders annually at
least 90% of such income.
Distributions
paid to both common and
preferred shareholders by the Trust from its net realized long-term capital
gains, if any, that the Trust designates as capital gains dividends (“capital
gain dividends”) are taxable as long-term capital gains, regardless of how long
you have held your shares. All other dividends paid to you by the Trust
(including dividends from short-term capital gains) from its current
or accumulated earnings and profits (“ordinary income dividends”) are generally
subject to tax as ordinary income.
In
general, the Trust does not expect
that a significant portion of its ordinary income dividends will be treated
as
qualified dividend income, which is eligible for taxation at the rates
applicable to long-term capital gains in the case of individual shareholders,
or
that a corporate shareholder will be able to claim a dividends received
deduction with respect to any significant portion of Trust
distributions.
Dividends
and other taxable
distributions are taxable to you even if they are reinvested in additional
common shares of the Trust. Dividends and other distributions paid by the Trust
are generally treated as received by you at the time the dividend or
distribution is made. If, however, the Trust pays you a dividend in January
that
was declared in the previous October, November or December and you were the
shareholder of record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the Trust and
received by you on December 31 of the year in which the dividend was
declared.
The
price of common shares purchased
at any time may reflect the amount of a forthcoming distribution. If you
purchase common shares just prior to a distribution, you will receive a
distribution that will be taxable to you even though it represents in part
a
return of your invested capital.
The
Trust will send you information
after the end of each year setting forth the amount and tax status of any
distributions paid to you by the Trust. Ordinary income dividends and capital
gain dividends may also be subject to state and local taxes.
If
you sell or otherwise dispose of
common shares of the Trust, you will generally recognize a gain or loss in
an
amount equal to the difference between your tax basis in such shares of the
Trust and the amount you receive in exchange for such shares. If you hold your
common shares as capital assets, any such gain or loss generally will be
long-term capital gain or loss if you have held such shares for more than one
year at the time of sale.
The
Trust may be required to
withhold, for U.S. federal backup withholding tax purposes, a portion of the
dividends, distributions and redemption proceeds payable to a non-corporate
shareholder who fails to provide the Trust (or its agent) with the shareholder’s
correct taxpayer identification number (in the case of an individual, generally,
such individual’s social security number) or to make the required certification,
or who has been notified by the Internal Revenue Service (the “IRS”) that such
shareholder is subject to backup withholding. Certain shareholders are exempt
from backup withholding. Backup withholding is not an additional tax and any
amount withheld may be refunded or credited against your U.S. federal income
tax
liability, if any, provided that you furnish the required information to the
IRS.
The
discussions set forth herein and
in the Statement of Additional Information do not constitute tax advice, and
you
are urged to consult your own tax advisor to determine the specific U.S.
federal, state, local and foreign tax consequences to you of investing in the
Trust.
CUSTODIAN
AND TRANSFER AGENT
The
Custodian of the assets of the
Trust will be PFPC Trust Company (8800 Tinicum Blvd., 4th Floor, Philadelphia,
PA 19153; telephone (877) 665-1287). The Custodian will perform custodial,
fund
accounting and portfolio accounting services. PFPC, Inc. (301 Bellevue Parkway,
Wilmington, Delaware 19809; telephone (877) 665-1287) will serve as the Trust’s
transfer agent with respect to its common shares.
LEGAL
OPINIONS
Certain
legal matters in connection
with the common shares will be passed upon for the Trust by Skadden, Arps,
Slate, Meagher & Flom LLP, New York, New York.
PRIVACY
PRINCIPLES OF THE TRUST
The
Trust is committed to maintaining
the privacy of its shareholders and to safeguarding their non-public personal
information. The following information is provided to help you understand what
personal information the Trust collects, how the Trust protects that information
and why, in certain cases, the Trust may share information with select other
parties.
Generally,
the Trust does not receive
any non-public personal information relating to its shareholders, although
certain non-public personal information of its shareholders may become available
to the Trust. The Trust does not disclose any non-public personal information
about its shareholders or former shareholders to anyone, except as permitted
by
law or as is necessary in order to service shareholder accounts (for example,
to
a transfer agent or third party administrator).
The
Trust restricts access to
non-public personal information about its shareholders to employees of the
Trust’s Investment Adviser and its affiliates with a legitimate business need
for the information. The Trust maintains physical, electronic and procedural
safeguards designed to protect the non-public personal information of its
shareholders.
TABLE
OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
|
Page
|
|
|
Use
of Proceeds
|
B-2
|
Investment
Restrictions
|
B-2
|
Investment
Policies and Techniques
|
B-3
|
Other
Investment Policies and Techniques
|
B-12
|
Management
of the Trust
|
B-15
|
Portfolio
Transactions and Brokerage
|
B-23
|
Repurchase
of Common Shares
|
B-23
|
Tax
Matters
|
B-24
|
Experts
|
B-29
|
Additional
Information
|
B-29
|
Appendix
A
|
A-1
|
Appendix
B
|
B-1
|
Highland
Credit Strategies Fund
Common
Shares
___________________________
P
R O S P E C T U S
__________________________
,
2007
The
information in this preliminary prospectus is not complete and may be changed.
We may not sell these securities until the Registration Statement filed with
the
Securities and Exchange Commission is effective. This
preliminary prospectus is not an offer to sell these securities and is not
soliciting an offer to buy these securities in any state where the offer or
sale
is not permitted.
Subject
to Completion, Dated November 2, 2007
Highland
Credit Strategies Fund
Statement
of Additional Information
Highland
Credit Strategies Fund (the
“Trust”) is a non-diversified, closed-end management investment company
registered under the Investment Company Act with no operating history. This
Statement of Additional Information registered under the Investment Company
Act
does not constitute a prospectus, but should be read in conjunction with the
prospectus relating thereto dated [·], 2007. This Statement of Additional
Information does not include all information that a prospective investor should
consider before purchasing common shares, and investors should obtain and read
the prospectus prior to purchasing such shares. A copy of the prospectus may
be
obtained without charge by calling 1-877-665-1287. You may also obtain a copy
of
the prospectus on the Securities and Exchange Commission’s web site
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the
prospectus.
TABLE
OF CONTENTS
|
Page
|
|
|
Use
of Proceeds
|
B-2
|
Investment
Restrictions
|
B-2
|
Investment
Policies and Techniques
|
B-3
|
Other
Investment Policies and Techniques
|
B-12
|
Management
of the Trust
|
B-15
|
Portfolio
Transactions and Brokerage
|
B-23
|
Repurchase
of Common Shares
|
B-23
|
Tax
Matters
|
B-24
|
Experts
|
B-29
|
Additional
Information
|
B-29
|
Appendix
A
|
A-1
|
Appendix
B
|
B-1
|
This
Statement of Additional Information is dated [•],
2007
USE
OF PROCEEDS
Pending
investment in securities that
meet the Trust’s investment objectives and policies, the net proceeds of the
Offer will be invested in short-term debt securities of the type described
under
“Investment Policies and Techniques — Short-Term Debt Securities.” We currently
anticipate that the Trust will be able to invest primarily in securities that
meet the Trust’s investment objectives and policies within approximately [·]
months after the completion of the Offer.
INVESTMENT
RESTRICTIONS
Except
as described below, the Trust,
as a fundamental policy, may not, without the approval of the holders of a
“majority of the outstanding”(1) common shares and any preferred shares, if any,
voting together as a single class, and of the holders of a majority of the
outstanding preferred shares, if any, voting as a separate class:
(1)
invest 25% or more of the value of its total assets in any single industry
or
group of industries;
(2)
issue senior securities or borrow money other than as permitted by the
Investment Company Act or pledge its assets other than to secure such issuances
or in connection with hedging transactions, short sales, securities lending,
when issued and forward commitment transactions and similar investment
strategies;
(3)
make loans of money or property to any person, except through loans of portfolio
securities up to a maximum of 33 1/3% of the Trust’s total assets, the purchase
of debt securities, including bank loans (senior loans) and participations
therein, or the entry into repurchase agreements up to a maximum of 33 1/3%
of
the Trust’s total assets;
(4)
underwrite the securities of other issuers, except to the extent that, in
connection with the disposition of portfolio securities or the sale of its
own
securities, the Trust may be deemed to be an underwriter;
(5)
purchase or sell real estate, except that the Trust may invest in securities
of
companies that deal in real estate or are engaged in the real estate business,
including real estate investment trusts and real estate operating companies,
and
instruments secured by real estate or interests therein and the Trust may
acquire, hold and sell real estate acquired through default, liquidation, or
other distributions of an interest in real estate as a result of the Trust’s
ownership of such other assets; or
(6)
purchase or sell commodities or commodity contracts for any purposes except
as,
and to the extent, permitted by applicable law without the Trust becoming
subject to registration with the Commodity Futures Trading Commission (the
“CFTC”) as a commodity pool.
As
currently relevant to the Trust,
the Investment Company Act requires an asset coverage of 200% for a closed-end
fund with borrowings exceeding 5% of the Trust’s assets (excluding temporary
borrowings).
(1)
|
When
used with respect to shares of the Trust, “majority of the outstanding”
shares means (i) 67% or more of the shares present at a meeting,
if the
holders of more than 50% of the shares are present or represented
by
proxy, or (ii) more than 50% of the shares, whichever is
less.
|
The
Trust is also subject to the
following non-fundamental restrictions and policies, which may be changed by
the
board of trustees and without shareholder approval. The Trust may
not:
|
(1)
|
make
any short sale of securities except in conformity with applicable
laws,
rules and regulations and unless after giving effect to such sale,
the
market value of all securities sold short does not exceed 25% of
the value
of the Trust’s total assets and the Trust’s aggregate short sales of a
particular class of securities of an issuer does not exceed 25% of
the
then outstanding securities of that class. The Trust may also make
short
sales “against the box” without respect to such limitations. In this type
of short sale, at the time of the sale, the Trust owns or has the
immediate and unconditional right to acquire at no additional cost
the
identical security; and
|
|
(2)
|
purchase
securities of open-end or closed-end investment companies except
in
compliance with the Investment Company Act or any exemptive relief
obtained thereunder. Under the Investment Company Act, the Trust
may
invest up to 10% of its total assets in the aggregate in shares of
other
investment companies and up to 5% of its total assets in any one
investment company, provided the investment does not represent more
than
3% of the voting stock of the acquired investment company at the
time such
shares are purchased. As a shareholder in any investment company,
the
Trust will bear its ratable share of that investment company’s expenses,
and will remain subject to payment of the Advisory Fees and other
expenses
with respect to assets so invested. Holders of common shares will
therefore be subject to duplicative expenses to the extent the Trust
invests in other investment companies. In addition, the securities
of
other investment companies may be leveraged and will therefore be
subject
to the risks of leverage. The net asset value and market value of
leveraged shares will be more volatile and the yield to shareholders
will
tend to fluctuate more than the yield generated by unleveraged
shares.
|
In
addition, to comply with the
federal tax requirements for qualification as a registered investment company,
the Trust’s investments must meet certain diversification requirements. See “Tax
Matters.”
The
percentage limitations applicable
to the Trust’s portfolio described in the prospectus and this Statement of
Additional Information apply only at the time of investment, except that the
percentage limitation with respect to borrowing applies at all times, and the
Trust will not be required to sell securities due to subsequent changes in
the
value of securities it owns.
INVESTMENT
POLICIES AND TECHNIQUES
The
following information supplements
the discussion of the Trust’s investment objectives, policies and techniques
that are described in the prospectus.
Short-Term
Debt Securities
(1)
For temporary defensive purposes or to keep cash on hand, the Trust may invest
up to 100% of its total assets in cash equivalents and short-term debt
securities. Short-term debt investments are defined to include, without
limitation, the following: U.S. Government securities, including bills, notes
and bonds differing as to maturity and rates of interest that are either issued
or guaranteed by the U.S. Treasury or by U.S. Government agencies or
instrumentalities. U.S. Government securities include securities issued by
(a)
the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and Government
National Mortgage Association, whose securities are supported by the full faith
and credit of the United States; (b) the Federal Home Loan Banks,
Federal
Intermediate Credit Banks, and Tennessee Valley Authority, whose securities
are
supported by the right of the agency to borrow from the U.S. Treasury; (c)
the
Federal National Mortgage Association, whose securities are supported by the
discretionary authority of the U.S. Government to purchase certain obligations
of the agency or instrumentality; and (d) the Student Loan Marketing
Association, whose securities are supported only by its credit. While the U.S.
Government provides financial support to such U.S. Government-sponsored agencies
or instrumentalities, no assurance can be given that it always will do so since
it is not so obligated by law. The U.S. Government, its agencies and
instrumentalities do not guarantee the market value of their securities.
Consequently, the value of such securities may fluctuate.
(2)
Certificates of deposit issued against funds deposited in a bank or a savings
and loan association. Such certificates are for a definite period of time,
earn
a specified rate of return, and are normally negotiable. The issuer of a
certificate of deposit agrees to pay the amount deposited plus interest to
the
bearer of the certificate on the date specified thereon. Certificates of deposit
purchased by the Trust may not be fully insured by the Federal Deposit Insurance
Corporation.
(3)
Repurchase agreements, which involve purchases of debt securities. At the time
the Trust purchases securities pursuant to a repurchase agreement, it
simultaneously agrees to resell and redeliver such securities to the seller,
who
also simultaneously agrees to buy back the securities at a fixed price and
time.
This assures a predetermined yield for the Trust during its holding period,
since the resale price is always greater than the purchase price and reflects
an
agreed-upon market rate. Such actions afford an opportunity for the Trust to
invest temporarily available cash. The Trust may enter into repurchase
agreements only with respect to obligations of the U.S. Government, its agencies
or instrumentalities; certificates of deposit; or bankers’ acceptances in which
the Trust may invest. Repurchase agreements may be considered loans to the
seller, collateralized by the underlying securities. The risk to the Trust
is
limited to the ability of the seller to pay the agreed-upon sum on the
repurchase date; in the event of default, the repurchase agreement provides
that
the Trust is entitled to sell the underlying collateral. If the value of the
collateral declines after the agreement is entered into, and if the seller
defaults under a repurchase agreement when the value of the underlying
collateral is less than the repurchase price, the Trust could incur a loss
of
both principal and interest. Highland monitors the value of the collateral
at
the time the action is entered into and at all times during the term of the
repurchase agreement. Highland does so in an effort to determine that the value
of the collateral always equals or exceeds the agreed-upon repurchase price
to
be paid to the Trust. If the seller were to be subject to a federal bankruptcy
proceeding, the ability of the Trust to liquidate the collateral could be
delayed or impaired because of certain provisions of the bankruptcy
laws.
(4)
Commercial paper, which consists of short-term unsecured promissory notes,
including variable rate master demand notes issued by corporations to finance
their current operations. Master demand notes are direct lending arrangements
between the Trust and a corporation. There is no secondary market for such
notes. However, they are redeemable by the Trust at any time. Highland will
consider the financial condition of the corporation (e.g., earning power, cash
flow and other liquidity ratios) and will continually monitor the corporation’s
ability to meet all of its financial obligations, because the Trust’s liquidity
might be impaired if the corporation were unable to pay principal and interest
on demand. Investments in commercial paper will be limited to commercial paper
rated in the highest categories by a major rating agency and which mature within
one year of the date of purchase or carry a variable or floating rate of
interest.
Equity
Securities
The
Trust may invest in equity
securities including preferred stocks, convertible securities, warrants and
depository receipts.
Preferred
Stock. Preferred stock has a preference over common
stock in liquidation (and generally dividends as well) but is subordinated
to
the liabilities of the issuer in all respects. As a general rule, the market
value of preferred stock with a fixed dividend rate and no conversion element
varies inversely with interest rates and perceived credit risk, while the market
price of convertible preferred stock generally also reflects some element of
conversion value. Because preferred stock is junior to debt securities and
other
obligations of the issuer, deterioration in the credit quality of the issuer
will cause greater changes in the value of a preferred stock than in a more
senior debt security with similar stated yield characteristics. Unlike interest
payments on debt securities, preferred stock dividends are payable only if
declared by the issuer’s board of directors. Preferred stock also may be subject
to optional or mandatory redemption provisions.
Convertible
Securities. A convertible security is a bond,
debenture, note, preferred stock or other security that may be converted into
or
exchanged for a prescribed amount of common stock or other equity security
of
the same or a different issuer within a particular period of time at a specified
price or formula. A convertible security entitles the holder to receive interest
paid or accrued on debt or the dividend paid on preferred stock until the
convertible security matures or is redeemed, converted or exchanged. Before
conversion, convertible securities have characteristics similar to
nonconvertible income securities in that they ordinarily provide a stable stream
of income with generally higher yields than those of common stocks of the same
or similar issuers, but lower yields than comparable nonconvertible securities.
The value of a convertible security is influenced by changes in interest rates,
with investment value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and other factors
also
may have an effect on the convertible security’s investment value. Convertible
securities rank senior to common stock in a corporation’s capital structure but
are usually subordinated to comparable nonconvertible securities. Convertible
securities may be subject to redemption at the option of the issuer at a price
established in the convertible security’s governing instrument.
Warrants. Warrants,
which are privileges issued by corporations enabling the owners to subscribe
to
and purchase a specified number of shares of the corporation at a specified
price during a specified period of time. Subscription rights normally have
a
short life span to expiration. The purchase of warrants involves the risk that
the Trust could lose the purchase value of a right or warrant if the right
to
subscribe to additional shares is not exercised prior to the warrants’
expiration. Also, the purchase of warrants involves the risk that the effective
price paid for the warrant added to the subscription price of the related
security may exceed the value of the subscribed security’s market price such as
when there is no movement in the level of the underlying security.
Depository
Receipts. The Trust may invest in both sponsored and
unsponsored American Depository Receipts (“ADRs”), European Depository Receipts
(“EDRs”), Global Depository Receipts (“GDRs”) and other similar global
instruments. ADRs typically are issued by an American bank or trust company
and
evidence ownership of underlying securities issued by a non-U.S. corporation.
EDRs, which are sometimes referred to as Continental Depository Receipts, are
receipts issued in Europe, typically by non-U.S. banks and trust companies,
that
evidence ownership of either non-U.S. or U.S. underlying securities. GDRs are
depository receipts structured like global debt issues to facilitate trading
on
an international basis. Unsponsored ADR, EDR and GDR programs are organized
independently and without the cooperation of the issuer of the underlying
securities. As a result, available information concerning the issuer may not
be
as current as for sponsored ADRs, EDRs and GDRs, and the prices of unsponsored
ADRs, EDRs and GDRs may be more volatile than if such instruments were sponsored
by the issuer. Investments in ADRs, EDRs and GDRs may present additional
investment considerations of non-U.S. securities.
Variable
and Floating Rate Instruments
The
Trust may purchase rated and
unrated variable and floating rate instruments. These instruments may include
variable amount master demand notes that permit the indebtedness thereunder to
vary in addition to providing for periodic adjustments in the interest rate.
The
Trust may invest in leveraged inverse floating rate debt instruments (“Inverse
Floaters”). The interest rate of an Inverse Floater resets in the opposite
direction from the market rate of interest to which it is indexed. An Inverse
Floater may be considered to be leveraged to the extent that its interest rate
varies by a magnitude that exceeds the magnitude of the change in the index
rate
of interest. The higher degree of leverage inherent in Inverse Floaters is
associated with greater volatility in their market values. Issuers of unrated
variable and floating rate instruments must satisfy the same criteria as set
forth above for the Trust. The absence of an active secondary market with
respect to particular variable and floating rate instruments, however, could
make it difficult for the Trust to dispose of a variable or floating rate
instrument if the issuer defaulted on its payment obligation or during periods
when the Trust is not entitled to exercise its demand rights.
With
respect to purchasable variable
and floating rate instruments, Highland will consider the earning power, cash
flows and liquidity ratios of the issuers and guarantors of such instruments
and, if the instruments are subject to a demand feature, will monitor their
financial status to meet payment on demand. Such instruments may include
variable amount master demand notes that permit the indebtedness thereunder
to
vary in addition to providing for periodic adjustments in the interest rate.
The
absence of an active secondary market with respect to particular variable and
floating rate instruments could make it difficult for the Trust to dispose
of a
variable or floating rate note if the issuer defaulted on its payment obligation
or during periods that the Trust is not entitled to exercise its demand rights,
and the Trust could, for these or other reasons, suffer a loss, with respect
to
such instruments. In determining average-weighted portfolio maturity, an
instrument will be deemed to have a maturity equal to either the period
remaining until the next interest rate adjustment or the time the Trust involved
can recover payment of principal as specified in the instrument, depending
on
the type of instrument involved.
Derivative
Transactions and Risk Management
Consistent
with its investment
objectives and policies set forth in the prospectus and in addition to its
option strategy, the Trust may also enter into certain risk management
transactions. In particular, the Trust may purchase and sell futures contracts,
exchange listed and over-the-counter put and call options on securities, equity
and other indices and futures contracts, forward foreign currency contracts,
and
may enter into various interest rate transactions. Derivative Transactions
may
be used to attempt to protect against possible changes in the market value
of
the Trust’s portfolio resulting from fluctuations in the securities markets and
changes in interest rates, to protect the Trust’s unrealized gains in the value
of its portfolio securities, to facilitate the sale of such securities for
investment purposes and to establish a position in the securities markets as
a
temporary substitute for purchasing particular securities. Any or all of these
Derivative Transactions may be used at any time. There is no particular strategy
that requires use of one technique rather than another. Use of any Derivative
Transaction is a function of market conditions. The ability of the Trust to
manage them successfully will depend on Highland’s ability to predict pertinent
market movements as well as sufficient correlation among the instruments, which
cannot be assured. The Derivative Transactions that the Trust may use are
described below. Although the Trust recognizes it is not likely that it will
use
certain of these strategies in light of its investment policies, it nevertheless
describes them here because the Trust may seek to use these strategies in
certain circumstances.
Futures
Contracts and
Options on Futures Contracts. In connection with its
Derivative Transactions and other risk management strategies, the Trust may
also
enter into contracts for the
purchase
or sale for future delivery (“futures contracts”) of securities, aggregates of
securities or indices or prices thereof, other financial indices and U.S.
government debt securities or options on the above. The Trust will engage in
such transactions only for bona fide risk management and other portfolio
management purposes.
Forward
Foreign Currency
Contracts. The Trust may enter into forward currency
contracts to purchase or sell foreign currencies for a fixed amount of U.S.
dollars or another foreign currency. A forward currency contract involves an
obligation to purchase or sell a specific currency at a future date, which
may
be any fixed number of days from the date of the forward currency contract
agreed upon by the parties, at a price set at the time the forward currency
contract is entered into. Forward currency contracts are traded directly between
currency traders (usually large commercial banks) and their
customers.
The
Trust may engage in various
forward currency contract strategies:
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The
Trust may purchase a forward currency contract to lock in the U.S.
dollar
price of a security denominated in a foreign currency that the Trust
intends to acquire. The Trust may sell a forward currency contract
to lock
in the U.S. dollar equivalent of the proceeds from the anticipated
sale of
a security or a dividend or interest payment denominated in a foreign
currency.
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The
Trust may also use forward currency contracts to shift the Trust’s
exposure to foreign currency exchange rate changes from one currency
to
another. For example, if the Trust owns securities denominated in
a
foreign currency and Highland believes that currency will decline
relative
to another currency, the Trust might enter into a forward currency
contract to sell the appropriate amount of the first foreign currency
with
payment to be made in the second
currency.
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The
Trust may also purchase forward currency contracts to enhance income
when
Highland anticipates that the foreign currency will appreciate in
value
but securities denominated in that currency do not present attractive
investment opportunities.
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The
Trust may also use forward currency contracts to offset against a
decline
in the value of existing investments denominated in a foreign currency.
Such a transaction would tend to offset both positive and negative
currency fluctuations, but would not offset changes in security values
caused by other factors.
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The
Trust could also enter into a forward currency contract to sell another
currency expected to perform similarly to the currency in which the
Trust’s existing investments are denominated. This type of transaction
could offer advantages in terms of cost, yield or efficiency, but
may not
offset currency exposure as effectively as a simple forward currency
transaction to sell U.S. dollars. This type of transaction may result
in
losses if the currency sold does not perform similarly to the currency
in
which the Trust’s existing investments are
denominated.
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The
Trust may also use forward currency contracts in one currency or
a basket
of currencies to attempt to offset against fluctuations in the value
of
securities denominated in a different currency if Highland anticipates
that there will be a correlation between the two
currencies.
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The
cost to the Trust of engaging in forward currency contracts varies
with
factors such as the currency involved, the length of the contract
period
and the market conditions then
prevailing.
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Because forward currency contracts are usually entered into on a principal
basis, no fees or commissions are involved.
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When
the Trust enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency
at the
maturity of the contract. Failure by the counterparty to do so would
result in the loss of some or all of any expected benefit of the
transaction. Secondary markets generally do not exist for forward
currency
contracts, with the result that closing transactions generally can
be made
for forward currency contracts only by negotiating directly with
the
counterparty. Thus, there can be no assurance that the Trust will
in fact
be able to close out a forward currency contract at a favorable price
prior to maturity. In addition, in the event of insolvency of the
counterparty, the Trust might be unable to close out a forward currency
contract. In either event, the Trust would continue to be subject
to
market risk with respect to the position, and would continue to be
required to maintain a position in securities denominated in the
foreign
currency or to maintain cash or liquid assets in a segregated account.
The
precise matching of forward currency contract amounts and the value
of the
securities involved generally will not be possible because the value
of
such securities, measured in the foreign currency, will change after
the
forward currency contract has been established. Thus, the Trust might
need
to purchase or sell foreign currencies in the spot (cash) market
to the
extent such foreign currencies are not covered by forward currency
contracts. The projection of short-term currency market movements
is
extremely difficult, and the successful execution of a short-term
strategy
is highly uncertain.
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Calls
on Securities,
Indices and Futures Contracts. In addition to its
option strategy, in order to enhance income or reduce fluctuations on net asset
value, the Trust may sell or purchase call options (“calls”) on securities and
indices based upon the prices of futures contracts and debt or equity securities
that are traded on U.S. and non-U.S. securities exchanges and in the
over-the-counter markets. A call option gives the purchaser of the option the
right to buy, and obligates the seller to sell, the underlying security, futures
contract or index at the exercise price at any time or at a specified time
during the option period. All such calls sold by the Trust must be “covered” as
long as the call is outstanding (i.e., the Trust must own the
instrument subject to the call or other securities or assets acceptable for
applicable segregation and coverage requirements). A call sold by the Trust
exposes the Trust during the term of the option to possible loss of opportunity
to realize appreciation in the market price of the underlying security, index
or
futures contract and may require the Trust to hold an instrument which it might
otherwise have sold. The purchase of a call gives the Trust the right to buy
a
security, futures contract or index at a fixed price. Calls on futures on
securities must also be covered by assets or instruments acceptable under
applicable segregation and coverage requirements.
Puts
on Securities,
Indices and Futures Contracts. In addition to its
option strategy, the Trust may purchase put options (“puts”) that relate to
securities (whether or not it holds such securities in its portfolio), indices
or futures contracts. For the same purposes, the Trust may also sell puts on
securities, indices or futures contracts on such securities if the Trust’s
contingent obligations on such puts are secured by segregated assets consisting
of cash or liquid debt securities having a value not less than the exercise
price. In selling puts, there is a risk that the Trust may be required to buy
the underlying security at a price higher than the current market
price.
Interest
Rate
Transactions. Among the Derivative Transactions in
which the Trust may enter into are interest rate swaps and the purchase or
sale
of interest rate caps and floors. The Trust expects to enter into these
transactions primarily to preserve a return or spread on a particular investment
or portion of its portfolio as a duration management technique or to protect
against any increase in the price of securities the Trust anticipates purchasing
at a later date. The Trust intends to use these transactions for risk management
purposes and not as a speculative investment. The Trust will not sell interest
rate caps or
floors
that it does not own. Interest rate swaps involve the exchange by the Trust
with
another party of their respective commitments to pay or receive interest,
e.g., an exchange of floating rate payments for fixed rate payments
with respect to a notional amount of principal. The purchase of an interest
rate
cap entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase
of
an interest rate floor entitles the purchaser, to the extent that a specified
index falls below a predetermined interest rate, to receive payments of interest
on a notional principal amount from the party selling such interest rate
floor.
The
Trust may enter into interest
rate swaps, caps and floors on either an asset based or liability-based basis,
depending on whether it is offsetting volatility with respect to its assets
or
liabilities, and will usually enter into interest rate swaps on a net basis,
i.e., the two payment streams are netted out, with the Trust receiving or
paying, as the case may be, only the net amount of the two payments on the
payment dates. Inasmuch as these Derivative Transactions are incurred into
for
good faith risk management purposes. Highland and the Trust believe such
obligations do not constitute senior securities, and, accordingly will not
treat
them as being subject to its borrowing restrictions. The Trust will accrue
the
net amount of the excess, if any, of the Trust’s obligations over its
entitlements with respect to each interest rate swap on a daily basis and will
designate on its books and records with a custodian an amount of cash or liquid
high grade securities having an aggregate net asset value at all times at least
equal to the accrued excess. The Trust will not enter into any interest rate
swap, cap or floor transaction unless the unsecured senior debt or the claims
paying ability of the other party thereto is rated in the highest rating
category of at least one nationally recognized statistical rating organization
at the time of entering into such transaction. If there is a default by the
other party to such a transaction, the Trust will have contractual remedies
pursuant to the agreements related to the transaction. The swap market has
grown
substantially in recent years with a large number of banks and investment
banking firms acting both as principals and as agents utilizing standardized
swap documentation. Caps and floors are more recent innovations for which
standardized documentation has not yet been developed and, accordingly, they
are
less liquid than swaps.
Credit
Derivatives. The Trust may engage in credit derivative
transactions. There are two broad categories of credit derivatives: default
price risk derivatives and market spread derivatives. Default price risk
derivatives are linked to the price of reference securities or loans after
a
default by the issuer or borrower, respectively. Market spread derivatives
are
based on the risk that changes in market factors, such as credit spreads, can
cause a decline in the value of a security, loan or index.
There
are three basic transactional
forms for credit derivatives: swaps, options and structured instruments. The
use
of credit derivatives is a highly specialized activity which involves strategies
and risks different from those associated with ordinary portfolio security
transactions. If Highland is incorrect in its forecasts of default risks, market
spreads or other applicable factors, the investment performance of the Trust
would diminish compared with what it would have been if these techniques were
not used. Moreover, even if Highland is correct in its forecasts, there is
a
risk that a credit derivative position may correlate imperfectly with the price
of the asset or liability being purchased. There is no limit on the amount
of
credit derivative transactions that may be entered into by the Trust. The
Trust’s risk of loss in a credit derivative transaction varies with the form of
the transaction. For example, if the Trust purchases a default option on a
security, and if no default occurs with respect to the security, the Trust’s
loss is limited to the premium it paid for the default option. In contrast,
if
there is a default by the grantor of a default option, the Trust’s loss will
include both the premium that it paid for the option and the decline in value
of
the underlying security that the default option protects.
Below
under “General Characteristics
of Risks of Derivative Transactions” is further information about the
characteristics, risks and possible benefits of Derivative Transactions and
the
Trust’s other
policies
and limitations (which are not fundamental policies) relating to investment
in
futures contracts and options. The principal risks relating to the use of
futures contracts and other Derivative Transactions are: (i) less than perfect
correlation between the prices of the instrument and the market value of the
securities in the Trust’s portfolio; (ii) possible lack of a liquid secondary
market for closing out a position in such instruments; (iii) losses resulting
from interest rate or other market movements not anticipated by Highland; and
(iv) the obligation to meet additional variation margin or other payment
requirements, all of which could result in the Trust being in a worse position
than if such techniques had not been used.
Certain
provisions of the Code may
restrict or affect the ability of the Trust to engage in Derivative
Transactions. See “Tax Matters.”
General
Characteristics and Risks of Derivative Transactions
In
order to manage the risk of its
securities portfolio, or to enhance income or gain as described in the
prospectus, the Trust will engage in Derivative Transactions. The Trust will
engage in such activities in the Investment Adviser’s discretion, and may not
necessarily be engaging in such activities when movements in interest rates
that
could affect the value of the assets of the Trust occur. The Trust’s ability to
pursue certain of these strategies may be limited by applicable regulations
of
the CFTC. Certain Derivative Transactions may give rise to taxable
income.
Put
and Call Options on Securities and Indices
The
Trust may purchase and sell put
and call options on securities and indices. A put option gives the purchaser
of
the option the right to sell and the writer the obligation to buy the underlying
security at the exercise price during the option period. The Trust may also
purchase and sell options on securities indices (“index options”). Index options
are similar to options on securities except that, rather than taking or making
delivery of securities underlying the option at a specified price upon exercise,
an index option gives the holder the right to receive cash upon exercise of
the
option if the level of the securities index upon which the option is based
is
greater, in the case of a call, or less, in the case of a put, than the exercise
price of the option. The purchase of a put option on a security could protect
the Trust’s holdings in a security or a number of securities against a
substantial decline in the market value. A call option gives the purchaser
of
the option the right to buy and the seller the obligation to sell the underlying
security or index at the exercise price during the option period or for a
specified period prior to a fixed date. The purchase of a call option on a
security could protect the Trust against an increase in the price of a security
that it intended to purchase in the future. In the case of either put or call
options that it has purchased, if the option expires without being sold or
exercised, the Trust will experience a loss in the amount of the option premium
plus any related commissions. When the Trust sells put and call options, it
receives a premium as the seller of the option. The premium that the Trust
receives for selling the option will serve as a partial offset, in the amount
of
the option premium, against changes in the value of the securities in its
portfolio. During the term of the option, however, a covered call seller has,
in
return for the premium on the option, given up the opportunity for capital
appreciation above the exercise price of the option if the value of the
underlying security increases, but has retained the risk of loss should the
price of the underlying security decline. Conversely, a secured put seller
retains the risk of loss should the market value of the underlying security
decline below the exercise price of the option, less the premium received on
the
sale of the option. The Trust is authorized to purchase and sell exchange listed
options and over-the-counter options (“OTC Options”) which are privately
negotiated with the counterparty. Listed options are issued by the Options
Clearing Corporation (“OCC”) which guarantees the performance of the obligations
of the parties to such options.
The
Trust’s ability to close out its
position as a purchaser or seller of an exchange listed put or call option
is
dependent upon the existence of a liquid secondary market on option exchanges.
Among the
possible
reasons for the absence of a liquid secondary market on an exchange are: (i)
insufficient trading interest in certain options; (ii) restrictions on
transactions imposed by an exchange; (iii) trading halts, suspensions or other
restrictions imposed with respect to particular classes or series of options
or
underlying securities; (iv) interruption of the normal operations on an
exchange; (v) inadequacy of the facilities of an exchange or OCC to handle
current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options on that exchange
that had been listed by the OCC as a result of trades on that exchange would
generally continue to be exercisable in accordance with their terms. OTC Options
are purchased from or sold to dealers, financial institutions or other
counterparties which have entered into direct agreements with the Trust. With
OTC Options, such variables as expiration date, exercise price and premium
will
be agreed upon between the Trust and the counterparty, without the
intermediation of a third party such as the OCC. If the counterparty fails
to
make or take delivery of the securities underlying an option it has written,
or
otherwise settle the transaction in accordance with the terms of that option
as
written, the Trust would lose the premium paid for the option as well as any
anticipated benefit of the transaction.
The
hours of trading for options on
securities may not conform to the hours during which the underlying securities
are traded. To the extent that the option markets close before the markets
for
the underlying securities, significant price movements can take place in the
underlying markets that cannot be reflected in the option markets.
Futures
Contracts and Related Options
Characteristics. The
Trust may sell financial futures contracts or purchase put and call options
on
such futures as an offset against anticipated market movements. The sale of
a
futures contract creates an obligation by the Trust, as seller, to deliver
the
specific type of financial instrument called for in the contract at a specified
future time for a specified price. Options on futures contracts are similar
to
options on securities except that an option on a futures contract gives the
purchaser the right in return for the premium paid to assume a position in
a
futures contract (a long position if the option is a call and a short position
if the option is a put).
Margin
Requirements. At the time a futures contract is
purchased or sold, the Trust must allocate cash or securities as a deposit
payment (“initial margin”). It is expected that the initial margin that the
Trust will pay may range from approximately 1% to approximately 5% of the value
of the securities or commodities underlying the contract. In certain
circumstances, however, such as periods of high volatility, the Trust may be
required by an exchange to increase the level of its initial margin payment.
Additionally, initial margin requirements may be increased generally in the
future by regulatory action. An outstanding futures contract is valued daily
and
the payment in case of “variation margin” may be required, a process known as
“marking to the market.” Transactions in listed options and futures are usually
settled by entering into an offsetting transaction, and are subject to the
risk
that the position may not be able to be closed if no offsetting transaction
can
be arranged.
Limitations
on Use of
Futures and Options on Futures. The Trust’s use of
futures and options on futures will in all cases be consistent with applicable
regulatory requirements and in particular the rules and regulations of the
CFTC.
The Trust currently may enter into such transactions without limit for bona
fide
strategic purposes, including risk management and duration management and other
portfolio strategies. The Trust may also engage in transactions in futures
contracts or related options for non-strategic purposes to enhance income or
gain provided that the Trust will not enter into a futures contract or related
option (except for closing transactions) for purposes other than bona fide
strategic purposes, or risk management including duration management if,
immediately thereafter, the sum of the amount
of
its initial deposits and premiums on open contracts and options would exceed
5%
of the Trust’s liquidation value, i.e., net assets (taken at current
value); provided, however, that in the case of an option that is in-the-money
at
the time of the purchase, the in-the-money amount may be excluded in calculating
the 5% limitation. The above policies are non-fundamental and may be changed
by
the Trust’s board of trustees at any time. Also, when required, an account of
cash equivalents designated on the books and records will be maintained and
marked to market on a daily basis in an amount equal to the market value of
the
contract.
Segregation
and Cover
Requirements. Futures contracts, interest rate swaps,
caps, floors and collars, short sales, reverse repurchase agreements and dollar
rolls, and listed or OTC options on securities, indices and futures contracts
sold by the Trust are generally subject to earmarking and coverage requirements
of either the CFTC or the SEC, with the result that, if the Trust does not
hold
the security or futures contract underlying the instrument, the Trust will
be
required to designate on its books and records an ongoing basis, cash, U.S.
government securities, or other liquid high grade debt obligations in an amount
at least equal to the Trust’s obligations with respect to such
instruments.
Such
Amounts Fluctuate as
the Obligations Increase or Decrease. The earmarking
requirement can result in the Trust maintaining securities positions it would
otherwise liquidate, segregating assets at a time when it might be
disadvantageous to do so or otherwise restrict portfolio
management.
Derivative
Transactions
Present Certain Risks. With respect to Derivative
Transactions and risk management, the variable degree of correlation between
price movements of strategic instruments and price movements in the position
being offset create the possibility that losses using the strategy may be
greater than gains in the value of the Trust’s position. The same is true for
such instruments entered into for income or gain. In addition, certain
instruments and markets may not be liquid in all circumstances. As a result,
in
volatile markets, the Trust may not be able to close out a transaction without
incurring losses substantially greater than the initial deposit. Although the
contemplated use of these instruments predominantly for Derivative Transactions
should tend to minimize the risk of loss due to a decline in the value of the
position, at the same time they tend to limit any potential gain which might
result from an increase in the value of such position. The ability of the Trust
to successfully utilize Derivative Transactions will depend on the Investment
Adviser’s and the sub-adviser’s ability to predict pertinent market movements
and sufficient correlations, which cannot be assured. Finally, the daily deposit
requirements in futures contracts that the Trust has sold create an on going
greater potential financial risk than do options transactions, where the
exposure is limited to the cost of the initial premium. Losses due to the use
of
Derivative Transactions will reduce net asset value.
Regulatory
Considerations. The Trust has claimed an exclusion from
the term “commodity pool operator” under the Commodity Exchange Act and,
therefore, is not subject to registration or regulation as a commodity pool
operator under the Commodity Exchange Act.
OTHER
INVESTMENT POLICIES AND TECHNIQUES
Restricted
and Illiquid Securities
Certain
of the Trust’s investments
may be illiquid. Illiquid securities are subject to legal or contractual
restrictions on disposition or lack an established secondary trading market.
The
sale of restricted and illiquid securities often requires more time and results
in higher brokerage charges or dealer discounts and other selling expenses
than
does the sale of securities eligible for trading on national securities
exchanges or in the over-the-counter markets. Restricted securities may sell
at
a price lower than similar securities that are not subject to restrictions
on
resale.
When-Issued
and Forward Commitment Securities
The
Trust may purchase securities on
a “when-issued” basis and may purchase or sell securities on a “forward
commitment” basis in order to acquire the security or to offset against
anticipated changes in interest rates and prices. When such transactions are
negotiated, the price, which is generally expressed in yield terms, is fixed
at
the time the commitment is made, but delivery and payment for the securities
take place at a later date. When-issued securities and forward commitments
may
be sold prior to the settlement date, but the Trust will enter into when-issued
and forward commitments only with the intention of actually receiving or
delivering the securities, as the case may be. If the Trust disposes of the
right to acquire a when-issued security prior to its acquisition or disposes
of
its right to deliver or receive against a forward commitment, it might incur
a
gain or loss. At the time the Trust enters into a transaction on a when-issued
or forward commitment basis, it will designate on its books and records cash
or
liquid debt securities equal to at least the value of the when-issued or forward
commitment securities. The value of these assets will be monitored daily to
ensure that their marked to market value will at all times equal or exceed
the
corresponding obligations of the Trust. There is always a risk that the
securities may not be delivered and that the Trust may incur a loss. Settlements
in the ordinary course, which may take substantially more than five business
days, are not treated by the Trust as when-issued or forward commitment
transactions and accordingly are not subject to the foregoing
restrictions.
Pay-In-Kind
Bonds
The
Trust may invest in Pay-in-kind,
or “PIK” bonds. PIK bonds are bonds which pay interest through the issuance of
additional debt or equity securities. Similar to zero coupon obligations, PIK
bonds also carry additional risk as holders of these types of securities realize
no cash until the cash payment date unless a portion of such securities is
sold
and, if the issuer defaults, the Trust may obtain no return at all on its
investment. The market price of PIK bonds is affected by interest rate changes
to a greater extent, and therefore tends to be more volatile, than that of
securities which pay interest in cash. Additionally, current federal tax law
requires the holder of certain PIK bonds to accrue income with respect to these
securities prior to the receipt of cash payments. To maintain its qualification
as a regulated investment company and avoid liability for federal income and
excise taxes, the Trust may be required to distribute income accrued with
respect to these securities and may have to dispose of portfolio securities
under disadvantageous circumstances in order to generate cash to satisfy these
distribution requirements.
Brady
Bonds
The
Trust’s emerging market debt
securities may include emerging market governmental debt obligations commonly
referred to as Brady Bonds. Brady Bonds are debt securities, generally
denominated in U.S. dollars, issued under the framework of the Brady Plan,
an
initiative announced by U.S. Treasury Secretary Nicholas F. Brady in 1989 as
a
mechanism for debtor nations (primarily emerging market countries) to
restructure their outstanding external indebtedness (generally, commercial
bank
debt). Brady Bonds are created through the exchange of existing commercial
bank
loans to foreign entities for new obligations in connection with debt
restructuring. A significant amount of the Brady Bonds that the Trust may
purchase have no or limited collateralization, and the Trust will be relying
for
payment of interest and (except in the case of principal collateralized Brady
Bonds) principal primarily on the willingness and ability of the foreign
government to make payment in accordance with the terms of the Brady Bonds.
A
substantial portion of the Brady Bonds and other sovereign debt securities
in
which the Trust may invest are likely to be acquired at a
discount.
Mezzanine
Investments
The
Trust may invest in certain high
yield securities known as mezzanine investments, which are subordinated debt
securities which are generally issued in private placements in connection with
an equity security (e.g., with attached warrants). Such mezzanine investments
may be issued with or without registration rights. Similar to other high yield
securities, maturities of mezzanine investments are typically seven to ten
years, but the expected average life is significantly shorter at three to five
years. Mezzanine investments are usually unsecured and subordinate to other
obligations of the issuer.
Loan
Participations and Assignments
The
Trust may invest in fixed and
floating rate loans (“Loans”) arranged through private negotiations between a
corporation or foreign government and one or more financial institutions
(“Lenders”). The Trust’s investments in Loans are expected in most instances to
be in the form of participations in Loans (“Participations”) and assignments of
all or a portion of Loans (“Assignments”) from third parties. Participations
typically will result in the Trust having a contractual relationship only with
the Lender not the borrower. The Trust will have the right to receive payments
of principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and the Trust and only upon receipt by the Lender
of
the payments by the borrower. In connection with purchasing Participations,
the
Trust generally has no direct right to enforce compliance by the borrower with
the terms of the loan agreement relating to the Loan, nor any rights of set-off
against the borrower, and the Trust may not directly benefit from any collateral
supporting the Loan in which is has purchased the Participation. As a result
the
Trust will assume the credit risk of both the borrower and the Lender that
is
selling the Participation. In the event of the insolvency of the Lender selling
a Participation, the Trust may be treated as a general creditor of the Lender
and may not benefit from any set-off between the Lender and the borrower. The
Trust will acquire Participations only if the Lender interpositioned between
the
Trust and the borrower is determined by Highland to be creditworthy. When the
Trust purchases Assignments from Lenders, the Trust will acquire direct rights
against the borrower on the Loan. However, since Assignments are arranged
through private negotiations between potential assignees and assignors, the
rights and obligations acquired by the Trust as the purchaser of an Assignment
may differ from, and be more limited than, those held by the assigning
Lender.
The
Trust may have difficulty
disposing of Assignments and Participations. Because there is no liquid market
for such securities, the Trust anticipates that such securities could be sold
only to a limited number of institutional investors. The lack of a liquid
secondary market will have an adverse impact on the value of such securities
and
on the Trust’s ability to dispose of particular Assignments or Participations
when necessary to meet the Trust’s liquidity needs or in response to a specific
economic event, such as a deterioration in the creditworthiness of the borrower.
The lack of a liquid secondary market for Assignments and Participations also
may make it more difficult for the Trust to assign a value to those securities
for purposes of valuing the Trust’s portfolio and calculating its net asset
value.
Structured
Investments
The
Trust may invest a portion of its
assets in interests in entities organized and operated solely for the purpose
of
restructuring the investment characteristics of securities. This type of
restructuring involves the deposit with or purchase by an entity, such as a
corporation or a trust, of specified instruments and the issuance by that entity
of one or more classes of securities (“Structured Investments”) backed by, or
representing interests in the underlying instruments. The cash flow on the
underlying instruments may be apportioned among the newly issued Structured
Investments to create securities with different investment characteristics
such
as varying maturities, payment priorities and interest rate provisions, and
the
extent of the payments made with respect to Structured Investments is dependent
on
the
extent of the cash flow on the underlying instruments. Because Structured
Investments of the type in which the Trust anticipates it will invest typically
involve no credit enhancement, their credit risk generally will be equivalent
to
that of the underlying instruments.
The
Trust is permitted to invest in a
class of Structured Investments that is either subordinated or not subordinated
to the right of payment of another class. Subordinated Structured Investments
typically have higher yields and present greater risks than unsubordinated
Structured Investments.
Certain
issuers of Structured
Investments may be deemed to be “investment companies” as defined in the
Investment Company Act. As a result, the Trust’s investment in these Structured
Investments may be limited by the restrictions contained in the Investment
Company Act. Structured Investments are typically sold in private placement
transaction, and there currently is no active trading market for Structured
Investments.
Project
Loans
The
Trust may invest in project
loans, which are fixed income securities of issuers whose revenues are primarily
derived from mortgage loans to multi-family, nursing home and other real estate
development projects. The principal payments on these mortgage loans will be
insured by agencies and authorities of the U.S. Government.
Zero
Coupons and Deferred Payment Obligations
The
Trust may invest in zero-coupon
bonds, which are normally issued at a significant discount from face value
and
do not provide for periodic interest payments. Zero-coupon bonds may experience
greater volatility in market value than similar maturity debt obligations which
provide for regular interest payments. Additionally, current federal tax law
requires the holder of certain zero-coupon bonds to accrue income with respect
to these securities prior to the receipt of cash payments. To maintain its
qualification as a regulated investment company and to potentially avoid
liability for federal income and excise taxes, the Trust may be required to
distribute income accrued with respect to these securities and may have to
dispose of Trust securities under disadvantageous circumstances in order to
generate cash to satisfy these distribution requirements.
The
Trust may invest in Deferred
Payment Securities. Deferred Payment Securities are securities that remain
Zero-Coupon Securities until a predetermined date, at which time the stated
coupon rate becomes effective and interest becomes payable at regular intervals.
Deferred Payment Securities are subject to greater fluctuations in value and
may
have lesser liquidity in the event of adverse market conditions than comparably
rated securities paying cash interest at regular interest payment
periods.
MANAGEMENT
OF THE TRUST
Trustees
The
board of trustees provides broad
oversight over the operations and affairs of the Trust and protects the
interests of shareholders. The board of trustees has overall responsibility
to
manage and control the business affairs of the Trust, including the complete
and
exclusive authority to establish policies regarding the management, conduct
and
operation of the Trust’s business. The names and ages of the trustees and
officers of the Trust, the year each was first elected or appointed to office,
their principal business occupations during the last five years, the number
of
funds overseen by each trustee and other directorships or trusteeships they
hold
are shown below. The business address of the Trust, Highland and their
board members and officers is Two Galleria Tower, 13455 Noel Road, Suite 800,
Dallas, Texas 75240, unless otherwise specified below.
|
|
|
|
Term
of Office and Length of Time Served(1)
|
|
Principal
Occupation(s) During Past Five Years
|
|
Number
of Portfolios in Highland Fund Complex Overseen by
Trustee(2)
|
|
Other
Directorships/ Trusteeships Held
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INDEPENDENT
TRUSTEES
|
|
|
|
|
Timothy
Hui
(Age
59)
|
|
Trustee
|
|
3
years and
Trustee
since
May
19, 2006
|
|
Dean
of Educational Resources
since
July 2006; Assistant
Provost
for Graduate Education
from
July 2004 to June 2006,
and
Assistant Provost for
Educational
Resources from
July
2001 to June 2004,
Philadelphia
Biblical University.
|
|
12
|
|
None
|
Scott
Kavanaugh
(Age
46)
|
|
Trustee
|
|
3
years and
Trustee
since
May
19, 2006
|
|
Private
Investor since February
2004.
Sales Representative at
Round
Hill Securities from
March
2003 to January 2004;
Executive
at Provident Funding
Mortgage
Corporation, February 2003 to July 2003; Executive Vice President.
Director and CAO, Commercial Capital Bank, January 2000 to February
2003;
Managing Principal and Chief Operating Officer, Financial Institutional
Partners Mortgage Company and the Managing Principal and President
of
Financial Institutional Partners, LLC (an investment banking firm),
April
1998 to February 2003.
|
|
12
|
|
None
|
James
F. Leary
(Age
77)
|
|
Trustee
|
|
3
years and
Trustee
since
May
19, 2006
|
|
Managing
Director, Benefit
Capital
Southwest, Inc. (a financial consulting firm) since
January
1999.
|
|
12
|
|
Board
Member of
Capstone
Group
of
Funds (7 portfolios).
|
Bryan
A. Ward
(Age
52)
|
|
Trustee
|
|
3
years and
Trustee
since
May
19, 2006
|
|
Senior
Manager since January
2002
and Special Projects
Advisor,
Accenture, LLP (consulting firm) with focus on the oil and gas industry,
from
September
1998 to December
2001.
|
|
12
|
|
None
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INTERESTED
TRUSTEE
|
|
|
|
|
R.
Joseph Dougherty
(Age
37)
|
|
Trustee
and Chairman of the Board
|
|
3
years and
Trustee
since
March
10, 2006
|
|
Senior
Portfolio Manager of the
Investment
Adviser since 2000.
Director
and Senior Vice
President
of the funds in the
Highland
Fund Complex.
|
|
12
|
|
None
|
OFFICERS
|
|
|
|
Term
of Office and Length of Time Served
|
|
Principal
Occupation(s) During Past Five Years
|
|
|
|
|
|
|
|
James
D. Dondero
(Age
45)
|
|
Chief
Executive Officer and President
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
President
and Director of Strand Advisors, Inc. (“Strand”), the General Partner of
the Investment Adviser. President of the funds in the Highland Fund
Complex.
|
Mark
Okada
(Age
45)
|
|
Executive
Vice President
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
Executive
Vice President of Strand and the funds in the Highland Fund
Complex.
|
M.
Jason Blackburn
(Age
31)
|
|
Chief
Financial Officer (Principal Accounting Officer), Treasurer and
Secretary
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
Assistant
Controller of the Investment Adviser since November 2001. Treasurer
and
Secretary of the funds in the Highland Fund Complex.
|
Michael
Colvin
(Age
31)
|
|
Chief
Compliance Officer
|
|
Indefinite
Term and Officer since May 19, 2006
|
|
General
Counsel and Chief Compliance Officer of the Investment Adviser since
June
2007 and Chief Compliance Officer of the funds in the Highland
Fund Complex since July 2007. Shareholder in the Corporate and Securities
Group at Greenberg Traurig, LLP, from January 2007 to June 2007.
Partner
from January 2003 to January
2007 and Associate from 1995 to 2002 in the Private Equity Practice
Group
at Weil,
Gotshal
& Manges, LLP.
|
__________
(1)
|
After
a Trustee’s initial term, each Trustee is expected to serve a three-year
term concurrent with the class of Trustees with which he serves.
Messrs.
Leary and Ward, as Class I Trustees, were re-elected in 2007; Messrs.
Hui
and Kavanaugh, as Class II Trustees, are expected to stand for
re-election in 2008; and Mr. Dougherty, the sole Class III Trustee,
is
expected to stand for re-election in
2009.
|
(2)
|
The
Highland Fund Complex consists of all of the registered investment
companies advised by Highland as of the date of this Statement of
Additional Information.
|
The
fees and expenses of the
Independent Trustees of the Trust are paid by the Trust. The trustees who are
members of the Highland organization receive no compensation from the Trust.
It
is estimated that the Independent Trustees will receive from the Trust the
amounts set forth below for the Trust’s calendar year ending December 31,
2007.
Name
of Independent Trustees
|
Aggregate
Compensation
from
the Trust
|
|
Total
Compensation from the Trust
and
Highland Fund Complex(1)
|
Timothy
K. Hui
|
$7,500
|
|
$ 97,500
|
Scott
F. Kavanaugh
|
$7,500
|
|
$ 97,500
|
James
F. Leary
|
$7,500
|
|
$ 97,500
|
Bryan
A. Ward
|
$7,500
|
|
$ 97,500
|
__________
(1)
|
Estimates
the total compensation to be earned by that person during the calendar
year ending December 31, 2007 from the registered investment companies
advised by Highland.
|
Share
Ownership
The
following table shows the dollar
range of equity securities beneficially owned by the Trust’s trustees in the
Trust and the aggregate dollar range of equity securities owned by the Trust’s
trustees in all funds overseen by the trustee in the Highland Fund Complex
as of
December 31, 2006.
Name
of Trustee
|
Dollar
Range of Equity Securities in the Trust
|
Aggregate
Dollar Range of Equity Securities Overseen by Trustees in the Family
of
Registered Investment Companies
|
Interested
Trustee
|
|
|
R.
Joseph Dougherty
|
$0
|
$100,001
– 500,000
|
Independent
Trustees
|
|
|
Timothy
K. Hui
|
$0
|
$1
– 10,0000
|
Scott
F. Kavanaugh
|
$0
|
$50,001
– 100,000
|
James
F. Leary
|
$0
|
$10,001
– 50,000
|
Bryan
A. Ward
|
$0
|
$1
– 10,000
|
Committees
In
connection with the board of
trustee’s responsibility for the overall management and supervision of the
Trust’s affairs, the trustees meet periodically throughout the year to oversee
the Trust’s activities, review contractual arrangements with service providers
for the Trust and review the Trust’s performance. To fulfill these duties, the
Trust has four committees: an Audit Committee, a Nominating Committee, a
Litigation Committee and a Qualified Legal Compliance Committee.
The
Audit Committee consists of Timothy
Hui, Scott Kavanaugh, James Leary and Bryan Ward. The Audit Committee acts
according to the Audit Committee charter. Scott Kavanaugh has been appointed
as
Chairman of the Audit Committee. The Audit Committee is responsible for (i)
oversight of the Trust’s accounting and financial reporting processes and the
audits of the Trust’s financial statements and (ii) providing assistance to the
board of trustees of the Trust in connection with its oversight of the integrity
of the Trust’s financial statements, the Trust’s compliance with legal and
regulatory requirements and the independent registered public accounting firm’s
qualifications, independence and performance. The board of trustees of the
Trust
has determined that the Trust has one audit committee financial expert serving
on its Audit Committee, Mr. Leary, who is independent for the purpose of the
definition of audit committee financial expert as applicable to the Trust.
The
Audit Committee met [·] times during its first full fiscal year of
operation.
The
Nominating Committee’s function is
to canvass, recruit, interview, solicit and nominate trustees. The Nominating
Committee considers recommendations for nominees from shareholders sent to
the
Secretary of the Trust, Two Galleria Tower, 13455 Noel Road, Suite 800, Dallas,
Texas 75240. A nomination submission must include all information relating
to
the recommended nominee that is required to be disclosed in solicitations or
proxy statements for the election of trustees, as well as information sufficient
to evaluate the factors listed above. Nomination submissions must be accompanied
by a written consent of the individual to stand for election if nominated by
the
Board of trustees and to serve if elected by the shareholders, and such
additional information must be provided regarding the recommended nominee as
reasonably requested by the Nominating Committee. The Nominating Committee
is
comprised of Messrs. Hui, Kavanaugh, Leary and Ward. The Nominating
Committee met [·] times during its first full fiscal year of
operation.
The
Litigation Committee’s function is
to seek to address any potential conflicts of interest between or among the
Trust and the Investment Adviser in connection with any potential or
existing
litigation
or other legal proceeding relating to securities held by the Trust and the
Investment Adviser or another client of the Investment Adviser. The Litigation
Committee is comprised of Messrs. Hui, Kavanaugh, Leary and Ward. The
Litigation Committee met [·] times during its first full fiscal year of
operation.
The
Qualified Legal Compliance
Committee (the “QLCC”) is charged with compliance with Rules 205.2(k) and
205.3(c) of the Code of Federal Regulations regarding alternative reporting
procedures for attorneys representing the Trust who appear and practice before
the Commission on behalf of the Trust. The QLCC is comprised of Messrs. Hui,
Kavanaugh, Leary and Ward. The QLCC met [·] times during its first
full fiscal year of operation.
Proxy
Voting Policies and Procedures
The
board of trustees of the Trust
has delegated the voting of proxies for Trust securities to Highland pursuant
to
Highland’s proxy voting policies and procedures. Under these policies and
procedures, Highland will vote proxies related to Trust securities in the best
interests of the Trust and its shareholders. A copy of Highland’s proxy voting
policies and procedures is attached as Appendix B to this Statement of
Additional Information. The Trust’s proxy voting record for the most recent
12-month period ending June 30 is available (i) without charge, upon request,
by
calling 1-877-665-1287 and (ii) on the Commission’s web site
(http://www.sec.gov).
Codes
of Ethics
The
Trust and the Investment Adviser
have adopted codes of ethics under Rule 17j-1 of the Investment Company Act.
These codes permit personnel subject to the codes to invest in securities,
including securities that may be purchased or held by the Trust. These codes
can
be reviewed and copied at the Commission’s Public Reference Room in Washington,
D.C. Information on the operation of the Public Reference Room may be obtained
by calling the Commission at 1-202-551-8090. The codes of ethics are available
on the EDGAR Database on the Commission’s web site (http://www.sec.gov), and
copies of these codes may be obtained, after paying a duplicating fee, by
electronic request at the following e-mail address: publicinfo@sec.gov, or
by
writing the Commission’s Public Reference Section, Washington, D.C.
20549-0102.
Administration
Services
Pursuant
to the Trust’s
administration services agreement, Highland performs the following services:
(i)
prepare monthly security transaction listings; (ii) supply various normal and
customary Trust statistical data as requested on an ongoing basis; (iii) prepare
for execution and file the Trust’s federal and state tax returns; prepare a
fiscal tax provision in coordination with the annual audit; prepare an excise
tax provision; and prepare all relevant 1099 calculations; (iv) coordinate
contractual relationships and communications between the Trust and its
contractual service providers; (v) coordinate printing of the Trust’s annual and
semi-annual shareholder reports; (vi) prepare income and capital gain
distributions; (vii) prepare the semiannual and annual financial statements;
(viii) monitor the Trust’s compliance with Internal Revenue Code, Commission and
prospectus requirements; (ix) prepare, coordinate with the Trust’s counsel and
coordinate the filing with the Commission: semi-annual reports on Form N-SAR
and
Form N-CSR; Form N-Q; and Form N-PX based upon information provided by the
Trust, assist in the preparation of Forms 3, 4 and 5 pursuant to Section 16
of
the Securities Exchange Act of 1934, as amended, and Section 30(f) of the
Investment Company Act for the officers and trustees of the Trust, such filings
to be based on information provided by those persons; (x) assist in the
preparation of notices of meetings of shareholders; (xi) assist in obtaining
the
fidelity bond and trustees’ and officers’/errors and omissions insurance
policies for the Trust in accordance with the requirements of Rule 17g-1 and
17d-1(d)(7)
under
the Investment Company Act as such bond and policies are approved by the Trust’s
board of trustees; (xii) monitor the Trust’s assets to assure adequate fidelity
bond coverage is maintained; (xiii) draft agendas and resolutions for quarterly
and special board meetings; (xiv) coordinate the preparation, assembly and
distribution of board materials; (xv) attend board meetings and draft minutes
thereof; (xvi) maintain the Trust’s calendar to assure compliance with various
filing and board approval deadlines; (xvii) furnish the Trust office space
in
the offices of Highland, or in such other place or places as may be agreed
upon
from time to time, and all necessary office facilities, simple business
equipment, supplies, utilities and telephone service for managing the affairs
and investments of the Trust; (xviii) assist the Trust in the handling of SEC
examinations and responses thereto; (xix) perform clerical, bookkeeping and
all
other administrative services not provided by the Trust’s other service
providers; (xx) determine or oversee the determination and publication of the
Trust’s net asset value in accordance with the Trust’s policy as adopted from
time to time by the Board of Trustees; (xxi) oversee the maintenance by the
Trust’s custodian and transfer agent and dividend disbursing agent of certain
books and records of the Trust as required under Rule 31a-1(b)(2)(iv) of the
Investment Company Act and maintain (or oversee maintenance by such other
persons as approved by the board of trustees) such other books and records
required by law or for the proper operation of the Trust; (xxii) prepare such
information and reports as may be required by any stock exchange or exchanges
on
which the Trust’s shares are listed; (xxiii) determine the amounts available for
distribution as dividends and distributions to be paid by the Trust to its
shareholders; prepare and arrange for the printing of dividend notices to
shareholders; and provide the Trust’s dividend disbursing agent and custodian
with such information as is required for such parties to effect the payment
of
dividends and distributions and to implement the Trust’s dividend reinvestment
plan; (xxiv) serve as liaison between the Trust and each of its service
providers; and (xxv) perform such additional administrative duties relating
to
the administration of the Trust as may subsequently be agreed upon in writing
between the Trust and Highland. Highland shall have the authority to engage
a
sub-administrator in connection with the administrative services of the Trust,
which sub-administrator may be an affiliate of Highland; provided, however,
that
Highland shall remain responsible to the Trust with respect to its duties and
obligations set forth in the administration services agreement.
Portfolio
Managers
The
portfolio managers of the Trust
are Kurtis Plumer, James Dondero and Mark Okada.
As
of June 30, 2007, Kurtis Plumer
managed the following client accounts:
Type
of Account
|
|
|
|
|
|
Number
of
Accounts
Subject
to a
Performance
Fee
|
|
Assets
Subject
to a
Performance
Fee
|
Registered
Investment Companies
|
|
|
|
|
|
|
|
Other
Pooled Investment Vehicles
|
|
|
|
|
|
|
|
Other
Accounts
|
|
|
|
|
|
|
|
As
of
June 30, 2007, James Dondero managed the following client accounts:
Type
of Account
|
|
|
|
|
|
Number
of
Accounts
Subject
to a
Performance
Fee
|
|
Assets
Subject
to a
Performance
Fee
|
Registered
Investment Companies
|
|
|
|
|
|
|
|
Other
Pooled Investment Vehicles
|
|
|
|
|
|
|
|
Other
Accounts
|
|
|
|
|
|
|
|
As
of June 30, 2007, Mark Okada
managed the following client accounts:
Type
of Account
|
|
Number
of
Accounts
|
|
Assets
of
Accounts
|
|
Number
of
Accounts
Subject
to a
Performance
Fee
|
|
Assets
Subject
to a
Performance
Fee
|
Registered
Investment Companies
|
|
|
|
|
|
|
|
Other
Pooled Investment Vehicles
|
|
|
|
|
|
|
|
Other
Accounts
|
|
|
|
|
|
|
|
The Investment Adviser has built a professional working environment, a firm-wide
compliance culture and compliance procedures and systems designed to protect
against potential incentives that may favor one account over another. The
Investment Adviser has adopted policies and procedures that address the
allocation of investment opportunities, execution of portfolio transactions,
personal trading by employees and other potential conflicts of interest that
are
designed to ensure that all client accounts are treated equitably over time.
Nevertheless, the Investment Adviser furnishes advisory services to numerous
clients in addition to the Trust, and the Investment Adviser may, consistent
with applicable law, make investment recommendations to other clients or
accounts (including accounts which are hedge funds or have performance or higher
fees paid to the Investment Adviser, or in which portfolio managers have a
personal interest in the receipt of such fees), which may be the same as or
different from those made to the Trust. In addition, the Investment Adviser,
its
affiliates and any officer, director, stockholder or employee may or may not
have an interest in the securities whose purchase and sale the Investment
Adviser recommends to the Trust. Actions with respect to securities of the
same
kind may be the same as or different from the action which the Investment
Adviser, or any of its affiliates, or any officer, director, stockholder,
employee or any member of their families may take with respect to the same
securities. Moreover, the Investment Adviser may refrain from rendering any
advice or services concerning securities of companies of which any of the
Investment Adviser’s (or its affiliates’) officers, directors or employees are
directors or officers, or companies as to which the Investment Adviser or any
of
its affiliates or the officers, directors and employees of any of them has
any
substantial economic interest or possesses material non-public information.
In
addition to its various policies and procedures designed to address these
issues, the Investment Adviser includes disclosure regarding these matters
to
its clients in both its Form ADV and investment advisory
agreements.
The
Investment Adviser, its
affiliates or their officers and employees serve or may serve as officers,
directors or principals of entities that operate in the same or related lines
of
business or of investment funds managed by affiliates of the Investment Adviser.
Accordingly, these individuals may have obligations to investors in those
entities or funds or to other clients, the fulfillment of which might not be
in
the best interests of the Trust. As a result, the Investment Adviser will face
conflicts in the allocation of investment opportunities to the Trust and other
funds and clients. In order to enable such affiliates to fulfill their fiduciary
duties to each of the clients for which they have responsibility, the Investment
Adviser will endeavor to allocate investment opportunities in a fair and
equitable manner which may, subject to applicable regulatory constraints,
involve pro rata co-investment by the Trust and such other clients or may
involve a rotation of opportunities among the Trust and such other
clients.
While
the Investment Adviser does not
believe there will be frequent conflicts of interest, if any, the Investment
Adviser and its affiliates have both subjective and objective procedures and
policies in place designed to manage the potential conflicts of interest between
the Investment Adviser’s fiduciary obligations to the Trust and their similar
fiduciary obligations to other clients so that, for example, investment
opportunities are allocated in a fair and equitable manner among the Trust
and
such other clients. An investment opportunity that is suitable for multiple
clients of the Investment Adviser and its affiliates may not be capable of
being
shared among some or all of such clients due to the limited scale
of
the
opportunity or other factors, including regulatory restrictions imposed by
the
Investment Company Act. There can be no assurance that the Investment Adviser’s
or its affiliates’ efforts to allocate any particular investment opportunity
fairly among all clients for whom such opportunity is appropriate will result
in
an allocation of all or part of such opportunity to the Trust. Not all conflicts
of interest can be expected to be resolved in favor of the Trust.
Under
current Commission regulations,
the Trust may be prohibited from co-investing with any unregistered fund managed
now or in the future by the Investment Adviser in certain private placements
in
which the Investment Adviser negotiates non-pricing terms. The Trust intends
to
file for exemptive relief from the Commission to enable it to co-invest with
other unregistered funds managed by the Investment Adviser.
Compensation
The
Investment Adviser’s financial
arrangements with its portfolio managers, its competitive compensation and
its
career path emphasis at all levels reflect the value senior management places
on
key resources. Compensation may include a variety of components and may vary
from year to year based on a number of factors including the relative
performance of a portfolio managers’ underlying account, the combined
performance of the portfolio managers underlying accounts, and the relative
performance of the portfolio managers underlying accounts measured against
other
employees. The principal components of compensation include a base salary,
a
discretionary bonus, various retirement benefits and one or more of the
incentive compensation programs established by the Investment Adviser such
as
Option It Plan and the Long-Term Incentive Plan.
Base
Compensation. Generally, portfolio managers receive base
compensation based on their seniority and/or their position with the firm,
which
may include the amount of assets supervised and other management roles within
the firm.
Discretionary
Compensation. In addition to base compensation, portfolio
managers may receive discretionary compensation, which can be a substantial
portion of total compensation. Discretionary compensation can include a
discretionary cash bonus as well as one or more of the following:
|
·
|
Option
It Plan. The purpose of this plan is to attract
and retain the highest quality employees for positions of substantial
responsibility, and to provide additional incentives to a select
group of
management or highly compensated employees of Highland so as to promote
the success of the Highland.
|
|
·
|
Long
Term Incentive Plan. The purpose of this plan is
to create positive morale and teamwork, to attract and retain key
talent,
and to encourage the achievement of common goals. This plan seeks
to
reward participating employees based on the increased value of Highland
through the use of Long-Term Incentive
Units.
|
Senior
portfolio managers who perform
additional management functions may receive additional compensation in these
other capacities. Compensation is structured such that key professionals benefit
from remaining with the firm.
Securities
Ownership of Portfolio Managers
To
be filed by
amendment.
PORTFOLIO
TRANSACTIONS AND BROKERAGE
In
placing portfolio transactions for
the Trust, the Investment Adviser will give primary consideration to securing
the most favorable price and efficient execution. Consistent with this policy,
the Investment Adviser may consider the financial responsibility, research
and
investment information and other services provided by brokers or dealers who
may
effect or be a party to any such transaction or other transactions to which
other clients of the Investment Adviser may be a party. Neither the Trust nor
the Investment Adviser has adopted a formula for allocation of the Trust’s
investment transaction business. The Investment Adviser has access to
supplemental investment and market research and security and economic analysis
provided by brokers who may execute brokerage transactions at a higher cost
to
the Trust than would otherwise result when allocating brokerage transactions
to
other brokers on the basis of seeking the most favorable price and efficient
execution. The Investment Adviser, therefore, is authorized to place orders
for
the purchase and sale of securities for the Trust with such brokers, subject
to
review by the Trust’s board of trustees from time to time with respect to the
extent and continuation of this practice. The services provided by such brokers
may be useful or beneficial to the Investment Adviser in connection with its
services to other clients.
On
occasions when the Investment
Adviser deems the purchase or sale of a security to be in the best interest
of
the Trust as well as other clients, the Investment Adviser, to the extent
permitted by applicable laws and regulations, may, but shall be under no
obligation to, aggregate the securities to be so sold or purchased in order
to
obtain the most favorable price or lower brokerage commissions and efficient
execution. In such event, allocation of the securities so purchased or sold,
as
well as the expenses incurred in the transaction, will be made by the Investment
Adviser in the manner it considers to be the most equitable and consistent
with
its fiduciary obligations to the Trust and to such other clients.
REPURCHASE
OF COMMON SHARES
The
Trust is a closed-end management
investment company and as such its shareholders will not have the right to
cause
the Trust to redeem their shares. Instead, the Trust’s common shares will trade
in the open market at a price that will be a function of several factors,
including dividend levels (which are in turn affected by expenses), net asset
value, call protection, dividend stability, relative demand for and supply
of
such shares in the market, general market and economic conditions and other
factors. Because shares of a closed-end investment company may frequently trade
at prices lower than net asset value, the Trust’s board of trustees may consider
action that might be taken to reduce or eliminate any material discount from
net
asset value in respect of common shares, which may include the repurchase of
such shares in the open market or in private transactions, the making of a
tender offer for such shares, or the conversion of the Trust to an open-end
investment company. The board of trustees may decide not to take any of these
actions. In addition, there can be no assurance that share repurchases or tender
offers, if undertaken, will reduce market discount.
Notwithstanding
the foregoing, at any
time when there are outstanding borrowings, the Trust may not purchase, redeem
or otherwise acquire any of its common shares unless (i) all accrued preferred
shares dividends have been paid and (ii) at the time of such purchase,
redemption or acquisition, the net asset value of the Trust’s portfolio
(determined after deducting the acquisition price of the common shares) is
at
least 200% of the liquidation value of the outstanding borrowings. Any service
fees incurred in connection with any tender offer made by the Trust will be
borne by the Trust and will not reduce the stated consideration to be paid
to
tendering shareholders.
Subject
to its investment
restrictions, the Trust may borrow to finance the repurchase of shares or to
make a tender offer. Interest on any borrowings to finance share repurchase
transactions or the accumulation of cash by the Trust in anticipation of share
repurchases or tenders will reduce the Trust’s
net
income. Any share repurchase, tender offer or borrowing that might be approved
by the Trust’s board of trustees would have to comply with the Securities
Exchange Act of 1934, as amended, the Investment Company Act and the rules
and
regulations thereunder.
Although
the decision to take action
in response to a discount from net asset value will be made by the board of
trustees at the time it considers such issue, it is the board’s present policy,
which may be changed by the board of trustees, not to authorize repurchases
of
common shares or a tender offer for such shares if: (1) such transactions,
if
consummated, would (a) result in the delisting of the common shares from the
New
York Stock Exchange, or (b) impair the Trust’s status as a regulated investment
company under the Code (which would make the Trust a taxable entity, causing
the
Trust’s income to be taxed at the corporate level in addition to the taxation of
shareholders who receive dividends from the Trust), or as a registered
closed-end investment company under the Investment Company Act; (2) the Trust
would not be able to liquidate portfolio securities in an orderly manner and
consistent with the Trust’s investment objectives and policies in order to
repurchase shares; or (3) there is, in the board’s judgment, any (a) material
legal action or proceeding instituted or threatened challenging such
transactions or otherwise materially adversely affecting the Trust, (b) general
suspension of or limitation on prices for trading securities on the New York
Stock Exchange, (c) declaration of a banking moratorium by federal or state
authorities or any suspension of payment by U.S. or New York banks, (d) material
limitation affecting the Trust or the issuers of its portfolio securities by
federal or state authorities on the extension of credit by lending institutions
or on the exchange of foreign currency, (e) commencement of war, armed
hostilities or other international or national calamity directly or indirectly
involving the United States or (f) other event or condition which would have
a
material adverse effect (including any adverse tax effect) on the Trust or
its
shareholders if shares were repurchased. The board of trustees may in the future
modify these conditions in light of experience.
The
repurchase by the Trust of its
shares at prices below net asset value will result in an increase in the net
asset value of those shares that remain outstanding. However, there can be
no
assurance that share repurchases or tender offers at or below net asset value
will result in the Trust’s shares trading at a price equal to their net asset
value. Nevertheless, the fact that the Trust’s shares may be the subject of
repurchase or tender offers from time to time, or that the Trust may be
converted to an open-end investment company, may reduce any spread between
market price and net asset value that might otherwise exist.
Before
deciding whether to take any
action if the common shares trade below net asset value, the Trust’s board of
trustees would likely consider all relevant factors, including the extent and
duration of the discount, the liquidity of the Trust’s portfolio, the impact of
any action that might be taken on the Trust or its shareholders and market
considerations. Based on these considerations, even if the Trust’s shares should
trade at a discount, the board of trustees may determine that, in the interest
of the Trust and its shareholders, no action should be taken.
TAX
MATTERS
The
following discussion summarizes
certain U.S. federal income tax considerations affecting the Trust and the
purchase, ownership and disposition of the Trust’s common and preferred shares
by shareholders that are U.S. persons, as defined for U.S. federal income tax
purposes. This discussion is based upon current provisions of the Internal
Revenue Code of 1986, as amended (the “Code”), the regulations promulgated
thereunder and judicial and administrative authorities, all of which are subject
to change or differing interpretations by the courts or the Internal Revenue
Service (the “IRS”), possibly with retroactive effect. No attempt is made to
present a detailed explanation of all U.S. federal tax concerns affecting the
Trust and its shareholders (including non-U.S. Shareholders owning large
positions in the Trust and others subject to special treatment under U.S.
federal income tax law).
The
discussions set forth herein and
in the prospectus do not constitute tax advice, and you are urged to consult
with your own tax advisor to determine the specific U.S. federal, state, local
and foreign tax consequences to you of investing in the Trust.
Taxation
of the Trust
The
Trust intends to elect to be
treated and to qualify annually as a regulated investment company under
Subchapter M of the Code. Accordingly, the Trust must, among other things,
meet
the following requirements regarding the source of its income and the
diversification of its assets:
(i)
The Trust must derive in each
taxable year at least 90% of its gross income from the following sources: (a)
dividends, interest (including tax-exempt interest), payments with respect
to
certain securities loans, gains from the sale or other disposition of stock,
securities or foreign currencies, or other income (including but not limited
to
gains from options, futures and forward contracts) derived with respect to
its
business of investing in such stock, securities or foreign currencies; and
(b)
interests in “qualified publicly traded partnerships” (as defined in the
Code).
(ii)
The Trust must diversify its
holdings so that, at the end of each quarter of each taxable year: (a) at least
50% of the value of the Trust’s total assets is represented by cash and cash
items, U.S. government securities, the securities of other regulated investment
companies and other securities, with such other securities limited, in respect
of any one issuer, to an amount not greater than 5% of the value of the Trust’s
total assets and not more than 10% of the outstanding voting securities of
such
issuer and (b) not more than 25% of the value of the Trust’s total assets is
invested in the securities (other than U.S. government securities and the
securities of other regulated investment companies) of: (I) any one issuer,
(II)
any two or more issuers that the Trust controls (by owning 20% or more of their
voting power) and that are determined to be engaged in the same business or
similar or related trades or businesses or (III) any one or more “qualified
publicly traded partnerships” (as defined in the Code).
As
a regulated investment company,
the Trust generally will not be subject to U.S. federal income tax on income
and
gains that the Trust distributes to its shareholders, provided that it
distributes each taxable year at least the sum of: (i) 90% of the Trust’s
investment company taxable income (which includes, among other items, dividends,
interest and the excess of any net short-term capital gain over net long-term
capital loss and other taxable income, other than any net long-term capital
gain, reduced by deductible expenses) determined without regard to the deduction
for dividends paid and (ii) 90% of the Trust’s net tax-exempt interest (the
excess of its gross tax-exempt interest over certain disallowed deductions).
The
Trust intends to distribute substantially all of such income each year. The
Trust will be subject to U.S. federal income tax at regular corporate rates
on
any taxable income or gains that it does not distribute to its
shareholders.
The
Code imposes a 4% nondeductible
excise tax on the Trust to the extent the Trust does not distribute by the
end
of any calendar year at least the sum of: (i) 98% of its ordinary income (not
taking into account any capital gain or loss) for the calendar year and (ii)
98%
of its capital gain in excess of its capital loss (adjusted for certain ordinary
losses) for a one-year period generally ending on October 31 of the calendar
year (unless an election is made to use the Trust’s fiscal year). In addition,
the minimum amounts that must be distributed in any year to avoid the excise
tax
will be increased or decreased to reflect any under-distribution or
over-distribution, as the case may be, from the previous year. While the Trust
intends to distribute any income and capital gain in the manner necessary to
minimize imposition of the 4% excise tax, there can be no assurance that
sufficient amounts of the Trust’s taxable income and capital gain will be
distributed to avoid entirely the imposition of the excise tax. In that event,
the Trust will be liable for the excise tax only on the amount by which it
does
not meet the foregoing distribution requirement.
If,
for any taxable year, the Trust
does not qualify as a regulated investment company, all of its taxable income
(including its net capital gain) will be subject to tax at regular corporate
rates without any deduction for distributions to shareholders, and such
distributions will be taxable to the shareholders as ordinary dividends to
the
extent of the Trust’s current or accumulated earnings and profits. Provided that
shareholders satisfy certain holding period and other requirements with respect
to their common shares, such dividends would be eligible (i) to be treated
as
qualified dividend income in the case of shareholders taxed as individuals
and
(ii) for the dividends received deduction in the case of shareholders taxed
as
corporations. The Trust may be required to recognize unrealized gains, pay
taxes
and make distributions (which may be subject to interest charges) before
requalifying for taxation as a regulated investment company. If the Trust fails
to qualify as a regulated investment company in any year, it must pay out its
earnings and profits accumulated in that year in order to qualify again as
a
regulated investment company. If the Trust fails to qualify as a regulated
investment company for a period greater than one taxable year, the Trust may
be
required to recognize and pay tax on any net built-in gains with respect to
certain of its assets (i.e., the excess of the aggregate gains, including items
of income, over aggregate losses that would have been realized with respect
to
such assets if the Trust had been liquidated) or, alternatively, to elect to
be
subject to taxation on such built-in gain recognized for a period of ten years,
in order to qualify as a regulated investment company in a subsequent
year.
Taxation
of the Trust’s Investments
Certain
of the Trust’s investment
practices are subject to special and complex U.S. federal income tax provisions
that may, among other things: (i) treat dividends that would otherwise
constitute qualified dividend income as non-qualified dividend income, (ii)
treat dividends that would otherwise be eligible for the corporate dividends
received deduction as ineligible for such treatment, (iii) disallow, suspend
or
otherwise limit the allowance of certain losses or deductions, (iv) convert
lower-taxed, long-term capital gain into higher-taxed, short-term capital gain
or ordinary income, (v) convert an ordinary loss or deduction into a capital
loss (the deductibility of which is more limited), (vi) cause the Trust to
recognize income or gain without a corresponding receipt of cash, (vii)
adversely affect the time as to when a purchase or sale of stocks or securities
is deemed to occur, (viii) adversely alter the characterization of certain
complex financial transactions or (ix) produce income that will not qualify
as
good income for purposes of the 90% annual gross income requirement described
above. These U.S. federal income tax provisions could therefore affect the
amount, timing and character of distributions to shareholders. The Trust intends
to monitor its transactions and may make certain tax elections and may be
required to dispose of securities or borrow money to mitigate the effect of
these provisions and prevent disqualification of the Trust as a regulated
investment company.
If
the Trust purchases shares in
certain foreign investment entities, called passive foreign investment companies
(“PFICs”), the Trust may be subject to U.S. federal income tax on a portion of
any “excess distribution” or gain from the disposition of such shares.
Additional charges in the nature of interest may be imposed on the Trust in
respect of deferred taxes arising from such distributions or gains. Elections
may be available to the Trust to mitigate the effect of this tax, but such
elections generally accelerate the recognition of income without the receipt
of
cash. Dividends paid by PFICs will not be qualified dividend
income.
If
the Trust invests in the shares of
a PFIC, or any other investment that produces income that is not matched by
a
corresponding cash distribution to the Trust, such as investments in debt
securities that have original issue discount, the Trust could be required to
recognize income that it has not yet received. Any such income would be treated
as income earned by the Trust and therefore would be subject to the distribution
requirements of the Code. This might prevent the Trust from distributing 90%
of
its net investment income as is required in order to avoid Trust-level U.S.
federal income taxation on all of its income, or might prevent the Trust from
distributing enough ordinary income and capital gain net income
to
avoid completely the imposition of the excise tax. To avoid this result, the
Trust may be required to borrow money or dispose of securities to be able to
make required distributions to the shareholders.
Dividend,
interest and other income
received by the Trust from investments outside the United States may be subject
to withholding and other taxes imposed by foreign countries. Tax treaties
between the United States and other countries may reduce or eliminate such
taxes. The Trust does not expect that it will be eligible to elect to treat
any
foreign taxes it pays as paid by its shareholders, who therefore will not be
entitled to credits for such taxes on their own tax returns. Foreign taxes
paid
by a Trust will reduce the return from the Trust’s investments.
Taxation
of Shareholders
The
Trust will determine either to
distribute or to retain for reinvestment all or part of its net capital gain.
If
any such gain is retained, the Trust will be subject to corporate income tax
(currently at a maximum rate of 35%) on such retained amount. In that event,
the
Trust expects to designate the retained amount as undistributed capital gain
in
a notice to its shareholders, each of whom: (i) will be required to include
in
income for U.S. federal income tax purposes as long-term capital gain its share
of such undistributed amounts, (ii) will be entitled to credit its proportionate
share of the tax paid by the Trust against its U.S. federal income tax liability
and to claim refunds to the extent that the credit exceeds such liability and
(iii) will increase its basis in its common shares of the Trust by an amount
equal to 65% of the amount of undistributed capital gain included in such
shareholder’s gross income.
Distributions
paid to you by the
Trust from its net realized long-term capital gains, if any, that the Trust
designates as capital gains dividends (“capital gain dividends”) are taxable as
long-term capital gains, regardless of how long you have held your common
shares. All other dividends paid to you by the Trust (including dividends from
short-term capital gains) from its current or accumulated earnings and profits
(“ordinary income dividends”) are generally subject to tax as ordinary income.
The Trust does not expect that a corporate shareholder will be able to claim
a
dividends received deduction with respect to any significant portion of the
Trust distributions.
Special
rules apply, however, to
ordinary income dividends paid to individuals with respect to taxable years
beginning on or before December 31, 2010. If you are an individual, any such
ordinary income dividend that you receive from the Trust generally will be
eligible for taxation at the rates applicable to long-term capital
gains to the extent that: (i) the ordinary income dividend is
attributable to “qualified dividend income” (i.e., generally dividends paid by
U.S. corporations and certain foreign corporations) received by the Trust,
(ii)
the Trust satisfies certain holding period and other requirements with respect
to the stock on which such qualified dividend income was paid and (iii) you
satisfy certain holding period and other requirements with respect to your
common shares. Ordinary income dividends subject to these special rules are
not
actually treated as capital gains, however, and thus will not be included in
the
computation of your net capital gain and generally cannot be used to offset
any
capital losses. In general, you may include as qualified dividend income only
that portion of the dividends that may be and are so designated by the Trust
as
qualified dividend income; however, the Trust does not expect that a significant
portion of its ordinary income dividends will be treated as qualified dividend
income.
Any
distributions that you receive
that are in excess of the Trust’s current or accumulated earnings and profits
will be treated as a tax-free return of capital to the extent of your adjusted
tax basis in your common shares, and thereafter as capital gain from the sale
of
common shares. The amount of any Trust distribution that is treated as a
tax-free return of capital will reduce your adjusted tax basis in your common
shares, thereby increasing your potential gain or reducing your potential loss
on any subsequent sale or other disposition of your common
shares.
For
holders of common shares that
participate in the Trust’s Automatic Dividend Reinvestment Plan, dividends and
other taxable distributions are taxable to you even if they are reinvested
in
additional common shares of the Trust. Dividends and other distributions paid
by
the Trust are generally treated under the Code as received by you at the time
the dividend or distribution is made. If, however, the Trust pays you a dividend
in January that was declared in the previous October, November or December
and
you were the shareholder of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Trust
and received by you on December 31 of the year in which the dividend was
declared.
The
price of common shares purchased
at any time may reflect the amount of a forthcoming distribution. If you
purchase common shares just prior to a distribution, you will receive a
distribution that will be taxable to you even though it represents in part
a
return of your invested capital.
The
Trust will send you information
after the end of each year setting forth the amount and tax status of any
distributions paid to you by the Trust. Ordinary income dividends and capital
gain dividends may also be subject to state and local taxes.
If
you sell or otherwise dispose of
common shares of the Trust, you will generally recognize a gain or loss in
an
amount equal to the difference between your adjusted tax basis in such common
shares of the Trust and the amount you receive upon disposition of such common
shares. If you hold your common shares as capital assets, any such gain or
loss
will be long-term capital gain or loss if you have held such common shares
for
more than one year at the time of sale. Any loss upon the sale or exchange
of
common shares held for six months or less will be treated as long-term capital
loss to the extent of any capital gain dividends received (including amounts
credited as an undistributed capital gain dividend) by you with respect to
such
common shares. Any loss you realize on a sale or exchange of common shares
will
be disallowed if you acquire other common shares (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days
before and ending 30 days after your sale or exchange of the common shares.
In
such case, your tax basis in the common shares acquired will be adjusted to
reflect the disallowed loss.
Current
U.S. federal income tax laws
tax both long-term and short-term capital gain of corporations at the rates
applicable to ordinary income. For non-corporate taxpayers, short-term capital
gain is currently taxed at rates applicable to ordinary income (currently at
a
maximum of 35%) while long-term capital gain generally is taxed at a maximum
rate of 15% with respect to taxable years beginning on or before December 31,
2010 (20% thereafter, unless changed by future legislation).
Shareholders
may be entitled to
offset their capital gain dividends with capital loss. The Code contains a
number of statutory provisions affecting the circumstances under which capital
loss may be offset against capital gain and limiting the use of loss from
certain investments and activities. Accordingly, shareholders that have capital
losses are urged to consult their tax advisors.
The
Trust may be required to
withhold, for U.S. federal backup withholding tax purposes, a portion of the
dividends, distributions and redemption proceeds payable to a shareholder who
fails to provide the Trust (or its agent) with the shareholder’s correct
taxpayer identification number (in the case of an individual, generally, such
individual’s social security number) or to make the required certification, or
who has been notified by the IRS that such shareholder is subject to backup
withholding. Corporate shareholders and certain other shareholders are exempt
from backup withholding. Backup withholding is not an additional tax and any
amount withheld may be refunded or credited against your U.S. federal income
tax
liability, if any, provided that you furnish the required information to the
IRS.
EXPERTS
[•],
located at [•], provides
accounting and auditing services to the Trust.
ADDITIONAL
INFORMATION
A
Registration Statement on Form N-2,
including amendments thereto, relating to the shares offered hereby, has been
filed by the Trust with the Commission, Washington, D.C. The prospectus and
this
Statement of Additional Information do not contain all of the information set
forth in the Registration Statement, including any exhibits and schedules
thereto. For further information with respect to the Trust and the Shares
offered hereby, reference is made to the Registration Statement. Statements
contained in the prospectus and this Statement of Additional Information as
to
the contents of any contract or other document referred to are not necessarily
complete and in each instance reference is made to the copy of such contract
or
other document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. A copy of the
Registration Statement may be inspected without charge at the Commission’s
principal office in Washington, D.C., and copies of all or any part thereof
may
be obtained from the Commission upon the payment of certain fees prescribed
by
the Commission.
FINANCIAL
STATEMENTS
The
Trust’s unaudited financial
statements appearing in the Trust’s semi-annual shareholder report for the
period ended June 30, 2007 are incorporated by reference in this Statement
of
Additional Information. The annual and semi-annual (unaudited) shareholder
reports are available upon request and without charge by writing to the Trust
at
Two Galleria Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 or by
calling (877) 665-1287.
APPENDIX
A
A
Standard & Poor’s issue credit
rating is a current opinion of the creditworthiness of an obligor with respect
to a specific financial obligation, a specific class of financial obligations,
or a specific financial program (including ratings on medium-term note programs
and commercial paper programs). It takes into consideration the creditworthiness
of guarantors, insurers, or other forms of credit enhancement on the obligation
and takes into account the currency in which the obligation is denominated.
The
issue credit rating is not a recommendation to purchase, sell, or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
Issue
credit ratings are based on
current information furnished by the obligors or obtained by Standard &
Poor’s from other sources it considers reliable. Standard & Poor’s does not
perform an audit in connection with any credit rating and may, on occasion,
rely
on unaudited financial information. Credit ratings may be changed, suspended,
or
withdrawn as a result of changes in, or unavailability of, such information,
or
based on other circumstances.
Issue
credit ratings can be either
long-term or short-term. Short-term ratings are generally assigned to those
obligations considered short-term in the relevant market. In the U.S., for
example, that means obligations with an original maturity of no more than 365
days, including commercial paper, are considered short-term. Short-term ratings
are also used to indicate the creditworthiness of an obligor with respect to
put
features on long-term obligations. The result is a dual rating, in which the
short-term rating addresses the put feature, in addition to the usual long-term
rating. Medium-term notes are assigned long-term ratings.
Long-Term
Issue Credit Ratings
Issue
credit ratings are based, in
varying degrees, on the following considerations:
|
·
|
Likelihood
of payment—capacity and willingness of the obligor to meet its financial
commitment on an obligation in accordance with the terms of the
obligation;
|
|
·
|
Nature
of and provisions of the obligation;
and
|
|
·
|
Protection
afforded by, and relative position of, the obligation in the event
of
bankruptcy, reorganization, or other arrangement under the laws of
bankruptcy and other laws affecting creditors’
rights.
|
The
issue rating definitions are
expressed in terms of default risk. As such, they pertain to senior obligations
of an entity. Junior obligations are typically rated lower than senior
obligations, to reflect the lower priority in bankruptcy, as noted above. (Such
differentiation applies when an entity has both senior and subordinated
obligations, secured and unsecured obligations, or operating company and holding
company obligations.) Accordingly, in the case of junior debt, the rating may
not conform exactly with the category definition.
AAA
An
obligation rated “AAA” has the
highest rating assigned by Standard & Poor’s. The obligor’s capacity to meet
its financial commitment on the obligation is extremely strong.
An
obligation rated “AA” differs from
the highest-rated obligations only to a small degree. The obligor’s capacity to
meet its financial commitment on the obligation is very strong.
A
An
obligation rated “A” is somewhat
more susceptible to the adverse effects of changes in circumstances and economic
conditions than obligations in higher-rated categories. However, the obligor’s
capacity to meet its financial commitment on the obligation is still
strong.
BBB
An
obligation rated “BBB” exhibits
adequate protection parameters. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the obligor
to
meet its financial commitment on the obligation.
BB,
B, CCC, CC, and C
Obligations
rated “BB”, “B”, “CCC”,
“CC”, and “C” are regarded as having significant speculative characteristics.
“BB” indicates the least degree of speculation and “C” the highest. While such
obligations will likely have some quality and protective characteristics, these
may be outweighed by large uncertainties or major exposures to adverse
conditions.
An
obligation rated “BB” is less
vulnerable to nonpayment than other speculative issues. However, it faces major
ongoing uncertainties or exposure to adverse business, financial, or economic
conditions which could lead to the obligor’s inadequate capacity to meet its
financial commitment on the obligation.
B
An
obligation rated “B” is more
vulnerable to nonpayment than obligations rated “BB”, but the obligor currently
has the capacity to meet its financial commitment on the obligation. Adverse
business, financial, or economic conditions will likely impair the obligor’s
capacity or willingness to meet its financial commitment on the
obligation.
CCC
An
obligation rated “CCC” is
currently vulnerable to nonpayment, and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its financial
commitment on the obligation. In the event of adverse business, financial,
or
economic conditions, the obligor is not likely to have the capacity to meet
its
financial commitment on the obligation.
CC
An
obligation rated “CC” is currently
highly vulnerable to nonpayment.
C
A
subordinated debt or preferred
stock obligation rated “C” is currently highly vulnerable to nonpayment. The “C”
rating may be used to cover a situation where a bankruptcy petition has been
filed or similar action taken, but payments on this obligation are being
continued. A “C” also will be assigned to a preferred stock issue in arrears on
dividends or sinking fund payments, but that is currently
paying.
D
An
obligation rated “D” is in payment
default. The “D” rating category is used when payments on an obligation are not
made on the date due even if the applicable grace period has not expired, unless
Standard & Poor’s believes that such payments will be made during such grace
period. The “D” rating also will be used upon the filing of a bankruptcy
petition or the taking of a similar action if payments on an obligation are
jeopardized.
Plus
(+) or minus (—)
The
ratings from “AA” to “CCC” may be
modified by the addition of a plus (+) or minus (—) sign to show relative
standing within the major rating categories.
NR
This
indicates that no rating has
been requested, that there is insufficient information on which to base a
rating, or that Standard & Poor’s does not rate a particular obligation as a
matter of policy.
Short-Term
Issue Credit Ratings
A-1
A
short-term obligation rated “A-1”
is rated in the highest category by Standard & Poor’s. The obligor’s
capacity to meet its financial commitment on the obligation is strong. Within
this category, certain obligations are designated with a plus sign (+). This
indicates that the obligor’s capacity to meet its financial commitment on these
obligations is extremely strong.
A-2
A
short-term obligation rated “A-2”
is somewhat more susceptible to the adverse effects of changes in circumstances
and economic conditions than obligations in higher rating categories. However,
the obligor’s capacity to meet its financial commitment on the obligation is
satisfactory.
A-3
A
short-term obligation rated “A-3”
exhibits adequate protection parameters. However, adverse economic conditions
or
changing circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
B
A
short-term obligation rated “B” is
regarded as having significant speculative characteristics. Ratings of “B-1”,
“B-2”, and “B-3” may be assigned to indicate finer distinctions within the
“B” category. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor’s inadequate capacity to meet its
financial commitment on the obligation.
B-1
A
short-term obligation rated “B-1”
is regarded as having significant speculative characteristics, but the obligor
has a relatively stronger capacity to meet its financial commitments over the
short-term compared to other speculative-grade obligors.
B-2
A
short-term obligation rated “B-2”
is regarded as having significant speculative characteristics, and the obligor
has an average speculative-grade capacity to meet its financial commitments
over
the short-term compared to other speculative-grade obligors.
B-3
A
short-term obligation rated “B-3”
is regarded as having significant speculative characteristics, and the obligor
has a relatively weaker capacity to meet its financial commitments over the
short-term compared to other speculative-grade obligors.
C
A
short-term obligation rated “C” is
currently vulnerable to nonpayment and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its financial
commitment on the obligation.
D
A
short-term obligation rated “D” is
in payment default. The “D” rating category is used when payments on an
obligation are not made on the date due even if the applicable grace period
has
not expired, unless Standard & Poor’s believes that such payments will be
made during such grace period. The “D” rating also will be used upon the filing
of a bankruptcy petition or the taking of a similar action if payments on an
obligation are jeopardized.
Active
Qualifiers (Currently applied and/or outstanding)
i
This
subscript is used for issues in
which the credit factors, terms, or both, that determine the likelihood of
receipt of payment of interest are different from the credit factors, terms
or
both that determine the likelihood of receipt of principal on the obligation.
The “i” subscript indicates that the rating addresses the interest portion of
the obligation only. The “i” subscript will always be used in conjunction with
the “p” subscript, which addresses likelihood of receipt of principal.
For example, a rated obligation could be assigned ratings of “AAAp NRi”
indicating that the principal portion is rated “AAA” and the interest portion of
the obligation is not rated.
L
Ratings
qualified with “L” apply only
to amounts invested up to federal deposit insurance limits.
P
This
subscript is used for issues in
which the credit factors, the terms, or both, that determine the likelihood
of
receipt of payment of principal are different from the credit factors, terms
or
both that determine the likelihood of receipt of interest on the obligation.
The
“p” subscript indicates that the rating addresses the principal portion of the
obligation only. The “p” subscript will always be used in conjunction with the
“i” subscript, which addresses likelihood of receipt of interest. For example,
a
rated obligation could be assigned ratings of “AAAp N.R.i” indicating that the
principal portion is rated “AAA” and the interest portion of the obligation is
not rated.
pi
Ratings
with a “pi” subscript are
based on an analysis of an issuer’s published financial information, as well as
additional information in the public domain. They do not, however, reflect
in-depth meetings with an issuer’s management and are therefore based on less
comprehensive information than ratings without a “pi” subscript. Ratings with a
“pi” subscript are reviewed annually based on a new year’s financial statements,
but may be reviewed on an interim basis if a major event occurs that may affect
the issuer’s credit quality.
pr
The
letters “pr” indicate that the
rating is provisional. A provisional rating assumes the successful completion
of
the project financed by the debt being rated and indicates that payment of
debt
service requirements is largely or entirely dependent upon the successful,
timely completion of the project. This rating, however, while addressing credit
quality subsequent to completion of the project, makes no comment on the
likelihood of or the risk of default upon failure of such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
Preliminary
Preliminary
ratings are assigned to
issues, including financial programs, in the following
circumstances.
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·
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Preliminary
ratings may be assigned to obligations, most commonly structured
and
project finance issues, pending receipt of final documentation and
legal
opinions. Assignment of a final rating is conditional on the receipt
and
approval by Standard & Poor’s of appropriate documentation. Changes in
the information provided to Standard & Poor’s could result in the
assignment of a different rating. In addition, Standard & Poor ‘s
reserves the right not to issue a final
rating.
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·
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Preliminary
ratings are assigned to Rule 415 Shelf Registrations. As specific
issues,
with defined terms, are offered from the master registration, a final
rating may be assigned to them in accordance with Standard & Poor’s
policies. The final rating may differ from the preliminary
rating.
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t
This
symbol indicates termination
structures that are designed to honor their contracts to full maturity or,
should certain events occur, to terminate and cash settle all their contracts
before their final maturity date.
Inactive
Qualifiers (No longer applied or outstanding)
*
This
symbol indicated continuance of
the ratings is contingent upon Standard & Poor ‘s receipt of an executed
copy of the escrow agreement or closing documentation confirming investments
and
cash flows. Discontinued use in August 1998.
This
qualifier was used to provide
additional information to investors that the bank may terminate its obligation
to purchase tendered bonds if the long-term credit rating of the issuer is
below
an investment-grade level and/or the issuer’s bonds are deemed taxable.
Discontinued use in January 2001.
q
A
“q”
subscript
indicates that the
rating is based solely on quantitative analysis of publicly available
information. Discontinued use in April 2001.
r
The
“r”
modifier
was assigned to
securities containing extraordinary risks, particularly market risks, that
are
not covered in the credit rating. The absence of an “r” modifier should not be
taken as an indication that an obligation will not exhibit extraordinary
non-credit related risks. Standard & Poor’s discontinued the use of the “r”
modifier for most obligations in June 2000 and for the balance of obligations
(mainly structured finance transactions) in November 2002.
Moody’s
Investors Service,
Inc.—A brief description of the applicable Moody’s Investors Service, Inc.
(“Moody’s”) rating symbols and their meanings (as published by Moody’s)
follows:
Long-Term
Obligation Ratings
Moody’s
long-term obligation ratings
are opinions of the relative credit risk of a fixed income obligations with
an
original maturity of one year or more. They address the possibility that a
financial obligation will not be honored as promised. Such ratings reflect
both
the likelihood of default and any financial loss suffered in the event of
default.
Moody’s
Long-Term Rating Definitions:
Aaa
Obligations
rated Aaa are judged to
be of the highest quality, with minimal credit risk.
Aa
Obligations
rated Aa are judged to be
of high quality and are subject to very low credit risk.
A
Obligations
rated A are considered
upper medium-grade and are subject to low credit risk.
Baa
Obligations
rated Baa are subject to
moderate credit risk. They are considered medium-grade and as such may possess
certain speculative characteristics.
Ba
Obligations
rated Ba are judged to
have speculative elements and are subject to substantial credit
risk.
Obligations
rated B are considered
speculative and are subject to high credit risk.
Caa
Obligations
rated Caa are judged to
be of poor standing and are subject to very high credit risk.
Ca
Obligations
rated Ca are highly
speculative and are likely in, or very near, default, with some prospect of
recovery of principal and interest.
C
Obligations
rated C are the lowest
rated class of bonds and are typically in default, with little prospect for
recovery of principal or interest.
Note: Moody’s
appends numerical modifiers 1, 2, and 3 to each generic rating classification
from Aa through Caa. The modifier 1 indicates that the obligation ranks in
the
higher end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates a ranking in the lower end of that generic
rating category.
Medium-Term
Note Ratings
Moody’s
assigns long-term ratings to
individual debt securities issued from medium-term note (MTN) programs, in
addition to indicating ratings to MTN programs themselves. Notes issued under
MTN programs with such indicated ratings are rated at issuance at the rating
applicable to all parí passu notes issued under the same program, at the
program’s relevant indicated rating, provided such notes do not exhibit any of
the characteristics listed below:
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·
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Notes
containing features that link interest or principal to the credit
performance of any third party or parties (i.e., credit-linked
notes);
|
|
·
|
Notes
allowing for negative coupons, or negative
principal
|
|
·
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Notes
containing any provision that could obligate the investor to make
any
additional payments
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|
·
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Notes
containing provisions that subordinate the
claim.
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For
notes with any of these
characteristics, the rating of the individual note may differ from the indicated
rating of the program.
For
credit-linked securities, Moody’s
policy is to “look through” to the credit risk of the underlying obligor.
Moody’s policy with respect to non-credit linked obligations is to rate the
issuer’s ability to meet the contract as stated, regardless of potential losses
to investors as a result of non-credit developments. In other words, as long
as
the obligation has debt standing in the event of bankruptcy, we will assign
the
appropriate debt class level rating to the instrument.
Market
participants must determine
whether any particular note is rated, and if so, at what rating level. Moody’s
encourages market participants to contact Moody’s Ratings Desks or visit
www.moodys.com directly if they have questions regarding ratings for specific
notes issued under a medium-term
note program. Unrated notes issued under an MTN program may be assigned an
NR
(not rated) symbol.
Short-Term
Ratings:
Moody’s
short-term ratings are
opinions of the ability of issuers to honor short-term financial obligations.
Ratings may be assigned to issuers, short-term programs or to individual
short-term debt instruments. Such obligations generally have an original
maturity not exceeding thirteen months, unless explicitly noted.
Moody’s
employs the following
designations to indicate the relative repayment ability of rated
issuers:
P-1
Issuers
(or supporting institutions)
rated Prime-1 have a superior ability to repay short-term debt
obligations.
P-2
Issuers
(or supporting institutions)
rated Prime-2 have a strong ability to repay short-term debt
obligations.
P-3
Issuers
(or supporting institutions)
rated Prime-3 have an acceptable ability to repay short-term
obligations.
NP
Issuers
(or supporting institutions)
rated Not Prime do not fall within any of the Prime rating
categories.
Note: Canadian
issuers rated P-1 or P-2 have their short-term ratings enhanced by the senior
most long-term rating of the issuer, its guarantor or support
provider.
APPENDIX
B
PROXY
VOTING POLICIES AND PROCEDURES
HIGHLAND
CAPITAL MANAGEMENT, L.P.
PROXY
VOTING POLICY
1. Application;
General Principles
1.1 This
proxy voting policy (the “Policy”) applies to securities held in Client accounts
as to which the above-captioned investment adviser (the “Company”) has voting
authority, directly or indirectly. Indirect voting authority exists
where the Company’s voting authority is implied by a general delegation of
investment authority without reservation of proxy voting authority.
1.2 The
Company shall vote proxies in respect of securities owned by or on behalf of
a
Client in the Client’s best economic interests and without regard to the
interests of the Company or any other Client of the Company.
2. Voting;
Procedures
2.1 Monitoring. A
settlement designee of the Company shall have responsibility for monitoring
portfolios managed by the Company for securities subject to a proxy
vote. Upon the receipt of a proxy notice related to a security held
in a portfolio managed by the Company, the settlement designee shall forward
all
relevant information to the portfolio manager(s) with responsibility for the
security.
2.2 Voting.
2.2.1 Upon
receipt of notice from the settlement designee, the portfolio manager(s) with
responsibility for purchasing the security subject to a proxy vote shall
evaluate the subject matter of the proxy and cause the proxy to be voted on
behalf of the Client. In determining how to vote a particular proxy,
the portfolio manager (s) shall consider, among other things, the interests
of
each Client account as it relates to the subject matter of the proxy, any
potential conflict of interest the Company may have in voting the proxy on
behalf of the Client and the procedures set forth in this Policy.
2.2.2 If
a proxy relates to a security held in a registered investment company or
business development company (“Retail Fund”) portfolio, the portfolio manager(s)
shall notify the Compliance Department and a designee from the Retail Funds
group. Proxies for securities held in the Retail Funds will be voted
by the designee from the Retail Funds group in a manner consistent with the
best
interests of the applicable Retail Fund and a record of each vote will be
reported to the Retail Fund’s Board of Directors in accordance with the
procedures set forth in Section 4 of this Policy.
2.3 Conflicts
of Interest. If the portfolio manager(s) determine that the
Company may have a potential material conflict of interest (as defined in
Section 3 of this Policy) in voting a particular proxy, the portfolio manager(s)
shall contact the Company’s Compliance Department prior to causing the proxy to
be voted.
2.3.1 For
a security held by a Retail Fund, the Company shall disclose the conflict and
the determination of the manner in which it proposes to vote to the Retail
Fund’s Board of Directors. The Company’s determination shall take
into account only the interests of the Retail Fund, and the Compliance
Department shall document the basis for the decision and furnish the
documentation to the Board of Directors.
2.3.2 For
a security held by an unregistered investment company, such as a hedge fund
and
structured products (“Non-Retail Funds”), where a material conflict of interest
has been identified the Company may resolve the conflict by following the
recommendation of a disinterested third party or by abstaining from
voting.
2.4 Non-Votes. The
Company may determine not to vote proxies in respect of securities of any issuer
if it determines it would be in its Client’s overall best interests not to
vote. Such determination may apply in respect of all Client holdings
of the securities or only certain specified Clients, as the Company deems
appropriate under the circumstances. As examples, the portfolio
manager(s) may determine: (a) not to recall securities on loan if, in its
judgment, the negative consequences to Clients of disrupting the securities
lending program would outweigh the benefits of voting in the particular instance
or (b) not to vote certain foreign securities positions if, in its judgment,
the
expense and administrative inconvenience outweighs the benefits to Clients
of
voting the securities.
2.5 Recordkeeping. Following
the submission of a proxy vote, the applicable portfolio manager(s) shall submit
a report of the vote to a settlement designee of the Company. Records
of proxy votes by the Company shall be maintained in accordance with Section
4
of this Policy.
2.6 Certification. On
a quarterly basis, each portfolio manager shall certify to the Compliance
Department that they have complied with this Policy in connection with proxy
votes during the period.
3. Conflicts
of Interest
3.1 Voting
the securities of an issuer where the following relationships or circumstances
exist are deemed to give rise to a material conflict of interest for purposes
of
this Policy:
3.1.1 The
issuer is a Client of the Company accounting for more than 5% of the Company’s
annual revenues.
3.1.2 The
issuer is an entity that reasonably could be expected to pay the Company more
than $1 million through the end of the Company’s next two full fiscal
years.
3.1.3 The
issuer is an entity in which a “Covered Person” (as defined in the Retail Funds’
and the Company’s Policies and Procedures Designed to Detect and Prevent Insider
Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940,
as
amended (each, a “Code of Ethics”)) has a beneficial interest contrary to the
position held by the Company on behalf of Clients.
3.1.4 The
issuer is an entity in which an officer or partner of the Company or a
relative1 of any such person is or was an officer, director or
employee, or such person or relative otherwise has received more than $150,000
in fees, compensation and other payment from the issuer during the Company’s
last three fiscal years; provided, however, that the Compliance
Department may deem such a relationship not to be a material conflict of
interest if the Company representative serves as an officer or director of
the
issuer at the direction of the Company for purposes of seeking control over
the
issuer.
1
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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 person’s
home.
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3.1.5 The
matter under consideration could reasonably be expected to result in a material
financial benefit to the Company through the end of the Company’s next two full
fiscal years (for example, a vote to increase an investment advisory fee for
a
Retail Fund advised by the Company or an affiliate).
3.1.6 Another
Client or prospective Client of the Company, directly or indirectly, conditions
future engagement of the Company on voting proxies in respect of any Client’s
securities on a particular matter in a particular way.
3.1.7 The
Company holds various classes and types of equity and debt securities of the
same issuer contemporaneously in different Client portfolios.
3.1.8 Any
other circumstance where the Company’s duty to serve its Clients’ interests,
typically referred to as its “duty of loyalty,” could be
compromised.
3.2 Notwithstanding
the foregoing, a conflict of interest described in Section 3.1 shall not be
considered material for the purposes of this Policy in respect of a specific
vote or circumstance if:
3.2.1 The
securities in respect of which the Company has the power to vote account for
less than 1% of the issuer’s outstanding voting securities, but only
if: (i) such securities do not represent one of the 10 largest
holdings of such issuer’s outstanding voting securities and (ii) such securities
do not represent more than 2% of the Client’s holdings with the
Company.
3.2.2 The
matter to be voted on relates to a restructuring of the terms of existing
securities or the issuance of new securities or a similar matter arising out
of
the holding of securities, other than common equity, in the context of a
bankruptcy or threatened bankruptcy of the issuer.
4. Recordkeeping
and Retention
4.1 The
Company shall retain records relating to the voting of proxies,
including:
4.1.1 Copies
of this Policy and any amendments thereto.
4.1.2 A
copy of each proxy statement that the Company receives regarding Client
securities.
4.1.3 Records
of each vote cast by the Company on behalf of Clients.
4.1.4 A
copy of any documents created by the Company that were material to making a
decision how to vote or that memorializes the basis for that
decision.
4.1.5 A
copy of each written request for information on how the Company voted proxies
on
behalf of the Client, and a copy of any written response by the Company to
any
(oral or written) request for information on how the Company voted.
4.2 These
records shall be maintained and preserved in an easily accessible place for
a
period of not less than five years from the end of the Company’s fiscal year
during which the last entry was made in the records, the first two years in
an
appropriate office of the Company.
4.3 The
Company may rely on proxy statements filed on the SEC’s EDGAR system or on proxy
statements and records of votes cast by the Company maintained by a third party,
such as a proxy voting service (provided the Company had obtained an undertaking
from the third party to provide a copy of the proxy statement or record promptly
on request).
4.4 Records
relating to the voting of proxies for securities held by the Retail Funds will
be reported periodically to the Retail Funds’ Boards of Directors and, with
respect to Retail Funds other than business development companies, to the SEC
on
an annual basis pursuant to Form N-PX.
Part
C
Other
Information
Item
25.
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Financial
Statements and
Exhibits
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1. Financial
Statements
Part
A — Financial Highlights.
Part
B — Unaudited financial statements for the period ended June 30, 2007 are
incorporated by reference to the Trust’s semi-annual report for the period ended
June 30, 2007.
2. Exhibits
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|
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(a)
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|
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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)
|
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Form
of Specimen Certificate(1)
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(e)
|
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Form
of Dividend Reinvestment Plan(1)
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(f)
|
|
|
Not
applicable
|
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(g)
|
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Form
of Investment Advisory Agreement(1)
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(h)
|
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Form
of Dealer Manager Agreement(3)
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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(1)
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(k)(3)
|
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Form
of Sub-Administration Services Agreement(1)
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(k)(4)
|
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Form
of Accounting Services Agreement(1)
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(k)(5)
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Form
of Marketing and Structuring Fee Agreement(1)
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(l)
|
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Opinion
and Consent of Counsel to the Trust(3)
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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(3)
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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(2)
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____________________
(1)
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Incorporated
by reference from the final Pre-Effective Amendment No. 6 to the
Trust’s
Registration Statement on Form N-2, filed on June 21, 2006.
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(2)
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Filed
herewith.
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(3)
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To
be filed by amendment.
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Item
26.
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Marketing
Arrangements
|
Not
applicable.
Item
27.
|
Other
Expenses of Issuance and
Distribution
|
Not
applicable.
Item
28.
|
Persons
Controlled by or Under Common Control with the
Registrant
|
None.
Item
29.
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Number
of Holders of Shares
|
As
of September 30, 2007:
Title
of Class
|
|
Number
of
Record
Holders
|
|
Common
Shares of Beneficial Interest
|
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[·]
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Article
V of the Registrant’s Agreement and Declaration of Trust provides as
follows:
|
5.1
No Personal Liability of Shareholders, Trustees, etc. No
Shareholder of the Trust shall be subject in such capacity to any
personal
liability whatsoever to any Person in connection with Trust Property
or
the acts, obligations or affairs of the Trust. Shareholders shall
have the
same limitation of personal liability as is extended to stockholders
of a
private corporation for profit incorporated under the Delaware General
Corporation Law. No trustee or officer of the Trust shall be subject
in
such capacity to any personal liability whatsoever to any Person,
save
only liability to the Trust or its Shareholders arising from bad
faith,
willful misfeasance, gross negligence or reckless disregard for his
duty
to such Person; and, subject to the foregoing exception, all such
Persons
shall look solely to the Trust
Property
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|
for
satisfaction of claims of any nature arising in connection with the
affairs of the Trust. If any Shareholder, trustee or officer, as
such, of
the Trust, is made a party to any suit or proceeding to enforce any
such
liability, subject to the foregoing exception, he shall not, on account
thereof, be held to any personal liability. Any repeal or modification
of
this Section 5.1 shall not adversely affect any right or protection
of a
trustee or officer of the Trust existing at the time of such repeal
or
modification with respect to acts or omissions occurring prior to
such
repeal or modification.
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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.
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(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.
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(c)
The Trust shall make advance payments in connection with the expenses
of
defending any action with respect to which indemnification might
be sought
hereunder if the Trust receives a written affirmation by the indemnitee
of
the indemnitee’s good faith belief that the standards of conduct necessary
for indemnification have been met and a written undertaking to reimburse
the Trust unless it
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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.
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(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.
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(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.
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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.
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5.4
No Duty of Investigation; Notice in Trust Instruments, etc. No
purchaser, lender, transfer agent or other person dealing with the
trustees or with any officer, employee or agent of the Trust shall
be
bound to make any inquiry concerning the validity of any transaction
purporting to be made by the trustees or by said officer, employee
or
agent or be liable for the application of money or property paid,
loaned,
or delivered to or on the order of the trustees or of said officer,
employee or agent. Every obligation, contract, undertaking, instrument,
certificate, Share, other security of the Trust, and every other
act or
thing whatsoever executed in connection with the Trust shall be
conclusively taken to have been executed or done by the executors
thereof
only in their capacity as trustees under this Declaration or in their
capacity as officers, employees or agents of the Trust. The trustees
may
maintain insurance for the protection of the Trust Property, its
Shareholders, trustees, officers, employees and agents in such amount
as
the trustees shall deem adequate to cover possible tort liability,
and
such other insurance as the trustees in their sole judgment shall
deem
advisable or is required by the Investment Company Act.
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5.5
Reliance on Experts, etc. Each trustee and officer or employee of
the Trust shall, in the performance of its duties, be fully and completely
justified and protected with regard to any act or any failure to
act
resulting from reliance in good faith upon the books of account or
other
records of the Trust, upon an opinion of counsel, or upon reports
made to
the Trust by any of the Trust’s officers or employees or by any advisor,
administrator, manager, distributor, selected dealer, accountant,
appraiser or other expert or consultant selected with reasonable
care by
the trustees, officers or employees of the Trust, regardless of whether
such counsel or expert may also be a trustee.
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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
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event
that a claim for indemnification against such liabilities (other
than the
payment by the Trust of expenses incurred or paid by a trustee, officer
or
controlling person of the Trust in the successful defense of any
action,
suit or proceeding) is asserted by such trustee, officer or controlling
person in connection with the securities being registered, the Trust
will,
unless in the opinion of its counsel the matter has been settled
by
controlling precedent, submit to a court of appropriate jurisdiction
the
question whether such indemnification by it is against public policy
as
expressed in the Securities Act of 1933 and will be governed by the
final
adjudication of such issue. Reference is made to Section 8 of the
underwriting agreement attached as Exhibit (h), which is incorporated
herein by reference and discusses the rights, responsibilities and
limitations with respect to indemnity and
contribution.
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Item
31.
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Business
and Other Connections of Investment
Advisor
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Highland
Capital Management, L.P. has not engaged in any other substantial business
since
January 1, 2003 other than that disclosed under “Management of the Trust”
in each of the prospectus and the Statement of Additional Information.
Information as to other businesses, professions, vocations or employment of
a
substantial nature engaged in by each partner and executive officer of Highland
Capital Management, L.P. is set forth in its Form ADV, as filed on the
Commission’s website (File No. 801-54874) and is incorporated herein by
reference.
Item
32.
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Location
of Accounts and
Records
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The
Trust’s accounts, books and other documents are currently located at the offices
of the Registrant, c/o Highland Capital Management, L.P., Two Galleria Tower,
13455 Noel Road, Suite 800, Dallas, Texas 75240 and at the offices of the
Registrant’s Custodian and Transfer Agent.
Item
33.
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Management
Services
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Not
Applicable.
(1)
The Trust hereby undertakes to suspend the offering of its units until it amends
its prospectus if (a) subsequent to the effective date of its Registration
Statement, the net asset value declines more than 10 percent from its net asset
value as of the effective date of the Registration Statement or (b) the net
asset value increases to an amount greater than its net proceeds as stated
in
the prospectus.
(2)
Not applicable.
(3)
Not applicable.
(4) The
Registrant hereby undertakes:
(a) to
file, during any period in which offers or sales are being made, a
post-effective amendment to the registration statement:
(i)
to include any prospectus required by Section 10(a)(3) of the 1933
Act;
(ii)
to reflect in the prospectus any facts or events 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
(iii)
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 any liability under the 1933 Act, each
such
post-effective amendment shall be deemed to be a new registration statement
relating to the securities offered herein, 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.
(5)
(a) For the purposes of determining any liability under the Securities Act
of
1933, the information omitted from the form of prospectus filed as part of
a
registration statement in reliance upon Rule 430A and contained in the form
of
prospectus filed by the Registrant under Rule 497 (h) under the Securities
Act
of 1933 shall be deemed to be part of the Registration Statement as of the
time
it was declared effective.
(b)
For the purpose of determining any liability under the Securities Act of 1933,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of the securities at that time shall be deemed to be the
initial bona fide offering thereof.
(6)
The Registrant undertakes to send by first class mail or other means designed
to
ensure equally prompt delivery within two business days of receipt of a written
or oral request, any Statement of Additional Information.
SIGNATURES
Pursuant
to the requirements of the Securities Act of 1933 and the Investment Company
Act
of 1940, the Registrant has duly caused this Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Dallas, and State of Texas, on the 2nd day of November,
2007.
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/s/
James D. Dondero*
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James
D. Dondero
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Chief
Executive Officer and President
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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 2nd day of November
2,
2007.
Name
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Title
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/s/
R. Joseph Dougherty*
R.
Joseph Dougherty
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Trustee
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/s/
Timothy Hui*
Timothy
Hui
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Trustee
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/s/
Scott Kavanaugh*
Scott
Kavanaugh
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Trustee
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/s/
James Leary*
James
Leary
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Trustee
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/s/
Bryan Ward*
Bryan
Ward
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Trustee
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/s/
James D. Dondero*
James
D. Dondero
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Chief
Executive Officer and President
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/s/
M. Jason Blackburn
M.
Jason Blackburn
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Chief
Financial Officer
(Principal
Accounting Officer), Treasurer and Secretary
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*By:
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/s/
M. Jason Blackburn
M.
Jason Blackburn
Attorney-in-Fact
November
2, 2007
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Exhibits
(s) Power
of Attorney