As filed with the Securities and Exchange Commission on February 28, 2008
1933 Act File No. 333-_____
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-14
[ X ] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] Pre-Effective Amendment No. __
[ ] Post-Effective Amendment No. __
Highland Credit Strategies Fund
(Exact Name of Registrant as Specified in Charter)
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 of Communications to:
Jennifer R. Gonzalez, Esq.
Kirkpatrick & Lockhart Preston Gates Ellis LLP
1601 K Street, NW
Washington, DC 20006
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 Proposed Proposed Amount of
Registered (1) Maximum Maximum Registration
Offering Aggregate Fee
Price Per Offering
Unit(1) Price(1)
-------------------------------------------------------------------------------------------------
Common Stock (par value $0.001) 10,695,187.17 $14.96 (2) $160,000,000 $6,288.00
-------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee.
(2) Net asset value per share for common stock on February 22, 2008.
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 Commission acting pursuant to said section 8(a),
may determine.
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
PROSPECT STREET INCOME SHARES INC.
Two Galleria Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
JOINT SPECIAL MEETING OF STOCKHOLDERS TO BE HELD [ ], 2008
[ ], 2008
Dear Stockholder:
You are being asked to vote on a proposed reorganization of Prospect Street
High Income Portfolio Inc. ("High Income Portfolio") or Prospect Street Income
Shares Inc. ("Income Shares"), as applicable (each an "Acquired Fund" and
together as the "Acquired Funds"), into Highland Credit Strategies Fund
("Acquiring Fund") (collectively, the Acquired Funds and the Acquiring Fund
being referred to herein as the "Funds").
The Board of Directors of each Acquired Fund has called a joint special
meeting of stockholders of the Acquired Funds (the "Meeting") to be held on [ ],
2008, at 13455 Noel Road, Suite 800, Dallas, Texas 75240, on [_____], at 10:00
a.m., Central Time, so that stockholders can vote on an Agreement and Plan of
Reorganization ("Agreement"). Each Agreement provides for the participating
Acquired Fund to transfer its assets to the Acquiring Fund in exchange for
common shares and cash (in lieu of fractional shares) of the Acquiring Fund and
the assumption by the Acquiring Fund of the Acquired Fund's liabilities and the
dissolution of the Acquired Fund under applicable state law ("Reorganization").
Prior to a Reorganization, it is anticipated that the preferred stock of a
participating Acquired Fund will be redeemed, with preferred stockholders
receiving a liquidation preference of $25,000 per share plus any accumulated and
unpaid dividends. As a result of a Reorganization, a common stockholder of the
participating Acquired Fund will become a common shareholder of the Acquiring
Fund. The attached combined Proxy Statement and Prospectus includes detailed
information about the proposed Reorganization and Agreement for each Acquired
Fund. AFTER CAREFUL CONSIDERATION, THE BOARD OF EACH ACQUIRED FUND UNANIMOUSLY
RECOMMENDS THAT YOU SUPPORT THE REORGANIZATION AND VOTE "FOR" THE APPLICABLE
PROPOSED AGREEMENT.
The investment objective of each Acquired Fund is similar to that of the
Acquiring Fund, although their investment policies, strategies and risks are
different, particularly with respect to Income Shares and the Acquiring Fund.
Highland Capital Management, L.P. is the investment adviser to each Fund. In
addition, the two portfolio managers for each Acquired Fund also manage the
Acquiring Fund with a third portfolio manager.
Your vote is very important to us regardless of the number of shares you
own. Whether or not you plan to attend the Meeting in person, please read the
Proxy Statement and Prospectus and cast your vote promptly. To vote, simply
date, sign and return the proxy card in the enclosed postage-paid envelope or
follow the instructions on the proxy card for voting by touch-tone telephone or
on the Internet.
It is important that your vote be received no later than the time of the
Meeting.
Sincerely,
R. Joseph Dougherty
Chairman of the Board
Prospect Street High Income Portfolio Inc.
Prospect Street Income Shares Inc.
IMPORTANT NOTICE
TO STOCKHOLDERS OF
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
AND
PROSPECT STREET INCOME SHARES INC.
QUESTIONS & ANSWERS
Although we recommend that you read the complete Proxy Statement and Prospectus
("Proxy Statement/Prospectus"), we have provided for your convenience a brief
overview of the proposals to be voted on at a special meeting of stockholders.
APPROVAL OF REORGANIZATIONS OF THE ACQUIRED FUNDS
Q: WHAT IS BEING PROPOSED AT THE STOCKHOLDER MEETING?
A: STOCKHOLDERS OF PROSPECT STREET HIGH INCOME PORTFOLIO INC. AND PROSPECT
STREET INCOME SHARES INC.: You are being asked to approve a proposed
reorganization (each a "Reorganization" and, together, the "Reorganizations") of
Prospect Street High Income Portfolio Inc. ("High Income Portfolio") or Prospect
Street Income Shares Inc. ("Income Shares"), as applicable (each an "Acquired
Fund" and together as the "Acquired Funds"), into Highland Credit Strategies
Fund ("Acquiring Fund") (collectively, the Acquired Funds and the Acquiring Fund
being referred to herein as the "Funds"), a closed-end fund that pursues a
similar investment objective and is managed by Highland Capital Management, L.P.
("Highland"), the same investment adviser as that of the Acquired Funds.
Q: WHY IS EACH REORGANIZATION BEING RECOMMENDED?
A: The Board of Directors of each Acquired Fund has determined that the
Reorganization in which its Fund would participate would benefit its common
stockholders. The Board of Trustees of the Acquiring Fund has determined that
the Reorganizations would benefit its common shareholders. The investment
objective of each Acquired Fund and the Acquiring Fund are similar, although
each Fund seeks to achieve its objective in different ways. High Income
Portfolio seeks to provide high current income, while seeking to preserve
stockholders' capital. Income Shares seeks to provide a high level of current
income, with capital appreciation as a secondary objective. The Acquiring Fund
seeks to provide both current income and capital appreciation. Each Fund is
managed by the same investment adviser and has the same members on its Board. In
addition, the two portfolio managers for each Acquired Fund also manage the
Acquiring Fund with a third portfolio manager. Prior to a Reorganization, it is
anticipated that the preferred stock of an Acquired Fund will be redeemed, with
preferred stockholders receiving a liquidation preference of $25,000 per share
plus any accumulated and unpaid dividends. A Reorganization will not be
completed unless, before the final stockholder vote thereon, the participating
Acquired Fund commences, and irrevocably commits to complete as expeditiously as
possible, the process for redeeming its preferred stock.
In reaching this determination, the Board of Directors of each Acquired Fund
also considered that if stockholders approve the Reorganization(s), Highland
would contractually agree to waive a portion of the Acquiring Fund's advisory
fee and administration fee for two years so that Highland would receive no
additional benefit from the Reorganization(s) for two years. The waivers are
intended to offset the additional revenue Highland would receive on each
Acquired Fund's assets (calculated as of the date of its reorganization) due to
the difference between the advisory fee rates of each Acquired Fund and the
Acquiring Fund and the fact that the Acquired Funds do not pay an administration
fee to Highland.
The Proxy Statement/Prospectus contains further explanation of the reasons that
the Boards of Directors/Trustees of the Funds unanimously recommend the
Reorganizations.
Q: HOW DOES THE ACQUIRING FUND'S INVESTMENT STRATEGY DIFFER FROM MY FUND?
A: The Acquiring Fund invests at least 80% of its assets 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. A significant portion of the Acquiring Fund's
assets may be invested in securities rated below investment grade (Ba/BB or
lower), which are commonly referred to as "junk securities."
STOCKHOLDERS OF HIGH INCOME PORTFOLIO: The investment strategy of the Acquiring
Fund is similar to High Income Portfolio's since both invest primarily in below
investment grade securities, but the Acquiring Fund has a greater focus on bank
loans. In addition, the Acquiring Fund is able to invest in more types of
securities and it invests approximately [75%] of its assets in senior loans as
of the date hereof.
STOCKHOLDERS OF INCOME SHARES: The investment strategy of Income Shares differs
from that of the Acquiring Fund. Income Shares invests in higher quality
securities, since it invests at least 50% of its total assets in debt securities
rated in the four highest categories (Baa/BBB or higher) by a rating agency or
nonrated debt securities deemed by Highland to be of comparable quality. A
significant portion of the Acquiring Fund's assets is invested in securities
rated below investment grade (Ba/BB or lower) and it currently invests
approximately [75%] of its assets in senior loans as of the date hereof.
Q: HOW WILL THE REORGANIZATIONS AFFECT ME?
A: If stockholders approve the Reorganizations of both Acquired Funds, the
assets and liabilities of the Acquired Funds will be combined with those of the
Acquiring Fund and the Acquired Funds will dissolve. As noted above, the
preferred stock of an Acquired Fund will be redeemed prior to its
Reorganization.
COMMON STOCKHOLDERS OF THE ACQUIRED FUNDS: If you are a holder of common stock
of an Acquired Fund, you will receive newly issued common shares of the
Acquiring Fund (though you may receive cash for fractional common shares), the
aggregate net asset value of which will equal the aggregate net asset value,
taking into account your Fund's proportionate share of the costs of the
Reorganizations, of the common stock you held immediately prior to your Fund's
Reorganization. The Acquiring Fund common shares received by Acquired Fund
common stockholders will likely trade on the New York Stock Exchange at a
discount from net asset value, which might be greater or less than the trading
discount of common stock of an Acquired Fund at the time of the closing of its
Reorganization.
PREFERRED STOCKHOLDERS OF THE ACQUIRED FUNDS: If you are a holder of preferred
stock of an Acquired Fund, prior to that Fund's Reorganization you will receive
the liquidation preference of the preferred stock you hold plus any accumulated
and unpaid dividends because the preferred stock will be redeemed prior to the
Reorganization.
Q: WILL I HAVE TO PAY ANY SALES LOAD, COMMISSION OR OTHER SIMILAR FEE IN
CONNECTION WITH THE REORGANIZATIONS?
A: You will pay no sales loads or commissions in connection with the
Reorganizations. However, part of the costs associated with the Reorganizations
will be borne by the Acquired Funds and thus indirectly by their common
stockholders.
Q: WILL MY DIVIDENDS BE AFFECTED BY THE PROPOSED REORGANIZATION?
A: COMMON STOCKHOLDERS OF INCOME SHARES: If you are a common stockholder of
Income Shares, you receive distributions on a quarterly basis. As shareholders
of the Acquiring Fund, you will receive distributions on a monthly basis. The
Acquiring Fund's current yield as of January 31, 2008 on a net asset value basis
is higher than that of Income Shares. It is expected that the shareholders of
the Acquiring Fund will not see any material change in its yield as a result of
the Reorganizations, although there can be no assurance that this will be the
case.
- 2 -
COMMON STOCKHOLDERS OF HIGH INCOME PORTFOLIO: If you are a common stockholder of
High Income Portfolio, you receive distributions on a monthly basis. As a
shareholder of the Acquiring Fund, you will also receive distributions on a
monthly basis. The Acquiring Fund's current yield as of January 31, 2008 on a
net asset value basis is higher than that of High Income Portfolio. It is
expected that the shareholders of Acquiring Fund will not see any material
change in its yield as a result of the Reorganizations, although there can be no
assurance that this will be the case.
PREFERRED STOCKHOLDERS OF THE ACQUIRED FUNDS: If you are a preferred stockholder
of an Acquired Fund, at the time you receive the liquidation preference of the
preferred stock you hold you will also receive any accumulated and unpaid
dividends.
The Acquiring Fund will not permit any holder of certificated common stock of an
Acquired Fund at the time of the Reorganization to reinvest dividends or other
distributions, transfer shares of the Acquiring Fund or pledge shares of the
Acquiring Fund until the certificates for stock of the Acquired Fund have been
surrendered to PFPC, Inc., the Acquiring Fund's transfer agent, or, in the case
of lost certificates, until an adequate surety bond has been posted. To obtain
information on how to return your stock certificates for an Acquired Fund if and
when the Reorganizations are completed, please call PFPC, Inc. at 877-665-1287.
If a shareholder is not, for the reasons above, permitted to reinvest dividends
or other distributions on shares of the Acquiring Fund, the Acquiring Fund will
pay all such dividends and other distributions in cash, notwithstanding any
election the shareholder may have made previously to reinvest dividends and
other distributions on stock of an Acquired Fund.
Q: WILL I HAVE TO PAY ANY FEDERAL INCOME TAXES AS A RESULT OF THE
REORGANIZATIONS?
A: Each Reorganization is intended to qualify as a "reorganization" within the
meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended.
If the Reorganizations so qualify, in general, stockholders of the Acquired
Funds will recognize no gain or loss upon the receipt solely of shares of the
Acquiring Fund in connection with the Reorganizations. However, stockholders of
the Acquired Funds may recognize gain or loss with respect to cash such holders
receive pursuant to the Reorganization in lieu of fractional shares.
Additionally, the Acquired Funds will recognize no gain or loss as a result of
the Reorganization or as a result of their dissolution. Neither the Acquiring
Fund nor its shareholders will recognize any gain or loss in connection with the
Reorganizations.
Q: WHAT HAPPENS IF STOCKHOLDERS OF ONE ACQUIRED FUND DO NOT APPROVE ITS
REORGANIZATION BUT STOCKHOLDERS OF THE OTHER ACQUIRED FUND DO APPROVE ITS
REORGANIZATION?
A: The Reorganizations are not contingent upon each other. An unfavorable vote
on a proposed Reorganization by the stockholders of one Acquired Fund will not
affect the consummation of the Reorganization by the other Acquired Fund, if
that Reorganization is approved by its stockholders.
Q: HOW DOES THE BOARD OF DIRECTORS OF EACH ACQUIRED FUND SUGGEST THAT I VOTE?
A: After careful consideration, the Board of Directors of each Acquired Fund
unanimously recommends that you vote "FOR" the Reorganization proposed for your
Fund.
- 3 -
GENERAL
Q: HOW DO I VOTE MY PROXY?
A: You may use the enclosed postage-paid envelope to mail your proxy card or you
may attend the meeting in person. You may also vote by phone by calling the
proxy solicitor at [ ].
Q: WHO DO I CALL IF I HAVE QUESTIONS?
A: We will be pleased to answer your questions about this proxy solicitation.
Please call [ ] with any questions.
- 4 -
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
PROSPECT STREET INCOME SHARES INC.
(EACH, A "FUND")
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD [_____]
This is the formal agenda for your Fund's stockholder meeting. It tells you what
matters will be voted on and the time and place of the meeting in case you want
to attend in person.
To the stockholders of each Fund:
A joint stockholder meeting for the Funds will be held at 13455 Noel Road, Suite
800, Dallas, Texas 75240, on [_____], at 10:00 a.m., Central Time, to consider
the following:
1. (A) For stockholders of Prospect Street High Income Portfolio Inc. ("High
Income Portfolio"), a proposal to approve an Agreement and Plan of
Reorganization between High Income Portfolio and Highland Credit Strategies
Fund (the "Acquiring Fund") pursuant to which High Income Portfolio will
transfer its assets to Acquiring Fund in exchange for Acquiring Fund shares
(and cash in lieu of certain fractional shares) and the Acquiring Fund's
assumption of High Income Portfolio's liabilities and High Income Portfolio
will dissolve under applicable state law. THE BOARD OF DIRECTORS OF HIGH
INCOME PORTFOLIO UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THIS PROPOSAL.
(B) For stockholders of Prospect Street Income Shares Inc. ("Income
Shares"), a proposal to approve an Agreement and Plan of Reorganization
between Income Shares and the Acquiring Fund pursuant to which Income
Shares will transfer its assets to Acquiring Fund in exchange for Acquiring
Fund shares (and cash in lieu of certain fractional shares) and the
Acquiring Fund's assumption of Income Shares' liabilities and Income Shares
will dissolve under applicable state law. THE BOARD OF DIRECTORS OF INCOME
SHARES UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THIS PROPOSAL.
2. Any other business that may properly come before the meeting.
Stockholders of record as of the close of business on [_____], are entitled to
vote at the meeting or any adjournment thereof. Your attention is called to the
accompanying Proxy Statement and Prospectus. Regardless of whether you plan to
attend the meeting, PLEASE COMPLETE, SIGN, DATE AND RETURN THE ENCLOSED PROXY
CARD PROMPTLY so that a quorum will be present and your shares may be voted. You
may also vote by calling the proxy solicitor at [ ]. If you are present at the
meeting, you may change your vote, if desired, at that time.
YOUR VOTE IS IMPORTANT, REGARDLESS OF THE NUMBER OF SHARES YOU OWN. YOU CAN VOTE
EASILY AND QUICKLY BY MAIL OR BY TELEPHONE. A SELF-ADDRESSED, POSTAGE-PAID
ENVELOPE HAS BEEN ENCLOSED FOR YOUR CONVENIENCE. YOU MAY ALSO VOTE BY CALLING
THE NUMBER ON THE PROXY CARD. PLEASE HELP AVOID THE EXPENSE OF A FOLLOW-UP
MAILING BY VOTING TODAY.
By order of the Boards of Directors,
M. Jason Blackburn
Secretary
Dated: [_____]
PROXY STATEMENT OF
PROSPECT STREET HIGH INCOME PORTFOLIO INC. ("HIGH INCOME PORTFOLIO")
PROSPECT STREET INCOME SHARES INC. ("INCOME SHARES")
(EACH, AN "ACQUIRED FUND")
AND
PROSPECTUS FOR
COMMON SHARES OF
HIGHLAND CREDIT STRATEGIES FUND
("CREDIT STRATEGIES FUND" OR THE "ACQUIRING FUND")
The address of the Acquired Funds and the Acquiring Fund (each, a "Fund") is Two
Galleria Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 and the
telephone number of each Fund is 1-877-665-1287.
* * * * * *
This Proxy Statement and Prospectus ("Proxy Statement/Prospectus") contains the
information stockholders of each Acquired Fund should know before voting on the
proposed reorganizations (each a "Reorganization" and, together, the
"Reorganizations"). Please read it carefully and retain it for future reference.
For ease of reading, "shares" and "shareholders" has been used in certain places
in the Proxy Statement/Prospectus to describe, respectively, the stock of each
Acquired Fund and holders of stock of each Acquired Fund.
HOW THE REORGANIZATIONS WILL WORK
o Each Acquired Fund will redeem its preferred shares prior to its
Reorganization. A Reorganization will not be completed unless, before the
final shareholder vote thereon, the participating Acquired Fund commences,
and irrevocably commits to complete as expeditiously as possible, the
process for redeeming its preferred shares. Pursuant to each
Reorganization, an Acquired Fund will transfer all of its assets to the
Acquiring Fund, which will assume each Acquired Fund's liabilities.
o If each Reorganization is approved by its respective shareholders, the
Acquiring Fund will issue newly issued common shares of beneficial
interest, with $0.001 par value ("Acquiring Fund Common Shares"), and cash
(in lieu of certain fractional shares) in an aggregate amount equal to the
value of each Acquired Fund's net assets attributable to its common shares.
These shares will be distributed to each Acquired Fund's common
shareholders in proportion to their holdings immediately prior to the
Reorganization.
o Each Acquired Fund will be dissolved and its shareholders will become
shareholders of the Acquiring Fund.
o The Reorganization of an Acquired Fund is conditioned upon the approval of
its shareholders. However, the Reorganizations are not contingent upon each
other and the Reorganization of one Acquired Fund will proceed, if approved
by its shareholders, even if the Reorganization for the other Acquired Fund
is not approved. If a Reorganization is not approved by an Acquired Fund,
that Fund will continue to exist and its Board of Directors will consider
what additional action, if any, to take.
o Each Reorganization is intended to result in no income or recognized gain
or loss for federal income tax purposes to the Acquiring Fund, the Acquired
Fund or the shareholders of the Funds, except for distributions of net
realized capital gains, if any, resulting from the sale of an Acquired
Fund's assets in connection with its Reorganization. In addition,
shareholders of the Acquired Funds may recognize gain or loss with respect
to cash such holders receive pursuant to the Reorganization in lieu of
fractional shares.
RATIONALE FOR THE REORGANIZATIONS
The Board of Directors of each Acquired Fund and the Board of Trustees of the
Acquiring Fund (each a "Board") believes that reorganizing each Acquired Fund
into the Acquiring Fund, a fund with a similar investment objective and having a
combined portfolio with greater assets, offers you potential benefits. These
potential benefits and Board considerations include:
o EXCHANGE OF COMMON SHARES AT NET ASSET VALUE ("NAV"). On its closing date,
a Reorganization will result in the Acquired Fund shareholders receiving
shares of the Acquiring Fund and cash (in lieu of certain fractional
shares) based on the Acquired Fund's NAV (I.E., the Acquired Fund will get
its NAV's worth of common shares of the Acquiring Fund and cash (in lieu of
certain fractional shares)). It should be noted, however, that shares of
the Acquiring Fund received in a Reorganization will likely trade at a
market discount from NAV following the Reorganization, so that an Acquired
Fund common shareholder may not be able to sell these shares for their NAV.
It should also be noted that since inception shares of the Acquiring Fund
generally have traded at a smaller discount or wider premium from NAV than
shares of either Acquired Fund. However, since late December until the
Board approved the Reorganization in February 2008, Acquiring Fund shares
have frequently traded at a larger discount from NAV than shares of either
Acquired Fund. The Acquired Fund commenced a rights offering in late
December and completed the rights offering on January 28, 2008.
Historically, rights offerings have increased the discount from NAV for a
fund.
o INCREASED USE OF CAPITAL LOSSES. Each Acquired Fund has sustained
substantial capital losses in recent years, which are available as "capital
loss carryovers" ("CLCs") in the current and future taxable years (through
their respective taxable years ending in 2013), but is not expected to be
able to generate enough capital gains to be offset by those CLCs before
they expire. SEE "Further Information on the Reorganizations - Federal
Income Tax Consequences of the Reorganizations." Because of its larger size
and investment policies and strategies, the Acquiring Fund is expected to
be better able to use those CLCs to offset post-Reorganization gains of the
combined Fund. The Acquiring Fund's use of such CLCs, however, will be
significantly limited due to the application of loss limitation rules under
the federal tax law.
o ENHANCED COMMON SHARE LIQUIDITY. Following the Reorganizations, the
substantially larger trading market in the common shares of the Acquiring
Fund, as compared to that of each Acquired Fund prior to the
Reorganizations, may provide Acquired Fund shareholders with enhanced
market liquidity. Trading discounts can result from many different factors,
however, and there is no assurance that a larger trading market for
Acquiring Fund's common shares will have the effect of reducing or
maintaining trading discounts.
o INCREASED ASSET SIZE. The Acquiring Fund will obtain additional assets
without incurring the commission expenses and generally greater other
expenses associated with offering new shares. In addition, the Acquiring
Fund is obtaining the additional portfolio securities of the Acquired Funds
without the commensurate brokerage costs, dealer spreads or other trading
expenses. It is also obtaining these securities in a manner that is likely
to minimize the market impact of such acquisition on the short-term prices
of these securities.
o ECONOMIES OF SCALE IN CERTAIN EXPENSES. A combined Fund offers economies of
scale that may lead to a reduction in certain expenses. With these reduced
expenses and the contractual fee waivers offered by the Funds' adviser, as
described below, the annual operating expenses of the combined Fund may be
lower than the current annual operating expenses of Income Shares, although
they are expected to be higher than High Income Portfolio's current annual
operating expenses. Each Fund incurs New York Stock Exchange ("NYSE")
listing fees, costs for legal, auditing, and custodial services, and
miscellaneous fees. Many of these expenses overlap and there may be an
opportunity to reduce them over time if the Funds are combined. However, it
is not expected that these economies of scale will be substantial.
- ii -
o PORTFOLIO MANAGEMENT EFFICIENCIES. Each Reorganization would permit
Acquired Fund shareholders to pursue similar investment goals in a larger
Fund. The greater asset size of the combined Fund may allow it, relative to
each Acquired Fund, to obtain better net prices on securities trades and
achieve greater diversification of portfolio holdings.
o SHAREHOLDERS' ABILITY TO MARGIN. Currently, stocks that trade below $5.00
are not marginable. The Reorganization would permit shareholders of High
Income Portfolio and Income Shares (if its shares continue to trade below
$5.00) to receive shares that they could margin. Additionally, marginable
securities may be more liquid that those that are not marginable as many
institutional/large investors are believed to avoid stocks that are not
marginable.
Each Board also considered that if shareholders approve a Reorganization,
Highland Capital Management, L.P. ("Adviser" or "Highland") would contractually
agree to waive a portion of Credit Strategies Fund's advisory fee and
administration fee for two years so that Highland would receive no additional
benefit from the Reorganization for two years. If Income Shares' shareholders
approve its Reorganization, such combined waivers would be at an annual rate of
0.70% of the sum of Income Shares' net assets attributable to common shares as
of the closing date of its Reorganization plus $30 million (representing the
value of its preferred shares that historically have been outstanding). If High
Income Portfolio's shareholders approve its Reorganization, such combined
waivers would be at an annual rate of 0.55% of the sum of High Income
Portfolio's net assets attributable to common shares as of the closing date of
its Reorganization plus $40 million (representing the value of its preferred
shares that historically have been outstanding). In each case, the amount of the
waivers are intended to offset the additional revenue Highland would receive on
each Acquired Fund's assets (including the value of its preferred shares that
historically have been outstanding) due to the difference between the advisory
fee rates of each Acquired Fund and Credit Strategies Fund and the fact that the
Acquired Funds do not pay an administration fee to Highland.
The Board of each Acquired Fund unanimously recommends that you vote FOR the
Reorganization of your Fund into Credit Strategies Fund. For further
information, please see the individual description of the proposal affecting
your Fund contained in the Proxy Statement/Prospectus.
WHO BEARS THE EXPENSES ASSOCIATED WITH THE REORGANIZATIONS
The costs associated with the Reorganizations will be borne by each of the
Acquired Funds and the Acquiring Fund in proportion to their respective net
assets determined at the close of regular trading on the NYSE on the date of the
Reorganizations' closing, provided that if they close at different times, that
determination will be made as of the date that the first Reorganization closes.
WHO IS ELIGIBLE TO VOTE
Shareholders of record on [_____] are entitled to attend and vote at the meeting
or any adjourned meeting. Each share is entitled to one vote. Shares represented
by properly executed proxy cards, unless revoked before or at the meeting, will
be voted according to shareholders' instructions. If you sign a proxy card but
do not fill in a vote, your shares will be voted for the Reorganization. If any
other business comes before the meeting, your shares will be voted at the
discretion of the persons named as proxies.
SHARES OF THE ACQUIRING FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED
OR ENDORSED BY, ANY BANK OR OTHER DEPOSITORY INSTITUTION. THESE SHARES ARE NOT
FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL
RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY.
SHARES OF THE ACQUIRING FUND HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION (THE "SEC"). THE SEC HAS NOT PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
The common shares of the Acquiring Fund are listed on the NYSE under the ticker
symbol "HCF" and will continue to be so listed subsequent to the
Reorganizations. The common shares of High Income Portfolio and Income Shares
are listed on the NYSE under the ticker symbols "PHY" and "CNN," respectively.
- iii -
WHERE TO GET MORE INFORMATION
--------------------------------------------------------------------------------
Credit Strategies Fund's annual
report to shareholders dated
December 31, 2007 Previously sent to the shareholders
of each respective Fund and on file
High Income Portfolio's annual with the SEC or available at no
report to shareholders dated charge by calling our toll free
October 31, 2007 number: 877-665-1287.
Income Shares' annual report to
shareholders dated December 31, 2007
--------------------------------------------------------------------------------
A Statement of Additional Information On file with the SEC or available at
dated [_____], which relates to this no charge by calling our toll free
Proxy Statement/Prospectus and the number: 877-665-1287. The statement
Reorganizations, has been filed with of additional information is
the SEC and contains additional incorporated by reference into
information about the Acquired Funds (and therefore legally part of) this
and the Acquiring Fund Proxy Statement/Prospectus.
--------------------------------------------------------------------------------
To ask questions about this Proxy Call our toll-free telephone number:
Statement/Prospectus 877-665-1287.
--------------------------------------------------------------------------------
The date of this Proxy Statement/Prospectus is [_____].
- iv -
TABLE OF CONTENTS
PAGE
----
INTRODUCTION...................................................................1
SUMMARY........................................................................1
RISK FACTORS AND SPECIAL CONSIDERATIONS........................................6
PROPOSAL 1(A) AND 1(B): REORGANIZATIONS OF THE ACQUIRED FUNDS................21
Description of the Reorganizations...................................22
Reasons for the Proposed Reorganizations.............................22
Comparative Fees and Expense Ratios..................................24
Comparative Performance..............................................24
Board's Evaluation and Recommendation.......................................24
Comparison of the Funds: Investment Objectives and Policies.................26
Comparison of High Income Portfolio to Credit Strategies Fund........26
Comparison of Income Shares to Credit Strategies Fund................31
Fee, Expense and Distributions on Preferred Shares Table for Common
Shareholders of the Funds............................................36
Information About the Funds.................................................42
Outstanding Securities...............................................42
Common Share Price Data..............................................42
Share Repurchases....................................................44
Dividends and Other Distributions....................................44
Dividend Reinvestment Plan...........................................45
Description of Capital Structure............................................48
High Income Portfolio and Income Shares..............................48
Credit Strategies Fund...............................................50
Federal Income Tax Matters..................................................53
Anti-Takeover Provisions....................................................54
High Income Portfolio and Income Shares..............................54
Credit Strategies Fund...............................................55
Past Performance of Each Fund...............................................57
Financial Highlights........................................................58
Further Information on the Reorganizations..................................62
Federal Income Tax Consequences of the Reorganizations...............62
Additional Terms of the Agreements and Plans of Reorganization.......63
Payment of Undistributed Income in Advance of Reorganizations........65
Capitalization..............................................................65
Management of the Funds.....................................................66
Trustees/Directors and Officers......................................66
Investment Adviser...................................................66
Administrator/Sub-Administrator/Accounting Services Agent............69
Portfolio Management.................................................69
Portfolio Transactions with Affiliates...............................70
Other Service Providers..............................................70
VOTING INFORMATION AND REQUIRED VOTE..........................................70
INFORMATION CONCERNING THE MEETING............................................72
Expenses and Methods of Solicitation..................................72
Revoking Proxies......................................................72
Outstanding Shares....................................................72
Other Business........................................................72
Shareholders' Proposals and Communications............................73
Proxy Statement/Prospectus Delivery...................................73
OWNERSHIP OF SHARES OF THE FUNDS..............................................73
EXPERTS.......................................................................73
AVAILABLE INFORMATION.........................................................73
APPENDIX A - FORM OF AGREEMENT AND PLAN OF REORGANIZATION....................A-1
APPENDIX B - DESCRIPTION OF INVESTMENT TYPES.................................B-1
- v -
INTRODUCTION
This Proxy Statement/Prospectus is being used by each Acquired Fund's Board to
solicit proxies to be voted at the special meeting of each Acquired Fund's
shareholders. This meeting will be held at 13455 Noel Road, Suite 800, Dallas,
Texas 75240, on [_____], at 10:00 a.m., Central Time. At the meeting, each
Acquired Fund will consider a proposal to approve an Agreement and Plan of
Reorganization providing for the Reorganization of the Acquired Fund into the
Acquiring Fund. This Proxy Statement/Prospectus is being mailed to your Fund's
shareholders on or about [_____].
For each proposal, this Proxy Statement/Prospectus includes information that is
specific to that proposal. A comparison summary is provided with respect to each
proposal. You should read carefully the sections of the proxy statement related
specifically to your Fund(s), the information relevant to the proposals, as well
as the Appendices and the enclosed materials, because they contain details that
are not in the summary.
SUMMARY
The following is a summary of certain information contained elsewhere in this
Proxy Statement/Prospectus and is qualified in its entirety by reference to the
more complete information contained in this Proxy Statement/Prospectus and in
the Statement of Additional Information. Shareholders should read the entire
Proxy Statement/Prospectus carefully.
PROPOSALS 1(A) AND 1(B): REORGANIZATIONS OF THE ACQUIRED FUNDS
THE PROPOSED REORGANIZATIONS. The Board of each Fund, including the
Trustees/Directors who are not "interested persons" (as defined in the
Investment Company Act of 1940, as amended (the "1940 Act")) of each Fund, has
unanimously approved the Agreement and Plan of Reorganization to which its Fund
is a participant. If the shareholders of an Acquired Fund approve the applicable
Agreement and Plan of Reorganization, then common shareholders of that Acquired
Fund will receive Acquiring Fund Common Shares and cash (in lieu of certain
fractional shares), and the Acquiring Fund will acquire all of the assets of the
Acquired Fund and assume all of the liabilities of that Acquired Fund. The
Acquired Fund will then terminate its registration under the 1940 Act and
dissolve under applicable state law. The aggregate value of Acquiring Fund
Common Shares and any cash you receive in a Reorganization will equal the
aggregate value, taking into account your Fund's proportionate share of the
costs of the Reorganizations, of your Acquired Fund Common Shares held
immediately prior to your Fund's Reorganization. Acquired Fund common
shareholders will receive cash for any Acquiring Fund fractional shares they
otherwise would be entitled to receive other than with respect to shares held in
a Dividend Reinvestment Plan account.
The closing date of each proposed Reorganization may differ, and the newly
issued Acquiring Fund Common Shares may be issued on different closing dates.
In addition, prior to a Reorganization, preferred shareholders of an Acquired
Fund will receive the liquidation preference associated with their preferred
shares plus any accumulated and unpaid dividends. A Reorganization will not be
completed unless, before the final shareholder vote thereon, the participating
Acquired Fund commences, and irrevocably commits to complete as expeditiously as
possible, the process for redeeming its preferred shares.
SUMMARY OF FUND COMPARISONS
INVESTMENT OBJECTIVES AND POLICIES. Each Acquired Fund is registered as a
diversified, closed-end management investment company under the 1940 Act. The
Acquiring Fund is registered as a non-diversified, closed-end management
investment company under the 1940 Act. The investment objective of each Acquired
Fund is similar to that of Credit Strategies Fund, although their investment
policies, strategies and risks are different, particularly with respect to
Income Shares and Credit Strategies Fund. High Income Portfolio seeks to provide
high current income, while seeking to preserve shareholders' capital. Income
Shares seeks to provide a high level of current income, with capital
appreciation as a secondary objective. Credit Strategies Fund seeks to provide
both current income and capital appreciation. Highland is the investment adviser
to each Fund. In addition, the two portfolio managers for each Acquired Fund
also manage Credit Strategies Fund with a third portfolio manager.
High Income Portfolio invests as least 65% of its total assets in high-yield,
fixed-income securities rated in the lower categories (Ba/BB or lower) by a
rating agency or nonrated fixed-income securities deemed by the Adviser to be of
comparable quality. High Income Portfolio typically invests a substantially
higher percentage of its assets in such securities.
Income Shares invests at least 50% of its total assets in debt securities rated
in the four highest categories (Baa/BBB or higher) by a rating agency or
nonrated debt securities deemed by the Adviser to be of comparable quality.
Credit Strategies Fund invests at least 80% of its assets 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. A significant portion of Credit Strategies Fund's
assets may be invested in securities rated below investment grade (Ba/BB or
lower), which are commonly referred to as "junk securities" or "high-yield
securities."
Please refer to the proposal for a further comparison of investment objectives
and policies.
DIVIDENDS AND OTHER DISTRIBUTIONS. Holders of common shares of Income Shares
receive distributions on a quarterly basis; holders of common shares of High
Income Portfolio and Credit Strategies Fund receive distributions on a monthly
basis. Credit Strategies Fund's current yield as of January 31, 2008 on a net
asset value basis is higher than that of either Acquired Fund. It is expected
that the shareholders of Credit Strategies Fund will not see any material change
in its yield as a result of the Reorganizations, although there can be no
assurance that this will be the case.
Holders of preferred shares of an Acquired Fund will also receive any
accumulated and unpaid dividends, at the time they receive the liquidation
preference of the preferred shares they hold.
PURCHASE AND SALE. Purchase and sale procedures for the common shares of the
Funds are similar. Investors typically purchase and sell common shares of the
Funds on the NYSE through a registered broker-dealer. Each Acquired Fund's
series of preferred shares are purchased and sold at separate auctions conducted
on a regular basis (unless a Fund elects, subject to certain conditions, to
declare a special dividend period). Credit Strategies Fund does not have any
preferred shares and does not plan to have any immediately after the
Reorganizations.
REDEMPTION PROCEDURES. Redemption procedures for the Funds are similar. The
common shares of each Fund have no redemption rights. However, the Board of each
Fund may consider open market share repurchases of, or tendering for, common
shares to seek to reduce or eliminate any discount in the market place of the
common shares from the NAV thereof. Each Fund's ability to repurchase, or tender
for, its common shares may be limited by the 1940 Act asset coverage
requirements and, in the Acquired Funds' case, by any rating agency requirements
required due to the issuance of preferred shares.
Provided certain conditions are met, the preferred shares are redeemable at the
option of each Acquired Fund, at a price equal to $25,000 per share plus, in
each case, accumulated and unpaid dividends (including additional dividends, if
any) on the redemption date. As noted above, the preferred shares will be
redeemed prior to each Reorganization.
EXPENSES. With the contractual fee waivers offered by Highland, the estimated
annual operating expenses of Credit Strategies Fund may be lower than the
current annual operating expenses of Income Shares, although they are expected
to be higher than High Income Portfolio's current annual operating expenses. The
higher expenses are due, in part, to Credit Strategies Fund leveraging by
borrowing pursuant to a credit facility rather than by issuing preferred shares.
While the use of a credit facility has been more expensive, it provides Credit
Strategies Fund greater flexibility to change the amount of its leverage
depending on market conditions. Over time, this flexibility may enable Credit
Strategies Fund to achieve greater performance, although there is no guarantee
or assurance as to the future performance of Credit Strategies Fund. Credit
Strategies Fund's 1-year performance as of December 31, 2007 on a net asset
value basis is better than Income Shares and its overall historical
premium/discount profile is better than that of each Acquired Fund. However,
- 2 -
more recently, Credit Strategies Fund's common shares have traded at a larger
discount from NAV than the common shares of either Acquired Fund. The Acquired
Fund also completed a rights offering on January 28, 2008. There is no guarantee
or assurance as to the future performance of Credit Strategies Fund. In
addition, although Credit Strategies Fund should provide increased liquidity to
shareholders of each Acquired Fund due to its substantially larger trading
market, there can be no assurance that will be the case.
BACKGROUND AND REASONS FOR THE PROPOSED REORGANIZATIONS. The Reorganizations
seek to combine two smaller funds (High Income Portfolio and Income Shares) into
one larger fund (Credit Strategies Fund) to achieve certain economies of scale
and other operational efficiencies. The Reorganizations will combine the assets
of these Funds by reorganizing the Acquired Funds with and into the Acquiring
Fund. The Board of each Acquired Fund, based upon its evaluation of all relevant
information, anticipates that the common shareholders of its respective Acquired
Fund should benefit from its Reorganization. The Board of the Acquiring Fund,
based upon its evaluation of all relevant information, anticipates that each
Reorganization should benefit holders of Acquiring Fund Common Shares. The
combined Fund resulting from the Reorganizations will have a larger asset base
than any of the Funds has currently; certain fixed administrative costs, such as
costs of, legal expenses, audit fees and other expenses, will be spread across
this larger asset base, thereby potentially lowering those costs for common
shareholders of the combined Fund. However, it is not expected that these
economies of scale will be substantial.
In addition, if shareholders approve the Reorganization(s), Highland would
contractually agree to waive a portion of Credit Strategies Fund's advisory fee
and administration fee for two years so that Highland would receive no
additional benefit from the Reorganization(s) for two years. The waivers are
intended to offset the additional revenue Highland would receive on each
Acquired Fund's assets (calculated as of the date of its reorganization) due to
the difference between the advisory fee rates of each Acquired Fund and Credit
Strategies Fund and the fact that the Acquired Funds do not pay an
administration fee to Highland. Assuming Income Shares' shareholders approve its
Reorganization and the Reorganization took place on January 31, 2008, the amount
of such waivers over two years would be $1,223,194. Assuming High Income
Portfolio's shareholders approve its Reorganization and the Reorganization took
place on January 31, 2008, the amount of such waivers over two years would be
$1,425,446. All shareholders of the combined Fund would benefit from such
waivers.
The Board of each Acquired Fund has determined that participation in the
applicable Reorganization is in the best interests of the Fund and that the
interests of its shareholders will not be diluted as a result of that
Reorganization. Similarly, the Acquiring Fund's Board has determined that
participation in each Reorganization is in the best interests of its common
shareholders and that the interests of such shareholders will not be diluted as
a result of each Reorganization. Preferred shareholders of the Acquired Funds
will not participate in the Reorganizations. As noted above, the preferred
shares will be redeemed prior to each Reorganization. In addition, as a result
of the Reorganizations, shareholders of each Fund, particularly the shareholders
of the Acquired Funds, will have a smaller percentage of ownership in the larger
combined Fund than they did in any of the separate Funds.
RATIONALE FOR THE REORGANIZATIONS. The Board of each Fund believes that
reorganizing each Acquired Fund into the Acquiring Fund, a fund with a similar
investment objective, and having a combined portfolio with greater assets,
offers you potential benefits. These potential benefits and Board considerations
include:
o EXCHANGE OF COMMON SHARES AT NAV. On its closing date, a
Reorganization will result in the Acquired Fund shareholders receiving
shares of the Acquiring Fund and cash (in lieu of certain fractional
shares) based on the Acquired Fund's NAV (I.E., the Acquired Fund will
get its NAV's worth of common shares of the Acquiring Fund and cash
(in lieu of certain fractional shares)). It should be noted, however,
that shares of the Acquiring Fund received in a Reorganization will
likely trade at a market discount from NAV following the
Reorganization, so that an Acquired Fund common shareholder may not be
able to sell these shares for their NAV. It should also be noted that
since inception shares of the Acquiring Fund generally have traded at
a smaller discount or wider premium from NAV than shares of either
Acquired Fund. However, since late December until the Board approved
the Reorganization in February 2008, Acquiring Fund shares have
frequently traded at a larger discount from NAV than shares of either
Acquired Fund. The Acquired Fund commenced a rights offering in late
December and completed the rights offering on January 28, 2008.
Historically, rights offerings have increased the discount from NAV
for a fund.
- 3 -
o INCREASED USE OF CAPITAL LOSSES. Each Acquired Fund has sustained
substantial capital losses in recent years, which are available as
CLCs in the current and future taxable years (through their respective
taxable years ending in 2013), but is not expected to be able to
generate enough capital gains to be offset by those CLCs before they
expire. SEE "Further Information on the Reorganizations - Federal
Income Tax Consequences of the Reorganizations." Because of its larger
size and investment policies and strategies, the Acquiring Fund is
expected to be better able to use those CLCs to offset
post-Reorganization gains of the combined Fund. The Acquiring Fund's
use of such CLCs, however, will be significantly limited due to the
application of loss limitation rules under the federal tax law.
o ENHANCED COMMON SHARE LIQUIDITY. Following the Reorganizations, the
substantially larger trading market in the common shares of the
Acquiring Fund, as compared to that of each Acquired Fund prior to the
Reorganizations, may provide Acquired Fund shareholders with enhanced
market liquidity. Trading discounts can result from many different
factors, however, and there is no assurance that a larger trading
market for Acquiring Fund's common shares will have the effect of
reducing or maintaining trading discounts.
o INCREASED ASSET SIZE. The Acquiring Fund will obtain additional assets
without incurring the commission expenses and generally greater other
expenses associated with offering new shares. In addition, the
Acquiring Fund is obtaining the additional portfolio securities of the
Acquired Funds without the commensurate brokerage costs, dealer
spreads or other trading expenses. It is also obtaining these
securities in a manner that is likely to minimize the market impact of
such acquisition on the short-term prices of these securities.
o ECONOMIES OF SCALE IN CERTAIN EXPENSES. A combined Fund offers
economies of scale that may lead to a reduction in certain expenses.
With these reduced expenses and the contractual fee waivers offered by
Highland, which is described below, the annual operating expenses of
the combined Fund may be lower than the current annual operating
expenses of Income Shares, although they are expected to be higher
than High Income Portfolio's current annual operating expenses. Each
Fund incurs NYSE listing fees, costs for legal, auditing, and
custodial services, and miscellaneous fees. Many of these expenses
overlap and there may be an opportunity to reduce them over time if
the Funds are combined. However, it is not expected that these
economies of scale will be substantial.
o PORTFOLIO MANAGEMENT EFFICIENCIES. Each Reorganization would permit
Acquired Fund shareholders to pursue similar investment goals in a
larger Fund. The greater asset size of the combined Fund may allow it,
relative to each Acquired Fund, to obtain better net prices on
securities trades and achieve greater diversification of portfolio
holdings.
o SHAREHOLDERS' ABILITY TO MARGIN. Currently, stocks that trade below
$5.00 are not marginable. The Reorganization would permit shareholders
of High Income Portfolio and Income Shares (if its shares continue to
trade below $5.00) to receive shares that they could margin.
Additionally, marginable securities may be more liquid that those that
are not marginable as many institutional/large investors are believed
to avoid stocks that are not marginable.
Each Board also considered that if shareholders approve a Reorganization,
Highland would contractually agree to waive a portion of Credit Strategies
Fund's advisory fee and administration fee for two years so that Highland would
receive no additional benefit from the Reorganization for two years. If Income
Shares' shareholders approve its Reorganization, such combined waivers would be
at an annual rate of 0.70% of the sum of Income Shares' net assets attributable
to common shares as of the closing date of its Reorganization plus $30 million
(representing the value of its preferred shares that historically have been
outstanding). If High Income Portfolio's shareholders approve its
Reorganization, such combined waivers would be at an annual rate of 0.55% of the
sum of High Income Portfolio's net assets attributable to common shares as of
the closing date of its Reorganization plus $40 million (representing the value
of its preferred shares that historically have been outstanding). In each case,
the amount of the waivers are intended to offset the additional revenue Highland
would receive on each Acquired Fund's assets (including the value of its
preferred shares that historically have been outstanding) due to the difference
between the advisory fee rates of each Acquired Fund and Credit Strategies Fund
- 4 -
and the fact that the Acquired Funds do not pay an administration fee to
Highland.
The Board of each Acquired Fund unanimously recommends that you vote FOR the
Reorganization of your Fund into Credit Strategies Fund. For further
information, please see the individual description of the proposal affecting
your Fund contained in the Proxy Statement/Prospectus.
EXPENSES ASSOCIATED WITH THE REORGANIZATIONS. The costs associated with the
Reorganizations will be borne by each of the Acquired Funds and the Acquiring
Fund in proportion to their respective net assets determined at the close of
regular trading on the NYSE on the date of the Reorganizations' closing,
provided that if they close at different times, that determination will be made
as of the date that the first Reorganization closes.
TAX CONSEQUENCES. Each Reorganization is intended to qualify as a
"reorganization" within the meaning of Section 368(a)(1) of the Internal Revenue
Code of 1986, as amended ("Code"). If the Reorganizations so qualify, in
general, shareholders of the Acquired Funds will recognize no gain or loss upon
the receipt solely of shares of the Acquiring Fund in connection with the
Reorganizations. However, shareholders of the Acquired Funds may recognize gain
or loss with respect to cash they receive pursuant to the Reorganization in lieu
of fractional Acquiring Fund shares. Additionally, the Acquired Funds will
recognize no gain or loss as a result of the Reorganization or as a result of
their dissolution. Neither the Acquiring Fund nor its shareholders will
recognize any gain or loss in connection with the Reorganizations.
REQUIRED VOTE. Shareholder approval of each Reorganization requires, with
respect to each respective Acquired Fund, the vote of: (1) the holders of at
least a majority of the common and preferred shares entitled to vote, voting as
a single class; and (2) the holders of at least a majority of the preferred
shares entitled to vote, voting as a separate class.
THE BOARD OF EACH ACQUIRED FUND UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR YOUR
FUND'S PROPOSED REORGANIZATION.
- 5 -
RISK FACTORS AND SPECIAL CONSIDERATIONS
---------------------------------------
Because each of Credit Strategies Fund and High Income Portfolio, under normal
market conditions, invests a substantial amount of its assets in below
investment grade securities (Income Shares also invests in below investment
grade securities but to a lesser extent), any general risks inherent in such
investments are equally applicable to Credit Strategies Fund and High Income
Portfolio and will apply to Credit Strategies Fund after the Reorganizations.
The general risks of investing in Credit Strategies Fund are described below and
the general risks that are unique to an Acquired Fund are indicated as such
below. The Reorganizations themselves are not expected to adversely affect the
right of common shareholders of any of the Funds. Preferred shareholders of the
Acquired Funds will not participate in the Reorganizations. As noted above, the
preferred shares will be redeemed prior to each Reorganization.
LIMITED OPERATING HISTORY. Credit Strategies Fund is a recently organized,
non-diversified, closed-end management investment company. It commenced
investment operations in June 2006 and has a limited operating history and
history of public trading that investors can use to evaluate its investment
performance and volatility.
THIS DOES NOT APPLY TO EITHER ACQUIRED FUND SINCE THEY ARE NOT RECENTLY
ORGANIZED.
INVESTMENT AND MARKET DISCOUNT RISK. An investment in Credit Strategies Fund'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 Credit Strategies
Fund's shares will fluctuate with market conditions and other factors. If 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 NAV.
RISKS OF NON-DIVERSIFICATION AND OTHER FOCUSED STRATEGIES. While the Adviser
will invest in a number of fixed-income and equity instruments issued by
different issuers and plans to employ multiple investment strategies with
respect to Credit Strategies Fund's portfolio, it is possible that a significant
amount of Credit Strategies Fund'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 Credit Strategies Fund's portfolio in any one issuer would
subject Credit Strategies Fund 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 Credit Strategies Fund's total assets) would subject Credit
Strategies Fund to a greater degree of risk with respect to economic downturns
relating to such industry. The focus of Credit Strategies Fund's portfolio in
any one investment strategy would subject Credit Strategies Fund to a greater
degree of risk than if Credit Strategies Fund's portfolio were varied in its
investments with respect to several investment strategies.
THE GENERAL RISKS OF NON-DIVERSIFICATION DO NOT APPLY TO EACH ACQUIRED FUND
SINCE THEY ARE DIVERSIFIED, CLOSED-END MANAGEMENT INVESTMENT COMPANIES UNDER THE
1940 ACT.
ILLIQUIDITY OF INVESTMENTS. The investments made by Credit Strategies Fund may
be illiquid, and consequently, Credit Strategies Fund may not be able to sell
such investments at prices that reflect the Adviser's assessment of their fair
value or the amount paid for such investments by Credit Strategies Fund.
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 Credit Strategies Fund and other factors. Furthermore, the nature of Credit
Strategies Fund'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 Credit Strategies Fund's portfolio that can be invested in
illiquid securities.
CREDIT STRATEGIES FUND HAS NO LIMIT ON THE AMOUNT OF ASSETS THAT CAN BE INVESTED
IN ILLIQUID SECURITIES. AS SUCH, THE GENERAL RISKS OF INVESTING IN ILLIQUID
SECURITIES ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED FUND, WHICH
HAVE LIMITS ON INVESTING IN ILLIQUID SECURITIES.
- 6 -
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 Credit Strategies Fund's investments may consist of loans and
participations therein originated by banks and other financial institutions,
typically referred to as "bank loans." Credit Strategies Fund'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 Credit Strategies Fund
are likely to be below investment grade.
Credit Strategies Fund 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, Credit Strategies Fund 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, Credit Strategies Fund 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 Credit
Strategies Fund may not directly benefit from the collateral supporting the debt
obligation in which it has purchased the participation. As a result, Credit
Strategies Fund 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 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.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN SENIOR
LOANS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS OF INVESTING IN SENIOR
LOANS ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED FUND.
SECOND LIEN LOANS RISK. Second lien loans are subject to the same risks
associated with investment in senior loans and non-investment grade securities.
See "Non-Investment Grade Securities Risk." 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.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN SECOND
LIENS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS OF INVESTING IN SECOND
LIENS ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED FUND.
- 7 -
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.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN OTHER
SECURED LOANS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS OF INVESTING
IN OTHER SECURED LOANS ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED
FUND.
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.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN
UNSECURED LOANS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS OF INVESTING
IN UNSECURED LOANS ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED
FUND.
RISKS OF INVESTING IN OBLIGATIONS OF STRESSED, DISTRESSED AND BANKRUPT ISSUERS.
Credit Strategies Fund 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 Credit Strategies Fund's portfolio that can be invested in stressed,
distressed or bankrupt issuers, and Credit Strategies Fund 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
Credit Strategies Fund. 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 Credit
Strategies Fund'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
- 8 -
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 Credit Strategies Fund's
purchase price of such debt obligations. Furthermore, if an anticipated
transaction does not occur, Credit Strategies Fund may be required to sell its
investment at a loss. Given the substantial uncertainties concerning
transactions involving stressed and distressed debt obligations in which Credit
Strategies Fund invests, there is a potential risk of loss by Credit Strategies
Fund of its entire investment in any particular investment.
Investments in companies undergoing a workout or operating under Chapter 11 of
the Bankruptcy Code are also, in certain circumstances, subject to certain
additional liabilities which may exceed the value of Credit Strategies Fund'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
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 Credit Strategies Fund and distributions by Credit Strategies Fund
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 Adviser, on behalf of Credit Strategies Fund, 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 Credit Strategies Fund does
choose to join a committee, Credit Strategies Fund 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 Credit
Strategies Fund would be successful in obtaining results most favorable to it in
such proceedings, although Credit Strategies Fund may incur significant legal
and other expenses in attempting to do so. As a result of participation by
Credit Strategies Fund on such committees, Credit Strategies Fund may be deemed
to have duties to other creditors represented by the committees, which might
thereby expose Credit Strategies Fund to liability to such other creditors who
disagree with Credit Strategies Fund's actions. Participation by Credit
Strategies Fund on such committees may cause Credit Strategies Fund to be
subject to certain restrictions on its ability to trade in a particular
investment and may also make Credit Strategies Fund an "insider" or an
"underwriter" for purposes of the federal securities laws. Either circumstance
will restrict Credit Strategies Fund's ability to trade in or acquire additional
positions in a particular investment when it might otherwise desire to do so.
RISKS OF INVESTING IN HIGH-YIELD SECURITIES. A portion of Credit Strategies
Fund'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. Credit
Strategies Fund may also invest in equity securities issued by entities whose
obligations are unrated or are rated below investment grade.
- 9 -
Credit Strategies Fund 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 Credit Strategies Fund will be 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 Credit Strategies Fund may not be protected by financial covenants
or limitations upon additional indebtedness and are unlikely to be secured by
collateral.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN
HIGH-YIELD SECURITIES THAN INCOME SHARES. AS SUCH, THE GENERAL RISKS OF
INVESTING IN HIGH-YIELD SECURITIES ARE GREATER FOR CREDIT STRATEGIES FUND THAN
INCOME SHARES.
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 Credit Strategies Fund. 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 Fund) or from subsequent transferees of
such payments (such as investors in the Fund). To the extent that any such
payments are recaptured from Credit Strategies Fund 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 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
Credit Strategies Fund 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 Credit
Strategies Fund.
- 10 -
RISKS OF INVESTING IN STRESSED, DISTRESSED OR BANKRUPT COMPANIES. Credit
Strategies Fund may invest in companies that are stressed, in distress, or
bankrupt. As such, they are subject to a multitude of legal, industry, market,
economic and governmental forces that make analysis of these companies
inherently difficult. Further, the Adviser relies on company management, outside
experts, market participants and personal experience to analyze potential
investments for Credit Strategies Fund. There can be no assurance that any of
these sources will prove credible, or that the Adviser's analysis will produce
conclusions that lead to profitable investments.
LEVERAGE RISK. Credit Strategies Fund has the ability to use leverage through
the issuance of preferred shares, borrowings from a credit facility or both.
Credit Strategies Fund currently leverages through borrowings from a credit
facility and has no present intention of issuing preferred shares. The use of
leverage, which can be described as exposure to changes in price at a ratio
greater than the amount of equity invested, either through the issuance of
preferred shares, borrowings or other forms of market exposure, magnifies both
the favorable and unfavorable effects of price movements in the investments made
by Credit Strategies Fund. Insofar as Credit Strategies Fund continues to employ
leverage in its investment operations, Credit Strategies Fund will be subject to
substantial risks of loss.
o Credit Facility. Credit Strategies Fund currently leverages through
borrowings from a credit facility. Credit Strategies Fund has entered
into a revolving credit agreement with The Bank of Nova Scotia
("Scotia") to borrow up to $290,000,000 (the "Loan Agreement"). Such
borrowings constitute financial leverage. The Loan Agreement contains
covenants that limit Credit Strategies Fund's ability to, without the
prior consent of Scotia: (i) pay dividends in certain circumstances,
(ii) incur additional debt, (iii) change its investment objectives,
policies and restrictions as set forth in Credit Strategies Fund's
prospectus in effect when the Loan Agreement became effective or (iv)
adopt or carry out any plan of liquidation, reorganization,
incorporation, recapitalization, merger or consolidation or sell,
transfer or otherwise dispose of all or a substantial part of its
assets. For instance, Credit Strategies Fund agreed not to purchase
assets not contemplated by the investment policies and restrictions in
effect when the Loan Agreement became effective. Furthermore, Credit
Strategies Fund 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 1940 Act. Such restrictions shall apply only so long
as the Loan Agreement remains in effect. Any senior security
representing indebtedness, as defined in Section 18(g) of the 1940
Act, must have asset coverage of at least 300%. Debt incurred under
the Loan Agreement will be considered a senior security for this
purpose.
The Loan Agreement has customary covenant, negative covenant and
default provisions. This credit facility with Scotia is not
convertible into any other securities of Credit Strategies Fund.
Outstanding amounts would be payable at maturity or such earlier times
as required by the Loan Agreement. Credit Strategies Fund may be
required to prepay outstanding amounts under the credit facility or
incur a penalty rate of interest in the event of the occurrence of
certain events of default. Credit Strategies Fund is expected to
indemnify the lenders under the credit facility against certain
liabilities they may incur in connection with the credit facility.
Credit Strategies Fund is required to pay commitment fees under the
terms of any such facility. With the use of borrowings, there is a
risk that the interest rates paid by Credit Strategies Fund on the
amount it borrows will be higher than the return on Credit Strategies
Fund's investments. The credit facility with Scotia may in the future
be replaced or refinanced by one or more credit facilities having
substantially different terms or by the issuance of preferred shares.
o Preferred Share Risk. Preferred share risk is the risk associated with
the issuance of the preferred shares to leverage the common shares. If
preferred shares are issued, the NAV and market value of the common
shares will be more volatile, and the yield to the holders of common
shares will tend to fluctuate with changes in the shorter-term
dividend rates on the preferred shares. If the dividend rate on the
preferred shares approaches the net rate of return on Credit
Strategies Fund's investment portfolio, the benefit of leverage to the
holders of the common shares would be reduced. If the dividend rate on
the preferred shares exceeds the net rate of return on Credit
Strategies Fund's portfolio, the leverage will result in a lower rate
of return to the holders of common shares than if Credit Strategies
Fund had not issued preferred shares.
- 11 -
In addition, Credit Strategies Fund will pay (and the holders of
common shares will bear) all costs and expenses relating to the
issuance and ongoing maintenance of the preferred shares, including
higher advisory fees. Accordingly, Credit Strategies Fund cannot
assure you that the issuance of preferred shares will result in a
higher yield or return to the holders of the common shares.
Similarly, any decline in the NAV of Credit Strategies Fund's
investments will be borne entirely by the holders of common shares.
Therefore, if the market value of Credit Strategies Fund's portfolio
declines, the leverage will result in a greater decrease in NAV to the
holders of common shares than if Credit Strategies Fund were not
leveraged. This greater NAV decrease will also tend to cause a greater
decline in the market price for the common shares. Credit Strategies
Fund might be in danger of failing to maintain the required asset
coverage of the preferred shares or of losing its ratings on the
preferred shares or, in an extreme case, Credit Strategies Fund's
current investment income might not be sufficient to meet the dividend
requirements on the preferred shares. In order to counteract such an
event, Credit Strategies Fund might need to liquidate investments in
order to fund a redemption of some or all of the preferred shares.
Liquidation at times of low prices may result in capital loss and may
reduce returns to the holders of common shares.
o Preferred Shareholders may have disproportionate influence over Credit
Strategies Fund. If preferred shares are issued, holders of preferred
shares may have differing interests than holders of common shares and
holders of preferred shares may at times have disproportionate
influence over Credit Strategies Fund's affairs. If preferred shares
are issued, holders of preferred shares, voting separately as a single
class, would have the right to elect two members of the board of
trustees at all times. The remaining members of the board of trustees
would be elected by holders of common shares and preferred shares,
voting as a single class. The 1940 Act also requires that, in addition
to any approval by shareholders that might otherwise be required, the
approval of the holders of a majority of any outstanding preferred
shares, voting separately as a class, would be required to (i) adopt
any plan of reorganization that would adversely affect the preferred
shares and (ii) take any action requiring a vote of security holders
under Section 13(a) of the 1940 Act, including, among other things,
changes in Credit Strategies Fund's subclassification as a closed-end
investment company or changes in its fundamental investment
restrictions.
o Portfolio Guidelines of Rating Agencies for Preferred Share and/or
Credit Facility. In order to obtain and maintain the required ratings
of loans from a credit facility, Credit Strategies Fund will be
required to comply with investment quality, diversification and other
guidelines established by Moody's Investors Service, Inc. ("Moody's")
and/or Standard & Poor's Ratings Services ("S&P") or the credit
facility, respectively. Such guidelines will likely be more
restrictive than the restrictions otherwise applicable to Credit
Strategies Fund as described herein. Credit Strategies Fund does not
anticipate that such guidelines would have a material adverse effect
on Credit Strategies Fund's common shareholders or its ability to
achieve its investment objectives. Credit Strategies Fund anticipates
that any preferred shares that it issues would be initially given the
highest ratings by Moody's ("Aaa") or by S&P ("AAA"), but no assurance
can be given that such ratings will be obtained. No minimum rating is
required for the issuance of preferred shares by Credit Strategies
Fund. Moody's and S&P receive fees in connection with their ratings
issuances.
CREDIT STRATEGIES FUND CURRENTLY USES LEVERAGE THROUGH BORROWINGS FROM A CREDIT
FACILITY AND EACH ACQUIRED FUND CURRENTLY USES LEVERAGE THROUGH THE ISSUANCE OF
PREFERRED SHARES. AS DISCUSSED ABOVE, THE GENERAL RISKS OF LEVERAGE ARE SOMEWHAT
DIFFERENT FOR A CREDIT FACILITY AS COMPARED TO PREFERRED SHARES.
COMMON STOCK RISK. Credit Strategies Fund will have exposure to common stocks.
Although common stocks have historically generated higher average total returns
than fixed income securities over the long-term, common stocks also have
experienced significantly more volatility in those returns. Therefore, Credit
Strategies Fund's exposure to common stocks could result in worse performance
than would be the case had Credit Strategies Fund 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 Credit Strategies Fund.
Also, the price of common stocks is sensitive to general movements in the stock
market and a drop in the stock market may depress the price of common stocks to
which Credit Strategies Fund 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
- 12 -
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.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN COMMON
STOCKS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS OF INVESTING IN
COMMON STOCKS ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED FUND.
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 Credit Strategies Fund invests will
declare dividends in the future or that if declared they will remain at current
levels or increase over time.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN COMMON
STOCKS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS RELATED TO DIVIDENDS
IS GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED FUND.
SMALL AND MID-CAP SECURITIES RISK. Credit Strategies Fund may invest in
companies with small or medium capitalizations. Securities issued by smaller and
medium companies can be more volatile than, and perform differently from, larger
company securities. There may be less trading in a smaller 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. Smaller and medium companies may have fewer business lines;
changes in any one line of business, therefore, may have a greater impact on a
smaller or medium company's security price than is the case for a larger
company. In addition, smaller or medium company securities may not be well known
to the investing public.
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN COMMON
STOCKS THAN EACH ACQUIRED FUND. AS SUCH, THE GENERAL RISKS OF INVESTING IN SMALL
AND MID-CAP SECURITIES ARE GREATER FOR CREDIT STRATEGIES FUND THAN EACH ACQUIRED
FUND.
NON-U.S. SECURITIES RISK. Credit Strategies Fund may invest up to 20% of its
total assets in non-U.S. securities, including emerging market securities.
Investing in non-U.S. securities involves certain risks not involved in domestic
investments, including, but not limited to: (i) fluctuations in foreign exchange
rates; (ii) future foreign economic, financial, political and social
developments; (iii) different legal systems; (iv) the possible imposition of
exchange controls or other foreign governmental laws or restrictions; (v) lower
trading volume; (vi) much greater price volatility and illiquidity of certain
non-U.S. securities markets; (vii) different trading and settlement practices;
(viii) less governmental supervision; (ix) changes in currency exchange rates;
(x) high and volatile rates of inflation; (xi) fluctuating interest rates; (xii)
less publicly available information; and (xiii) different accounting, auditing
and financial recordkeeping standards and requirements.
Certain countries in which Credit Strategies Fund 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.
Because Credit Strategies Fund will 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 in Credit Strategies Fund and the
unrealized appreciation or depreciation of investments. Currencies of certain
countries may be volatile and therefore may affect the value of securities
denominated in such currencies, which means that Credit Strategies Fund's NAV or
current income could decline as a result of changes in the exchange rates
between foreign currencies and the U.S. dollar. Certain investments in non-U.S.
securities also may be subject to foreign withholding taxes. These risks often
are heightened for investments in smaller, emerging capital markets. 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)
- 13 -
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. Credit Strategies
Fund may invest in countries in which foreign investors, including Highland,
have had no or limited prior experience.
THE GENERAL RISKS OF INVESTING IN NON-U.S. SECURITIES ARE GREATER FOR CREDIT
STRATEGIES FUND THAN HIGH INCOME PORTFOLIO SINCE HIGH INCOME PORTFOLIO CAN
INVEST UP TO 10% OF ITS TOTAL ASSETS IN FOREIGN SECURITIES. THE GENERAL RISKS OF
INVESTING IN NON-U.S. SECURITIES DO NOT APPLY TO INCOME SHARES SINCE IT
GENERALLY DOES NOT INVEST IN NON-U.S. SECURITIES.
EMERGING MARKETS RISK. Credit Strategies Fund 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 Credit
Strategies Fund's investment opportunities including restrictions on investing
in issuers or industries deemed sensitive to relevant national interests.
THE GENERAL RISKS OF INVESTING IN NON-U.S. SECURITIES ARE GREATER FOR CREDIT
STRATEGIES FUND THAN HIGH INCOME PORTFOLIO SINCE HIGH INCOME PORTFOLIO CAN
INVEST UP TO 10% OF ITS TOTAL ASSETS IN FOREIGN SECURITIES. THE GENERAL RISKS OF
INVESTING IN NON-U.S. SECURITIES DO NOT APPLY TO INCOME SHARES SINCE IT
GENERALLY DOES NOT INVEST IN NON-U.S. SECURITIES.
THE GENERAL RISKS OF INVESTING IN EMERGING MARKETS DO NOT APPLY TO EACH ACQUIRED
FUND SINCE THEY GENERALLY DO NOT INVEST IN EMERGING MARKETS.
FOREIGN CURRENCY RISK. Because Credit Strategies Fund 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
Credit Strategies Fund, 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 Credit Strategies Fund's NAV
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, Credit Strategies Fund may
enter into foreign currency transactions in an attempt to enhance total return
which may further expose Credit Strategies Fund to the risks of foreign currency
movements and other risks. The use of foreign currency transactions can result
in Credit Strategies Fund incurring losses as a result of the imposition of
exchange controls, suspension of settlements or the inability of Credit
Strategies Fund to deliver or receive a specified currency.
THE GENERAL RISKS RELATED TO FOREIGN CURRENCY IS GREATER FOR CREDIT STRATEGIES
FUND THAN HIGH INCOME PORTFOLIO SINCE HIGH INCOME PORTFOLIO CAN INVEST UP TO 10%
OF ITS TOTAL ASSETS IN FOREIGN SECURITIES. THE GENERAL RISKS RELATED TO FOREIGN
CURRENCY DO NOT APPLY TO INCOME SHARES SINCE IT GENERALLY DOES NOT INVEST IN
NON-U.S. SECURITIES.
INVESTMENTS IN UNSEASONED COMPANIES. Credit Strategies Fund may invest in the
securities of smaller, 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 Credit Strategies Fund 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 Credit Strategies Fund may invest.
- 14 -
INITIAL PUBLIC OFFERINGS (IPOS) RISK. Credit Strategies Fund may invest in
shares of companies through IPOs. IPOs and companies that have recently gone
public have the potential to produce substantial gains for Credit Strategies
Fund. However, there is no assurance that Credit Strategies Fund will have
access to profitable IPOs. The investment performance of Credit Strategies Fund
during periods when it is unable to invest significantly or at all in IPOs may
be lower than during periods when Credit Strategies Fund 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. Credit Strategies Fund 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.
Securities lending is subject to the risk that loaned securities may not be
available to Credit Strategies Fund on a timely basis and Credit Strategies Fund
may, therefore, lose the opportunity to sell the securities at a desirable
price. Any loss in the market price of securities loaned by Credit Strategies
Fund that occurs during the term of the loan would be borne by Credit Strategies
Fund and would adversely affect Credit Strategies Fund'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 Credit Strategies Fund
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, Credit Strategies Fund 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 Credit Strategies Fund 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 Credit Strategies Fund 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, Credit Strategies Fund 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 Credit Strategies Fund received when it wrote the option.
While Credit Strategies Fund'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, Credit
Strategies Fund risks a loss equal to the entire exercise price of the option
minus the put premium.
THE GENERAL RISKS OF INVESTING IN OPTIONS ON SECURITIES DO NOT APPLY TO EACH
ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST IN OPTIONS ON SECURITIES.
EXCHANGE-LISTED OPTION RISKS. There can be no assurance that a liquid market
will exist when Credit Strategies Fund 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
- 15 -
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
Credit Strategies Fund 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 stocks, an increase in interest rates,
changes in the actual or perceived volatility of the stock market and the
underlying common stocks and the remaining time to the options' expiration.
Additionally, the exercise price of an option may be adjusted downward before
the option's expiration as a result of the occurrence of certain corporate
events affecting the underlying equity security, such as extraordinary
dividends, stock splits, merger or other extraordinary distributions or events.
A reduction in the exercise price of an option would reduce Credit Strategies
Fund's capital appreciation potential on the underlying security.
THE GENERAL RISKS OF INVESTING IN EXCHANGE-LISTED OPTIONS DO NOT APPLY TO EACH
ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST IN EXCHANGE-LISTED OPTIONS.
OVER-THE-COUNTER OPTION RISK. Credit Strategies Fund may write (sell) unlisted
("OTC" or "over-the-counter") options, and options written by Credit Strategies
Fund 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. Credit
Strategies Fund may be required to treat as illiquid those securities being used
to cover certain written OTC options. The OTC options written by Credit
Strategies Fund will not be issued, guaranteed or cleared by the Options
Clearing Corporation. In addition, Credit Strategies Fund'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, Credit
Strategies Fund may be unable to liquidate an OTC option position.
THE GENERAL RISKS OF INVESTING IN OVER-THE-COUNTER OPTIONS DO NOT APPLY TO EACH
ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST IN OVER-THE-COUNTER OPTIONS.
INDEX OPTION RISK. Credit Strategies Fund 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 Credit
Strategies Fund, cannot provide in advance for their potential settlement
obligations by acquiring and holding the underlying securities. Credit
Strategies Fund 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 Credit Strategies Fund for writing the option. The value
of index options written by Credit Strategies Fund, 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 Credit Strategies Fund 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.
THE GENERAL RISKS OF INVESTING IN INDEX OPTIONS DO NOT APPLY TO EACH ACQUIRED
FUND SINCE THEY GENERALLY DO NOT INVEST IN INDEX OPTIONS.
- 16 -
INTEREST RATE RISK. Interest rate risk is the risk that debt securities, and
Credit Strategies Fund'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 NAV of the common shares will fluctuate with interest rate changes and the
corresponding changes in the value of Credit Strategies Fund's debt security
holdings.
PREPAYMENT RISK. If interest rates fall, the principal on bonds held by Credit
Strategies Fund may be paid earlier than expected. If this happens, the proceeds
from a prepaid security may be reinvested by Credit Strategies Fund in
securities bearing lower interest rates, resulting in a possible decline in
Credit Strategies Fund's income and distributions to shareholders. Credit
Strategies Fund 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.
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.
THE GENERAL RISKS OF INVESTING IN ASSET-BACKED SECURITIES DO NOT APPLY TO EACH
ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST IN ASSET-BACKED SECURITIES.
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 Credit Strategies Fund's
mortgage-backed securities will result in an unforeseen loss of interest income
to Credit Strategies Fund as Credit Strategies Fund 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.
THE GENERAL RISKS OF INVESTING IN MORTGAGE-BACKED SECURITIES DO NOT APPLY TO
EACH ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST IN MORTGAGE-BACKED
SECURITIES.
NON-INVESTMENT GRADE SECURITIES RISK. There is no limit on the amount of Credit
Strategies Fund's portfolio that may be invested in below investment grade
securities. Non-investment grade securities are commonly referred to as "junk
securities." Investments in lower grade securities will expose Credit Strategies
Fund to greater risks than if Credit Strategies Fund owned only higher grade
debt securities. Because of the substantial risks associated with lower grade
securities, you could lose money on your investment in common shares of Credit
Strategies Fund, both in the short-term and the long-term. 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
retail secondary market for lower grade debt securities may be less liquid than
that of higher rated debt securities. Adverse conditions could make it difficult
at times for Credit Strategies Fund to sell certain securities or could result
in lower prices than those used in calculating Credit Strategies Fund's NAV.
- 17 -
CREDIT STRATEGIES FUND CAN INVEST A GREATER PERCENTAGE OF ITS ASSETS IN
NON-INVESTMENT GRADE SECURITIES THAN INCOME SHARES. AS SUCH, THE GENERAL RISKS
OF INVESTING IN NON-INVESTMENT GRADE SECURITIES ARE GREATER FOR CREDIT
STRATEGIES FUND THAN INCOME SHARES.
DERIVATIVES RISK. Derivative transactions in which Credit Strategies Fund may
engage for hedging and speculative purposes or to enhance total return,
including engaging in transactions such as options, futures, swaps, foreign
currency transactions including forward foreign currency contracts, currency
swaps or options on currency and currency futures and other derivatives
transactions ("Derivative Transactions"), also involve certain risks and special
considerations. 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. Furthermore, the ability to successfully use Derivative
Transactions depends on the 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 Credit Strategies Fund 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 Credit
Strategies Fund to sell or purchase portfolio securities at inopportune times or
for prices other than current market values, may limit the amount of
appreciation Credit Strategies Fund can realize on an investment or may cause
Credit Strategies Fund to hold a security that it might otherwise sell. The use
of foreign currency transactions can result in Credit Strategies Fund's
incurring losses as a result of the imposition of exchange controls, suspension
of settlements or the inability of Credit Strategies Fund to deliver or receive
a specified currency. Additionally, amounts paid by Credit Strategies Fund as
premiums and cash or other assets held in margin accounts with respect to
Derivative Transactions are not otherwise available to Credit Strategies Fund
for investment purposes.
To the extent that Credit Strategies Fund purchases options pursuant to a
hedging strategy, Credit Strategies Fund will be subject to the following
additional risks. If a put or call option purchased by Credit Strategies Fund 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), Credit Strategies Fund will lose its entire investment in the option.
Also, where a put or call option on a particular security is purchased to hedge
against price movements in a related security, the price of the put or call
option may move more or less than the price of the related security. If
restrictions on exercise were imposed, Credit Strategies Fund might be unable to
exercise an option it had purchased. If Credit Strategies Fund were unable to
close out an option that it had purchased on a security, it would have to
exercise the option in order to realize any profit or the option may expire
worthless.
THE GENERAL RISKS OF INVESTING IN DERIVATIVES DO NOT APPLY TO EACH ACQUIRED FUND
SINCE THEY GENERALLY DO NOT INVEST IN DERIVATIVES.
MARKET RISK GENERALLY. The profitability of a significant portion of Credit
Strategies Fund'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 Adviser will be able to predict accurately these price and interest rate
movements. With respect to certain investment strategies Credit Strategies Fund
utilizes, there is a high degree of market risk.
REINVESTMENT RISK. Credit Strategies Fund reinvests the cash flows received from
a security. The additional income from such reinvestment, sometimes called
interest-on-interest, is dependent 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 Credit Strategies Fund receives upon the maturity or sale of a
portfolio security.
- 18 -
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, Credit Strategies Fund is
exposed to reinvestment risk, i.e., Credit Strategies Fund 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 Credit Strategies Fund 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, Credit Strategies Fund 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 shares issued by the Fund would likely increase, which would tend
to further reduce returns to common shareholders.
ARBITRAGE RISKS. Credit Strategies Fund may engage 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 Adviser will be able
to hedge Credit Strategies Fund's portfolio in the manner necessary to employ
successfully Credit Strategies Fund's strategy.
THE GENERAL RISKS OF USING ARBITRAGE STRATEGIES DO NOT APPLY TO EACH ACQUIRED
FUND SINCE THEY GENERALLY DO NOT USE ARBITRAGE STRATEGIES.
SHORT SALES RISK. Short sales by Credit Strategies Fund that are not made
"against the box" theoretically involve unlimited loss potential since the
market price of securities sold short may increase without limit. 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 Credit Strategies Fund
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. Credit Strategies
Fund may mitigate such losses by replacing the securities sold short before the
market price has increased significantly. Under adverse market conditions,
Credit Strategies Fund 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.
THE GENERAL RISKS OF USING SHORT SALES DO NOT APPLY TO EACH ACQUIRED FUND SINCE
THEY GENERALLY DO NOT USE SHORT SALES.
RISKS OF INVESTING IN STRUCTURED FINANCE SECURITIES. A portion of Credit
Strategies Fund'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 Credit Strategies Fund 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,
- 19 -
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:
o 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 Credit Strategies
Fund owns a preferred security that is deferring its distributions,
Credit Strategies Fund may be required to report income for tax
purposes although it has not yet received such income.
o 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.
o Liquidity. Preferred securities may be substantially less liquid than
many other securities, such as common stocks or U.S. government
securities.
o 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.
THE GENERAL RISKS OF INVESTING IN PREFERRED SECURITIES DO NOT APPLY TO EACH
ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST IN PREFERRED SECURITIES.
RISKS OF INVESTING IN SYNTHETIC SECURITIES. In addition to credit risks
associated with holding non-investment grade loans and high-yield debt
securities, with respect to synthetic securities Credit Strategies Fund 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). Credit Strategies Fund generally will
have no right to directly enforce compliance by the Reference Obligor with the
terms of the Reference Obligation or any rights of set-off against the Reference
Obligor, nor have any voting rights with respect to the Reference Obligation.
Credit Strategies Fund 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, Credit Strategies Fund
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, a large amount of synthetic securities with any
one counterparty subjects the holders of such synthetic securities to an
additional degree of risk with respect to defaults by such counterparty as well
as by the Reference Obligor. The Adviser may not perform independent credit
analyses of the counterparties, any such counterparty, or an entity guaranteeing
such counterparty, 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 Credit Strategies Fund's assets that may be invested in
these securities.
THE GENERAL RISKS OF INVESTING IN SYNTHETIC SECURITIES DO NOT APPLY TO EACH
ACQUIRED FUND SINCE THEY GENERALLY DO NOT INVEST 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.
- 20 -
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 have resulted 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. Terrorism in the U.S. and around the world has had a similar global
impact and has increased geopolitical risk. The Adviser does not know how long
the securities markets will continue to 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. Given the risks described above, an
investment in the common shares of Credit Strategies Fund may not be appropriate
for all investors. You should carefully consider your ability to assume these
risks before making an investment in Credit Strategies Fund.
RISKS OF INVESTING IN A FUND WITH ANTI-TAKEOVER PROVISIONS. Credit Strategies
Fund's Agreement and Declaration of Trust includes provisions that could limit
the ability of other entities or persons to acquire control of Credit Strategies
Fund or convert Credit Strategies Fund 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 NAV.
KEY ADVISER PERSONNEL RISK. Credit Strategies Fund's ability to identify and
invest in attractive opportunities is dependent upon Highland, its investment
adviser. If one or more key individuals leave Highland, Highland may not be able
to hire qualified replacements or may require an extended time to do so. This
situation could prevent Credit Strategies Fund from achieving its investment
objectives.
PROPOSAL 1(A) AND 1(B): REORGANIZATIONS OF THE ACQUIRED FUNDS
The Reorganizations seek to combine two smaller funds (High Income Portfolio and
Income Shares) into one larger fund (Credit Strategies Fund) to achieve certain
economies of scale and other operational efficiencies. Each Acquired Fund is
registered as a diversified, closed-end management investment company under the
1940 Act. The Acquiring Fund is registered as a non-diversified, closed-end
management investment company under the 1940 Act. Highland is the investment
adviser to each Fund.
The investment objective of each Acquired Fund is similar to that of Credit
Strategies Fund, although each Fund seeks to achieve its objective in different
ways. High Income Portfolio seeks to provide high current income, while seeking
to preserve shareholders' capital. Income Shares seeks to provide a high level
of current income, with capital appreciation as a secondary objective. Credit
Strategies Fund seeks to provide both current income and capital appreciation.
High Income Portfolio invests as least 65% of its total assets in high-yield,
fixed-income securities rated in the lower categories (Ba/BB or lower) by a
rating agency or nonrated fixed-income securities deemed by the Adviser to be of
comparable quality. High Income Portfolio typically invests a substantially
higher percentage of its assets in such securities.
Income Shares invests at least 50% of its total assets in debt securities rated
in the four highest categories (Baa/BBB or higher) by a rating agency or
nonrated debt securities deemed by the Adviser to be of comparable quality.
Credit Strategies Fund invests at least 80% of its assets 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. A significant portion of Credit Strategies Fund's
assets may be invested in securities rated below investment grade (Ba/BB or
lower), which are commonly referred to as "junk securities" or "high-yield
securities."
The investment policies of each Fund are different, particularly with respect to
investments in senior loans. Credit Strategies Fund invests more heavily in
senior loans than either Acquired Fund. Income Shares invests a greater
proportion of its assets in investment grade securities than Credit Strategies
Fund. Credit Strategies Fund also has the ability to invest in certain types of
securities in which the Acquired Funds may not invest. Please see the charts
- 21 -
below comparing each Acquired Fund's investment objectives and policies to that
of Credit Strategies Fund for more information.
DESCRIPTION OF THE REORGANIZATIONS
You are being asked to approve an Agreement and Plan of Reorganization to which
your Fund is a party, a form of which is attached to this Proxy
Statement/Prospectus as Appendix A (each, an "Agreement"). Additional
information about each Reorganization and Agreement is set forth below under
"Further Information on the Reorganizations." The Agreements provide for
Reorganizations on the following terms:
o Pursuant to each Reorganization, the Acquiring Fund will acquire all
of the assets and assume all of the liabilities of the participating
Acquired Fund. This will result in the addition of each Acquired
Fund's assets to the Acquiring Fund's portfolio. The NAV of each Fund
will be the most recently calculated NAV prior to the closing of its
Reorganization.
o The Acquiring Fund will issue and cause to be listed on the NYSE newly
issued Acquiring Fund Common Shares (and cash in lieu of certain
fractional shares) in an amount equal to the value of each Acquired
Fund's net assets attributable to its common shares (taking into
account the Acquired Fund's proportionate share of the costs of the
Reorganizations). Those shares will be distributed to common
shareholders of record of each Acquired Fund in proportion to their
holdings of that Acquired Fund's shares immediately prior to the
Reorganization. Acquired Fund common shareholders will receive cash
for any Acquiring Fund fractional shares they otherwise would be
entitled to receive other than with respect to shares held in a
Dividend Reinvestment Plan account. As a result, common shareholders
of each Acquired Fund will end up as common shareholders of the
Acquiring Fund.
o After the Reorganization, the participating Acquired Fund will then
(1) de-register with the SEC, (2) de-list from the NYSE, and (3)
dissolve under Maryland corporate law.
In addition, prior to a Reorganization, preferred shareholders of an Acquired
Fund will receive the liquidation preference associated with their preferred
shares plus any accumulated and unpaid dividends. A Reorganization will not be
completed unless, before the final shareholder vote thereon, the participating
Acquired Fund commences, and irrevocably commits to complete as expeditiously as
possible, the process for redeeming its preferred shares.
The distribution of Acquiring Fund Common Shares pursuant to the Reorganization
of an Acquired Fund will be accomplished by opening new accounts on the books of
the Acquiring Fund in the names of that Acquired Fund's common shareholders of
record as of the closing date of the Reorganization and transferring the
Acquiring Fund Common Shares to those accounts. Each such account for a former
common shareholder of an Acquired Fund will be credited with the PRO RATA number
of Acquiring Fund Common Shares (rounded down, in the case of fractional shares
held other than in a Dividend Reinvestment Plan account, to the next largest
number of whole shares) due such shareholder. If fractional Acquiring Fund
Common Shares otherwise would have been credited to an account, the Acquiring
Fund will issue cash for such fractional shares (except for shares held in a
Dividend Reinvestment Plan account). See "Further Information on the
Reorganizations -- Additional Terms of the Agreement and Plan of Reorganization"
below for a description of the procedures to be followed by the Acquired Funds'
shareholders to obtain Acquiring Fund Common Shares (and cash in lieu of
fractional shares, if any).
REASONS FOR THE PROPOSED REORGANIZATIONS
The Boards of the Funds considered the Reorganizations over several meetings
held on September 7, 2007, November 6, 2007, December 14, 2007 and February 20,
2008. At the meeting held on February 20, 2008, the Board of each Fund,
including the Trustees/Directors who are not "interested persons" (as defined in
the 1940 Act) of each Fund, unanimously approved the Agreement(s) to which its
Fund is a participant.
The Board of each Acquired Fund has determined that participation in the
applicable Reorganization is in the best interests of the Fund and that the
interests of its shareholders will not be diluted as a result of that
Reorganization. Similarly, the Acquiring Fund's Board has determined that
participation in each Reorganization is in the best interests of its common
- 22 -
shareholders and that the interests of such shareholders will not be diluted as
a result of each Reorganization. Preferred shareholders of the Acquired Funds
will not participate in the Reorganizations. As noted above, the preferred
shares will be redeemed prior to each Reorganization. In addition, as a result
of the Reorganizations, shareholders of each Fund, particularly the shareholders
of the Acquired Funds, will have a smaller percentage of ownership in the larger
combined Fund than they did in any of the separate Funds.
The Board of each Fund believes that reorganizing each Acquired Fund into the
Acquiring Fund, a fund with a similar investment objective, and having a
combined portfolio with greater assets, offers you potential benefits. The Board
considered the following matters, among others, in approving the proposals:
o EXCHANGE OF COMMON SHARES AT NAV. On its closing date, a
Reorganization will result in the Acquired Fund shareholders receiving
shares of the Acquiring Fund and cash (in lieu of certain fractional
shares) based on the Acquired Fund's NAV (I.E., the Acquired Fund will
get its NAV's worth of common shares of the Acquiring Fund and cash
(in lieu of certain fractional shares)). It should be noted, however,
that shares of the Acquiring Fund received in a Reorganization will
likely trade at a market discount from NAV following the
Reorganization, so that an Acquired Fund common shareholder may not be
able to sell these shares for their NAV. It should also be noted that
since inception shares of the Acquiring Fund generally have traded at
a smaller discount or wider premium from NAV than shares of either
Acquired Fund. However, since late December until the Board approved
the Reorganization in February 2008, Acquiring Fund shares have
frequently traded at a larger discount from NAV than shares of either
Acquired Fund. The Acquired Fund commenced a rights offering in late
December and completed the rights offering on January 28, 2008.
Historically, rights offerings have increased the discount from NAV
for a fund.
o INCREASED USE OF CAPITAL LOSSES. Each Acquired Fund has sustained
substantial capital losses in recent years, which are available as
CLCs in the current and future taxable years (through their respective
taxable years ending in 2013), but is not expected to be able to
generate enough capital gains to be offset by those CLCs before they
expire. SEE "Further Information on the Reorganizations - Federal
Income Tax Consequences of the Reorganizations." Because of its larger
size and investment policies and strategies, the Acquiring Fund is
expected to be better able to use those CLCs to offset
post-Reorganization gains of the combined Fund. The Acquiring Fund's
use of such CLCs, however, will be significantly limited due to the
application of loss limitation rules under the federal tax law.
o ENHANCED COMMON SHARE LIQUIDITY. Following the Reorganizations, the
substantially larger trading market in the common shares of the
Acquiring Fund, as compared to that of each Acquired Fund prior to the
Reorganizations, may provide Acquired Fund shareholders with enhanced
market liquidity. Trading discounts can result from many different
factors, however, and there is no assurance that a larger trading
market for Acquiring Fund's common shares will have the effect of
reducing or maintaining trading discounts.
o INCREASED ASSET SIZE. The Acquiring Fund will obtain additional assets
without incurring the commission expenses and generally greater other
expenses associated with offering new shares. In addition, the
Acquiring Fund is obtaining the additional portfolio securities of the
Acquired Funds without the commensurate brokerage costs, dealer
spreads or other trading expenses. It is also obtaining these
securities in a manner that is likely to minimize the market impact of
such acquisition on the short-term prices of these securities.
o ECONOMIES OF SCALE IN CERTAIN EXPENSES. A combined Fund offers
economies of scale that may lead to a reduction in certain expenses.
With these reduced expenses and the contractual fee waivers offered by
Highland, which is described below, the annual operating expenses of
the combined Fund may be lower than the current annual operating
expenses of Income Shares, although they are expected to be higher
than High Income Portfolio's current annual operating expenses. Each
Fund incurs NYSE listing fees, costs for legal, auditing, and
custodial services, and miscellaneous fees. Many of these expenses
overlap and there may be an opportunity to reduce them over time if
the Funds are combined. However, it is not expected that these
economies of scale will be substantial.
- 23 -
o PORTFOLIO MANAGEMENT EFFICIENCIES. Each Reorganization would permit
Acquired Fund shareholders to pursue similar investment goals in a
larger Fund. The greater asset size of the combined Fund may allow it,
relative to each Acquired Fund, to obtain better net prices on
securities trades and achieve greater diversification of portfolio
holdings.
o SHAREHOLDERS' ABILITY TO MARGIN. Currently, stocks that trade below
$5.00 are not marginable. The Reorganization would permit shareholders
of High Income Portfolio and Income Shares (if its shares continue to
trade below $5.00) to receive shares that they could margin.
Additionally, marginable securities may be more liquid that those that
are not marginable as many institutional/large investors are believed
to avoid stocks that are not marginable.
Each Board also considered that if shareholders approve a Reorganization,
Highland would contractually agree to waive a portion of Credit Strategies
Fund's advisory fee and administration fee for two years so that Highland would
receive no additional benefit from the Reorganization for two years. If Income
Shares' shareholders approve its Reorganization, such combined waivers would be
at an annual rate of 0.70% of the sum of Income Shares' net assets attributable
to common shares as of the closing date of its Reorganization plus $30 million
(representing the value of its preferred shares that historically have been
outstanding). If High Income Portfolio's shareholders approve its
Reorganization, such combined waivers would be at an annual rate of 0.55% of the
sum of High Income Portfolio's net assets attributable to common shares as of
the closing date of its Reorganization plus $40 million (representing the value
of its preferred shares that historically have been outstanding). In each case,
the amount of the waivers are intended to offset the additional revenue Highland
would receive on each Acquired Fund's assets (including the value of its
preferred shares that historically have been outstanding) due to the difference
between the advisory fee rates of each Acquired Fund and Credit Strategies Fund
and the fact that the Acquired Funds do not pay an administration fee to
Highland.
The Boards of each Fund also considered that the Adviser would benefit from the
Reorganizations. For example, the Adviser may achieve cost savings due to the
Acquiring Fund's lower fixed costs, which may result in reduced costs resulting
from a consolidated portfolio management effort. The Boards believe, however,
that these savings will not amount to a significant economic benefit to the
Adviser.
COMPARATIVE FEES AND EXPENSE RATIOS
The Acquiring Fund's PRO FORMA annual operating expenses, which reflect the
contractual fee waivers offered by Highland and the proceeds of a rights
offering completed by the Acquiring Fund on January 28, 2008, may be lower than
the current annual operating expenses of Income Shares, although they are
expected to be higher than High Income Portfolio's annual operating expenses. In
addition, a combined Fund offers economies of scale that may lead to a reduction
in certain expenses. The Acquiring Fund's higher expenses are due, in part, to
its leveraging by borrowing pursuant to a credit facility rather than by issuing
preferred shares. While the use of a credit facility has been more expensive, it
provides the Acquiring Fund greater flexibility to change the amount of its
leverage depending on market conditions. Over time, this flexibility may enable
the Acquiring Fund to achieve greater performance, although there is no
guarantee or assurance as to the future performance of Credit Strategies Fund.
Credit Strategies Fund's 1-year performance as of December 31, 2007 on a net
asset value basis is better than Income Shares and its overall historical
premium/discount profile is better than that of each Acquired Fund. However,
more recently, Acquiring Fund Common Shares have traded at a larger discount
from NAV than shares of either Acquired Fund. The Acquired Fund also completed a
rights offering on January 28, 2008. There is no guarantee or assurance as to
the future performance, liquidity or premium/discount portfolio of Credit
Strategies Fund.
A full comparison of advisory fee rates and expense ratios is included below.
COMPARATIVE PERFORMANCE
The Boards also considered details of the relative performance of each Acquired
Fund and the Acquiring Fund.
- 24 -
BOARD'S EVALUATION AND RECOMMENDATION
For the reasons described herein, the Board of each Acquired Fund, including the
Directors who are not "interested persons" (as defined in the 1940 Act) of that
Fund, the Acquiring Fund or the Adviser, approved the Reorganization in which
that Acquired Fund would participate. In particular, the Directors determined
that participation in the Reorganization involving that Fund is in its best
interests and that the interests of its shareholders would not be diluted as a
result of the Reorganization. Similarly, the Board of the Acquiring Fund,
including the Trustees who are not "interested persons" (as defined in the 1940
Act) of any Fund or the Adviser, approved each Reorganization. They also
determined that participation in each Reorganization is in the Acquiring Fund's
best interests and that the interests of its shareholders would not be diluted
as a result of each Reorganization.
------------------------------------------------------------------
THE DIRECTORS OF EACH ACQUIRED FUND UNANIMOUSLY RECOMMEND
THAT SHAREHOLDERS VOTE FOR THE RESPECTIVE PROPOSAL TO APPROVE
THE AGREEMENT AND PLAN OF REORGANIZATION.
------------------------------------------------------------------
- 25 -
COMPARISON OF THE FUNDS: INVESTMENT OBJECTIVES AND POLICIES
The following tables compare the investment objectives and policies of High
Income Portfolio and Income Shares to Credit Strategies Fund and summarize the
types of investments that each may engage in. For a more complete description of
the types of investments, please refer to Appendix B.
COMPARISON OF HIGH INCOME PORTFOLIO TO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
HIGH INCOME PORTFOLIO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
Business The Fund is a diversified, closed-end management The Fund is a non-diversified, closed-end
investment company organized as a Maryland management investment company organized as a
corporation. Delaware statutory trust.
----------------------------------------------------------------------------------------------------------------------------
Net Assets (January $89.6 million $721.3 million (this includes the proceeds of a
31, 2008) rights offering completed by Credit Strategies
Fund on January 28, 2008)
----------------------------------------------------------------------------------------------------------------------------
Listing (Common NYSE under the ticker symbol "PHY" NYSE under the ticker symbol "HCF"
Shares)
----------------------------------------------------------------------------------------------------------------------------
Rating of Preferred Aaa/AAA Not applicable
Shares
----------------------------------------------------------------------------------------------------------------------------
Fiscal Year End 10/31 12/31
----------------------------------------------------------------------------------------------------------------------------
Investment Adviser Highland Capital Management, L.P. Highland Capital Management, L.P.
----------------------------------------------------------------------------------------------------------------------------
Portfolio Managers James Dondero James Dondero
Mark Okada Mark Okada
Kurtis Plumer
----------------------------------------------------------------------------------------------------------------------------
Investment The Fund's investment objective is to provide The Fund's investment objectives are to provide
Objective(s) high current income, while seeking to preserve both current income and capital appreciation.
shareholders' capital, through investment in a
professionally managed, diversified portfolio of
high-yield, high risk securities (commonly
referred to as "junk" bonds or securities).
----------------------------------------------------------------------------------------------------------------------------
Primary Investment Under normal market conditions, the Fund invests The Fund pursues its objectives by investing
Strategies at least 65% of its total assets in high-yield, primarily in the following categories of
fixed-income securities rated in the lower securities and instruments of corporations and
categories ("Ba"/"BB" or lower) by a nationally other business entities: (i) secured and
recognized rating agency or nonrated unsecured floating and fixed rate loans; (ii)
fixed-income securities deemed by the Adviser to bonds and other debt obligations; (iii) debt
be of comparable quality to the rated debt obligations of stressed, distressed and bankrupt
securities in which the Fund may invest. The issuers; (iv) structured products, including but
Fund typically invests and currently intends to not limited to, mortgage-backed and other
continue to invest a substantially higher asset-backed securities and collateralized debt
percentage of its assets in such securities to obligations; and (v) equities.
the extent the Adviser believes market
conditions favor such investments. Additionally, within the categories of
obligations and securities in which the Fund may
The Fund reserves the right, under normal market invest, Highland may employ various trading
conditions, to invest up to 35% of its total strategies, including but not limited to, capital
assets in money market instruments and fixed structure arbitrage, pair trades, and shorting.
income securities rated higher than "Ba"/"BB" or The Fund may also invest in these categories of
the unrated equivalent as determined by the obligations and securities through the use of
Adviser, although the percentage invested in derivatives.
such securities may increase under other than
normal market conditions. Highland will seek to achieve its capital
----------------------------------------------------------------------------------------------------------------------------
- 26 -
----------------------------------------------------------------------------------------------------------------------------
HIGH INCOME PORTFOLIO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
appreciation objective by investing in category
Under current Moody's and S&P guidelines (iii) and (v) obligations and securities, and to
relating to the receipt of ratings on the a lesser extent, in category (i), (ii), and (iv)
preferred shares, the Fund is limited in its use obligations.
of certain types of securities in which it may
otherwise invest, and certain strategies in Under normal market conditions, at least 80% of
which the Fund may otherwise engage, pursuant to the Fund's assets will be invested in one or more
the investment policies and strategies stated of these principal investment categories. Subject
below. Such instruments consist of, among only to this general guideline, the Adviser has
others: securities that are not readily broad discretion to allocate the Fund's assets
marketable; private placements (other than Rule among these investment categories and to change
144A securities); and securities not within the allocations as conditions warrant. The Adviser
diversification guidelines of Moody's or S&P. has full discretion regarding the capital markets
Accordingly, although the Fund reserves the from which it can access investment opportunities
right to invest in such securities and to engage in accordance with the investment limitations set
in such strategies to the extent described in forth in this prospectus. A significant portion
the Prospectus and this SAI, it is anticipated of the Fund's assets may be invested in
that they will not ordinarily constitute in securities rated below investment grade, which
total more than 20% of the Fund's total assets. are commonly referred to as "junk securities."
The Fund seeks to achieve its objective of
preserving shareholders' capital through careful
selection of the Fund's high-yield, high risk
investments, portfolio diversification, and
portfolio monitoring and repositioning.
----------------------------------------------------------------------------------------------------------------------------
Leverage and The Fund employs leverage through the issuance The Fund employs leverage through borrowings
Borrowing of preferred shares and, as of January 31, 2008, through a credit facility and, as of January 31,
the Fund had 1,600 preferred shares outstanding 2008, the Fund had borrowings of approximately
with a liquidation preference of $40 million. $100 million.
----------------------------------------------------------------------------------------------------------------------------
Diversification The Fund is a diversified investment company. The Fund is a non-diversified investment
company.
----------------------------------------------------------------------------------------------------------------------------
Concentration The Fund may not invest 25% or more of its The Fund may not invest 25% or more of its assets
assets in the securities of issuers in one in the securities of issuers in one industry.
industry.
----------------------------------------------------------------------------------------------------------------------------
Illiquid Securities The Fund may invest up to 30% of its total There is no limit on the amount of the Fund's
assets in securities that are not readily portfolio that can be invested in illiquid
marketable. securities.
----------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover The Fund's portfolio turnover rate may exceed The Adviser anticipates that the Fund will
100% per year. experience high portfolio turnover.
----------------------------------------------------------------------------------------------------------------------------
Senior Loans, The Fund may invest up to 10% of its total There is no limit on the amount of the Fund's
Unsecured Loans, assets in senior loans, unsecured loans, second portfolio that can be invested in senior loans,
Second Lien Loans lien loans and other secured loans. including bank loans, unsecured loans, second
and Other Secured lien loans and other secured loans.
Loans
----------------------------------------------------------------------------------------------------------------------------
Investment Grade The Fund may invest up to 35% of its total There is no limit on the amount of the Fund's
Securities assets in investment grade securities, however, portfolio that can be invested in investment
the Fund generally does not invest in investment grade securities, however, a significant portion
grade securities. of the Fund's assets may be invested in
securities rated below investment grade, which
are commonly referred to as "junk securities."
----------------------------------------------------------------------------------------------------------------------------
Non-Investment The Fund invests at least 65% of its total There is no limit on the amount of the Fund's
----------------------------------------------------------------------------------------------------------------------------
- 27 -
----------------------------------------------------------------------------------------------------------------------------
HIGH INCOME PORTFOLIO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
Grade Securities assets in high-yield, fixed-income securities portfolio that can be invested in non-investment
rated in the lower categories ("Ba"/"BB" or grade securities and a significant portion of the
lower) by a nationally recognized rating agency Fund's assets may be invested in securities rated
or nonrated fixed-income securities deemed by below investment grade, which are commonly
the Adviser to be of comparable quality to the referred to as "junk securities."
rated debt securities in which the Fund may
invest.
----------------------------------------------------------------------------------------------------------------------------
Asset-Backed The Fund generally does not invest in The Fund may invest in asset-backed securities
Securities and asset-backed securities and mortgage-backed and mortgage-backed securities.
Mortgaged-Backed securities.
Securities
----------------------------------------------------------------------------------------------------------------------------
Collateralized Loan The Fund may invest in collateralized loan The Fund may invest in collateralized loan
Obligations and obligations and bond obligations. obligations and bond obligations. The Fund
Bond Obligations invests in the lower tranches of collateralized
bond obligations.
----------------------------------------------------------------------------------------------------------------------------
Distressed Debt and The Fund may invest in the securities and other The Fund may invest in the securities and other
Stressed Debt obligations of stressed, distressed and bankrupt obligations of stressed, distressed and bankrupt
issuers. issuers, including debt obligations that are in
covenant or payment default.
----------------------------------------------------------------------------------------------------------------------------
Equity Securities The Fund may invest up to 20% of its total There is no limit on the amount of the Fund's
assets in equity securities, including common portfolio that can be invested in equity
stocks, certain preferred stocks and depositary securities including common stock, preferred
receipts, as well as warrants to purchase equity stocks, convertible securities, warrants and
or other securities. depository receipts.
----------------------------------------------------------------------------------------------------------------------------
Money Market The Fund may invest in money market instruments The Fund may invest in money market instruments
Instruments and U.S. and U.S. government securities. and U.S. government securities.
Government Securities
----------------------------------------------------------------------------------------------------------------------------
Other Investment The Fund generally does not invest in the The Fund may invest in the securities of other
Companies securities of other investment companies. investment companies (including exchange traded
funds ("ETFs")) to the extent that such
investments are consistent with the Fund's
investment objectives and principal investment
strategies and permissible under the 1940 Act.
----------------------------------------------------------------------------------------------------------------------------
Zero-Coupon The Fund may invest up to 20% of its total The Fund may invest in zero-coupon bonds and
Securities and assets in zero coupon securities, including deferred payment obligations and there is no
Deferred Payment step-up bonds. limit on the amount of the Fund's portfolio that
Obligations can be invested in these securities.
----------------------------------------------------------------------------------------------------------------------------
Derivatives The Fund may use derivatives and other The Fund may purchase and sell derivative
transactions and generally only uses options, instruments such as exchange-listed and
financial futures and options on financial over-the-counter put and call options on
futures. The Fund has a policy to limit to 20% securities, financial futures, equity,
of the Fund's total assets the portion of the fixed-income and interest rate indices, and other
Fund's assets that may be subject to such financial instruments, purchase and sell
transactions or invested in such instruments. 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 Fund also may purchase
derivative instruments that combine features of
these instruments. Apart from senior loan based
derivatives, derivatives are not a significant
part of the Fund's investments.
----------------------------------------------------------------------------------------------------------------------------
- 28 -
----------------------------------------------------------------------------------------------------------------------------
HIGH INCOME PORTFOLIO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
Senior Loan Based The Fund generally does not invest in senior The Fund may obtain exposure to senior loans and
Derivatives loan based derivatives. baskets of senior loans through the use of
derivative instruments.
----------------------------------------------------------------------------------------------------------------------------
Swaps The Fund generally does not invest in swaps. The Fund may invest in swaps including credit
default swaps, interest rate swaps, total return
swaps and currency swaps. The Fund may use swaps
for risk management purposes and as a speculative
investment.
----------------------------------------------------------------------------------------------------------------------------
Credit Linked The Fund generally does not invest in credit The Fund may invest in CLNs for risk management
Notes linked notes ("CLNs"). purposes and to vary its portfolio. A CLN is a
derivative instrument.
----------------------------------------------------------------------------------------------------------------------------
Options The Fund may write (sell) call options which are The Fund may purchase and sell put and call
traded on national securities exchanges with options on securities and indices.
respect to securities in its portfolio. The Fund
may only write "covered" call options. However,
the Fund generally does not use options.
----------------------------------------------------------------------------------------------------------------------------
Futures Contracts The Fund does not trade in futures contracts or The Fund may enter into contracts for the
and Options on related options on futures contracts. However, purchase or sale for future delivery ("futures
Futures Contracts the Fund may do so, subject to the approval of contracts") of securities, aggregates of
the Board of Directors, for hedging purposes. securities or indices or prices thereof, other
financial indices and U.S. government debt
securities or options on the above. The Fund will
engage in such transactions only for bona fide
risk management and other portfolio management
purposes.
----------------------------------------------------------------------------------------------------------------------------
Foreign Currency The Fund may buy or sell foreign currencies or The Fund may enter into foreign currency
and Forward deal in forward foreign currency contracts for transactions in an attempt to enhance total
Foreign Currency hedging purposes. return. The Fund may enter into forward currency
Contracts contracts to purchase or sell foreign currencies
for a fixed amount of U.S. dollars or another
foreign currency.
----------------------------------------------------------------------------------------------------------------------------
Short Sales The Fund may only sell a security short if it The Fund may engage in short sales against the
owns at least an equal amount of the security box and not against the box. Subject to the
sold short or another security convertible or requirements of the 1940 Act and the Code, the
exchangeable for an equal amount of the security Fund will not make a short sale if, after giving
sold short without payment of further effect to such sale, the market value of all
compensation (a short sale against-the-box). securities sold short by the Fund exceeds 25% of
the value of its total assets. The Fund may make
short sales against the box without respect to
such limitations.
----------------------------------------------------------------------------------------------------------------------------
Repurchase The Fund may enter into repurchase agreements The Fund may invest up to 33 1/3% of its assets
Agreements with respect to up to 25% of the value of its in repurchase agreements.
total assets. However, the Fund generally does
not enter into repurchase agreements.
----------------------------------------------------------------------------------------------------------------------------
- 29 -
----------------------------------------------------------------------------------------------------------------------------
HIGH INCOME PORTFOLIO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------------
Reverse Repurchase The Fund may enter into reverse repurchase The Fund may enter into reverse repurchase
Agreements agreements up to 5% of the value of its total agreements.
assets. However, the Fund generally does not
enter into reverse repurchase agreements.
----------------------------------------------------------------------------------------------------------------------------
Inverse Floaters The Fund generally does not invest in inverse The Fund may invest in inverse floaters.
floaters.
----------------------------------------------------------------------------------------------------------------------------
Pay-in-kind Bonds The Fund may invest in pay-in-kind ("PIK") bonds. The Fund may invest in PIK bonds.
----------------------------------------------------------------------------------------------------------------------------
When-Issued, The Fund may purchase securities on a The Fund may purchase securities on a when-issued
Delayed-Delivery and when-issued or delayed-delivery basis. The Fund basis and may purchase or sell securities on a
Forward Commitment does not purchase or sell securities on a "forward commitment" basis.
Purchases "forward commitment" basis.
----------------------------------------------------------------------------------------------------------------------------
Securities Loans The Fund may lend up to 33 1/3% of its assets. The Fund may lend up to 33 1/3% of its assets.
----------------------------------------------------------------------------------------------------------------------------
Foreign Securities The Fund may invest up to 10% of the value of The Fund may invest up to 20% of its assets in
its total assets in securities principally non-U.S. credit or securities market investments.
traded in foreign markets and Eurodollar
certificates of deposit issued by branches of
U.S. and foreign banks. The Fund will use
currency transactions only for hedging and not
speculation.
----------------------------------------------------------------------------------------------------------------------------
Temporary Defensive Under certain market conditions, the Fund may Under certain market conditions, the Fund may
Position adopt a temporary defensive position to invest adopt a temporary defensive position to invest
its assets in cash or cash equivalents. its assets in cash or cash equivalents.
----------------------------------------------------------------------------------------------------------------------------
- 30 -
COMPARISON OF INCOME SHARES TO CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
INCOME SHARES CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
Business The Fund is a diversified, closed-end management The Fund is a non-diversified, closed-end
investment company organized as a Maryland management investment company organized as a
corporation. Delaware statutory trust.
----------------------------------------------------------------------------------------------------------------------------
Net Assets (January $57.4 million $721.3 million (this includes the proceeds of a
31, 2008) rights offering completed by Credit Strategies
Fund on January 28, 2008)
----------------------------------------------------------------------------------------------------------------------------
Listing (Common NYSE under the ticker symbol "CNN" NYSE under the ticker symbol "HCF"
Shares)
----------------------------------------------------------------------------------------------------------------------------
Rating of Preferred Aaa/AAA Not applicable
Shares
----------------------------------------------------------------------------------------------------------------------------
Fiscal Year End 12/31 12/31
----------------------------------------------------------------------------------------------------------------------------
Investment Adviser Highland Capital Management, L.P. Highland Capital Management, L.P.
----------------------------------------------------------------------------------------------------------------------------
Portfolio Managers James Dondero James Dondero
Mark Okada Mark Okada
Kurtis Plumer
----------------------------------------------------------------------------------------------------------------------------
Investment The Fund's primary investment objective is to The Fund's investment objectives are to provide
Objective(s) provide a high level of current income, with both current income and capital appreciation.
capital appreciation as a secondary objective.
----------------------------------------------------------------------------------------------------------------------------
Primary Investment The Fund's policy is to invest at least 50% of The Fund pursues its objectives by investing
Strategies its total assets in debt securities rated in the primarily in the following categories of
four highest categories ("Baa"/"BBB" or higher) securities and instruments of corporations and
assigned by a nationally recognized rating other business entities: (i) secured and
agency, or other securities such as United unsecured floating and fixed rate loans; (ii)
States and Canadian government securities, bonds and other debt obligations; (iii) debt
obligations of or guaranteed by banks, obligations of stressed, distressed and bankrupt
commercial paper and cash equivalents, or issuers; (iv) structured products, including but
nonrated debt securities deemed by the Adviser not limited to, mortgage-backed and other
to be of comparable quality to the rated debt asset-backed securities and collateralized debt
securities in which the Fund may invest. obligations; and (v) equities.
Securities rated "Baa" or "BBB" possess
speculative characteristics. The Fund also may Additionally, within the categories of
invest in other securities, including debt obligations and securities in which the Fund may
securities rated below the four highest rating invest, Highland may employ various trading
categories, including the lowest rating strategies, including but not limited to, capital
category, which is reserved for securities in structure arbitrage, pair trades, and shorting.
default and are commonly referred to as "junk The Fund may also invest in these categories of
bonds." obligations and securities through the use of
derivatives.
The Fund may invest up to 25% of the value of
its total assets in other debt securities and Highland will seek to achieve its capital
securities which may be convertible into or appreciation objective by investing in category
exchangeable for, or carry warrants to purchase, (iii) and (v) obligations and securities, and to
common stock or other interests not included in a lesser extent, in category (i), (ii), and (iv)
the description above and preferred stock and obligations.
common stock.
Under normal market conditions, at least 80% of
The Fund will invest at least 80% of the value the Fund's assets will be invested in one or more
of its total assets in income producing of these principal investment categories. Subject
securities. The Fund will not invest more than only to this general guideline, the Adviser has
25% of the value of its total assets in broad discretion to allocate the Fund's assets
----------------------------------------------------------------------------------------------------------------------------
- 31 -
----------------------------------------------------------------------------------------------------------------------------
INCOME SHARES CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
restricted securities, which are securities among these investment categories and to change
acquired in private placement transactions. allocations as conditions warrant. The Adviser
has full discretion regarding the capital markets
from which it can access investment opportunities
in accordance with the investment limitations set
forth in this prospectus. A significant portion
of the Fund's assets may be invested in
securities rated below investment grade, which
are commonly referred to as :junk securities."
----------------------------------------------------------------------------------------------------------------------------
Leverage and The Fund employs leverage through the issuance The Fund employs leverage through borrowings
Borrowing of preferred shares and, as of January 31, 2008, through a credit facility and, as of January 31,
the Fund had 1,200 preferred shares outstanding 2008, the Fund had borrowings of approximately
with a liquidation preference of $30 million. $100 million.
----------------------------------------------------------------------------------------------------------------------------
Diversification The Fund is a diversified investment company. The Fund is a non-diversified investment
company.
----------------------------------------------------------------------------------------------------------------------------
Concentration The Fund may not invest 25% or more of its The Fund may not invest 25% or more of its assets
assets in the securities of issuers in one in the securities of issuers in one industry.
industry except that at times when a significant
portion of the market for corporate debt
securities is composed of issues in the electric
utility industry or the telephone utility
industry, as the case may be, the Fund may
invest up to 35% of its assets in the issues of
such industry subject to certain conditions.
----------------------------------------------------------------------------------------------------------------------------
Illiquid Securities The Fund will not invest more than 25% of the There is no limit on the amount of the Fund's
value of its total assets in restricted portfolio that can be invested in illiquid
securities, which are securities acquired in securities.
private placement transactions.
----------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover The Fund's portfolio turnover rate may exceed The Adviser anticipates that the Fund will
100% per year. experience high portfolio turnover.
----------------------------------------------------------------------------------------------------------------------------
Senior Loans, The Fund may invest up to 10% of its total There is no limit on the amount of the Fund's
Unsecured Loans, assets in senior loans, unsecured loans, second portfolio that can be invested in senior loans,
Second Lien Loans lien loans and other secured loans. including bank loans, unsecured loans, second
and Other Secured lien loans and other secured loans.
Loans
----------------------------------------------------------------------------------------------------------------------------
Investment Grade The Fund invests at least 50% of its total There is no limit on the amount of the Fund's
Securities assets in debt securities rated in the four portfolio that can be invested in investment
highest categories ("Baa"/"BBB" or higher) grade securities, however, a significant portion
assigned by a nationally recognized rating of the Fund-s assets may be invested in
agency, or other securities such as United securities rated below investment grade, which
States and Canadian government securities, are commonly referred to as "junk securities."
obligations of or guaranteed by banks,
commercial paper and cash equivalents, or
nonrated debt securities deemed by the Adviser
to be of comparable quality to the rated debt
securities in which the Fund may invest.
----------------------------------------------------------------------------------------------------------------------------
Non-Investment The Fund may invest up to 50% of its total There is no limit on the amount of the Fund's
Grade Securities assets in high-yield, fixed-income securities portfolio that can be invested in non-investment
rated in the lower categories ("Ba"/"BB" or grade securities and a significant portion of the
lower) by a nationally recognized rating agency Fund's assets may be invested in securities rated
or nonrated fixed-income securities deemed by below investment grade, which are commonly
the Adviser to be of comparable quality to the referred to as "junk securities."
rated debt securities in which the Fund may
invest.
----------------------------------------------------------------------------------------------------------------------------
- 32 -
----------------------------------------------------------------------------------------------------------------------------
INCOME SHARES CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
Asset-Backed The Fund generally does not invest in The Fund may invest in asset-backed securities
Securities and asset-backed securities and mortgage-backed and mortgage-backed securities.
Mortgaged-Backed securities.
Securities
----------------------------------------------------------------------------------------------------------------------------
Collateralized Loan The Fund generally does not invest in The Fund may invest in collateralized loan
Obligations and Bond collateralized loan obligations and bond obligations and bond obligations. The Fund
Obligations obligations. invests in the lower tranches of collateralized
bond obligations.
----------------------------------------------------------------------------------------------------------------------------
Distressed Debt and The Fund may invest in the securities and other The Fund may invest in the securities and other
Stressed Debt obligations of stressed, distressed and bankrupt obligations of stressed, distressed and bankrupt
issuers, however, the Fund generally does not issuers, including debt obligations that are in
invest in securities that are in payment default. covenant or payment default.
----------------------------------------------------------------------------------------------------------------------------
Equity Securities The Fund may invest up to 25% of its total There is no limit on the amount of the Fund's
assets in equity securities, including portfolio that can be invested in equity
securities which may be convertible into or securities including common stock, preferred
exchangeable for, or carry warrants to purchase, stocks, convertible securities, warrants and
common stock, preferred stock and common stock. depository receipts.
----------------------------------------------------------------------------------------------------------------------------
Money Market The Fund may invest in money market instruments The Fund may invest in money market instruments
Instruments and U.S. and U.S. government securities. and U.S. government securities.
Government Securities
----------------------------------------------------------------------------------------------------------------------------
Other Investment The Fund generally does not invest in the The Fund may invest in the securities of other
Companies securities of other investment companies. investment companies (including ETFs) to the
extent that such investments are consistent with
the Fund's investment objectives and principal
investment strategies and permissible under the
1940 Act.
----------------------------------------------------------------------------------------------------------------------------
Zero-Coupon The Fund generally does not invest in The Fund may invest in zero-coupon bonds and
Securities and zero-coupon securities or deferred payment deferred payment obligations and there is no
Deferred Payment obligations. limit on the amount of the Fund's portfolio that
Obligations can be invested in these securities.
----------------------------------------------------------------------------------------------------------------------------
Derivatives The Fund may use interest rate futures contracts The Fund may purchase and sell derivative
or fixed income options, subject to certain instruments such as exchange-listed and
restrictions. However, the Fund generally does over-the-counter put and call options on
not enter into these transactions. 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 Fund also may purchase
----------------------------------------------------------------------------------------------------------------------------
- 33 -
----------------------------------------------------------------------------------------------------------------------------
INCOME SHARES CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
derivative instruments that combine features of
these instruments. Apart from senior loan based
derivatives, derivatives are not a significant
part of the Fund's investments.
----------------------------------------------------------------------------------------------------------------------------
Senior Loan Based The Fund generally does not invest in senior The Fund may obtain exposure to senior loans and
Derivatives loan based derivatives. baskets of senior loans through the use of
derivative instruments.
----------------------------------------------------------------------------------------------------------------------------
Swaps The Fund generally does not invest in swaps. The Fund may invest in swaps including credit
default swaps, interest rate swaps, total return
swaps and currency swaps. The Fund may use swaps
for risk management purposes and as a speculative
investment.
----------------------------------------------------------------------------------------------------------------------------
Credit Linked Notes The Fund generally does not invest in CLNs. The Fund may invest in CLNs for risk management
purposes and to vary its portfolio. A CLN is a
derivative instrument.
----------------------------------------------------------------------------------------------------------------------------
Options The Fund may write fixed income options, subject The Fund may purchase and sell put and call
to certain conditions. The Fund does not options on securities and indices.
generally enter into these transactions.
----------------------------------------------------------------------------------------------------------------------------
Futures Contracts and The Fund may use interest rate futures The Fund may enter into contracts for the
Options on Futures contracts, subject to certain conditions. The purchase or sale for future delivery ("futures
Contracts Fund does not generally enter into these contracts") of securities, aggregates of
transactions. securities or indices or prices thereof, other
financial indices and U.S. government debt
securities or options on the above. The Fund will
engage in such transactions only for bona fide
risk management and other portfolio management
purposes.
----------------------------------------------------------------------------------------------------------------------------
Foreign Currency The Fund generally does not purchase foreign The Fund may enter into foreign currency
and Forward currency or enter into forward foreign currency transactions in an attempt to enhance total
Foreign Currency contracts. return. The Fund may enter into forward currency
Contracts contracts to purchase or sell foreign currencies
for a fixed amount of U.S. dollars or another
foreign currency.
----------------------------------------------------------------------------------------------------------------------------
Short Sales The Fund may only sell a security short if it The Fund may engage in short sales against the
owns at least an equal amount of the security box and not against the box. Subject to the
sold short or another security convertible or requirements of the 1940 Act and the Code, the
exchangeable for an equal amount of the security Fund will not make a short sale if, after giving
sold short without payment of further effect to such sale, the market value of all
compensation (a short sale against-the-box). securities sold short by the Fund exceeds 25% of
However, the Fund generally does not engage in the value of its total assets. The Fund may make
short sales. short sales against the box without respect to
such limitations.
----------------------------------------------------------------------------------------------------------------------------
Repurchase Agreements The Fund generally does not enter into The Fund may invest up to 33 1/3% of its assets
repurchase agreements. in repurchase agreements.
----------------------------------------------------------------------------------------------------------------------------
Reverse The Fund may enter into reverse repurchase The Fund may enter into reverse repurchase
Repurchase agreements up to 5% of the value of its total agreements.
Agreements assets. However, the Fund generally does not
enter into reverse repurchase agreements.
----------------------------------------------------------------------------------------------------------------------------
- 34 -
----------------------------------------------------------------------------------------------------------------------------
INCOME SHARES CREDIT STRATEGIES FUND
----------------------------------------------------------------------------------------------------------------------------
Inverse Floaters The Fund may invest in inverse floaters. The Fund may invest in inverse floaters.
However, the Fund generally does not invest in
inverse floaters.
----------------------------------------------------------------------------------------------------------------------------
Pay-in-kind Bonds The Fund may invest in PIK bonds. The Fund may invest in PIK bonds.
----------------------------------------------------------------------------------------------------------------------------
When-Issued, The Fund generally does not purchase securities The Fund may purchase securities on a when-issued
Delayed-Delivery and on a when-issued or delayed-delivery basis and basis and may purchase or sell securities on a
Forward Commitment does not purchase or sell securities on a "forward commitment" basis.
Purchases "forward commitment" basis.
----------------------------------------------------------------------------------------------------------------------------
Securities Loans The Fund may lend up to 25% of its net assets. The Fund may lend up to 33 1/3% of its assets.
----------------------------------------------------------------------------------------------------------------------------
Foreign Securities The Fund may invest up to 50% of its total The Fund may invest up to 20% of its assets in
assets in securities (payable in U.S. dollars) non-U.S. credit or securities market investments.
of, or guaranteed by, the Government of Canada
or a Province of Canada or any instrumentality
or political subdivision thereof.
----------------------------------------------------------------------------------------------------------------------------
Temporary Defensive Under certain market conditions, the Fund may Under certain market conditions, the Fund may
Position adopt a temporary defensive position to invest adopt a temporary defensive position to invest
its assets in cash or cash equivalents. its assets in cash or cash equivalents.
----------------------------------------------------------------------------------------------------------------------------
- 35 -
FEE, EXPENSE AND DISTRIBUTIONS ON PREFERRED SHARES TABLE FOR COMMON
SHAREHOLDERS OF THE FUNDS
SUMMARY OF EXPENSE COMPARISON
As the tables below indicate, with the contractual fee waivers offered by
Highland and the proceeds of a rights offering completed by Credit Strategies
Fund on January 28, 2008, the PRO FORMA annual operating expenses of Credit
Strategies Fund may be lower than the annual operating expenses of Income
Shares, although they are expected to be higher than High Income Portfolio's
annual operating expenses. In addition, a combined Fund offers the potential for
economies of scale that may lead to a slight reduction in certain expenses.
THE FUNDS' EXPENSES
The tables below illustrate the change in operating expenses expected as a
result of the Reorganization. The tables set forth (i) the fees, expenses and
distributions to preferred shareholders paid by High Income Portfolio for the
period ended October 31, 2007, (ii) the fees, expenses and distributions to
preferred shareholders paid by Income Portfolio for the period ended December
31, 2007; (iii) the fees, expenses, and interest payments on borrowed funds paid
by Credit Strategies Fund for the period ended December 31, 2007; and (iv) the
PRO FORMA fees, expenses and interest payments on borrowed funds for the
Acquiring Fund for the period ended December 31, 2007, assuming each of the
Reorganizations had been completed at the beginning of such period. The
following tables show each Fund's expenses as a percentage of net assets
attributable to common shares and reflect the issuance of preferred shares in an
amount equal to 29.33% of High Income Portfolio's total assets and 33.97% of
Income Shares' total assets and borrowing in an amount equal to 28.54% of Credit
Strategies Fund's total assets and 28.54% of the combined Fund's total assets
after the Reorganizations are completed.
As described herein, an unfavorable vote by the shareholders of one Acquired
Fund will not affect the consummation of the Reorganization by the other
Acquired Fund if approved by such other Acquired Fund's shareholders. It is
anticipated that the most favorable expense ratio will be achieved for each
Acquired Fund if both of the Reorganizations are approved and consummated and
that a less favorable resulting expense ratio for each Acquired Fund will result
if such Acquired Fund is the only Fund that participates in the Reorganization
with the Acquiring Fund. As such, the following tables illustrate the
anticipated change in operating expenses expected as a result of (i) both
Acquired Funds approving and participating in the Reorganization, (ii)
Reorganization of only High Income Portfolio into the Acquiring Fund, and (iii)
Reorganization of only Income Shares into the Acquiring Fund.
I. Both Acquired Funds Participating in the Reorganization:
-----------------------------------------------------------
PRO FORMA
ACTUAL COMBINED(1)
-----------------------------------------------------
HIGH CREDIT
INCOME INCOME STRATEGIES CREDIT
PORTFOLIO SHARES FUND STRATEGIES FUND
(PHY) (CNN) (HCF) (HCF)
COMMON SHAREHOLDER TRANSACTION
EXPENSES(2)
Sales Load (as a percentage of None(3) None(3) None(3) None(3)
offering price)
Dividend Reinvestment Plan Fees None(4) None(4) None(5) None(5)
- 36 -
(Unaudited)
ACTUAL
PERCENTAGE OF NET ASSETS ATTRIBUTABLE TO
COMMON SHARES (ASSUMING LEVERAGE AS PRO FORMA
DESCRIBED ABOVE) COMBINED(1)
---------------------------------------------------
HIGH CREDIT CREDIT
INCOME INCOME STRATEGIES STRATEGIES
PORTFOLIO SHARES FUND FUND
(PHY) (CNN) (HCF) (HCF)
ANNUAL EXPENSES (as a
percentage of net assets
attributable to common
shares)
Management Fee 0.89% 0.73% 1.64%* 1.64%*
Interest Payments on 0.01% 0.07% 2.16% 2.16%
Borrowed Funds
Other Expenses
Dividend Income From 0.00% 0.00% 0.03% 0.03%
Short Positions
Other Expenses(6) 0.45% 0.71% 0.23% 0.20%
Total Other Expenses 0.45% 0.71% 0.26% 0.23%
Total Annual Expenses 1.35% 1.51% 4.06% 4.03%
Dividends on Preferred 1.99%(7)(8) 2.48%(7)(9) 0.00% 0.00%
Shares
Total Annual Fund 3.34% 3.99% 4.06% 4.03%
Operating Expenses and
Dividends on Preferred
Shares
Minus: Expense Waivers(10) 0.00% 0.00% 0.00% 0.15%
Net Annual Fund Operating 3.34% 3.99% 4.06% 3.88%
Expenses and Dividends
on Preferred Shares
* Management fees are both the investment advisory and administrative services
fees paid to Highland.
(1) The PRO FORMA combined column shown assumes both Reorganizations are
completed. As described herein, an unfavorable vote by one Acquired Fund will
not affect the consummation of the Reorganization by the other Acquired Fund if
approved by such other Acquired Fund's shareholders. The PRO FORMA combined
column also reflects the proceeds of the rights offering completed by the
Acquiring Fund on January 28, 2008.
(2) No expense information is presented with respect to preferred shares because
holders of preferred shares do not bear any transaction or operating expenses of
any of the Funds and will not bear any transaction or operating expenses of the
combined Fund.
(3) Shares of Funds purchased on the secondary market are not subject to sales
charges but may be subject to brokerage commissions or other charges. The table
does not include an underwriting commission paid by shareholders in the initial
offering of each Fund.
(4) Each participant in the Fund's dividend reinvestment plan pays a
proportionate share of the brokerage commissions incurred with respect to open
market purchases in connection with such plan.
(5) 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 plan
account. Each participant in the Credit Strategies Fund's Dividend Reinvestment
Plan will pay a pro rata share of brokerage commissions incurred when dividend
reinvestment occurs in open-market purchases because the NAV per common share is
greater than the market value per common share.
(6) In connection with the Reorganizations, there are certain other transaction
expenses not reflected in "Other Expenses" which include, but are not limited
to: costs related to the preparation, printing and distributing of this Proxy
Statement/Prospectus to shareholders; costs related to preparation and
distribution of materials distributed to each Fund's Board; expenses incurred in
connection with the preparation of each Agreement and the registration statement
- 37 -
on Form N-14; SEC filing fees; legal and audit fees; portfolio transfer taxes
(if any); and any similar expenses incurred in connection with the
Reorganizations.
(7) Dividend rates on preferred shares are set in the auction process.
Prevailing interest rate, yield curve and market circumstances at the time at
which the dividend rate on preferred shares for the next dividend period are set
substantially influence the rate determined in an auction. As these factors
change over time, so too do the dividend rates set. In this regard, the dividend
rates for each Fund's preferred shares were set on different dates and therefore
do not provide a direct comparison of what these rates would be if established
on the same date.
(8) Reflects a dividend rate of 5.31% based on the actual dividends paid on
preferred shares during the period noted above.
(9) Reflects a dividend rate of 5.35% based on the actual dividends paid on
preferred shares during the period noted above.
(10) If shareholders approve a Reorganization, the Adviser would contractually
agree to waive a portion of Credit Strategies Fund's advisory fee and
administration fee for two years. If Income Shares' shareholders approve its
Reorganization, such combined waivers would be at an annual rate of 0.70% of the
sum of Income Shares' net assets attributable to common shares as of the closing
date of its Reorganization plus $30 million (representing the value of its
preferred shares that historically have been outstanding). If High Income
Portfolio's shareholders approve its Reorganization, such combined waivers would
be at an annual rate of 0.55% of the sum of High Income Portfolio's net assets
attributable to common shares as of the closing date of its Reorganization plus
$40 million (representing the value of its preferred shares that historically
have been outstanding). In each case, the amount of the waivers are intended to
offset the additional revenue Highland would receive on each Acquired Fund's
assets (including the value of its preferred shares that historically have been
outstanding) due to the difference between the advisory fee rates of each
Acquired Fund and Credit Strategies Fund and the fact that the Acquired Funds do
not pay an administration fee to Highland. The calculations for the PRO FORMA
combined numbers utilize the net assets of each Acquired Fund as of December 31,
2007. The net assets of each Acquired Fund may differ on the closing date of its
Reorganization.
II. Reorganization of only High Income Portfolio into the Acquiring Fund:
-------------------------------------------------------------------------
PRO FORMA
ACTUAL COMBINED(1)
---------------------------------------
HIGH CREDIT CREDIT
INCOME STRATEGIES STRATEGIES
PORTFOLIO FUND (HCF) FUND (HCF)
(PHY)
COMMON SHAREHOLDER TRANSACTION
EXPENSES(2)
Sales Load (as a percentage of None(3) None(3) None(3)
offering price)
Dividend Reinvestment Plan Fees None(4) None(5) None(5)
(Unaudited)
ACTUAL
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON
SHARES (ASSUMING LEVERAGE PRO FORMA
AS DESCRIBED ABOVE) COMBINED(1)
---------------------------------------------
HIGH CREDIT CREDIT STRATEGIES
INCOME STRATEGIES FUND (HCF)
PORTFOLIO FUND (HCF)
(PHY)
ANNUAL EXPENSES (as a
percentage of net assets
attributable to common shares)
Management Fee 0.89% 1.64%* 1.64%*
Interest Payments on 0.01% 2.16% 2.16%
Borrowed Funds
Other Expenses
Dividend Income From Short 0.00% 0.03% 0.03%
Positions
Other Expenses(6) 0.45% 0.23% 0.20%
- 38 -
Total Other Expenses 0.45% 0.26% 0.23%
Total Annual Expenses 1.35% 4.06% 4.03%
Dividends on Preferred Shares 1.99%(7)(8) 0.00% 0.00%
Total Annual Fund Operating 3.34% 4.06% 4.03%
Expenses and Dividends on
Preferred Shares
Minus: Expense Waivers(9) 0.00% 0.00% 0.09%
Net Annual Fund Operating 3.34% 4.06% 3.94%
Expenses and Dividends on
Preferred Shares
* Management fees are both the investment advisory and administrative services
fees paid to Highland.
(1) The PRO FORMA combined column shown assumes that High Income Portfolio was
the only Acquired Fund in the Reorganization completed. As described herein, an
unfavorable vote by one Acquired Fund will not affect the consummation of the
Reorganization by the other Acquired Fund if approved by such other Acquired
Fund's shareholders. The PRO FORMA combined column also reflects the proceeds of
the rights offering completed by the Acquiring Fund on January 28, 2008.
(2) No expense information is presented with respect to preferred shares because
holders of preferred shares do not bear any transaction or operating expenses of
any of the Funds and will not bear any transaction or operating expenses of the
combined Fund.
(3) Shares of Funds purchased on the secondary market are not subject to sales
charges but may be subject to brokerage commissions or other charges. The table
does not include an underwriting commission paid by shareholders in the initial
offering of each Fund.
(4) Each participant in the Fund's dividend reinvestment plan pays a
proportionate share of the brokerage commissions incurred with respect to open
market purchases in connection with such plan.
(5) 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 plan
account. Each participant in the Credit Strategies Fund's Dividend Reinvestment
Plan will pay a pro rata share of brokerage commissions incurred when dividend
reinvestment occurs in open-market purchases because the NAV per common share is
greater than the market value per common share.
(6) In connection with the Reorganizations, there are certain other transaction
expenses not reflected in "Other Expenses" which include, but are not limited
to: costs related to the preparation, printing and distributing of this Proxy
Statement/Prospectus to shareholders; costs related to preparation and
distribution of materials distributed to each Fund's Board; expenses incurred in
connection with the preparation of each Agreement and the registration statement
on Form N-14; SEC filing fees; legal and audit fees; portfolio transfer taxes
(if any); and any similar expenses incurred in connection with the
Reorganizations.
(7) Dividend rates on preferred shares are set in the auction process.
Prevailing interest rate, yield curve and market circumstances at the time at
which the dividend rate on preferred shares for the next dividend period are set
substantially influence the rate determined in an auction. As these factors
change over time, so too do the dividend rates set. In this regard, the dividend
rates for each Fund's preferred shares were set on different dates and therefore
do not provide a direct comparison of what these rates would be if established
on the same date.
(8) Reflects a dividend rate of 5.31% based on the actual dividends paid on
preferred shares during the period noted above.
(9) If High Income Portfolio's shareholders approve its Reorganization, the
Adviser would contractually agree to waive a portion of Credit Strategies Fund's
advisory fee and administration fee for two years so that such combined waivers
would be at an annual rate of 0.55% of the sum of High Income Portfolio's net
assets attributable to common shares as of the closing date of its
Reorganization plus $40 million (representing the value of its preferred shares
that historically have been outstanding). The amount of the waivers are intended
to offset the additional revenue Highland would receive on High Income
Portfolio's assets (including the value of its preferred shares that
historically have been outstanding) due to the difference between the advisory
fee rates of High Income Portfolio and Credit Strategies Fund and the fact that
High Income Portfolio does not pay an administration fee to Highland. The
calculations for the PRO FORMA combined numbers utilize the net assets of High
Income Portfolio as of December 31, 2007. The net assets of High Income
Portfolio may differ on the closing date of its Reorganization.
- 39 -
III. Reorganization of only Income Shares into the Acquiring Fund:
------------------------------------------------------------------
PRO FORMA
ACTUAL COMBINED(1)
---------------------------------------
INCOME CREDIT CREDIT
SHARES STRATEGIES STRATEGIES
(CNN) FUND (HCF) FUND (HCF)
COMMON SHAREHOLDER TRANSACTION
EXPENSES(2)
Sales Load (as a percentage None(3) None(3) None(3)
of offering price)
Dividend Reinvestment Plan None(4) None(5) None(5)
Fees
(Unaudited)
ACTUAL
PERCENTAGE OF NET
ASSETS ATTRIBUTABLE
TO COMMON SHARES
(ASSUMING LEVERAGE AS PRO FORMA
DESCRIBED ABOVE) COMBINED(1)
----------------------------------------
INCOME CREDIT CREDIT
SHARES STRATEGIES STRATEGIES
(CNN) FUND (HCF) FUND (HCF)
ANNUAL EXPENSES (as a
percentage of net assets
attributable to common shares)
Management Fee 0.73% 1.64%* 1.64%*
Interest Payments on 0.07% 2.16% 2.16%
Borrowed Funds
Other Expenses
Dividend Income From Short 0.00% 0.03% 0.03%
Positions
Other Expenses(6) 0.71% 0.23% 0.21%
Total Other Expenses 0.71% 0.26% 0.24%
Total Annual Expenses 1.51% 4.06% 4.04%
Dividends on Preferred Shares 2.48%(7)(8) 0.00% 0.00%
Total Annual Fund Operating 3.99% 4.06% 4.04%
Expenses and Dividends on
Preferred Shares
Minus: Expense Waivers(9) 0.00% 0.00% 0.08%
Net Annual Fund Operating 3.99% 4.06% 3.96%
Expenses and Dividends on
Preferred Shares
* Management fees are both the investment advisory and administrative services
fees paid to Highland.
(1) The PRO FORMA combined column shown assumes that Income Shares was the only
Acquired Fund in the Reorganization completed. As described herein, an
unfavorable vote by one Acquired Fund will not affect the consummation of the
Reorganization by the other Acquired Fund if approved by such other Acquired
Fund's shareholders. The PRO FORMA combined column also reflects the proceeds of
the rights offering completed by the Acquiring Fund on January 28, 2008.
(2) No expense information is presented with respect to preferred shares because
holders of preferred shares do not bear any transaction or operating expenses of
any of the Funds and will not bear any transaction or operating expenses of the
combined Fund.
(3) Shares of Funds purchased on the secondary market are not subject to sales
charges but may be subject to brokerage commissions or other charges. The table
does not include an underwriting commission paid by shareholders in the initial
offering of each Fund.
- 40 -
(4) Each participant in the Fund's dividend reinvestment plan pays a
proportionate share of the brokerage commissions incurred with respect to open
market purchases in connection with such plan.
(5) 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 plan
account. Each participant in the Credit Strategies Fund's Dividend Reinvestment
Plan will pay a pro rata share of brokerage commissions incurred when dividend
reinvestment occurs in open-market purchases because the NAV per common share is
greater than the market value per common share.
(6) In connection with the Reorganizations, there are certain other transaction
expenses not reflected in "Other Expenses" which include, but are not limited
to: costs related to the preparation, printing and distributing of this Proxy
Statement/Prospectus to shareholders; costs related to preparation and
distribution of materials distributed to each Fund's Board; expenses incurred in
connection with the preparation of each Agreement and the registration statement
on Form N-14; SEC filing fees; legal and audit fees; portfolio transfer taxes
(if any); and any similar expenses incurred in connection with the
Reorganizations.
(7) Dividend rates on preferred shares are set in the auction process.
Prevailing interest rate, yield curve and market circumstances at the time at
which the dividend rate on preferred shares for the next dividend period are set
substantially influence the rate determined in an auction. As these factors
change over time, so too do the dividend rates set. In this regard, the dividend
rates for each Fund's preferred shares were set on different dates and therefore
do not provide a direct comparison of what these rates would be if established
on the same date.
(8) Reflects a dividend rate of 5.35% based on the actual dividends paid on
preferred shares during the period noted above.
(9) If Income Shares' shareholders approve its Reorganization, the Adviser would
contractually agree to waive a portion of Credit Strategies Fund's advisory fee
and administration fee for two years so that such combined waivers would be at
an annual rate of 0.70% of the sum of Income Shares' net assets attributable to
common shares as of the closing date of its Reorganization plus $30 million
(representing the value of its preferred shares that historically have been
outstanding). The amount of the waivers are intended to offset the additional
revenue Highland would receive on Income Shares' assets (including the value of
its preferred shares that historically have been outstanding) due to the
difference between the advisory fee rates of Income Shares and Credit Strategies
Fund and the fact that Income Shares does not pay an administration fee to
Highland. The calculations for the PRO FORMA combined numbers utilize the net
assets of Income Shares as of December 31, 2007. The net assets of Income Shares
may differ on the closing date of its Reorganization.
The purpose of the tables in this section is to assist you in understanding the
various costs and expenses that a shareholder will bear directly or indirectly
by investing in a Fund's common shares and the Acquiring Fund's costs and
expenses that are expected to be incurred in the first year following the
Reorganizations.
EXAMPLE
The following example is intended to help you compare the costs of investing in
the Acquiring Fund PRO FORMA after the Reorganizations with the costs of
investing in the Acquired Funds and the Acquiring Fund without the
Reorganizations. An investor would pay the following expenses on a $1,000
investment in common shares, assuming (i) the operating expense ratio for each
Fund (as a percentage of net assets attributable to common shares) set forth in
the table above for years 1 through 10, (ii) dividends on preferred shares as
set forth in the table above (iii) average borrowings under Credit Strategies
Fund's credit facility of $253.2 million prior to the Reorganizations, (iv)
borrowings under Credit Strategies Fund's credit facility of $310.4 million
after the Reorganizations, (v) a 5% annual return throughout the period (vi) and
the contractual fee waivers noted above after the Reorganizations.
ASSUMING LEVERAGE
(Unaudited)
1 Year 3 Years 5 Years 10 Years
---------------------------------------------
High Income Portfolio (PHY) $34 $103 $174 $363
Income Shares (CNN) $40 $122 $205 $420
Credit Strategies Fund (HCF) $41 $124 $208 $426
Pro Forma Combined - Credit Strategies Fund (HCF)(1) $39 $120 $204 $423
Pro Forma Combined - Credit Strategies Fund (HCF)(2) $40 $121 $205 $423
Pro Forma Combined - Credit Strategies Fund (HCF)(3) $40 $121 $206 $424
- 41 -
(1) The PRO FORMA combined row shown assumes each of the Reorganizations is
completed. As described herein, an unfavorable vote by one Acquired Fund will
not affect the consummation of the Reorganization by the other Acquired Fund if
approved by such other Acquired Fund.
(2) The PRO FORMA combined row shown assumes that High Income Portfolio was the
only Acquired Fund in the Reorganization completed. As described herein, an
unfavorable vote by one Acquired Fund will not affect the consummation of the
Reorganization by the other Acquired Fund if approved by such other Acquired
Fund.
(3) The PRO FORMA combined row shown assumes that Income Shares was the only
Acquired Fund in the Reorganization completed. As described herein, an
unfavorable vote by one Acquired Fund will not affect the consummation of the
Reorganization by the other Acquired Fund if approved by such other Acquired
Fund.
The example set forth above assumes the reinvestment of all dividends and other
distributions at NAV. The example should not be considered a representation of
past or future expenses or annual rates of return. Actual expenses or annual
rates of return may be more or less than those assumed for purposes of the
example.
INFORMATION ABOUT THE FUNDS
OUTSTANDING SECURITIES
Set forth below is information about each Fund's common shares as of December
31, 2007.
CREDIT STRATEGIES FUND
-------------------------------------------------------------------------------------------------
TITLE OF CLASS AMOUNT AUTHORIZED AMOUNT HELD BY FUND AMOUNT OUTSTANDING
-------------------------------------------------------------------------------------------------
Common Shares Unlimited - 46,056,165*
-------------------------------------------------------------------------------------------------
* This includes shares issued by Credit Strategies Fund pursuant to a rights
offering completed on January 28, 2008. Excluding shares of the rights offering,
Credit Strategies Fund had 34,520,550 shares outstanding on December 31, 2007.
HIGH INCOME PORTFOLIO
-------------------------------------------------------------------------------------------------
TITLE OF CLASS AMOUNT AUTHORIZED AMOUNT HELD BY FUND AMOUNT OUTSTANDING
-------------------------------------------------------------------------------------------------
Common Shares 100,000,000 - 30,874,699
-------------------------------------------------------------------------------------------------
INCOME SHARES
-------------------------------------------------------------------------------------------------
TITLE OF CLASS AMOUNT AUTHORIZED AMOUNT HELD BY FUND AMOUNT OUTSTANDING
-------------------------------------------------------------------------------------------------
Common Shares 15,000,000 - 9,947,104
-------------------------------------------------------------------------------------------------
Set forth below is information about High Income Portfolio's and Income Shares'
preferred shares as of December 31, 2007.
HIGH INCOME PORTFOLIO
-------------------------------------------------------------------------------------------------
TITLE OF CLASS AMOUNT AUTHORIZED AMOUNT HELD BY FUND AMOUNT OUTSTANDING
-------------------------------------------------------------------------------------------------
Series W 1,000,000 - 1,600
-------------------------------------------------------------------------------------------------
INCOME SHARES
-------------------------------------------------------------------------------------------------
TITLE OF CLASS AMOUNT AUTHORIZED AMOUNT HELD BY FUND AMOUNT OUTSTANDING
-------------------------------------------------------------------------------------------------
Series T 1,000,000 - 1,200
-------------------------------------------------------------------------------------------------
COMMON SHARE PRICE DATA
The following table sets forth the high and low sales prices for common shares
of each Fund on the NYSE for each full quarterly period within the two most
recent fiscal years or since inception and each full quarter since the beginning
of the current fiscal year, along with the NAV and discount or premium to NAV
for each quotation.
The Funds only make public their net asset values on a weekly basis.
Accordingly, the net asset value and the premium and discount from net asset
value in the table below are based on the publicly available net asset values
- 42 -
for the week in which the high and low sales price occurred. Since the net asset
value and the premium and discount from net asset value is based on the publicly
available net asset values for the week, which may not fall on the same date as
the high and low sales prices, the range of net asset values and the premium and
discount from net asset value for the common shares during the periods shown may
be broader or more narrow than what is shown in this table.
CREDIT STRATEGIES FUND
-------------------------------------------------------------------------------------------------
QUARTERLY PERIOD HIGH PRICE NET ASSET PREMIUM LOW PRICE NET ASSET PREMIUM
ENDING VALUE (DISCOUNT) VALUE (DISCOUNT)
-------------------------------------------------------------------------------------------------
December 31, 2007 $18.80 $19.32 -2.69% $15.67 $17.99 -12.89%
-------------------------------------------------------------------------------------------------
September 30, 2007 $20.17 $20.60 -2.09% $16.25 $19.33 -15.93%
-------------------------------------------------------------------------------------------------
June 30, 2007 $21.14 $20.51 3.07% $19.80 $20.45 -3.18%
-------------------------------------------------------------------------------------------------
March 31, 2007 $21.69 $20.29 6.90% $20.37 $20.30 0.34%
-------------------------------------------------------------------------------------------------
December 31, 2006 $21.48 $19.97 7.56% $20.10 $19.36 3.82%
-------------------------------------------------------------------------------------------------
September 30, 2006 $21.30 $19.09 11.58% $19.82 $19.13 3.61%
-------------------------------------------------------------------------------------------------
June 30, 2006 $20.60 $19.07 8.02% $20.18 $19.06 5.88%
-------------------------------------------------------------------------------------------------
HIGH INCOME PORTFOLIO
-------------------------------------------------------------------------------------------------
QUARTERLY PERIOD HIGH PRICE NET ASSET PREMIUM LOW PRICE NET ASSET PREMIUM
ENDING VALUE (DISCOUNT) VALUE (DISCOUNT)
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
January 31, 2008 $3.02 $3.38 -10.65% $2.59 $2.91 -11.00%
-------------------------------------------------------------------------------------------------
October 31, 2007 $3.09 $3.48 -11.29% $2.59 $3.30 -21.52%
-------------------------------------------------------------------------------------------------
July 31, 2007 $3.35 $3.64 -7.97% $2.98 $3.43 -13.12%
-------------------------------------------------------------------------------------------------
April 30, 2007 $3.32 $3.64 -8.79% $3.09 $3.43 -9.91%
-------------------------------------------------------------------------------------------------
January 31, 2007 $3.27 $3.48 -6.03% $3.19 $3.45 -7.54%
-------------------------------------------------------------------------------------------------
October 31, 2006 $3.27 $3.40 -3.82% $3.14 $3.40 -7.65%
-------------------------------------------------------------------------------------------------
July 31, 2006 $3.37 $3.64 -7.42% $3.10 $3.51 -11.68%
-------------------------------------------------------------------------------------------------
April 30, 2006 $3.40 $3.63 -6.34% $2.97 $3.47 -14.41%
-------------------------------------------------------------------------------------------------
January 31, 2006 $3.11 $3.53 -11.90% $2.71 $3.20 -15.31%
-------------------------------------------------------------------------------------------------
INCOME SHARES
-------------------------------------------------------------------------------------------------
QUARTERLY PERIOD HIGH PRICE NET ASSET PREMIUM LOW PRICE NET ASSET PREMIUM
ENDING VALUE (DISCOUNT) VALUE (DISCOUNT)
-------------------------------------------------------------------------------------------------
December 31, 2007 $5.61 $6.27 -10.50% $5.02 $6.04 -16.95%
-------------------------------------------------------------------------------------------------
September 30, 2007 $6.10 $6.62 -7.85% $5.10 $6.22 -18.01%
-------------------------------------------------------------------------------------------------
June 30, 2007 $6.14 $6.77 -9.31% $6.03 $6.79 -11.19%
-------------------------------------------------------------------------------------------------
March 31, 2007 $6.34 $6.82 -7.04% $6.02 $6.59 -8.65%
-------------------------------------------------------------------------------------------------
December 31, 2006 $6.08 $6.70 -9.25% $5.82 $6.39 -8.92%
-------------------------------------------------------------------------------------------------
September 30, 2006 $5.96 $6.42 -7.17% $5.58 $6.32 -11.71%
-------------------------------------------------------------------------------------------------
June 30, 2006 $5.94 $6.40 -7.19% $5.57 $6.36 -12.42%
-------------------------------------------------------------------------------------------------
March 31, 2006 $5.98 $6.50 -8.00% $5.55 $6.40 -13.28%
-------------------------------------------------------------------------------------------------
As of January 31, 2008, (i) the net value per share for common shares of the
Acquiring Fund was $15.66 and the market price per share was $14.05,
representing a discount to NAV of -10.28%, (ii) the NAV per share for common
shares of High Income Portfolio was $2.90 and the market price per share was
$2.62, representing a discount to NAV of -9.66%, and (iii) the NAV per share for
common shares of Income Shares was $5.77 and the market price per share was
$5.18, representing a discount to NAV of -10.05%.
The NAV per share and market price per share of the common shares of each Fund
may fluctuate prior to the closing date of its Reorganization. Depending on
market conditions immediately prior to the closing date of a Reorganization,
Acquiring Fund Common Shares may trade at a larger or smaller discount to NAV
than an Acquired Fund's common shares. This could result in the Acquiring Fund
Common Shares having a market value that is greater or less than the market
value of an Acquired Fund's common shares on the closing date of a
Reorganization.
- 43 -
SHARE REPURCHASES
Common shares of Credit Strategies Fund have traded at a premium to NAV at
certain times and at a discount to NAV at certain times. Common shares of both
the Acquired Funds have traded at a premium to NAV at certain times and at a
discount to NAV at certain times.
Each Fund may from time to time take action to attempt to reduce or eliminate a
market value discount from NAV by repurchasing their common shares in the open
market or by tendering for their common shares at NAV.
So long as any preferred shares are outstanding, High Income Portfolio and
Income Shares may not purchase, redeem or otherwise acquire any common shares
unless (1) all accumulated dividends on the preferred shares or any other
preferred shares have been paid or set aside for payment through the date of
such purchase, redemption or other acquisition and (2) at the time of such
purchase, redemption or acquisition certain asset coverage requirements
(determined after deducting the acquisition price of the common shares) are met.
Repurchases of common shares may result in High Income Portfolio and Income
Shares being required to redeem preferred shares to satisfy asset coverage
requirements.
Subject to its investment restrictions, a Fund 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 a Fund in
anticipation of share repurchases or tenders will reduce the Fund's net income.
The Fund will comply with the Securities Exchange Act of 1934, as amended (the
"1934 Act"), the 1940 Act and the rules and regulations thereunder in connection
with any share repurchase, tender offer or borrowing that might be approved by
the Fund's Board. Any such borrowings will be subject to the limitations imposed
by the 1940 Act and the Rating Agency Guidelines.
The repurchase by a Fund of its common shares at prices below NAV will result in
an increase in the NAV of those common shares that remain outstanding. However,
there can be no assurance that common share repurchases or tender offers at or
below NAV will result in the Fund's common shares trading at a price equal to
their NAV. Nevertheless, the fact that a Fund's common shares may be the subject
of repurchase or tender offers from time to time, or that the Fund may be
converted to an open-end investment company, may reduce any spread between
market price and NAV that might otherwise exist.
In addition, a purchase by the Fund of its common shares will decrease the
Fund's total assets which would likely have the effect of increasing the Fund's
expense ratio. Any purchase by the Fund of its common shares at a time when
preferred shares are outstanding will increase the leverage applicable to the
outstanding common shares then remaining.
Before deciding whether to take any action if the common shares trade below NAV,
a Fund's Board would likely consider all relevant factors, including the extent
and duration of the discount, the liquidity of the Fund's portfolio, the impact
of any action that might be taken on the Fund or its shareholders and market
considerations. Based on these considerations, even if a Fund's shares should
trade at a discount, the Fund's Board may determine that, in the interest of the
Fund and its shareholders, no action should be taken.
DIVIDENDS AND OTHER DISTRIBUTIONS
ALL FUNDS.
Distributions on each Fund's common shares are declared based on annual
projections of net investment income (defined as dividends and interest income,
net of Fund expenses). High Income Portfolio and Credit Strategies Fund pay
monthly distributions to common shareholders. Income Shares pays quarterly
distributions to common shareholders. As a result of market conditions or
investment decisions, the amount of distributions may exceed net investment
income earned at certain times throughout the period. It is anticipated that, on
an annual basis, the amount of distributions to common shareholders will not
exceed net investment income (as defined above) allocated to common shareholders
for income tax purposes. Each Fund intends to pay any capital gain distributions
annually.
- 44 -
Various factors will affect the level of each Fund's current income and current
gains, such as its asset mix, and each Fund's use of options. To permit each
Fund to maintain more stable monthly dividends and annual distributions, each
Fund 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 each Fund for any particular period may be
more or less than the amount of income and gains actually earned by each Fund
during the applicable period. Undistributed income and gains will add to each
Fund's NAV and, correspondingly, distributions from undistributed income and
gains and from capital, if any, will be deducted from each Fund's NAV.
Shareholders will automatically have all dividends and other distributions
reinvested in common shares of each Fund issued by each Fund or purchased in the
open market in accordance with each Fund's Dividend Reinvestment Plan unless an
election is made to receive cash. Each participant in each Fund'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 Dividend Reinvestment Plan of the
Acquiring Fund are subject to a sales fee and a brokerage commission. See
"Dividend Reinvestment Plan."
HIGH INCOME PORTFOLIO AND INCOME SHARES.
So long as any preferred shares of High Income Portfolio or Income Shares are
outstanding, common shareholders of each Fund will not be entitled to receive
any dividends of or other distributions from each Fund, unless at the time of
such declaration, (1) all accrued dividends on preferred shares or accrued
interest on borrowings have been paid and (2) the value of each Fund's total
assets (determined after deducting the amount of such dividend or other
distribution), less all liabilities and indebtedness of each Fund not
represented by senior securities, is at least 300% of the aggregate amount of
such securities representing indebtedness and at least 200% of the aggregate
amount of securities representing indebtedness plus the aggregate liquidation
value of the outstanding preferred shares (expected to equal the aggregate
original purchase price of the outstanding preferred shares plus redemption
premium, if any, together with any accrued and unpaid dividends thereon, whether
or not earned or declared and on a cumulative basis). In addition to the
requirements of the 1940 Act, each Fund is required to comply with other asset
coverage requirements as a condition of each Fund obtaining a rating of the
preferred shares from a rating agency. These requirements include an asset
coverage test more stringent than under the 1940 Act.
DIVIDEND REINVESTMENT PLAN
Each Fund offers its shareholders a Dividend Reinvestment Plan (the "Plan"),
which offers the opportunity to earn compounded yields. The terms of each Plan
is set forth below.
HIGH INCOME PORTFOLIO AND INCOME SHARES. If your common shares are registered
directly with the Fund or if you hold your common shares with a brokerage firm
that participates in the Fund's Plan, unless you elect by written notice to the
Fund to receive cash distributions, all dividends, including any capital gain
distributions, on your common shares will be automatically reinvested by PFPC
Inc. (the "Plan Agent"), in additional common shares under the Plan. If you
elect to receive cash distributions, you will receive all distributions in cash
paid by check mailed directly to you by PFPC Inc., as dividend paying agent.
If you decide to participate in the Plan, the number of common shares you will
receive will be determined as follows:
(1) If the common shares are trading at or above NAV at the time of
valuation, the Fund will issue new shares of common shares at a price
equal to the greater of (i) NAV per share of common shares on that date
or (ii) 95% of the market price on that date.
(2) If common shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and will
purchase common shares in the open market, on the American Stock
Exchange or elsewhere, for the participants' accounts. It is possible
that the market price for the common shares may increase before the Plan
Agent has completed its purchases. Therefore, the average purchase price
per share of common shares paid by the Plan Agent may exceed the market
price at the time of valuation, resulting in the purchase of fewer
shares of common shares than if the dividend or distribution had been
paid in common shares issued by the Fund. The Plan Agent will use all
- 45 -
dividends and other distributions received in cash to purchase common
shares in the open market within 30 days of the valuation date except
where temporary curtailment or suspension of purchases is necessary to
comply with federal securities laws. Interest will not be paid on any
uninvested cash payments.
You may elect to opt out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 331-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you or your broker (on
your behalf) will receive (a) your whole shares in non-certificated form and (b)
a cash payment for any fraction of a share in your account. If you wish, the
Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all common shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any common shares so
held only in accordance with proxies returned to the Fund. Any proxy you receive
will include all common shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in common shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and other distributions does not mean that
you do not have income tax liability thereon. Income from distributions is
realized even if you do not receive cash. Consult your financial advisor for
more information.
If you hold your common shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Directors the change is warranted. There is no direct service
charge to participants in the Plan; however, the Fund reserves the right to
amend the Plan to include a service charge payable by the participants.
Additional information about the Plan may be obtained by writing PFPC Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809.
CREDIT STRATEGIES FUND. Unless the registered owner of common shares elects to
receive cash by contacting the Plan Agent, all dividends declared for the common
shares of Credit Strategies Fund will be automatically paid in the form of, or
reinvested by the Plan Agent (agent for shareholders in administering Credit
Strategies Fund's Plan) in, additional common shares of Credit Strategies Fund.
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 Credit Strategies
Fund 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 Credit
Strategies Fund 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 Credit Strategies Fund ("newly
issued shares") or (ii) by purchase of outstanding common shares on the open
market ("open-market purchases") on the NYSE or elsewhere.
If, on the payment date for any dividend, the market price per common share plus
estimated brokerage commissions is greater than the NAV per common share (such
condition being referred to herein as "market premium"), the Fund will issue
- 46 -
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 NAV per common share on the payment date; provided that, if the
NAV 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 NAV 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 Credit Strategies Fund 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 NAV per
common share, the average per common share purchase price paid by the Plan Agent
may exceed the NAV 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 NAV per
common share at the close of business on the last purchase date; provided that,
if the NAV 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 Credit Strategies Fund. 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.
Credit Strategies Fund reserves the right to amend or terminate the Plan. There
is no direct service charge to participants in the Plan; however, Credit
Strategies Fund 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.
- 47 -
DESCRIPTION OF CAPITAL STRUCTURE
HIGH INCOME PORTFOLIO AND INCOME SHARES
COMMON SHARES
High Income Portfolio was incorporated in Maryland on May 13, 1988. High Income
Portfolio's Articles of Incorporation, as amended and supplemented ("Charter")
authorize the issuance of up to 100,000,000 common shares, $0.03 par value per
share. Income Shares was incorporated in Maryland on March 19, 1973. Income
Shares' Charter authorizes the issuance of up to 15,000,000 common shares, $1.00
par value per share. Each Acquired Fund's common shares have equal rights as to
voting, dividends and liquidation. All common shares issued and outstanding are
fully paid and nonassessable. Shares of common shares have no preemptive,
conversion or redemption rights and are freely transferable. The voting rights
of the common shares are noncumulative, which means that the holders of more
than 50% of the common shares voting for the election of Directors can elect all
of those Directors that are subject to election by the holders of the common
shares if they choose to do so, and, in that event, the holders of the remaining
common shares voting for the election of Directors will not be able to elect any
Directors. The holders of the common shares vote as a single class with the
holders of the preferred shares on all matters except as described below under
"Voting Rights." Each Acquired Fund's Charter may generally be amended by the
affirmative vote of holders of common shares and preferred shares entitled to
cast a majority of all votes entitled to be cast on the matter.
So long as any preferred shares of an Acquired Fund are outstanding, holders of
the Acquired Fund's common shares will not be entitled to receive any dividends
of or other distributions from the Acquired Fund, unless at the time of such
declaration (1) all accrued dividends on preferred shares or accrued interest on
borrowings have been paid and (2) the value of the Acquired Fund's total assets
(determined after deducting the amount of such dividend or other distribution),
less all of its liabilities and indebtedness not represented by senior
securities, is at least 300% of the aggregate amount of such securities
representing indebtedness and at least 200% of the aggregate amount of
securities representing indebtedness plus the aggregate liquidation value of the
outstanding preferred shares (expected to equal the aggregate original purchase
price of the outstanding preferred shares plus redemption premium, if any,
together with any accrued and unpaid dividends thereon, whether or not earned or
declared and on a cumulative basis). In addition to the requirements of the 1940
Act, the Acquired Funds are required to comply with other asset coverage
requirements as a condition of each Acquired Fund obtaining a rating of the
preferred shares from a rating agency. These requirements include an asset
coverage test more stringent than that under the 1940 Act.
PREFERRED SHARES
Under the 1940 Act, each Acquired Fund is permitted to have outstanding more
than one series of preferred shares as long as neither a single series has
priority over another series nor holders of preferred shares have pre-emptive
rights to purchase any other preferred shares that might be issued. Each
Acquired Fund's Charter authorizes the issuance of a class of preferred shares
(which class may be divided into more than one series) as the Directors may,
without shareholder approval, authorize. The preferred shares has such
preferences, voting powers, terms of redemption, if any, and special or relative
rights or privileges (including conversion rights, if any) as the Directors may
determine and as are set forth in the respective Acquired Fund's Charter
establishing the terms of the preferred shares. Any decision to offer preferred
shares is subject to market conditions and to the Board of Directors' and the
Adviser's continuing belief that leveraging the respective Acquired Fund's
capital structure through the issuance of preferred shares is likely to benefit
the holders of common shares. Each Acquired Fund is authorized to issue a
maximum of 1,000,000 preferred shares. To date, High Income Portfolio's
Directors have authorized the creation of, and High Income Portfolio has issued,
3,000 Auction Rate Cumulative Preferred Shares, having a par value of $0.001 per
share, with a liquidation preference of $25,000 per share, classified as Series
W Auction Rate Cumulative Preferred Shares. As of January 31, 2007, High Income
Portfolio had redeemed 1,400 preferred shares and had a total of $40 million
preferred shares outstanding. To date, Income Shares' Directors have authorized
the creation of, and Income Shares has issued, 1,200 Auction Rate Cumulative
Preferred Shares, having a par value of $0.01 per share, with a liquidation
preference of $25,000 per share, classified as Series T Auction Rate Cumulative
Preferred Shares, all of which were outstanding as of January 31, 2007.
- 48 -
The preferred shares have complete priority over common shares as to
distribution of assets. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of either Acquired Fund,
holders of preferred shares will be entitled to receive a preferential
liquidating distribution (expected to equal the original purchase price per
share plus accumulated and unpaid dividends thereon, whether or not earned or
declared) before any distribution of assets is made to holders of common shares.
After the payment to the holders of preferred shares of the full preferential
amounts, the holders of preferred shares as such will have no right or claim to
any of the remaining assets of the relevant Acquired Fund. Neither the
consolidation nor merger of either Acquired Fund with or into any other
corporation or corporations, nor the sale, lease, exchange or transfer by either
Acquired Fund of all or substantially all of its property and assets, will be
deemed to be a liquidation, dissolution or winding up of that Acquired Fund.
VOTING RIGHTS
Except as noted below, each Acquired Fund's common shares and preferred shares
have equal voting rights of one vote per share and vote together as a single
class. In elections of Directors, the holders of preferred shares, as a separate
class, vote to elect two Directors, the holders of the common shares, as a
separate class, vote to elect two Directors and the holders of the preferred
shares and the common shares, voting together as a single class, elect the
remaining Directors. In addition, during any period ("Voting Period") in which
either Acquired Fund has not paid dividends on the preferred shares in an amount
equal to two full years' dividends, the holders of preferred shares, voting as a
single class, are entitled to elect (in addition to the two Directors set forth
above) the smallest number of additional Directors as is necessary to assure
that a majority of the Directors have been elected by the holders of preferred
shares.
In an instance when an Acquired Fund has not paid dividends as set forth in the
immediately preceding paragraph, the terms of office of all persons who are
Directors of the Acquired Fund at the time of the commencement of a Voting
Period will continue, notwithstanding the election by the holders of the
preferred shares of the number of Directors that such holders are entitled to
elect. The persons elected by the holders of the preferred shares, together with
the incumbent Directors elected by the holders of the common shares, will
constitute the duly elected Directors of the Acquired Fund. When all dividends
in arrears on the preferred shares have been paid or provided for, the terms of
office of the additional Directors elected by the holders of the preferred
shares will terminate.
The common shares and preferred shares of each Acquired Fund vote as separate
classes on amendments to the Charter that would adversely affect their
respective interests.
In addition, so long as any High Income Portfolio preferred shares are
outstanding:
(1) High Income Portfolio may not be voluntarily liquidated,
dissolved, wound up, merged or consolidated and may not sell all or
substantially all of its assets, without the approval of at least a
majority of the preferred shares, voting as a separate class;
(2) the adoption of any plan of reorganization adversely
affecting the preferred shares requires the approval of holders of a
majority of the preferred shares, voting as a separate class;
(3) High Income Portfolio may not, without the affirmative vote
of at least a majority of the preferred shares outstanding, voting as a
separate class, file a voluntary application for relief under federal
bankruptcy law or any similar application under state law for so long as
High Income Portfolio is solvent and does not foresee becoming
insolvent;
(4) the approval of a majority of the outstanding preferred
shares, voting as a separate class, is required to approve any action
requiring a vote of security holders under Section 13(a) of the 1940 Act
including, among other things, changes in High Income Portfolio's
investment objective, changes in certain investment restrictions
described under "Investment Restrictions" in the SAI and changes in High
Income Portfolio's subclassification as a closed-end investment company;
and
- 49 -
(5) the approval of a majority of the outstanding preferred
shares, voting as a separate class, is required to amend, alter or
repeal any of the authorized preferences, rights or powers of the
holders of preferred shares.
In addition, so long as any Income Shares' preferred shares are outstanding:
(1) Income Shares may not be voluntarily liquidated, dissolved,
wound up, merged or consolidated and may not sell all or substantially
all of its assets, without the approval of at least a majority of the
preferred shares, voting as a separate class;
(2) the adoption of any plan of reorganization adversely
affecting the preferred shares requires the approval of holders of a
majority of the preferred shares, voting as a separate class;
(3) Income Shares may not, without the affirmative vote of at
least a majority of the preferred shares outstanding, voting as a
separate class, file a voluntary application for relief under federal
bankruptcy law or any similar application under state law for so long as
Income Shares is solvent and does not foresee becoming insolvent; and
(4) the approval of a majority of the outstanding preferred
shares, voting as a separate class, is required to approve any action
requiring a vote of security holders under Section 13(a) of the 1940 Act
including, among other things, changes in Income Shares' investment
objectives, changes in certain investment restrictions described under
"Investment Restrictions" in the SAI and changes in Income Shares'
subclassification as a closed-end investment company.
The required vote for certain of the items listed above for each of the Acquired
Funds, such as items 1, 2 and 4, may be subject to the supermajority voting
requirements referred to under "Anti-Takeover Provisions" below, if they have
not been approved, authorized or adopted by the affirmative vote of at least 80%
of the total number of Continuing Directors. "Continuing Directors" are those
Directors who have been directors of Income Shares since May 2002 or are those
Directors who have been directors of High Income Portfolio since March 2001 or
who have subsequently become directors and whose election is approved by a
majority of the Continuing Directors then on the Board. The common shares and
preferred shares for each Acquired Fund also will vote separately to the extent
otherwise required under Maryland law or the 1940 Act, as in effect from time to
time. To the extent required under the 1940 Act, certain actions by shareholders
of each Acquired Fund require a vote of a majority of that Fund's outstanding
voting securities. If applicable, the class vote of holders of preferred shares
described above will in each case be in addition to a separate vote of the
requisite percentage of common shares and preferred shares, voting together as a
single class, necessary to authorize the action in question.
CREDIT STRATEGIES FUND
COMMON SHARES
Credit Strategies Fund is a statutory trust organized under the laws of Delaware
pursuant to an Agreement and Declaration of Trust dated as of March 10, 2006
("Declaration of Trust"). Credit Strategies Fund 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 is fully
paid and non-assessable, except that the trustees shall have the power to cause
shareholders to pay expenses of Credit Strategies Fund 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. Credit Strategies Fund 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.
Credit Strategies Fund 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. Credit Strategies Fund will send annual
- 50 -
and semi-annual reports, including financial statements, to all holders of its
shares.
While Credit Strategies Fund has filed a registration statement to permit it to
offer additional shares from time to time, such registration statement has not
been declared effective and Credit Strategies Fund has no present intention of
offering any additional shares on that registration statement. Any additional
offerings of shares will require approval by Credit Strategies Fund's Board. Any
additional offering of common shares will be subject to the requirements of the
1940 Act, which provides that shares may not be issued at a price below the then
current NAV, exclusive of sales load, except in connection with an offering to
existing holders of common shares or with the consent of a majority of Credit
Strategies Fund's common shareholders. Credit Strategies Fund currently issues
additional shares under its Dividend Reinvestment Plan and, if approved, Credit
Strategies Fund will issue additional shares pursuant to the Reorganizations.
Any additional offerings of common shares would result in current shareholders
owning a smaller proportionate interest in Credit Strategies Fund than they
owned prior to such offering to the extent that shareholders do not purchase
sufficient shares in such offering to maintain their percentage interest. Credit
Strategies Fund's net asset value would be reduced immediately following an
offering of the shares due to the costs of such offering, which will be borne
entirely by Credit Strategies Fund. The sale of shares by Credit Strategies Fund
(or the perception that such sales may occur) may have an adverse effect on
prices of shares in the secondary market. An increase in the number of shares
available may put downward pressure on the market price for shares. If Credit
Strategies Fund were unable to invest the proceeds of an additional offering of
shares as intended, Credit Strategies Fund's per share distribution may decrease
and the Trust may not participate in market advances to the same extent as if
such proceeds were fully invested as planned.
Unlike open-end funds, closed-end funds like Credit Strategies Fund 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 NYSE or
otherwise. Shares of closed-end investment companies frequently trade on an
exchange at prices lower than NAV. 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, NAV, relative demand for and supply of such
shares in the market, general market and economic conditions and other factors
beyond the control of Credit Strategies Fund, Credit Strategies Fund cannot
assure you that common shares will trade at a price equal to or higher than NAV
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."
PREFERRED SHARES
The Declaration of Trust provides that Credit Strategies Fund's Board may
authorize and issue preferred shares with rights as determined by the Board, by
action of the Board without the approval of the holders of the common shares.
Holders of common shares have no preemptive right to purchase any preferred
shares that might be issued. Whenever preferred shares are outstanding, the
holders of common shares will not be entitled to receive any distributions from
Credit Strategies Fund unless all accrued dividends on preferred shares have
been paid, unless asset coverage (as defined in the 1940 Act) with respect to
preferred shares would be at least 200% after giving effect to the distributions
and unless certain other requirements imposed by any rating agencies rating the
preferred shares have been met.
Credit Strategies Fund may issue preferred shares as part of its leverage
strategy. We cannot assure you, however, that any preferred shares will be
issued. Although the terms of any preferred shares, including dividend rate,
liquidation preference and redemption provisions, will be determined by the
Board, subject to applicable law and the Declaration of Trust, it is likely that
the preferred shares will be structured to carry a relatively short-term
dividend rate reflecting interest rates on short-term bonds, by providing for
the periodic redetermination of the dividend rate at relatively short intervals
through an auction, remarketing or other procedure. Credit Strategies Fund also
believes that it is likely that the liquidation preference, voting rights and
redemption provisions of the preferred shares will be similar to those stated
below.
- 51 -
LIQUIDATION PREFERENCE. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of Credit Strategies Fund, the holders of
preferred shares will be entitled to receive a preferential liquidating
distribution, which is expected to equal the original purchase price per
preferred share plus accrued and unpaid dividends, whether or not declared,
before any distribution of assets is made to holders of common shares. After
payment of the full amount of the liquidating distribution to which they are
entitled, the holders of preferred shares will not be entitled to any further
participation in any distribution of assets by Credit Strategies Fund.
VOTING RIGHTS. The 1940 Act requires that the holders of any preferred shares,
voting separately as a single class, have the right to elect at least two
trustees at all times. The remaining trustees will be elected by holders of
common shares and preferred shares, voting together as a single class. In
addition, subject to the prior rights, if any, of the holders of any other class
of senior securities outstanding, the holders of any preferred shares have the
right to elect a majority of the trustees of Credit Strategies Fund at any time
two years' dividends on any preferred shares are unpaid. The 1940 Act also
requires that, in addition to any approval by shareholders that might otherwise
be required, the approval of the holders of a majority of any outstanding
preferred shares, voting separately as a class, would be required to (i) adopt
any plan of reorganization that would adversely affect the preferred shares, and
(ii) take any action requiring a vote of security holders under Section 13(a) of
the 1940 Act, including, among other things, changes in Credit Strategies Fund's
subclassification as a closed-end investment company or changes in its
fundamental investment restrictions. As a result of these voting rights, Credit
Strategies Fund's ability to take any such actions may be impeded to the extent
that there are any preferred shares outstanding. The board of trustees presently
intends that, except as otherwise indicated in this prospectus and except as
otherwise required by applicable law, holders of preferred shares will have
equal voting rights with holders of common shares (one vote per share, unless
otherwise required by the 1940 Act) and will vote together with holders of
common shares as a single class.
The affirmative vote of the holders of a majority of the outstanding preferred
shares, voting as a separate class, will be required to amend, alter or repeal
any of the preferences, rights or powers of holders of preferred shares so as to
affect materially and adversely such preferences, rights or powers, or to
increase or decrease the authorized number of preferred shares. The class vote
of holders of preferred shares described above will in each case be in addition
to any other vote required to authorize the action in question.
REDEMPTION, PURCHASE AND SALE OF PREFERRED SHARES BY CREDIT STRATEGIES FUND. The
terms of the preferred shares are expected to provide that (i) they are
redeemable by Credit Strategies Fund in whole or in part at the original
purchase price per share plus accrued dividends per share, (ii) Credit
Strategies Fund may tender for or purchase preferred shares and (iii) Credit
Strategies Fund may subsequently resell any shares so tendered for or purchased.
Any redemption or purchase of preferred shares by Credit Strategies Fund will
reduce the leverage applicable to the common shares, while any resale of shares
by Credit Strategies Fund will increase that leverage.
THE DISCUSSION ABOVE DESCRIBES THE POSSIBLE OFFERING OF PREFERRED SHARES BY
CREDIT STRATEGIES FUND. If the Board determines to proceed with such an
offering, the terms of the preferred shares may be the same as, or different
from, the terms described above, subject to applicable law and the Declaration
of Trust. The board of trustees, without the approval of the holders of common
shares, may authorize an offering of preferred shares or may determine not to
authorize such an offering and may fix the terms of the preferred shares to be
offered.
OTHER SHARES
The Board (subject to applicable law and the 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.
Credit Strategies Fund currently does not expect to issue any other classes of
shares, or series of shares, except for the common shares.
CREDIT FACILITY
Credit Strategies Fund currently leverages through borrowings from a credit
facility. Credit Strategies Fund has entered into a revolving credit agreement
with The Bank of Nova Scotia ("Scotia") to borrow up to $290,000,000 (the "Loan
Agreement"). Such borrowings constitute financial leverage. The Loan Agreement
contains covenants that limit Credit Strategies Fund's ability to, without the
- 52 -
prior consent of Scotia: (i) pay dividends in certain circumstances, (ii) incur
additional debt, (iii) change its investment objectives, policies and
restrictions as set forth in Credit Strategies Fund's prospectus in effect when
the Loan Agreement became effective or (iv) adopt or carry out any plan of
liquidation, reorganization, incorporation, recapitalization, merger or
consolidation or sell, transfer or otherwise dispose of all or a substantial
part of its assets. For instance, Credit Strategies Fund agreed not to purchase
assets not contemplated by the investment policies and restrictions in effect
when the Loan Agreement became effective. Furthermore, Credit Strategies Fund
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 1940 Act. Such restrictions shall apply
only so long as the Loan Agreement remains in effect. Any senior security
representing indebtedness, as defined in Section 18(g) of the 1940 Act, must
have asset coverage of at least 300%. Debt incurred under the Loan Agreement
will be considered a senior security for this purpose.
FEDERAL INCOME TAX MATTERS
The following discussion summarizes certain federal income tax considerations
affecting the Funds and their shareholders that are "United States persons" (as
defined in the Code). For more information, please see the Statement of
Additional Information, under "Federal Income Tax Matters." Because each
shareholder's tax situation is unique, ask your tax professional about the tax
consequences to you of an investment in a Fund.
Each Fund intends to qualify annually as a regulated investment company under
the Code. Accordingly, each Fund generally will not be subject to federal income
tax on income and gains that it distributes to its shareholders.
Distributions a Fund makes from its net capital gain (I.E., the excess of net
long-term capital gain over net short-term capital loss), if any, that it
designates as capital gain dividends, are taxable as long-term capital gain,
regardless of how long you have held your common shares. All dividends a Fund
pays from its investment company taxable income (consisting generally of net
investment income, the excess, if any, of net short-term capital gain over net
long-term capital loss, and net gains and losses from certain foreign currency
transactions, if any, all determined without regard to any deduction for
dividends paid) ("ordinary income dividends") are generally subject to tax as
ordinary income.
In general, the Funds do 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 net capital gain in the case of
individual shareholders (a maximum of 15%), or that a corporate shareholder will
be able to claim a dividends-received reduction with respect to any significant
portion of Fund distributions.
Dividends and other taxable distributions are taxable to you even if they are
reinvested in additional common shares of a Fund. Dividends and other
distributions generally are treated as received by you at the time the
distribution is made. If, however, an Acquired Fund pays you a distribution in
January that was declared in the previous October, November or December to
shareholders of record on a date in one of those months, then that distribution
will be treated for tax purposes as being paid by the Fund and received by you
on December 31 of the year in which the distribution was declared.
The price of common shares purchased at any time may reflect the amount of a
forthcoming distribution. Accordingly, if you purchase common shares just before
a distribution, that distribution will be taxable to you even though it
represents in part a return of your invested capital.
Each Fund sends in shareholders information after the end of each calendar year
setting forth the amount and tax status of any distributions it made during that
year. Distributions also may be subject to state and local taxes.
If you sell or otherwise dispose of common shares, you generally will recognize
a gain or loss in an amount equal to the difference between your tax basis in
those shares and the amount you receive on the disposition. If you hold your
common shares as a capital asset, any such gain or loss generally will be
long-term capital gain or loss if you have held the shares for more than one
year at the time of sale or exchange thereof.
- 53 -
A Fund will be required to withhold, for federal backup withholding tax
purposes, 28% of the distributions (and redemption proceeds, if any) payable to
a noncorporate shareholder who fails to provide the Fund (or its agent) with the
shareholder's correct taxpayer identification number (in the case of an
individual, generally, the individual's social security number) or to make
required certifications or who has been notified by the Internal Revenue Service
("IRS") that the 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
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 FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO
YOU OF INVESTING IN A FUND.
ANTI-TAKEOVER PROVISIONS
HIGH INCOME PORTFOLIO AND INCOME SHARES
Each Acquired Fund's Charter includes certain "supermajority" voting provisions
that could have the effect of limiting the ability of other entities or persons
to acquire control of either Acquired Fund or cause either Acquired Fund to
engage in certain transactions. These provisions could have the effect of
depriving holders of common shares of an opportunity to sell their shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of either Acquired Fund. In addition, holders of a minority of
the total shares outstanding and entitled to vote may have a veto power over
matters which management and/or a majority of the shareholders may believe is
desirable and beneficial. However, by discouraging attempts to acquire control
of either Acquired Fund, these provisions may enable the relevant Acquired Fund
to avoid adverse effects of such attempts such as increasing the expenses of the
relevant Acquired Fund and interfering with the normal operation of the relevant
Acquired Fund. They also promote continuity and stability, and they enhance each
Acquired Fund's ability to continue to pursue long-term strategies that are
consistent with its investment objective.
Specifically, each Charter provides for a "supermajority" voting requirement to
effect any of the following actions: (1) any amendment to the Charter to make
the Fund's shares "redeemable securities" or to convert the Fund from a
"closed-end company" to an "open-end company" (as such terms are defined in the
1940 Act), (2) any shareholder proposal regarding the Fund's investment
objective or specific investment restrictions, policies or decisions made or to
be made with respect to the Fund's assets, (3) any shareholder proposal as to
the voluntary liquidation or dissolution of the Fund or any amendment to the
Charter to terminate the existence of the Fund, (4) business combinations such
as a merger, consolidation, share exchange or the sale of all or substantially
all of the Fund's assets, and, (5) any amendment to Article VI of the Charter of
High Income, and any amendment to article Eighth of the Charter of Income
Shares.
The Charter of each Acquired Fund requires the affirmative vote of the holders
of at least 80% of the votes then entitled to be cast by the holders of the
common shares and the preferred shares, voting as a single class, and an
affirmative vote of the holders of at least 80% of the preferred shares, voting
as a separate class, and at least 80% of the entire Board of Directors to
authorize any of the foregoing items, unless such action had been approved,
adopted or authorized by the affirmative vote of at least 80% of the total
number of Continuing Directors (as defined below), in which case (A) for items
(1) and (2) above, approval would require the affirmative vote of the lesser of
(a) 67% or more of the voting securities present or represented by proxy, if the
holders of more than 50% of outstanding voting securities are present or
represented by proxy, or (b) more than 50% of the outstanding voting securities,
and (B) for items (3) and (4) above, the affirmative vote of at least a majority
of the Fund's securities entitled to vote on the matter, subject, in the case of
both (A) and (B), to the preferred shares voting both with the common shares as
a single class and separately, as described below.
Each Acquired Fund's Board of Directors has determined that the voting
requirements described above, which are greater than the minimum requirements
under Maryland law or the 1940 Act and which can only be changed by a favorable
vote of the holders of at least 80% of the holders of the common shares and
preferred shares, voting as a single class, and a favorable vote of at least 80%
of the preferred shares, voting separately, and at least 80% of the entire Board
of Directors or a majority of the Continuing Directors, are in the best
interests of shareholders generally.
- 54 -
The Fund's by-laws currently contain other provisions permitted by Maryland law
to deter attempts to obtain control of the Fund as follows: (1) the Fund's
Secretary may call a special meeting of shareholders only on the request of the
shareholders entitled to cast at least a majority of all the votes entitled to
be cast at the meeting and only if the request states the matters proposed to be
acted upon at it and the requesting shareholders bear the costs of the Fund's
notification of each shareholder entitled to notice of the meeting, (2) the
number of Directors and the positions on the Board to be filled by vote of the
holders of particular classes of shares to, if applicable, the exclusion of
other classes of shares, shall be fixed from time to time only by resolution of
the Board of Directors adopted by a majority of the Directors then in office and
(3) the shareholders of the Fund may remove any Director only by the affirmative
vote of at least two-thirds (2/3) of all the votes entitled to be cast by the
shareholders generally in the election of such Director, and if the Directors
have been divided into classes, a Director may not be removed without cause. The
Fund has also established a classified or "staggered" Board of Directors. The
effect of this structure may make it more difficult for shareholders to change a
majority of Directors because it would take two annual meetings to replace the
majority of the Directors.
The Fund's Board of Directors may elect to submit to the Fund's shareholders at
any time a proposal to convert the Fund to an open-end investment company and in
connection therewith to redeem any outstanding preferred shares, as would be
required upon such conversion by the 1940 Act. In determining whether to
exercise its discretion to submit this issue to shareholders, the Board of
Directors would consider all factors then relevant, including the relationship
of the market price of the common shares to NAV, the extent to which the Fund's
capital structure is leveraged and the possibility of re-leveraging, the spread,
if any, between yields on high-yield securities in the Fund's portfolio as
compared to interest and dividend charges on senior securities and general
market and economic conditions. In addition to any vote required by Maryland
law, conversion of the Fund to an open-end investment company would require the
affirmative vote of the holders of a majority (as defined in the 1940 Act) of
each class of shares entitled to be voted on the matter, including the preferred
shares, voting as a separate class. 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 1940 Act) at their NAV, less
such redemption charges, if any, as might be in effect at the time of
redemption. Conversion of the Fund to an open-end investment company would
require the redemption of any outstanding preferred shares. The Board of
Directors believes, however, that the closed-end structure is desirable in light
of the Fund's investment objective and policies. Therefore, it is currently not
likely that the Board of Directors would vote to convert the Fund to an open-end
fund. The Fund's Charter requires (except under certain circumstances) the
affirmative vote of the holders of at least 80% of the votes then entitled to be
cast by shareholders and the affirmative vote of at least 80% of the preferred
shares, voting as a separate class and at least 80% of the entire Board of
Directors to authorize, among other things, any amendment to the Fund's Charter
to make the Fund's shares "redeemable securities" or to convert the Fund from a
closed-end company to an open-end company.
CREDIT STRATEGIES FUND
Credit Strategies Fund's Declaration of Trust includes provisions that could
have the effect of limiting the ability of other entities or persons to acquire
control of the Fund 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 Fund. Such attempts could have the
effect of increasing the expenses of the Fund and disrupting the normal
operation of the Fund. 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 Declaration of Trust requires the favorable vote of a majority
of the Fund'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
Fund, 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 1940 Act) of the Fund 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,
- 55 -
beneficially owns 5% or more of the outstanding shares of all outstanding
classes or series of shares of beneficial interest of the Fund.
The 5% holder transactions subject to these special approval requirements are:
the merger or consolidation of the Fund or any subsidiary of the Fund with or
into any Principal Shareholder; the issuance of any securities of the Fund 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 Fund to any Principal Shareholder, except assets having an
aggregate fair market value of less than 2% of the total assets of the Fund,
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 Fund or any subsidiary of the Fund, in
exchange for securities of the Fund, 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 Fund, 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 Fund to an open-end investment company, the 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 Fund, 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 1940 Act) of the Fund shall be required. The foregoing vote would
satisfy a separate requirement in the 1940 Act that any conversion of the Fund
to an open-end investment company be approved by the shareholders. If approved
in the foregoing manner, conversion of the Fund 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 Fund'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 NYSE 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 1940 Act, at their NAV, less
such redemption charge, if any, as might be in effect at the time of a
redemption. The Fund 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 Fund were
converted to an open-end fund, it is likely that new shares would be sold at NAV
plus a sales load. The board of trustees believes, however, that the closed-end
structure is desirable in light of the Fund's investment objectives and
policies. Therefore, you should assume that it is not likely that the board of
trustees would vote to convert the Fund to an open-end fund.
For the purposes of calculating "a majority of the outstanding voting
securities" under the Declaration of Trust, each class and series of the Fund
shall vote together as a single class, except to the extent required by the 1940
Act or the 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 Fund 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 1940 Act, are in the best interest of shareholders generally. Reference
should be made to the Declaration of Trust, on file with the SEC for the full
text of these provisions.
- 56 -
PAST PERFORMANCE OF EACH FUND
As shown in the table below, the performance of Credit Strategies Fund on a net
asset value basis has exceeded that of Income Shares for the one-year period
ended December 31, 2007. However, there is no guarantee or assurance as to the
future performance of Credit Strategies Fund. Each Fund's performance at market
price may differ from its results at NAV. Although market price performance
generally reflects investment results, it may also be influenced by several
factors, including changes in investor perceptions of each Fund or its
investment adviser, market conditions, fluctuations in supply and demand for
each Fund's shares and changes in each Fund's distributions.
TOTAL RETURNS AS OF DECEMBER 31, 2007
------------------------------------------------------------------
HIGH INCOME INCOME SHARES** CREDIT
PORTFOLIO* STRATEGIES FUND
------------------------------------------------------------------
NAV Market NAV Market NAV Market
Price Price Price
------------------------------------------------------------------
1 year -1.51% -6.58% -4.26% -10.10% -0.35% -17.05%
------------------------------------------------------------------
3 years 2.63% -0.21% 2.28% 0.85% N/A N/A
------------------------------------------------------------------
5 years 20.05% 15.51% 8.13% 7.31% N/A N/A
------------------------------------------------------------------
10 years 1.13% -0.13% 3.19% 1.04% N/A N/A
------------------------------------------------------------------
* Prior to January 21, 2000, High Income Portfolio was managed by a different
investment adviser.
** Prior to July 31, 2001, Income Shares was managed by a different investment
adviser.
- 57 -
FINANCIAL HIGHLIGHTS
HIGH INCOME PORTFOLIO
--------------------------------------------------------------------------------------------------------
For the Year Ended October 31, 2007 2006 2005 2004 2003
(audited) (audited) (audited) (audited) (audited)
--------------------------------------------------------------------------------------------------------
NAV, beginning of period $3.39 $3.25 $3.08 $2.61 $1.77
Net investment income(a) $0.37 $0.35 $0.36 $0.35 $0.37
Net realized and unrealized gain/(loss) on
investments(a) -(b) $0.11 $0.14 $0.47 $0.81
Distributions to preferred stockholders $(0.07) $(0.06) $(0.04) $(0.02) $(0.02)
Total from investment operations $0.30 $0.40 $0.46 $0.80 $1.16
--------------------------------------------------------------------------------------------------------
Distributions:
Distributions from accumulated net investment
income to common shareholders $(0.28) $(0.26) $(0.29) $(0.33) $(0.32)
Total distributions to common shareholders $(0.28) $(0.26) $(0.29) $(0.33) $(0.32)
--------------------------------------------------------------------------------------------------------
NAV, end of year $3.41 $3.39 $3.25 $3.08 $2.61
Market price per share, end of year $3.01 $3.23 $2.77 $3.24 $2.96
--------------------------------------------------------------------------------------------------------
Total investment return based on market
value(c) 1.63% 26.86% (6.90)% 21.61% 66.45%
--------------------------------------------------------------------------------------------------------
Net Assets - end of year(d) 105,411 104,535 100,443 93,894 74,113
Preferred shares outstanding, end of year(d) 40,000 40,000 40,000 40,000 40,000
Asset Coverage:
Per indebtedness N/A N/A N/A N/A N/A
Per preferred share(e) 382% 372% 351% 334% 285%
--------------------------------------------------------------------------------------------------------
Ratio of total expenses to average net
assets, applicable to common stock(f) 1.35%(g) 1.67% 1.85% 2.18% 4.07%
Ratio of net investment income to average net
assets, applicable to common stock(f) 10.80% 10.15% 10.08% 11.88% 16.60%
--------------------------------------------------------------------------------------------------------
Portfolio turnover 216.17% 150.28% 72.84% 81.25% 111.35%
--------------------------------------------------------------------------------------------------------
(a) Calculation is based on average shares outstanding during the indicated
period due to the per share effect of the Fund's rights offerings.
(b) Represents less than $0.005 per share.
(c) Total investment return based on market value may result in substantially
different returns than investment return based on net asset value, because
market value can be significantly greater or less than the net asset value.
Total investment return calculation assumes reinvestment of dividends, and does
not contemplate any over-distribution.
(d) Dollars in thousands
(e) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the principal amount of the debt outstanding and aggregate liquidation
preference of the outstanding shares of Series W Auction Rate Cumulative
Preferred Shares.
(f) Ratios do not reflect the effect of dividend payments to preferred
stockholders.
(g) Ratio of total expenses to average net assets include interest expense of
0.01% for the year ended October 31, 2007.
- 58 -
--------------------------------------------------------------------------------------------------------
For the Year Ended October 31, 2002(b) 2001(b) 2000(b)(i) 1999(b)(i) 1998(b)(i)
(unaudited)(unaudited)(unaudited) (unaudited)(unaudited)
--------------------------------------------------------------------------------------------------------
NAV, beginning of period $3.12 $5.30 $6.98 $7.97 $11.94
Net investment income(a) $0.46 $0.74 $1.12 $1.08 $1.30
Net realized and unrealized gain/(loss) on
investments(a) $(0.95) $(1.96) $(1.77) $(1.00) $(3.76)
Distributions to preferred stockholders $(0.05) $(0.07) - - $(0.03)
Total from investment operations $(0.54) $(1.29) $(0.65) $0.08 $(2.49)
--------------------------------------------------------------------------------------------------------
Distributions:
Distributions from accumulated net investment
income $(0.42) $(0.76) $(1.03) $(1.26) $(1.26)
Distributions from return of capital(c) $(0.39) $(0.14) - - -
Total distributions to common shareholders $(0.81) $(0.90) $(1.03) $(1.26) $(1.26)
--------------------------------------------------------------------------------------------------------
Effect of sale of common stock and related - $0.01 - $0.19 $(0.22)
expenses from rights offering
NAV, end of year $1.77 $3.12 $5.30 $6.98 $7.97
Market price per share, end of year $2.02 $4.24 $5.69 $7.94 $10.25
--------------------------------------------------------------------------------------------------------
Total investment return based on market
value(d) (42.19)% (9.82)% (8.31)% (11.78)% (7.63)%
--------------------------------------------------------------------------------------------------------
Net Assets - end of year(e) 49,182 86,048 142,924 186,167 157,800
Preferred shares outstanding, end of year(e) 40,000 40,000 - - -
Indebtedness, end of year(e) - - 71,000 50,000 40,000
Asset Coverage:
Per indebtedness(f) N/A N/A 330% 472% 495%
Per preferred stock share(g) 187% 215% N/A N/A N/A
--------------------------------------------------------------------------------------------------------
Ratio of total expenses to average net
assets, applicable to common stock(h) 3.22% 3.75% 4.46% 2.67% 2.67%
Ratio of net investment income to average net
assets, applicable to common stock(h) 15.99% 20.06% 17.59% 13.72% 11.92%
--------------------------------------------------------------------------------------------------------
Portfolio turnover 96.89% 73.63% 104.99% 126.45% 156.48%
--------------------------------------------------------------------------------------------------------
(a) Calculation is based on average shares outstanding during the indicated
period due to the per share effect of the Fund's rights offerings.
(b) Presentation of distributions paid to preferred shareholders has been
changed from prior financial reports filed by the Fund due to the
reclassification from total distributions to total from investment operations
presented above.
(c) Taxes are calculated on a calendar year, whereas this data is calculated on
a fiscal year ended 10/31.
(d) Total investment return based on market value may result in substantially
different returns than investment return based on net asset value, because
market value can be significantly greater or less than the net asset value.
Total investment return calculation assumes reinvestment of dividends, and does
not contemplate any over-distribution.
(e) Dollars in thousands
(f) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the principal amount of the debt outstanding.
(g) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the principal amount of the debt outstanding and aggregate liquidation
preference of the outstanding shares of Series W Auction Rate Cumulative
Preferred Shares.
(h) Ratios do not reflect the effect of dividend payments to preferred
stockholders.
(i) As of January 21, 2000, the Fund entered into a new advisory agreement with
Highland. For periods prior to that date, the Fund was advised by a different
investment adviser.
- 59 -
INCOME SHARES
--------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2007 2006 2005 2004 2003
(audited) (audited) (audited) (audited) (audited)
--------------------------------------------------------------------------------------------------------
NAV, beginning of period $6.59 $6.40 $6.75 $6.49 $5.90
Net investment income(a) $0.66 $0.63 $0.58 $0.59 $0.60
Net realized and unrealized gain/(loss) on
investments $(0.78) $0.16 $(0.37) $0.29 $0.65
Distributions to preferred shareholders $(0.16) $(0.15) $(0.10) $(0.05) $(0.04)
Total from investment operations $(0.28) $0.64 $0.11 $0.83 $1.21
--------------------------------------------------------------------------------------------------------
Distributions:
Distributions from accumulated net investment
income to common shareholders $(0.45) $(0.45) $(0.46) $(0.55) $(0.62)
Distributions from tax return of capital to
common shareholders - - - $(0.02) -
Total distributions $(0.45) $(0.45) $(0.46) $(0.57) $(0.62)
--------------------------------------------------------------------------------------------------------
NAV, end of year $5.86 $6.59 $6.40 $6.75 $6.49
Market price per share, end of year $5.05 $6.08 $5.45 $6.21 $6.33
--------------------------------------------------------------------------------------------------------
Total investment return based on market (10.27%) 20.23% (5.28)% 7.63% 27.52%
value(b)
--------------------------------------------------------------------------------------------------------
Net Assets - end of year(c) $58,301 $65,552 $63,689 $66,183 $63,529
Preferred shares outstanding, end of year(c) $30,000 $30,000 $30,000 $30,000 $30,000
Asset Coverage:
Per indebtedness(d) N/A N/A N/A N/A N/A
Per preferred stock share(e) 294% 319% 312% 321% 312%
--------------------------------------------------------------------------------------------------------
Ratio of total expenses to average net
assets, applicable to common stock excluding
interest expense(f) 1.44% 1.52% 1.40% 1.36% 1.55%
Ratio of total expenses to average net
assets, applicable to common stock including
interest expense(f) 1.51% 1.52% 1.40% 1.36% 1.55%
Ratio of net investment income to average net
assets, applicable to common stock(f) 10.08% 9.81% 8.79% 9.06% 9.73%
--------------------------------------------------------------------------------------------------------
Portfolio turnover rate 222.25% 146.23% 60.23% 41.32% 51.87%
--------------------------------------------------------------------------------------------------------
(a) Per share net investment income or loss is calculated by dividing net
investment income by the average number of shares outstanding during the year.
(b) Total investment return based on market value may result in substantially
different returns than investment return based on net asset value, because
market value can be significantly greater or less than the net asset value.
Total investment return assumes reinvestment of dividends.
(c) Dollars in thousands.
(d) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the principal amount of the debt outstanding.
(e) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the liquidation preference of the outstanding shares of Series T
preferred stock.
(f) Ratios do not reflect the effect of dividend payments to preferred
shareholders.
- 60 -
--------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2002 2001(b) 2000(b) 1999(b) 1998(b)
(unaudited)(unaudited)(unaudited) (unaudited)(unaudited)
--------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------
NAV, beginning of period $6.77 $7.21 $8.49 $9.70 $10.75
Net investment income(a) $0.75 $0.80 $0.90 $0.96 $0.97
Net realized and unrealized gain/(loss) on
investments $(0.74) $(0.55) $(1.28) $(1.21) $(1.06)
Distributions to preferred shareholders $(0.05) $(0.04) - - -
Total from investment operations $(0.04) $0.21 $(0.38) $(0.25) $(0.09)
--------------------------------------------------------------------------------------------------------
Distributions:
Distributions from accumulated net investment
income to common shareholders $(0.83) $(0.60) $(0.90) $(0.96) $(0.96)
Total distributions $(0.83) $(0.60) $(0.90) $(0.96) $(0.96)
--------------------------------------------------------------------------------------------------------
Effect of related preferred shares offering
cost - $(0.05) - - -
NAV, end of year $5.90 $6.77 $7.21 $8.49 $9.70
Market price per share, end of year $5.45 $6.44 $6.81 $7.13 $10.19
--------------------------------------------------------------------------------------------------------
Total Investment Return(c):
Based on market price per share (2.48)% 3.34% 8.25% (20.63)% (7.10)%
Based on net asset value per share (0.59)% 2.27% (4.48)% (2.58)% (0.84)%
--------------------------------------------------------------------------------------------------------
Net Assets - end of year(e) 57,160 63,846 66,959 77,968 87,286
Preferred shares outstanding, end of year(e) $30,000 $30,000 $0 $0 $0
Credit facility indebtedness, end of year(e) $0 $0 $30,000 $30,000 $30,000
Asset Coverage:
Per indebtedness(f) N/A N/A 323% 360% 391%
Per preferred stock share(g) 291% 313% N/A N/A N/A
--------------------------------------------------------------------------------------------------------
Ratio of operating expenses to average net
assets, applicable to common stock 1.63% 1.29% 1.03% 0.97% 0.95%
Ratio of total expenses to average net
assets, applicable to common stock(d) 1.63% 3.06% 4.03% 3.66% 3.53%
Ratio of net investment income to average net
assets, applicable to common stock(d) 11.93% 11.31% 11.38% 10.45% 9.92%
--------------------------------------------------------------------------------------------------------
Portfolio turnover 26.71% 35.77% 33.04% 36.16% 26.74%
--------------------------------------------------------------------------------------------------------
(a) Per share net investment income or loss is calculated by dividing net
investment income by the average number of shares outstanding during the year.
(b) As of July 30, 2001, the Fund entered into a new advisory agreement with
Highland Capital Management, L.P. For periods prior to that date, a different
investment adviser advised the Fund.
(c) Total investment return based on market value may result in substantially
different returns than investment return based on net asset value, because
market value can be significantly greater or less than the net asset value.
Investment return assumes reinvestment of dividends.
(d) For the year ended December 31, 2001 and prior, this ratio included interest
paid on the Bank Credit Facility. In 2001 the Bank Credit Facility was replaced
with preferred stock. Dividends paid on the preferred stock are classified as a
financing activity, and are not included in this ratio.
(e) Dollars in thousands.
(f) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the principal amount of the debt outstanding.
(g) Calculated by subtracting the Fund's total liabilities (not including bank
loans and senior securities) from the Fund's total assets and dividing such
amount by the liquidation preference of the outstanding shares of Series T
preferred stock.
- 61 -
CREDIT STRATEGIES FUND
-------------------------------------------------------------------------------------------------------
For the year For the
ended period ended
12/31/2007 12/31/2006(a)
(audited) (audited)
-------------------------------------------------------------------------------------------------------
NAV, beginning of period $20.08 $19.06
-------------------------------------------------------------------------------------------------------
Income from Investment Operations:
Net investment income $1.71 $0.71
Net realized and unrealized gain/(loss) on investments $(1.85) $0.91
Total from investment operations $(0.14) $1.62
-------------------------------------------------------------------------------------------------------
Less Distributions Declared to Common Shareholders:
From net investment income $(1.65) $(0.60)
From net realized gains $(0.30) -
Total distributions declared to common shareholders $(1.95) $(0.60)
-------------------------------------------------------------------------------------------------------
NAV, end of period $17.99 $20.08
Market Value, end of period $15.82 $21.16
Market Value Total Return(c) (17.05)% 9.06%(b)
-------------------------------------------------------------------------------------------------------
Ratios and Supplemental Data:
Net Assets - end of period (in 000s) 621,078 692,964
-------------------------------------------------------------------------------------------------------
Common Share Information at End of Period:
Ratios based on average net assets of common shares:
Net operating expenses 1.87% 1.53%
Interest expenses 2.16% 1.03%
Dividend income from short positions 0.03% N/A
Net expenses 4.06% 2.56%
Net investment income 8.64% 7.37%
Ratios based on managed net assets of common shares:
Net operating expenses 1.36% 1.31%
Interest expenses 1.58% 0.89%
Dividend income from short positions 0.02% N/A
Net expenses 2.96% 2.20%
Net investment income 6.31% 6.33%
-------------------------------------------------------------------------------------------------------
Portfolio turnover rate 66.49% 45.95%(b)
-------------------------------------------------------------------------------------------------------
(a) The Fund commenced investment operations on June 29, 2006.
(b) Not annualized.
(c) 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 Fund's Dividend reinvestment plan
FURTHER INFORMATION ON THE REORGANIZATIONS
FEDERAL INCOME TAX CONSEQUENCES OF THE REORGANIZATIONS
Each Reorganization is intended to be a tax-free reorganization for federal
income tax purposes. As a condition to consummation of each Reorganization,
Kirkpatrick & Lockhart Preston Gates Ellis LLP ("Tax Counsel") will deliver an
opinion ("Tax Opinion") to the Acquired Fund participating therein and to the
Acquiring Fund, dated as of that Reorganization's closing date, substantially to
the effect that, based on the facts and assumptions stated therein (as well as
certain representations of each Fund) and the existing federal income tax law,
and conditioned on that Reorganization's being consummated in accordance with
the applicable Agreement, for federal income tax purposes, with respect to that
Reorganization and the Funds participating therein:
- 62 -
o The Reorganization will qualify as a "reorganization" (as defined in
section 368(a)(1) of the Code, and each Fund will be a "party to a
reorganization" (within the meaning of section 368(b) of the Code);
o Neither Fund will recognize any gain or loss on the Reorganization;
o The Acquiring Fund's tax basis in each asset the Acquired Fund
transfers to it will be the same as the Acquired Fund's tax basis
therein immediately before the Reorganization, and the Acquiring
Fund's holding period for each such asset will include the Acquired
Fund's holding period therefor (except where the Acquiring Fund's
investment activities have the effect of reducing or eliminating an
asset's holding period);
o The Acquired Fund's shareholders will not recognize any gain or loss
on the receipt of Acquiring Fund Common Shares pursuant to the
Reorganization, except to the extent such shareholders are paid cash
in lieu of fractional shares of Acquiring Fund Common Shares in the
Reorganization; and
o The tax basis in the Acquiring Fund Common Shares that an Acquired
Fund shareholder receives pursuant to the Reorganization will be the
same as the aggregate tax basis in the Acquired Fund common shares the
shareholder holds immediately before the Reorganization, and the
shareholder's holding period for those Acquiring Fund Common Shares
will include the holding period for that Acquired Fund common shares
(provided the shareholder holds those shares as a capital asset at the
closing date of the Reorganization).
Notwithstanding the second and third bullet points above, the Tax Opinion may
state that no opinion is expressed as to the effect of a Reorganization on the
Funds or the Acquired Fund's shareholders with respect to any transferred asset
as to which any unrealized gain or loss is required to be recognized for federal
income tax purposes at the end of a taxable year (or on the termination or
transfer thereof) under a mark-to-market system of accounting.
The Tax Opinion is not binding on the IRS or the courts and is not a guarantee
that the tax consequences of the Reorganizations will be as described above.
Prior to the closing of a Reorganization, the Acquired Fund participating
therein will distribute to its shareholders all of its investment company
taxable income and net realized capital gain (after reduction by any available
capital loss carryforwards), if any, that have not previously been distributed
to them.
The Acquiring Fund's ability to use pre-Reorganization capital losses of each
Acquired Fund to offset post-Reorganization capital gains of the combined Fund
will be limited due to the application of loss limitation rules under the
federal tax law. Those rules, as applied to the Funds, generally
(1) permit each Fund, as a regulated investment company, to use CLCs
(that is, capital losses sustained in a taxable year) in each of the
eight succeeding taxable years,
(2) permit the Acquiring Fund to succeed to each Acquired Fund's CLCs,
(3) prevent the Acquiring Fund, as a "gain corporation" (I.E., a
corporation the fair market value of the assets of which on the closing
date of the Reorganizations exceeds its adjusted basis therein on that
date by more than $10 million ("net unrealized built-in gain")), from
offsetting any amount of either Acquired Fund's CLCs against any part of
the net unrealized built-in gain the Acquiring Fund recognizes during
the five-year period beginning on that date, and
(4) limit the Acquiring Fund's use of an Acquired Fund's CLCs that are
not prevented by clause (3) to (a) an annual amount equal to the product
of the Acquired Fund's value at the time of the Reorganization
multiplied by a specified rate that varies each month (currently
[4.34]%).
At the date hereof, Income Shares had CLCs from prior taxable years aggregating
almost $28.8 million, most of which will expire, in the absence of its
Reorganization, by the end of its 2009 taxable year; based on Income Shares'
(unaudited) net asset value of approximately $57.4 million at January 31, 2008,
the Acquiring Fund would only be able to use less than $2.5 million of those
- 63 -
CLCs each year pursuant to clause (4) above, and only against recognized gains
attributable to appreciation after the Reorganizations, with the result that a
large part of those CLCs will expire unused. Similarly, at the date hereof, High
Income Portfolio had CLCs from prior taxable years aggregating almost $133.5
million, a majority of which will expire, in the absence of its Reorganization,
by the end of its 2009 taxable year; based on High Income Portfolio's
(unaudited) value of approximately $89.5 million at January 31, 2008, the
Acquiring Fund would be able to use only about $3.9 million of High Income
Portfolio's CLCs each year pursuant to clause (4) above, and only against
recognized gains attributable to appreciation after the Reorganizations, with
the result that a very large part of those CLCs also will expire unused. But if
the Acquiring Fund recognizes sufficient gains attributable to
post-Reorganization appreciation, it nevertheless would be able to use
approximately [$34] million of the Acquired Funds' combined CLCs through its
taxable year ending December 31, [2013]. As a consequence, if the Acquiring Fund
recognizes significant net capital gains in the future, it can be expected that
an Acquired Fund's shareholders would receive taxable distributions from the
Acquiring Fund earlier than they would have received from that Acquired Fund if
its Reorganization had not occurred and it had generated comparable gains.
ADDITIONAL TERMS OF THE AGREEMENTS AND PLANS OF REORGANIZATION
Certain terms of each Agreement are described above. The following is a summary
of certain additional terms of each Agreement. This summary and any other
description of the terms of each Agreement contained in this Proxy
Statement/Prospectus are qualified in their entirety by Appendix A hereto, which
is the form of each Agreement.
SURRENDER OF SHARE CERTIFICATES. If your shares are represented by one or more
share certificates before the closing date of the applicable Reorganization, you
must either surrender the certificate to your Fund(s) or deliver to your Fund(s)
a lost certificate affidavit, in the form of and accompanied by the surety bonds
that your Fund(s) may require (collectively, an "Affidavit"). On the closing
date of a Reorganization, all share certificates of the participating Acquired
Fund that have not been surrendered will be canceled, will no longer evidence
ownership of that Fund's shares and will evidence ownership of the Acquiring
Fund's Common Shares. Until such share certificates have been so surrendered, no
dividends payable after a Reorganization to the holders of record as of the
closing date of Acquired Fund common shares represented by these certificates
will be reinvested pursuant to the Acquiring Fund's Dividend Reinvestment Plan,
but will instead be paid in cash. Once such certificates have been surrendered,
a holder of shares of an Acquired Fund who currently elects to receive dividends
in cash will continue to receive dividends from the Acquiring Fund in cash; all
holders who currently elect to participate in the Dividend Reinvestment Plan of
a Fund will have their dividends automatically reinvested in shares of the
Acquiring Fund. Shareholders may not redeem or transfer Acquiring Fund shares
received in the Reorganization until they have surrendered their Fund share
certificates or delivered an Affidavit. The Acquiring Fund will not issue share
certificates in the Reorganizations. Upon consummation of each Reorganization,
holders of Acquired Fund common shares will be entitled to receive cash in lieu
of any fractional Acquiring Fund Common Shares held other than in a Dividend
Reinvestment Plan Account.
CONDITIONS TO CLOSING A REORGANIZATION. The obligation of each Fund to
consummate its Reorganization is subject to the satisfaction of certain
conditions, including the performance by the other participating Fund of all of
its obligations under the Agreement and the receipt of all consents, orders and
permits necessary to consummate the Reorganization.
The obligations of the Funds that are parties to an Agreement are subject to
approval of that Agreement by the necessary vote of the outstanding shares of
the participating Acquired Fund, in accordance with the provisions of that
Acquired Fund's Charter and By-Laws. Those Funds' obligations are also subject
to the receipt of a favorable opinion of Tax Counsel as to the federal income
tax consequences of their Reorganization.
TERMINATION OF AN AGREEMENT. The Boards of the Funds that are parties to an
Agreement may terminate the Agreement by mutual consent (even if shareholders of
the applicable Acquired Fund have already approved it) at any time before the
closing date of the Reorganization, if the Boards believe that proceeding with
that Reorganization would no longer be advisable.
EXPENSES OF A REORGANIZATION. The costs associated with the Reorganizations will
be borne by each of the Acquired Funds and the Acquiring Fund in proportion to
their respective net assets determined at the close of regular trading on the
- 64 -
NYSE on the date of the Reorganizations' closing, provided that if they close at
different times, that determination will be made as of the date that the first
Reorganization closes. Neither the Funds nor the Adviser will pay any expenses
of shareholders arising out of or in connection with the Reorganizations.
PAYMENT OF UNDISTRIBUTED INCOME IN ADVANCE OF REORGANIZATIONS
Each Acquired Fund generally retains an amount of earned net income that is not
distributed in regular dividend payments in order to provide a reserve to
regularize dividend payments over time. Each Acquired Fund intends to declare
and pay a special dividend on its common shares in advance of the Reorganization
of that Fund, distributing such reserved income. The record date for such
special dividends will be a date following the approval of the Reorganization.
If a Reorganization is not approved, no such special dividend will be declared
or paid for the Acquired Fund for which the Reorganization has not been
approved.
CAPITALIZATION
With respect to each Proposal, the following tables set forth the capitalization
of each Fund as of December 31, 2007, and the PRO FORMA combined capitalization
of the Acquiring Fund as if all proposed Reorganizations had occurred on that
date, as well as the PRO FORMA combined capitalization of the Acquiring Fund as
if each Reorganization had occurred on that date absent any of the other
Reorganizations. The tables also assume the outstanding preferred shares of each
Acquired Fund were redeemed prior its respective Reorganization and reflect the
proceeds received from the Acquiring Fund's rights offering completed on January
28, 2008. The tables should not be relied upon to determine the amount of
Acquiring Fund shares that will actually be received and distributed.
IF THE REORGANIZATION OF YOUR FUND(S) HAD TAKEN PLACE ON DECEMBER 31, 2007:
--------------------------------------------------------------------------------------------------
(Unaudited) ACTUAL ADJUSTMENT PRO
FORMA
COMBINED
--------------------------------------------------------------------------------------------------
High Income Credit Credit
Income Shares Strategies Strategies
Portfolio Fund Fund
--------------------------------------------------------------------------------------------------
SHARES OUTSTANDING
--------------------------------------------------------------------------------------------------
Common shares 30,874,699 9,947,104 34,520,550 11,535,615* 55,374,655
--------------------------------------------------------------------------------------------------
Preferred shares 1,600 1,200 - (2,800) -
--------------------------------------------------------------------------------------------------
NET ASSETS
--------------------------------------------------------------------------------------------------
Common shares 96,357,317 58,300,946 621,078,161 143,001,508** 918,737,932
--------------------------------------------------------------------------------------------------
Preferred shares and accrued 40,000,000 30,000,000 - (70,000,000) -
dividends
--------------------------------------------------------------------------------------------------
NET ASSETS INCLUDING PREFERRED 136,357,317 88,300,946 621,078,161 73,001,508 918,737,932
SHARES
--------------------------------------------------------------------------------------------------
NET ASSET VALUE PER COMMON SHARE 3.12 5.86 17.99 16.59
--------------------------------------------------------------------------------------------------
* Shares issued by Credit Strategies Fund pursuant to a rights offering
completed on January 28, 2008.
** Reflects the proceeds received from the rights offering completed on January
28, 2008 reduced by the estimated Reorganization expenses of $561,950.
IF THE REORGANIZATION OF YOUR FUND(S) HAD TAKEN PLACE ON DECEMBER 31, 2007:
--------------------------------------------------------------------------------------------------
(Unaudited) ACTUAL ADJUSTMENT PRO
FORMA
COMBINED
--------------------------------------------------------------------------------------------------
High Income Credit Strategies Credit
Portfolio Fund Strategies
Fund
--------------------------------------------------------------------------------------------------
SHARES OUTSTANDING
--------------------------------------------------------------------------------------------------
Common shares 30,874,699 34,520,550 11,535,615* 51,860,469
--------------------------------------------------------------------------------------------------
Preferred shares (Series W) 1,600 - (1,600) -
--------------------------------------------------------------------------------------------------
NET ASSETS
--------------------------------------------------------------------------------------------------
Common shares 96,357,317 621,078,161 143,001,508** 860,436,986
--------------------------------------------------------------------------------------------------
Preferred shares and accrued 40,000,000 - (40,000,000) -
dividends
--------------------------------------------------------------------------------------------------
NET ASSETS INCLUDING PREFERRED 136,357,317 621,078,161 103,001,508 860,436,986
SHARES
--------------------------------------------------------------------------------------------------
NET ASSET VALUE PER COMMON SHARE 3.12 17.99 16.59
--------------------------------------------------------------------------------------------------
- 65 -
* Shares issued by Credit Strategies Fund pursuant to a rights offering
completed on January 28, 2008.
** Reflects the proceeds received from the rights offering completed on January
28, 2008 reduced by the estimated Reorganization expenses of $561,950.
IF THE REORGANIZATION OF YOUR FUND(S) HAD TAKEN PLACE ON DECEMBER 31, 2007:
--------------------------------------------------------------------------------------------------
(Unaudited)
ACTUAL ADJUSTMENT PRO
FORMA
COMBINED
--------------------------------------------------------------------------------------------------
Income Credit Strategies Credit
Shares Fund Strategies
Fund
--------------------------------------------------------------------------------------------------
SHARES OUTSTANDING
--------------------------------------------------------------------------------------------------
Common Shares 9,947,104 34,520,550 11,535,615* 46,056,165
--------------------------------------------------------------------------------------------------
Preferred Shares (Series T) 1,200 - (1,200) -
--------------------------------------------------------------------------------------------------
NET ASSETS
--------------------------------------------------------------------------------------------------
Common shares 58,300,946 621,078,161 143,001,508** 822,380,615
--------------------------------------------------------------------------------------------------
Preferred Shares and accrued 30,000,000 - (30,000,000) -
dividends
--------------------------------------------------------------------------------------------------
NET ASSETS INCLUDING PREFERRED 88,300,946 621,078,161 113,001,508 822,380,615
SHARES
--------------------------------------------------------------------------------------------------
NET ASSET VALUE PER COMMON SHARE 5.86 17.99 16.59
--------------------------------------------------------------------------------------------------
* Shares issued by Credit Strategies Fund pursuant to a rights offering
completed on January 28, 2008.
** Reflects the proceeds received from the rights offering completed on January
28, 2008 reduced by the estimated Reorganization expenses of $561,950.
MANAGEMENT OF THE FUNDS
TRUSTEES/DIRECTORS AND OFFICERS
The Directors of each Acquired Fund are the same individuals as the Trustees of
the Acquiring Fund. Each Fund's Board provides broad supervision over the
affairs of each Fund. The officers of each Fund are responsible for the Fund's
operations. The Trustees/Directors and officers of the Funds, together with
their principal occupations during the past five years, are listed in the
Statement of Additional Information. Each of the Trustees/Directors serves as a
Trustee/Director for other closed-end investment companies for which the Adviser
serves as investment adviser.
INVESTMENT ADVISER
Highland acts as each Fund's investment adviser. Highland is located at Two
Galleria Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. As of December
31, 2007, the Adviser managed approximately $37.4 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., of which Mr. Dondero is the sole stockholder. Messrs.
Dondero and Okada have managed portfolios together since 1990.
Since each Fund employs leverage, the Adviser benefits because each Fund's
assets subject to an advisory fee increase with leverage. Furthermore, the
Adviser also benefits to the extent that each Fund's assets subject to an
advisory fee are derived from the reinvested collateral received on portfolio
securities loaned.
The 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 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
Adviser furnishes advisory services to numerous clients in addition to each
Fund, and the 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 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 each Fund. In addition, the
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
Adviser recommends to each Fund. Actions with respect to securities of the same
kind may be the same as or different from the action which the 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
Adviser may refrain from rendering any advice or services concerning securities
- 66 -
of companies of which any of the Adviser's (or its affiliates') officers,
directors or employees are directors or officers, or companies as to which the
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 Adviser includes disclosure regarding these matters to
its clients in both its Form ADV and investment advisory agreements.
The Adviser may also have clients that invest in different levels of the capital
structure of a company, such as equity versus senior loans, or that take
contrary provisions in multiple levels of the capital structure. This may create
situations where a client could be disadvantaged because of the investment
activities conducted by the Adviser for other client accounts.
The 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
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 each Fund. As a result, the Adviser will face
conflicts in the allocation of investment opportunities to each Fund 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 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 each Fund and such other clients or may involve a rotation of
opportunities among each Fund and such other clients.
While the Adviser does not believe there will be frequent conflicts of interest,
if any, the Adviser and its affiliates have both subjective and objective
procedures and policies in place designed to manage the potential conflicts of
interest between the Adviser's fiduciary obligations to each Fund and their
similar fiduciary obligations to other clients so that, for example, investment
opportunities are allocated in a fair and equitable manner among each Fund and
such other clients. An investment opportunity that is suitable for multiple
clients of the 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 1940 Act. There
can be no assurance that the 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 each Fund. Not all conflicts of interest can be expected to be
resolved in favor of each Fund.
Under current SEC regulations, each Fund may be prohibited from co-investing
with any unregistered fund managed now or in the future by the Adviser in
certain private placements in which the Adviser negotiates non-pricing terms.
HIGH INCOME PORTFOLIO
The Adviser has overall responsibility for the management of High Income
Portfolio's portfolio. High Income Portfolio and the Adviser have entered into
an Advisory Agreement, dated as of January 21, 2000, that requires the Adviser
to provide all investment advisory and portfolio management services for High
Income Portfolio. It also requires the Adviser to assist in managing and
supervising all aspects of the general day-to-day business activities and
operations of High Income Portfolio, including custodial, transfer agency,
dividend disbursing, accounting, auditing, compliance and related services. The
Adviser provides High Income Portfolio with the personnel necessary to
administer High Income Portfolio. The agreement with the Adviser can be canceled
by the Board of Directors and the Adviser upon not less than 30 nor more than 60
days' written notice.
The Adviser bears its expenses of providing the services described above. High
Income Portfolio pays all operating and other expenses of High Income Portfolio
not borne by the Adviser including, but not limited to, audit and legal fees,
transfer agent, registrar and custodian fees, expenses in preparing tender
offers, shareholder reports and proxy solicitation materials and other
miscellaneous business expenses. High Income Portfolio also pays all taxes
imposed on it and all brokerage commissions and loan-related fees.
The Adviser earned $967,015, $961,707 and $953,801 in management fees for the
fiscal years ended October 31, 2005, 2006 and 2007, respectively. Management
fees paid by High Income Portfolio to the Adviser were calculated at 0.65% (on
an annual basis) of High Income Portfolio's average weekly net asset value
defined as total assets of the Fund less accrued liabilities (excluding the
- 67 -
principal amount of any bank any loan, notes and the liquidation preference of
preferred shares and including accrued and unpaid dividends on the preferred
shares), up to and including $175 million of net assets, 0.55% on the next $50
million of net assets and 0.50% of the excess of net assets over $225 million. A
discussion regarding the basis for the approval of the investment advisory
agreement by High Income Portfolio's board is available in High Income
Portfolio's report to shareholders for the period ended April 30, 2007.
INCOME SHARES
The Adviser has overall responsibility for the management of Income Shares.
Income Shares and the Adviser have entered into an Investment Advisory
Agreement, dated as of July 30, 2001, pursuant to which the Adviser is
responsible for the selection and ongoing monitoring of Income Shares'
investment portfolio. The Adviser provides Income Shares with the personnel
necessary to administer Income Shares. The agreement with the Adviser can be
terminated on 60 days' written notice.
The Adviser bears its expenses of providing the services described above. The
Adviser currently receives from Income Shares a management fee calculated at an
annual rate of 0.50% of the average weekly net assets of Income Shares. The
definition of net assets includes the assets acquired through the Fund's use of
leverage. The Adviser earned $325,838, $470,503 and $473,658 in management fees
for the fiscal years ended December 31, 2005, 2006 and 2007, respectively. A
discussion regarding the basis for the approval of the investment advisory
agreement by Income Shares' board is available in Income Shares' report to
shareholders for the period ended June 30, 2007.
Income Shares pays all operating and other expenses of Income Shares not borne
by the Adviser including, but not limited to, directors' fees not borne by the
Adviser, custodian expenses, legal fees, costs of keeping Income Shares' books
and records, fees and expenses of independent accountants, costs of acquiring
and disposing of portfolio securities, interest, taxes, stock exchange listing
expenses and fees, costs and fees of registration with and reporting to the SEC,
costs of Income Shares' Automatic Dividend Reinvestment Plan, and fees and
expenses of Income Shares' transfer agent, registrar, custodian and dividend
disbursing agent. However, if such costs and expenses (excluding interest,
taxes, brokerage charges and expenses, extraordinary costs and expenses and
expenses incident to the public offering of shares other than those offered
through the Automatic Dividend Reinvestment Plan) borne by Income Shares in any
fiscal year exceed 1.5% of average net assets up to $30,000,000 plus 1.0% of
average net assets over $30,000,000, the Adviser is obligated to reimburse
Income Shares for any excess pursuant to the Investment Advisory Agreement. The
determination of whether such reimbursement is due is made monthly, on an
accrual basis, and to the extent that such reimbursement is due it serves as an
offset against the investment advisory fee payable monthly by Income Shares to
the Adviser. To the extent permitted under the 1940 Act, if, at the end of
Income Shares' fiscal year, full reimbursement has not been accomplished by such
monthly offsetting, the balance due must be paid by the Adviser to Income
Shares.
CREDIT STRATEGIES FUND
The Adviser provides the following services to Credit Strategies Fund: (i)
furnishes an investment program for Credit Strategies Fund; (ii) determines,
subject to the overall supervision and review of the board of trustees, the
investments to be purchased, held, sold or exchanged by Credit Strategies Fund
and the portion, if any, of the assets of Credit Strategies Fund to be held
uninvested; (iii) makes changes in the investments of Credit Strategies Fund;
and (iv) votes, exercises consents and exercises all other rights pertaining to
such investments. Subject to the foregoing, the Adviser, at its own expense,
will have the authority to engage one or more sub-advisers in connection with
the portfolio management of Credit Strategies Fund, which sub-advisers may be
affiliates of the Adviser; provided, however, that the Adviser shall remain
responsible to Credit Strategies Fund with respect to its duties and obligations
set forth in the investment advisory agreement.
In return for its advisory services, the Adviser will receive an annual fee,
payable monthly, in an amount equal to 1.00% of the average weekly value of
Credit Strategies Fund's Managed Assets (the "Advisory Fee"). The Adviser earned
$3,879,925 and $9,368,976 in management fees for the fiscal periods ended
December 31, 2006 and 2007, respectively. (The Fund commenced investment
operations on June 29, 2006). "Managed Assets" means the total assets of Credit
Strategies Fund, 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
- 68 -
(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 Credit
Strategies Fund's investment objectives and policies, and/or (iv) any other
means. The accrued fees will be payable monthly as promptly as possible after
the end of each month during which the investment advisory agreement is in
effect. The Adviser may waive a portion of its fees. A discussion regarding the
basis for the approval of the investment advisory agreement by Credit Strategies
Fund's board is available in Credit Strategies Fund's report to shareholders for
the period ending June 30, 2006.
In addition to the advisory fee of Highland, Credit Strategies Fund 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
Adviser or others for registration and maintenance of Credit Strategies Fund's
registrations with the SEC and other jurisdictions and taxes, if any.
ADMINISTRATOR/SUB-ADMINISTRATOR/ACCOUNTING SERVICES AGENT
Under an administration agreement dated June 29, 2006, Highland provides
administration services to Credit Strategies Fund, provides executive and other
personnel necessary to administer Credit Strategies Fund and furnishes office
space. Highland will receive an annual fee, payable monthly, in an amount equal
to 0.20% of the average weekly value of Credit Strategies Fund's Managed Assets.
Highland earned for administration services $775,985 and $1,873,796 in fees for
the fiscal periods ended December 31, 2006 and 2007, respectively. 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 June 29, 2006,
Highland has delegated certain administrative functions to PFPC Inc., at an
annual rate, payable by Highland, of 0.01% of the average weekly value of Credit
Strategies Fund's Managed Assets.
Each Acquired Fund is a party to an administration and accounting services
agreement with PFPC Inc. dated April 10, 2006 pursuant to which PFPC Inc.
provides administrative and accounting services to each Acquired Fund. PFPC Inc.
will receive an annual fee, payable monthly, in an amount equal to 0.026%,
subject to a minimum fee, of the average weekly value of each Acquired Fund's
Managed Assets plus certain other fees. For the fiscal periods ended December
31, 2006 and 2007, Income Shares paid $44,334 and $69,562, respectively, to PFPC
Inc. in fees for such services. For the fiscal periods ended October 31, 2006
and 2007, High Income Portfolio paid $41,130 and $65,876, respectively, to PFPC
Inc. in fees for such services.
PORTFOLIO MANAGEMENT
Each Fund is managed by James Dondero and Mark Okada. Kurtis Plumer also manages
the Acquiring Fund. The investment decisions are not subject to the oversight,
approval or ratification of a committee.
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 Fund 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.
- 69 -
Kurtis Plumer, CFA. Mr. Plumer is a Senior Portfolio Manager and head of the
Multi-Strategies group at Highland where he is responsible for managing the
sourcing, investing and monitoring process. He has over 15 years of experience
in distressed, high yield bond and leveraged loan products. Prior to joining
Highland in 1999, Mr. Plumer was a distressed high yield bond trader at Lehman
Brothers in New York, where he managed a $250 million portfolio invested in
global distressed securities. While at Lehman, he also traded emerging market
sovereign bonds. Prior to joining Lehman Brothers, Mr. Plumer was a corporate
finance banker at NationsBanc Capital Markets, Inc. (now Bank of America Capital
Markets, Inc.) where he focused on M&A and financing transactions for the bank's
clients. Mr. Plumer earned a BBA in Economics and Finance from Baylor University
and an MBA in Strategy and Finance from the Kellogg School at Northwestern
University. Mr. Plumer is a Chartered Financial Analyst.
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 Credit
Strategies Fund.
PORTFOLIO TRANSACTIONS WITH AFFILIATES
In placing portfolio transactions for the Funds, the Adviser will give primary
consideration to securing the most favorable price and efficient execution.
Consistent with this policy, the 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 Adviser may be a party. Neither
the Funds nor the Adviser has adopted a formula for allocation of the Funds'
investment transaction business. The 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 Funds
than would otherwise result when allocating brokerage transactions to other
brokers on the basis of seeking the most favorable price and efficient
execution. The Adviser, therefore, is authorized to place orders for the
purchase and sale of securities for the Funds with such brokers, subject to
review by the Funds' Boards 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 Adviser in connection with its services to other
clients.
On occasions when the Adviser deems the purchase or sale of a security to be in
the best interest of the Funds as well as other clients, the 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 Adviser in
the manner it considers to be the most equitable and consistent with its
fiduciary obligations to the Funds and to such other clients.
OTHER SERVICE PROVIDERS
The custodian of the assets of the Funds is 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) serves as the transfer agent for the Funds with respect to their
common shares.
VOTING INFORMATION AND REQUIRED VOTE
------------------------------------
Each Acquired Fund common and preferred share is entitled to one vote.
Approval of Proposal 1(A) and 1(B) requires, with respect to the applicable
Acquired Fund, the vote of:
(1) the holders of at least a majority of the common and preferred
shares entitled to vote, voting as a single class; and
(2) the holders of at least a majority of the preferred shares entitled
to vote, voting as a separate class.
- 70 -
If the accompanying form of proxy card is properly executed and returned in time
to be voted at the meeting, the shares covered thereby will be voted in
accordance with the instructions marked thereon. Executed and returned proxy
cards that are unmarked will be voted FOR the applicable proposal and in the
discretion of the persons named as proxies in connection with any other matter
which may properly come before the meeting or any adjournment thereof. The
Boards of the Acquired Funds do not know of any matter to be considered at the
meeting other than the proposals referred to in this Proxy Statement/Prospectus.
The presence in person or by proxy of shareholders of an Acquired Fund entitled
to cast at least a majority of the votes entitled to be cast shall constitute a
quorum ("Quorum") for that Fund's meeting. If a Quorum is not present at the
meeting, or if a Quorum is present but sufficient votes to approve a proposal
are not received, the persons named as proxies may propose one or more
adjournments of the meeting to permit further solicitation of proxies. Any
adjournment will require the affirmative vote of a majority of those shares
affected by the adjournment that are represented at the meeting in person or by
proxy.
Shares represented by properly executed proxies which are either votes to
abstain or broker non-votes will be treated as shares that are present and
entitled to vote for purposes of determining a Quorum and has the same effect as
a vote "against" the proposal.
The following table summarizes how the quorum and voting requirements for the
proposal are determined:
-------------------------------------------------------------------------------------------------
SHARES QUORUM VOTING FOR PROPOSAL
-------------------------------------------------------------------------------------------------
In General All shares "present" in Shares "present" in person
person or by proxy are will be voted in person at
counted towards a quorum. the meeting. Shares present
by proxy will be voted in
accordance with instructions.
-------------------------------------------------------------------------------------------------
Proxy with no Voting Considered "present" at Voted "for" a proposal.
Instruction (other than Broker meeting.
Non-Vote)
-------------------------------------------------------------------------------------------------
Broker Non-Vote* Considered "present" at Not voted. Same effect as a
meeting. vote "against" a proposal.
-------------------------------------------------------------------------------------------------
Vote to Abstain Considered "present" at Not voted. Same effect as a
meeting. vote "against" a proposal.
-------------------------------------------------------------------------------------------------
Proportionately Voted Preferred Considered "present" at Voted in proportion to
Shares with No Voting meeting. preferred shares for which
Instruction the broker received
instructions.
-------------------------------------------------------------------------------------------------
* Broker Non-Votes shall not include preferred shares which the broker is
permitted to proportionately vote in accordance with applicable law or rules of
a national securities exchange.
An unfavorable vote on a proposed Reorganization by the shareholders of one
Acquired Fund will not affect the consummation of a Reorganization by the other
Acquired Fund, if such Reorganization is approved by the shareholders of such
other Acquired Fund. If the required approval of shareholders is not obtained
with respect to a proposal, the Acquired Fund subject to the proposal will
continue to engage in business and the respective Board will consider what
further action may be appropriate.
Income Shares' common and preferred shareholders and High Income Portfolio's
common shareholders who object to the proposed Reorganization(s) are not
entitled under Maryland law or the relevant Charter to demand payment for, or an
appraisal of, their shares. Under Maryland law, High Income Portfolio's
preferred shareholders who object to its proposed Reorganization are entitled to
demand payment for, or an appraisal of, their shares. However, before the final
stockholder vote thereon, the High Income Portfolio will commence, and
irrevocably commit to complete as expeditiously as possible, the process for
redeeming its preferred stock. This redemption which will be completed before a
Reorganization will extinguish any appraisal rights.
However, shareholders should be aware that the Reorganizations as proposed are
not expected to result in recognition of gain or loss to shareholders for
federal income tax purposes (except to the extent such shareholders are paid
- 71 -
cash in lieu of fractional Acquiring Fund Common Shares in the Reorganization)
and that shares of each Fund may be sold at any time prior to the consummation
of the proposed Reorganizations.
CERTAIN VOTING INFORMATION REGARDING PREFERRED SHARES. Pursuant to the rules of
the NYSE, preferred shares of each Fund held in "street name" may be voted under
certain conditions by broker-dealer firms and counted for purposes of
establishing a quorum of that Fund if no instructions are received one business
day before the meeting or, if adjourned, one business day before the day to
which the meeting is adjourned. These conditions include, among others, that (i)
at least 30% of a Fund's preferred shares outstanding have voted on the
proposal, and (ii) less than 10% of a Fund's preferred shares outstanding have
voted against such proposal. In such instance, the broker-dealer firm will vote
such uninstructed Fund's preferred shares on the proposal in the same proportion
as the votes cast by all Fund preferred shareholders who voted on such proposal.
Each Fund will include shares held of record by broker-dealers as to which such
authority has been granted in its tabulation of the total number of shares
present for purposes of determining whether the necessary quorum of shareholders
of such Fund exists.
INFORMATION CONCERNING THE MEETING
----------------------------------
EXPENSES AND METHODS OF SOLICITATION
In addition to the mailing of these proxy materials, proxies may be solicited by
telephone, by fax or in person by the Trustees/Directors, officers and employees
of each Fund; by personnel of the Adviser and its transfer agent, PFPC, Inc.; or
by broker-dealer firms. Persons holding shares as nominees will be reimbursed by
the relevant Fund, upon request, for their reasonable expenses in sending
soliciting material to the principals of the accounts. The costs associated with
the Reorganizations, including the proxy solicitation expenses, will be borne by
each of the Acquired Funds and the Acquiring Fund in proportion to their
respective net assets determined at the close of regular trading on the NYSE on
the date of the Reorganizations' closing, provided that if they close at
different times, that determination will be made as of the date that the first
Reorganization closes.
The Altman Group has been retained to assist in the solicitation of proxies at a
cost of approximately [ ] per Fund plus reasonable expenses.
REVOKING PROXIES
A shareholder may revoke his or her proxy by appearing at the meeting and voting
in person, or by giving written notice of such revocation to the Acquired Fund
Secretary or by returning a later-dated proxy before the meeting.
OUTSTANDING SHARES
As of [ ], 2008 (the "record date"), the number of shares of beneficial interest
of each Acquired Fund outstanding was as follows:
FUND SHARES OUTSTANDING
-------------------------------------------------------------------------
HIGH INCOME PORTFOLIO
Common Shares
Preferred Shares, Series W
INCOME SHARES
Common Shares
Preferred Shares, Series T
OTHER BUSINESS
Directors do not intend to present any other business at the special meeting nor
are they aware that any shareholder intends to do so. If, however, any other
matters are properly brought before the special meeting, the persons named in
the accompanying proxy will vote thereon in accordance with their judgment.
- 72 -
SHAREHOLDERS' PROPOSALS AND COMMUNICATIONS
Any proposals of shareholders that are intended for inclusion in an Acquired
Fund's proxy statement and form of proxy card for the Acquired Fund's 2008
annual meeting of shareholders must be received at the Acquired Fund's principal
executive office no later than December 21, 2007 and must comply with all other
legal requirements. The date after which notice of a shareholder proposal
submitted is considered untimely and persons holding proxies will have
discretionary voting authority over such proposals, except as otherwise provided
under applicable law, is March 6, 2008.
Shareholders of the Acquired Funds who wish to communicate with Directors should
send communications to the attention of the Secretary of the Acquired Funds, Two
Galleria Tower, Suite 800, 13455 Noel Road, Dallas, Texas 75240, and
communications will be directed to the Director or Directors indicated in the
communication or, if no Director or Directors are indicated, to the Chairman of
the Board.
PROXY STATEMENT/PROSPECTUS DELIVERY
"Householding" is the term used to describe the practice of delivering one copy
of a document to a household of shareholders instead of delivering one copy of a
document to each shareholder in the household. Shareholders of each Fund who
share a common address and who have not opted out of the householding process
should receive a single copy of this Proxy Statement/Prospectus together with
one proxy card for each account. If you received more than one copy of this
Proxy Statement/Prospectus, you may elect to household in the future; if you
received a single copy of this Proxy Statement/Prospectus, you may opt out of
householding in the future; and you may, in any event, obtain an additional copy
of this Proxy Statement/Prospectus by writing to each Fund at the following
address: 13455 Noel Road, Suite 800, Dallas, Texas 75240, or by calling each
Fund at the following number: (877) 665-1287.
OWNERSHIP OF SHARES OF THE FUNDS
--------------------------------
To the knowledge of each Fund, as of [ ], 2008, the following persons owned of
record or beneficially 5% or more of the outstanding common shares or preferred
shares of each Fund, respectively:
The directors/trustees and officers of each Fund, as a group, own more than 1%
of each Fund's outstanding common shares. The table below indicates the
ownership of the respective directors/trustees and officers in each of the
Funds:
EXPERTS
-------
The independent registered public accounting firm for each Acquired Fund is
Deloitte & Touche LLP, JP Morgan Chase Tower, 2200 Ross Avenue, Suite 1600,
Dallas, TX 75201-6778. The independent registered public accounting firm for the
Acquiring Fund is PricewaterhouseCoopers LLP, 2001 Ross Avenue, Suite 1800,
Dallas, TX 75201. The financial highlights and financial statements, including
the reports of the respective independent registered public accounting firm, of
(i) High Income Portfolio, for the period ended October 31, 2007, (ii) Income
Shares, for the period ended December 31, 2007, and (iii) Credit Strategies
Fund, for the period ended December 31, 2007, are incorporated by reference into
this Proxy Statement/Prospectus. The financial statements for each Fund's fiscal
year ended 2007 and financial highlights have been independently audited by the
independent registered public accounting firm for each Fund, as stated in their
reports appearing in the statement of additional information. These financial
statements and financial highlights have been included in reliance on their
reports given on their authority as experts in accounting and auditing.
AVAILABLE INFORMATION
---------------------
Each Fund is subject to the informational requirements of the 1934 Act and the
1940 Act and files reports, proxy statements and other information with the SEC.
These reports, proxy statements and other information filed by the Funds can be
inspected and copied (for a duplication fee) at the public reference facilities
of the SEC at 100 F Street, N.E., Washington, D.C., and at the Central Regional
Office (1801 California Street, Suite 4800, Denver, CO 80202). Copies of these
materials can also be obtained by mail from the Public Reference Section of the
SEC at 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates. In
addition, copies of these documents may be viewed on-screen or downloaded from
the SEC's Internet site at http://www.sec.gov.
- 73 -
In addition, reports, proxy statements and other information concerning the
Funds may be inspected at the offices of the NYSE, 20 Broad Street, New York,
New York 10005.
- 74 -
APPENDIX A
The Form of Agreement and Plan of Reorganization has been included to provide
investors with information regarding its terms. It is not intended to provide
any factual information about the Funds. Accordingly, shareholders should not
rely on the representations and warranties in the Form of Agreement and Plan of
Reorganization as characterizations of the actual state of facts at the time
they were made or otherwise. In addition, the Form of Agreement and Plan of
Reorganization may be revised from that shown here prior to its execution, and
may be amended after its execution.
FORM OF
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION ("AGREEMENT") is made as of __
_______, 2008, between [PROSPECT STREET HIGH INCOME PORTFOLIO INC.] [PROSPECT
STREET INCOME SHARES INC.][(1)], a Maryland corporation ("ACQUIRED FUND"), and
HIGHLAND CREDIT STRATEGIES FUND, a Delaware statutory trust ("ACQUIRING FUND")
(each, a "FUND").
The Funds wish to effect a reorganization described in section
368(a)(1)(C) of the Internal Revenue Code of 1986, as amended ("CODE"), and
intend this Agreement to be, and adopt it as, a "plan of reorganization" within
the meaning of the regulations under the Code ("REGULATIONS").(2) The
reorganization will consist of (1) the transfer of Acquired Fund's assets to
Acquiring Fund in exchange solely for the issuance to Acquired Fund of shares of
beneficial interest in Acquiring Fund (and, if necessary or desirable, Acquiring
Fund's delivery to Acquired Fund of cash in lieu of fractional shares) and
Acquiring Fund's assumption of Acquired Fund's liabilities, (2) the distribution
of such shares (and cash, if applicable) to Acquired Fund's stockholders in
liquidation thereof, and (3) Acquired Fund's dissolution, all on the terms and
conditions set forth in this Agreement (collectively, "REORGANIZATION").
Each of Acquired Fund's Board of Directors and Acquiring Fund's Board of
Trustees (each, a "BOARD"), including a majority of the members thereof who are
not "interested persons" (as such term is defined in the Investment Company Act
of 1940, as amended ("1940 ACT")) thereof, (1) has duly adopted and approved
this Agreement and the transactions contemplated hereby and (2) has determined
that participation in those transactions is in the best interests of its Fund
and that the interests of the existing stockholders/shareholders thereof will
not be diluted as a result thereof.
Acquired Fund is authorized to issue [101,000,000] [16,000,000] shares
of capital stock, of which (1) [100,000,000] [15,000,000] shares are classified
as common stock, par value $0.03 per share ("ACQUIRED FUND COMMON STOCK") and
(2) 1,000,000 shares are classified as Auction Rate Cumulative Preferred Shares,
par value [$0.001] [$0.01] per share, with a liquidation preference of $25,000
per share plus an amount equal to accumulated but unpaid dividends thereon
(whether or not earned or declared) ("ACQUIRED FUND PREFERRED STOCK"). Acquired
--------------------------
[(1) In this "Form" of Agreement, wherever text is surrounded by consecutive
pairs of brackets, the text in the first pair of brackets is included in the
Agreement involving Prospect Street High Income Portfolio Inc. and the text in
the second pair of brackets is included in the Agreement involving Prospect
Street Income Shares Inc.]
(2) On or about the date hereof, Acquiring Fund also is entering into an
Agreement and Plan of Reorganization with [Prospect Street Income Shares Inc.]
[Prospect Street High Income Portfolio Inc.], a Maryland corporation ("OTHER
ACQUIRED FUND"), containing substantially the same terms as herein, regarding
the reorganization of those entities ("OTHER REORGANIZATION"). The consummation
of the Reorganization is not contingent on the consummation of the Other
Reorganization.
Fund intends to redeem the Acquired Fund Preferred Stock before the EFFECTIVE
TIME (as defined in paragraph 3.1). Acquiring Fund is authorized to issue an
unlimited number of shares of beneficial interest, par value $0.001 per share
("ACQUIRING FUND SHARES"). All outstanding shares of each Fund are fully paid,
non-assessable, and have full voting rights.
Based on its review of the Funds' respective investment portfolios, each
Fund has determined that those portfolios generally are compatible and, as a
result, believes that all or substantially all of the ASSETS (as defined in
paragraph 1.1) can be transferred to and held by Acquiring Fund pursuant to the
Reorganization.
In consideration of the mutual promises contained herein, the parties
agree as follows:
1. PLAN OF REORGANIZATION
----------------------
1.1. Subject to the requisite approval of Acquired Fund's stockholders
and the terms and conditions hereof, Acquired Fund shall assign, sell, convey,
transfer, and deliver all of its assets described in paragraph 1.2 ("ASSETS") to
Acquiring Fund. In exchange therefor, Acquiring Fund shall -
(a) issue and deliver to Acquired Fund the number of Acquiring
Fund Shares determined by dividing Acquired Fund's net value (computed
as set forth in paragraph 2.1) by the net asset value ("NAV") of an
Acquiring Fund Share (computed as set forth in paragraph 2.2) (and, if
necessary or desirable, deliver to Acquired Fund cash in lieu of
fractional Acquiring Fund Shares); and
(b) assume all of Acquired Fund's liabilities described in
paragraph 1.3 ("LIABILITIES").
Such transactions shall take place at the CLOSING (as defined in paragraph 3.1).
1.2. The Assets shall consist of all assets and property -- including
all cash, cash equivalents, securities, commodities, futures interests,
receivables (including interest and dividends receivable), claims and rights of
action, rights to register stock under applicable securities laws, books and
records, and deferred and prepaid expenses (other than unamortized
organizational expenses) shown as assets on Acquired Fund's books -- Acquired
Fund owns at the VALUATION TIME (as defined in paragraph 2.1).
1.3. The Liabilities shall consist of all of Acquired Fund's
liabilities, debts, obligations, and duties of whatever kind or nature existing
at the Valuation Time, whether absolute, accrued, contingent, or otherwise,
whether known or unknown, whether or not arising in the ordinary course of
business, whether or not determinable at the Valuation Time, and whether or not
specifically referred to in this Agreement, excluding REORGANIZATION EXPENSES
(as defined in paragraph 4.3.9) borne by Acquiring Fund and/or the Other
Acquired Fund pursuant to paragraph 7.2. Notwithstanding the foregoing, Acquired
Fund agrees to use its best efforts to discharge all its known Liabilities
before the Effective Time.
1.4. At the Effective Time (or as soon thereafter as is reasonably
practicable), Acquired Fund shall distribute the Acquiring Fund Shares (and, if
applicable, the cash) it receives pursuant to paragraph 1.1(a) to the holders of
A-2
record at the Effective Time of Acquired Fund Common Stock (each, a
"STOCKHOLDER"), in exchange for their Acquired Fund Common Stock, and shall
completely liquidate. The distribution of such shares shall be accomplished by
Acquiring Fund's transfer agent's opening accounts on Acquiring Fund's
shareholder records in the names of the Stockholders (except Stockholders in
whose names accounts thereon already exist) and crediting each Stockholder's
newly opened or pre-existing account with the respective PRO RATA number of
Acquiring Fund Shares due such Stockholder. All outstanding Acquired Fund Common
Stock, including any represented by certificates, shall simultaneously be
canceled on Acquired Fund's stockholder records. Acquiring Fund shall not issue
certificates representing the Acquiring Fund Shares issued in connection with
the Reorganization.
1.5. If it is necessary or desirable to distribute cash in lieu of
fractional Acquiring Fund Shares, then fractional Acquiring Fund Shares that the
Stockholders (except the agent for Acquired Fund's dividend reinvestment plan)
would otherwise be entitled to receive pursuant to paragraph 1.4 shall not be
distributed to them. In that event, each such Stockholder instead shall receive
an amount of cash equal to the fraction of an Acquiring Fund Share it otherwise
would have received multiplied by the NAV per Acquiring Fund Share at the
Valuation Time.
1.6. Acquired Fund shall declare and, immediately before the Valuation
Time, shall pay (a) to the holders of the Acquired Fund Common Stock one or more
dividends and/or other distributions in an amount large enough so that, together
with the dividends described in (b) below, it will have distributed
substantially all (and in any event not less than 98%) of its (i) "investment
company taxable income" (within the meaning of section 852(b)(2) of the Code),
computed without regard to any deduction for dividends paid, and (ii) "net
capital gain" (as defined in section 1222(11) of the Code), after reduction by
any capital loss carryforward, for the current taxable year through the
Effective Time and (b) to the holders of the Acquired Fund Preferred Stock, if
any is then outstanding, all accumulated unpaid dividends.
1.7. As soon as reasonably practicable after the distribution of the
Acquiring Fund Shares (and, if applicable, cash) pursuant to paragraph 1.4, (a)
Acquired Fund shall be dissolved and any further actions shall be taken in
connection therewith as required by applicable law and (b) the Acquired Fund
Common Stock shall be delisted from the New York Stock Exchange ("NYSE") and
Acquired Fund's registration under the 1940 Act shall be terminated.
1.8. Any reporting responsibility of Acquired Fund to a public
authority, including the responsibility for filing regulatory reports, tax
returns, and other documents with the Securities and Exchange Commission
("COMMISSION"), any state securities commission, any federal, state, and local
tax authorities, and any other relevant regulatory authority, is and shall
remain its responsibility up to and including the date on which it is dissolved.
1.9. Any transfer taxes payable on issuance of Acquiring Fund Shares in
a name other than that of the registered holder on Acquired Fund's stockholder
records of the Acquired Fund Common Stock actually or constructively exchanged
therefor shall be paid by the person to whom such Acquiring Fund Shares are to
be issued, as a condition of such transfer.
1.10. After Acquired Fund's stockholders approve this Agreement,
Acquired Fund shall file articles of transfer complying with section 3-109 of
the Maryland General Corporation Law (Titles 1-3 of the Corporations and
A-3
Associations Article of the Maryland Code) ("ARTICLES OF TRANSFER") with the
Department of Assessments and Taxation of the State of Maryland ("DEPARTMENT").
2. VALUATION
---------
2.1. For purposes of paragraph 1.1(a), Acquired Fund's net value shall
be (a) the value of the Assets computed at the close of regular trading on the
NYSE on the date of the Closing ("VALUATION TIME"), using the valuation
procedures adopted by its Board.
2.2. For purposes of paragraph 1.1(a), the NAV per Acquiring Fund Share
shall be computed at the Valuation Time, using the valuation procedures adopted
by Acquiring Fund's Board.
2.3. All computations pursuant to paragraphs 2.1 and 2.2 shall be made
by or under the direction of Highland Capital Management, L.P. ("ADVISER").
3. CLOSING AND EFFECTIVE TIME
--------------------------
3.1. Unless the Funds agree otherwise, (a) the Reorganization, together
with related acts necessary to consummate it ("CLOSING"), shall occur at
Acquiring Fund's offices on the later of (i) the date the Articles of Transfer
are accepted for record by the Department or (ii) a later date specified in the
Articles of Transfer not more than 30 days after they are so accepted (which
later date must be a day on which the NYSE is open for regular trading
("BUSINESS DAY")), and (b) all acts taking place at the Closing shall be deemed
to take place simultaneously at the close of business (4:00 p.m., Eastern Time)
on that date ("EFFECTIVE TIME"). If, immediately before the Valuation Time, (i)
the NYSE or another primary trading market for portfolio securities of either
Fund (each, an "EXCHANGE") is closed to trading or trading thereon is restricted
or (ii) trading or the reporting of trading on an Exchange or elsewhere is
disrupted, so that, in either Board's judgment, accurate appraisal of Acquired
Fund's net value and/or the NAV on an Acquiring Fund Share is impracticable, the
Effective Time shall be postponed until the first day on which the NYSE is open
for regular trading after the day when such trading has been fully resumed and
such reporting has been restored.
3.2. Acquired Fund shall direct its fund accounting and pricing agent to
deliver at the Closing a certificate of an authorized officer verifying that the
information (including adjusted basis and holding period, by lot) concerning the
Assets, including all portfolio securities, transferred by Acquired Fund to
Acquiring Fund, as reflected on Acquiring Fund's books immediately after the
Closing, does or will conform to such information on Acquired Fund's books
immediately before the Closing. Acquired Fund shall direct its custodian to
deliver at the Closing a certificate of an authorized officer stating that (a)
the Assets it holds will be transferred to Acquiring Fund at the Effective Time
and (b) all necessary taxes in conjunction with the delivery of the Assets,
including all applicable federal and state stock transfer stamps, if any, have
been paid or provision for payment has been made.
3.3. Acquired Fund shall deliver to Acquiring Fund at the Closing a list
of the Stockholders' names and addresses, and the number of full and fractional
(rounded to the third decimal place) outstanding shares of Acquired Fund Common
Stock each Stockholder owns, at the Effective Time, certified by Acquired Fund's
A-4
Secretary or Assistant Secretary. Acquiring Fund shall direct its transfer agent
to deliver at the Closing a certificate as to the opening of accounts on
Acquiring Fund's shareholder records in the names of the Stockholders (except
Stockholders in whose names accounts thereon already exist). Acquiring Fund
shall issue and deliver to Acquired Fund a confirmation, or other evidence
satisfactory to Acquired Fund, that the Acquiring Fund Shares to be credited to
Acquired Fund at the Effective Time have been credited to its account on such
records. At the Closing, each Fund shall deliver to the other bills of sale,
checks, assignments, stock certificates, receipts, or other documents the other
Fund or its counsel reasonably requests.
3.4. Each Fund shall deliver to the other at the Closing a certificate
executed in its name by its President or a Vice President in form and substance
satisfactory to the recipient and dated the date of the Closing, to the effect
that the representations and warranties it made in this Agreement are true and
correct at the Effective Time except as they may be affected by the transactions
contemplated hereby.
4. REPRESENTATIONS AND WARRANTIES
------------------------------
4.1. Acquired Fund represents and warrants to Acquiring Fund as follows:
4.1.1. Acquired Fund (a) is a corporation that is duly organized,
validly existing, and in good standing under the laws of the State of
Maryland and (b) has the power to own all its properties and assets and
to carry on its business as described in documents filed with the
Commission; and its Articles of Incorporation ("CHARTER") are on file
with the Department;
4.1.2. Acquired Fund is duly registered as a closed-end
management investment company under the 1940 Act, such registration is
in full force and effect, and no proceeding has been instituted to
suspend such registration;
4.1.3. At the Effective Time, Acquired Fund will have good and
marketable title to the Assets and full right, power, and authority to
sell, assign, transfer, and deliver the Assets free of any liens or
other encumbrances (except securities that are subject to "securities
loans," as referred to in section 851(b)(2) of the Code, or that are
restricted to resale by their terms), and on delivery and payment for
the Assets, Acquiring Fund will acquire good and marketable title
thereto, subject to no restrictions on the full transfer thereof,
including restrictions that might arise under the Securities Act of
1933, as amended ("1933 ACT"), except as previously disclosed in writing
to and accepted by Acquiring Fund;
4.1.4. Acquired Fund is not currently engaged in, and Acquired
Fund's execution, delivery, and performance of this Agreement and
consummation of the Reorganization will not result in, (1) a material
violation of any provision of Maryland law, the Charter or Acquired
Fund's By-Laws, or any agreement, indenture, instrument, contract,
lease, or other undertaking (each, an "UNDERTAKING") to which Acquired
Fund is a party or by which it is bound or (2) the acceleration of any
obligation, or the imposition of any penalty, under any Undertaking,
A-5
judgment, or decree to which Acquired Fund is a party or by which it is
bound;
4.1.5. All material contracts and other commitments of or
applicable to Acquired Fund (other than this Agreement and certain
investment contracts, including options, futures, and forward contracts)
will terminate, or provision for discharge of any liabilities of
Acquired Fund thereunder will be made, at or before the Effective Time,
without either Fund's incurring any liability or penalty with respect
thereto and without diminishing or releasing any rights Acquired Fund
may have had with respect to actions taken or omitted or to be taken by
any other party thereto before the Closing;
4.1.6. Except as previously disclosed in writing to and accepted
by Acquiring Fund, (a) no litigation, administrative proceeding, action,
or investigation of or before any court, governmental body, or
arbitrator is presently pending or, to Acquired Fund's knowledge,
threatened against Acquired Fund or any of its properties or assets
that, if adversely determined, would materially and adversely affect
Acquired Fund's financial condition or the conduct of its business, and
(b) Acquired Fund knows of no facts that might form the basis for the
institution of any such litigation, proceeding, or investigation and is
not a party to or subject to the provisions of any order, decree, or
judgment of any court or governmental body that materially or adversely
affects Acquired Fund's business or its ability to consummate the
transactions contemplated hereby;
4.1.7. The execution, delivery, and performance of this Agreement
have been duly authorized at the date hereof by all necessary action on
the part of Acquired Fund's Board, which has made the determinations
required by Rule 17a-8(a) under the 1940 Act; and this Agreement
constitutes a valid and legally binding obligation of Acquired Fund,
enforceable in accordance with its terms, subject to the effect of
bankruptcy, insolvency, fraudulent transfer, reorganization,
receivership, moratorium, and other laws affecting the rights and
remedies of creditors generally and general principles of equity;
4.1.8. No governmental consents, approvals, authorizations, or
filings are required under the 1933 Act, the Securities Exchange Act of
1934, as amended, or the 1940 Act (collectively, "FEDERAL SECURITIES
LAWS") or state securities laws, and no authorizations, consents, or
orders of any court are required, for Acquired Fund's execution or
performance of this Agreement, except for (a) Acquiring Fund's filing
with the Commission of a registration statement on Form N-14 relating to
the Acquiring Fund Shares issuable hereunder, and any supplement or
amendment thereto ("REGISTRATION STATEMENT"), including therein a
prospectus and proxy statement ("PROSPECTUS/STATEMENT"), and (b)
consents, approvals, authorizations, and filings that have been made or
received or may be required after the Effective Time;
4.1.9. On the effective date of the Registration Statement, at
the time of the STOCKHOLDERS MEETING (as defined in paragraph 6.1), and
at the Effective Time, the Prospectus/Statement will (a) comply in all
material respects with the applicable provisions of the Federal
Securities Laws and the rules and regulations thereunder and (b) not
contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which such
A-6
statements were made, not misleading; provided that the foregoing shall
not apply to statements in or omissions from the Prospectus/Statement
made in reliance on and in conformity with information furnished by
Acquiring Fund for use therein;
4.1.10. Acquired Fund incurred the Liabilities in the ordinary
course of its business; and there are no Liabilities other than those
disclosed or provided for in Acquired Fund's financial statements
referred to in paragraph 4.1.18 and Liabilities incurred by Acquired
Fund in the ordinary course of its business subsequent to [October 31,
2007] [December 31, 2007], none of which has been materially adverse to
the business, assets, or results of Acquired Fund's operations;
4.1.11. For each taxable year of its operation (including the
taxable year ending at the Effective Time), Acquired Fund has met (or
for its current taxable year will meet) the requirements of Subchapter M
of Chapter 1 of the Code ("SUBCHAPTER M") for qualification as a
regulated investment company ("RIC") and has been (or for such year will
be) eligible to and has computed (or for such year will compute) its
federal income tax under section 852 of the Code; from the time Acquired
Fund's Board approved the transactions contemplated hereby ("APPROVAL
TIME") through the Effective Time, Acquired Fund has invested and will
invest its assets in a manner that ensures its compliance with the
foregoing and paragraph 4.1.12; from the time it commenced operations
through the Effective Time, Acquired Fund has conducted and will conduct
its "historic business" (within the meaning of section 1.368-1(d)(2) of
the Regulations) in a substantially unchanged manner; from the Approval
Time through the Effective Time, Acquired Fund (1) has not disposed of
and/or acquired, and will not dispose of and/or acquire, any assets (a)
for the purpose of satisfying Acquiring Fund's investment objective or
policies or (b) for any other reason except in the ordinary course of
its business as a RIC and (2) has not otherwise changed, and will not
otherwise change, its historic investment policies; Acquired Fund has no
earnings and profits accumulated in any taxable year in which the
provisions of Subchapter M did not apply to it; and Acquired Fund has
not at any time since its inception been liable for, and is not now
liable for, any material tax pursuant to sections 852 or 4982 of the
Code, except as previously disclosed in writing to and accepted by
Acquiring Fund;
4.1.12. Acquired Fund is in the same line of business as
Acquiring Fund is in, for purposes of section 1.368-1(d)(2) of the
Regulations, and did not enter into such line of business as part of the
plan of reorganization;
4.1.13. At the Effective Time, at least 33 1/3% of Acquired Fund's
portfolio assets will meet Acquiring Fund's investment objectives,
strategies, policies, risks, and restrictions, and Acquired Fund did not
alter and will not alter its portfolio in connection with the
Reorganization to meet such 33 1/3% threshold;
4.1.14. To the best of Acquired Fund's management's knowledge, at
the record date for Acquired Fund's stockholders entitled to vote on
approval of this Agreement, there was no plan or intention by its
stockholders to sell, exchange, or otherwise dispose of a number of
shares of Acquired Fund Common Stock (or Acquiring Fund Shares to be
A-7
received in the Reorganization), in connection with the Reorganization,
that would reduce their ownership of the Acquired Fund Common Stock (or
the equivalent Acquiring Fund Shares) to a number of shares that was
less than 50% of the number of shares of Acquired Fund Common Stock at
such date;
4.1.15. Acquired Fund is not under the jurisdiction of a court in
a "title 11 or similar case" (as defined in section 368(a)(3)(A) of the
Code);
4.1.16. During the five-year period ending at the Effective Time,
(a) neither Acquired Fund nor any person "related" (as defined in
section 1.368-1(e)(4) of the Regulations) ("RELATED") to it will have
acquired Acquired Fund Common Stock, either directly or through any
transaction, agreement, or arrangement with any other person, with
consideration other than Acquiring Fund Shares or Acquired Fund Common
Stock and (b) no distributions will have been made with respect to
Acquired Fund Common Stock, other than normal, regular dividend
distributions made pursuant to Acquired Fund's historic dividend-paying
practice and other distributions that qualify for the deduction for
dividends paid (within the meaning of section 561 of the Code) referred
to in sections 852(a)(1) and 4982(c)(1)(A) of the Code;
4.1.17. By the Effective Time, Acquired Fund shall have duly and
timely filed all federal, state, local, and foreign tax returns required
by law to have been filed by such date (giving effect to properly and
timely filed extensions of time to file); Acquired Fund has timely paid
all taxes payable pursuant to such filed returns except for amounts that
alone or in the aggregate would not reasonably be expected to have a
material adverse effect; and Acquired Fund is in compliance in all
material respects with applicable Regulations pertaining to the
reporting of, and withholding in respect of, distributions on and
repurchases, if any, of its stock and is not liable for any material
penalties that could be imposed thereunder;
4.1.18. The Statement of Assets and Liabilities (including
Schedule of Investments), Statement of Operations, and Statement of
Changes in Net Assets (collectively, "STATEMENTS") of Acquired Fund at
and for the fiscal year (in the case of the last Statement, for the two
fiscal years) ended [October 31, 2007] [December 31, 2007], have been
audited by Deloitte & Touche LLP, an independent registered public
accounting firm, and are in accordance with generally accepted
accounting principles ("GAAP"), and copies thereof have been delivered
to Acquiring Fund; to Acquired Fund's management's best knowledge and
belief, there are no known contingent liabilities of Acquired Fund
required to be reflected on a balance sheet (including the notes
thereto) in accordance with GAAP consistently applied at such date that
are not disclosed therein; and such audited Statements present fairly,
in all material respects, Acquired Fund's financial condition at such
date in accordance with GAAP consistently applied and the results of its
operations and changes in its net assets for the period then ended;
4.1.19. Since [October 31, 2007] [December 31, 2007], there has
not been any material adverse change in Acquired Fund's financial
condition, assets, liabilities, or business, other than changes
occurring in the ordinary course of business, or any incurrence by
A-8
Acquired Fund of indebtedness maturing more than one year from the date
such indebtedness was incurred, except as previously disclosed in
writing to and accepted by Acquiring Fund; for purposes of this
representation, a decline in NAV or price per share of Acquired Fund
Common Stock due to declines in market values of securities Acquired
Fund holds or the discharge of Acquired Fund's liabilities shall not
constitute a material adverse change;
4.1.20. All issued and outstanding Acquired Fund Common Stock is,
and at the Effective Time will be, duly and validly issued and
outstanding, fully paid, and non-assessable by Acquired Fund and has
been offered and sold in every state and the District of Columbia in
compliance in all material respects with applicable registration
requirements of the 1933 Act and state securities laws; all issued and
outstanding Acquired Fund Common Stock will, at the Effective Time, be
held by the persons and in the amounts set forth on Acquired Fund's
stockholder records, as provided in paragraph 3.3; and Acquired Fund
does not have outstanding any options, warrants, or other rights to
subscribe for or purchase any Acquired Fund Common Stock, nor are there
outstanding any securities convertible into any Acquired Fund Common
Stock;
4.1.21. Not more than 25% of the value of Acquired Fund's total
assets (excluding cash, cash items, and U.S. government securities) is
invested in the stock and securities of any one issuer, and not more
than 50% of the value of such assets is invested in the stock and
securities of five or fewer issuers;
4.1.22. No registration of any Asset under the 1933 Act or any
state securities or blue sky laws would be required if it was, at the
Effective Time, the subject of a public distribution by either Fund,
except as previously disclosed in writing to and accepted by Acquiring
Fund; and
4.1.23. Its Board has not adopted a resolution electing to be
subject to the Maryland Business Combination Act or the Maryland Control
Share Acquisition Act.
4.2. Acquiring Fund represents and warrants to Acquired Fund as follows:
4.2.1. Acquiring Fund (a) is a statutory trust that is duly
organized, validly existing, and in good standing under the laws of the
State of Delaware and (b) has the power to own all its properties and
assets and to carry on its business as described in documents filed with
the Commission; and its Certificate of Trust has been filed with the
office of the Secretary of State of Delaware;
4.2.2. Acquiring Fund is duly registered as a closed-end
management investment company under the 1940 Act, such registration is
in full force and effect, and no proceeding has been instituted to
suspend such registration;
4.2.3. No consideration other than Acquiring Fund Shares (and
Acquiring Fund's assumption of the Liabilities and, if necessary or
desirable, cash in lieu of fractional Acquiring Fund Shares) will be
issued in exchange for the Assets in the Reorganization;
A-9
4.2.4. The Acquiring Fund Shares to be issued and delivered
hereunder will, at the Effective Time, have been duly authorized by
Acquiring Fund and, when issued and delivered as provided herein
(including the receipt of consideration in exchange therefor exceeding
their par value), will be duly and validly issued and outstanding shares
of Acquiring Fund, fully paid and non-assessable by Acquiring Fund;
4.2.5. Acquiring Fund's Agreement and Declaration of Trust
("DECLARATION") permits it to vary its shareholders' investment.
Acquiring Fund does not have a fixed pool of assets -- it is a managed
portfolio of securities, and Adviser has the authority to buy and sell
securities for it;
4.2.6. Acquiring Fund is not currently engaged in, and Acquiring
Fund's execution, delivery, and performance of this Agreement will not
result in, (1) a material violation of any provision of Delaware law,
the Declaration or Acquiring Fund's By-Laws, or any Undertaking to which
Acquiring Fund is a party or by which it is bound or (2) the
acceleration of any obligation, or the imposition of any penalty, under
any Undertaking, judgment, or decree to which Acquiring Fund is a party
or by which it is bound;
4.2.7. Except as previously disclosed in writing to and accepted
by Acquired Fund, (a) no litigation, administrative proceeding, action,
or investigation of or before any court, governmental body, or
arbitrator is presently pending or, to Acquiring Fund's knowledge,
threatened against Acquiring Fund or any of its properties or assets
that, if adversely determined, would materially and adversely affect
Acquiring Fund's financial condition or the conduct of its business, and
(b) Acquiring Fund knows of no facts that might form the basis for the
institution of any such litigation, proceeding, or investigation and is
not a party to or subject to the provisions of any order, decree, or
judgment of any court or governmental body that materially or adversely
affects Acquiring Fund's business or its ability to consummate the
transactions contemplated hereby;
4.2.8. The execution, delivery, and performance of this Agreement
have been duly authorized at the date hereof by all necessary action on
the part of Acquiring Fund's Board, which has made the determinations
required by Rule 17a-8(a) under the 1940 Act; and this Agreement
constitutes a valid and legally binding obligation of Acquiring Fund,
enforceable in accordance with its terms, subject to the effect of
bankruptcy, insolvency, fraudulent transfer, reorganization,
receivership, moratorium, and other laws affecting the rights and
remedies of creditors generally and general principles of equity;
4.2.9. No governmental consents, approvals, authorizations, or
filings are required under the Federal Securities Laws or state
securities laws, and no authorizations, consents, or orders of any court
are required, for Acquiring Fund's execution or performance of this
Agreement, except for (a) the filing with the Commission of the
Registration Statement and (b) such consents, approvals, authorizations,
and filings as have been made or received or as may be required
subsequent to the Effective Time;
4.2.10. On the effective date of the Registration Statement, at
the time of the Stockholders Meeting, and at the Effective Time, the
Prospectus/Statement will (a) comply in all material respects with the
A-10
applicable provisions of the Federal Securities Laws and the rules and
regulations thereunder and (b) not contain any untrue statement of a
material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading;
provided that the foregoing shall not apply to statements in or
omissions from the Prospectus/Statement made in reliance on and in
conformity with information furnished by Acquired Fund for use therein;
4.2.11. For each taxable year of Acquiring Fund's operation
(including the taxable year in which the Effective Time occurs),
Acquiring Fund has met (or for its current taxable year will meet) the
requirements of Subchapter M for qualification as a RIC and has been (or
for such year will be) eligible to and has computed (or for such year
will compute) its federal income tax under section 852 of the Code;
Acquiring Fund intends to continue to meet all such requirements for the
next taxable year; Acquiring Fund has no earnings and profits
accumulated in any taxable year in which the provisions of Subchapter M
did not apply to it; and Acquiring Fund has not at any time since its
inception been liable for, and is not now liable for, any material tax
pursuant to sections 852 or 4982 of the Code, except as previously
disclosed in writing to and accepted by Acquired Fund;
4.2.12. Following the Reorganization, Acquiring Fund (a) will
continue Acquired Fund's "historic business" (within the meaning of
section 1.368-1(d)(2) of the Regulations) and (b) will use a significant
portion of Acquired Fund's "historic business assets" (within the
meaning of section 1.368-1(d)(3) of the Regulations) in a business;
moreover, Acquiring Fund (c) has no plan or intention to sell or
otherwise dispose of any of the Assets, except for dispositions made in
the ordinary course of such business and dispositions necessary to
maintain its status as a RIC, and (d) expects to retain substantially
all the Assets in the same form as it receives them in the
Reorganization, unless and until subsequent investment circumstances
suggest the desirability of change or it becomes necessary to make
dispositions thereof to maintain such status;
4.2.13. Acquiring Fund is in the same line of business as Acquired
Fund was in preceding the Reorganization, for purposes of section
1.368-1(d)(2) of the Regulations, and did not enter into such line of
business as part of the plan of reorganization; following the
Reorganization, Acquiring Fund will continue, and has no intention to
change, such line of business; and at the Effective Time, (1) at least
33 1/3% of Acquired Fund's portfolio assets will meet Acquiring Fund's
investment objectives, strategies, policies, risks, and restrictions and
(2) Acquiring Fund has no plan or intention to change any of its
investment objectives, strategies, policies, risks, or restrictions
after the Reorganization;
4.2.14. There is no plan or intention for Acquiring Fund to be
dissolved or merged into another statutory trust or a corporation or
business trust or any "fund" thereof (as defined in section 851(g)(2) of
the Code) following the Reorganization;
A-11
4.2.15. During the five-year period ending at the Effective Time,
neither Acquiring Fund nor any person Related to it will have acquired
Acquired Fund Common Stock with consideration other than Acquiring Fund
Shares;
4.2.16. By the Effective Time, Acquiring Fund shall have duly and
timely filed all federal, state, local, and foreign tax returns required
by law to have been filed by such date (giving effect to properly and
timely filed extensions of time to file); Acquiring Fund has timely paid
all taxes payable pursuant to such filed returns except for amounts that
alone or in the aggregate would not reasonably be expected to have a
material adverse effect; and Acquiring Fund is in compliance in all
material respects with applicable Regulations pertaining to the
reporting of distributions on and repurchases, if any, of its shares and
to withholding in respect of distributions to shareholders and is not
liable for any material penalties that could be imposed thereunder;
4.2.17. Acquiring Fund's Statements at and for the fiscal year
(in the case of its Statement of Changes in Net Assets, for the two
fiscal years) ended December 31, 2007, have been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting
firm, and are in accordance with GAAP, and copies thereof have been
delivered to Acquired Fund; to Acquiring Fund's management's best
knowledge and belief, there are no known contingent liabilities of
Acquiring Fund required to be reflected on a balance sheet (including
the notes thereto) in accordance with GAAP consistently applied at such
date that are not disclosed therein; and such audited Statements present
fairly, in all material respects, Acquiring Fund's financial condition
at such date in accordance with GAAP consistently applied and the
results of its operations and changes in its net assets for the period
then ended;
4.2.18. Since December 31, 2007, there has not been any material
adverse change in Acquiring Fund's financial condition, assets,
liabilities, or business, other than changes occurring in the ordinary
course of business, or any incurrence by Acquiring Fund of indebtedness
maturing more than one year from the date such indebtedness was
incurred, except as previously disclosed in writing to and accepted by
Acquired Fund; for purposes of this representation, a decline in NAV or
price per Acquiring Fund Share due to declines in market values of
securities Acquiring Fund holds or the discharge of Acquiring Fund's
liabilities shall not constitute a material adverse change;
4.2.19. Assuming the truthfulness and correctness of Acquired
Fund's representation and warranty in paragraph 4.1.21, immediately
after the Reorganization, (a) not more than 25% of the value of
Acquiring Fund's total assets (excluding cash, cash items, and U.S.
government securities) will be invested in the stock and securities of
any one issuer and (b) not more than 50% of the value of such assets
will be invested in the stock and securities of five or fewer issuers;
4.2.20. Acquiring Fund does not directly or indirectly own, nor
at the Effective Time will it directly or indirectly own, nor has it
directly or indirectly owned at any time during the past five years, any
Acquired Fund Common Stock;
A-12
4.2.21. Acquiring Fund has no plan or intention to issue
additional Acquiring Fund Shares following the Reorganization except to
the agent for its dividend reinvestment plan and in connection with the
Other Reorganization; nor does Acquiring Fund, or any person Related to
it, have any plan or intention to acquire -- during the five-year period
beginning at the Effective Time, either directly or through any
transaction, agreement, or arrangement with any other person -- with
consideration other than Acquiring Fund Shares, any Acquiring Fund
Shares issued to the Stockholders pursuant to the Reorganization; and
4.2.22. All issued and outstanding Acquiring Fund Shares are, and
at the Effective Time will be, duly and validly issued and outstanding,
fully paid, and non-assessable by Acquiring Fund and have been offered
and sold in every state and the District of Columbia in compliance in
all material respects with applicable registration requirements of the
1933 Act and state securities laws; and Acquiring Fund does not have
outstanding any options, warrants, or other rights to subscribe for or
purchase any Acquiring Fund Shares, nor are there outstanding any
securities convertible into any Acquiring Fund Shares.
4.3. Each Fund represents and warrants to the other Fund as follows:
4.3.1. The fair market value of the Acquiring Fund Shares each
Stockholder receives (together with cash in lieu of fractional Acquiring
Fund Shares, if any) will be approximately equal to the fair market
value of its Acquired Fund Common Stock it actually or constructively
surrenders in exchange therefor;
4.3.2. Its management (a) is unaware of any plan or intention of
Stockholders to sell, or otherwise dispose of (1) any portion of their
Acquired Fund Common Stock before the Reorganization to any person
Related to either Fund or (2) any portion of the Acquiring Fund Shares
they receive in the Reorganization to any person Related to Acquiring
Fund, (b) does not anticipate dispositions of such Acquiring Fund Shares
at the time of or soon after the Reorganization to exceed the usual rate
and frequency of dispositions of Acquired Fund Common Stock, and (c)
expects that the percentage of stockholder interests, if any, that will
be disposed of as a result of or at the time of the Reorganization will
be DE MINIMIS;
4.3.3. The Stockholders will pay their own expenses (such as fees
of personal investment or tax advisers for advice concerning the
Reorganization), if any, incurred in connection with the Reorganization;
4.3.4. The fair market value of the Assets on a going concern
basis will equal or exceed the Liabilities to be assumed by Acquiring
Fund and those to which the Assets are subject;
4.3.5. There is no intercompany indebtedness between the Funds
that was issued or acquired, or will be settled, at a discount;
4.3.6. Pursuant to the Reorganization, Acquired Fund will transfer
to Acquiring Fund, and Acquiring Fund will acquire, at least 90% of the
fair market value of the net assets, and at least 70% of the fair market
A-13
value of the gross assets, Acquired Fund held immediately before the
Reorganization; for the purposes of this representation, any amounts
Acquired Fund uses to pay its Reorganization expenses and to make
redemptions and distributions immediately before the Reorganization
(except (a) regular, normal dividend distributions (i) made to conform
to its policy of distributing all or substantially all of its income and
gains to avoid the obligation to pay federal income tax and/or the
excise tax under section 4982 of the Code and (ii) on the Acquired Fund
Preferred Stock and (b) redemptions of the Acquired Fund Preferred
Stock) will be included as assets it held immediately before the
Reorganization;
4.3.7. None of the compensation received by any Stockholder who
or that is an employee of or service provider to Acquired Fund will be
separate consideration for, or allocable to, any of the Acquired Fund
Common Stock such Stockholder held; none of the Acquiring Fund Shares
any such Stockholder receives will be separate consideration for, or
allocable to, any employment agreement, investment advisory agreement,
or other service agreement; and the compensation paid to any such
Stockholder will be for services actually rendered and will be
commensurate with amounts paid to third parties bargaining at
arm's-length for similar services;
4.3.8. Immediately after the Reorganization, the Stockholders
will not own shares constituting "control" (as defined in section 304(c)
of the Code) of Acquiring Fund;
4.3.9. No expenses incurred by Acquired Fund or on its behalf in
connection with the Reorganization will be paid or assumed by Acquiring
Fund, Adviser, or any third party unless such expenses are solely and
directly related to the Reorganization (determined in accordance with
the guidelines set forth in Rev. Rul. 73-54, 1973-1 C.B. 187)
("REORGANIZATION EXPENSES"), and no cash or property other than
Acquiring Fund Shares will be transferred to Acquired Fund or any of its
stockholders with the intention that such cash or property be used to
pay any expenses (even Reorganization Expenses) thereof; and
4.3.10. The aggregate value of the acquisitions and distributions
limited by paragraphs 4.1.16, 4.2.15, and 4.2.21 will not exceed 50% of
the value (without giving effect to such acquisitions and distributions)
of the proprietary interest in Acquired Fund at the Effective Time.
5. COVENANTS
---------
5.1. Each Fund covenants to operate its business in the ordinary course
between the date hereof and the Closing, it being understood that:
(a) such ordinary course will include declaring and paying
customary dividends and other distributions and such changes in
operations as are contemplated by each Fund's normal business
activities; and
(b) each Fund will retain exclusive control of the composition of
its portfolio until the Closing.
A-14
5.2. Acquired Fund covenants that the Acquiring Fund Shares to be
delivered hereunder are not being acquired for the purpose of making any
distribution thereof, other than in accordance with the terms hereof.
5.3. Acquired Fund covenants that it will assist Acquiring Fund in
obtaining information Acquiring Fund reasonably requests concerning the
beneficial ownership of Acquired Fund Common Stock.
5.4. Acquired Fund covenants that its books and records (including all
books and records required to be maintained under the 1940 Act and the rules and
regulations thereunder) regarding Acquired Fund will be turned over to Acquiring
Fund at the Closing.
5.5. Each Fund covenants to cooperate in preparing the
Prospectus/Statement in compliance with applicable federal securities laws.
5.6. Each Fund covenants that it will, from time to time, as and when
requested by the other Fund, execute and deliver or cause to be executed and
delivered all assignments and other instruments, and will take or cause to be
taken all further action, the other Fund may deem necessary or desirable in
order to vest in, and confirm to, (a) Acquiring Fund title to and possession of
all the Assets and (b) Acquired Fund title to and possession of the Acquiring
Fund Shares to be delivered hereunder, and otherwise to carry out the intent and
purpose hereof.
5.7. Acquiring Fund covenants to use all reasonable efforts to obtain
the approvals and authorizations required by the 1933 Act, the 1940 Act, and
state securities laws it deems appropriate to continue its operations after the
Effective Time.
5.8. Acquiring Fund shall cause the Acquiring Fund Shares to be issued
hereunder to be listed on the NYSE at the Effective Time.
5.9. Once Acquired Fund files the notice and commences the redemption
process described in paragraph 6.5, it covenants to complete such process as
expeditiously as possible.
5.10. Subject to this Agreement, each Fund covenants to take or cause to
be taken all actions, and to do or cause to be done all things, reasonably
necessary, proper, or advisable to consummate and effectuate the transactions
contemplated hereby.
6. CONDITIONS PRECEDENT
--------------------
Each Fund's obligations hereunder shall be subject to (a) performance by
the other Fund of all its obligations to be performed hereunder at or before the
Effective Time, (b) all representations and warranties of the other Fund
contained herein being true and correct in all material respects at the date
hereof and, except as they may be affected by the transactions contemplated
hereby, at the Effective Time, with the same force and effect as if made at the
Effective Time, and (c) the following further conditions that, at or before the
Effective Time:
6.1. This Agreement and the transactions contemplated hereby shall have
been duly adopted and approved by both Boards, and Acquired Fund shall have
called a meeting of its stockholders to consider and act on this Agreement and
A-15
to take all other action necessary to obtain approval of the transactions
contemplated hereby ("STOCKHOLDERS MEETING").
6.2. All necessary filings shall have been made with the Commission and
state securities authorities, and no order or directive shall have been received
that any other or further action is required to permit the parties to carry out
the transactions contemplated hereby; the Registration Statement shall have
become effective under the 1933 Act, no stop orders suspending the effectiveness
thereof shall have been issued, and, to each Fund's best knowledge, no
investigation or proceeding for such purpose shall have been instituted or be
pending, threatened, or contemplated under the 1933 Act or the 1940 Act; the
Commission shall not have issued an unfavorable report with respect to the
Reorganization under section 25(b) of the 1940 Act nor instituted any
proceedings seeking to enjoin consummation of the transactions contemplated
hereby under section 25(c) of the 1940 Act; and all consents, orders, and
permits of federal, state, and local regulatory authorities (including the
Commission and state securities authorities) either Fund deems necessary to
permit consummation, in all material respects, of the transactions contemplated
hereby shall have been obtained, except where failure to obtain same would not
involve a risk of a material adverse effect on either Fund's assets or
properties, provided that either Fund may for itself waive any of such
conditions.
6.3. At the Effective Time, no action, suit, or other proceeding shall
be pending (or, to either Fund's knowledge, threatened to be commenced) before
any court, governmental agency, or arbitrator in which it is sought to enjoin
the performance of, restrain, prohibit, affect the enforceability of, or obtain
damages or other relief in connection with, the transactions contemplated
hereby.
6.4. The Funds shall have received an opinion of Kirkpatrick & Lockhart
Preston Gates Ellis LLP ("TAX COUNSEL") as to the federal income tax
consequences mentioned below ("TAX OPINION"). In rendering the Tax Opinion, Tax
Counsel may rely as to factual matters, exclusively and without independent
verification, on (a) the representations and warranties made in this Agreement,
which Tax Counsel may treat as representations and warranties made to it, and,
if Tax Counsel requests, in separate letters addressed to Tax Counsel and (b)
the certificates delivered pursuant to paragraph 3.4. The Tax Opinion shall be
substantially to the effect that, based on the facts and assumptions stated
therein and conditioned on consummation of the Reorganization in accordance with
this Agreement (without taking into account any amendment thereof to which Tax
Counsel has not agreed), for federal income tax purposes:
6.4.1. Acquiring Fund's acquisition of the Assets in exchange
solely for Acquiring Fund Shares (and, if necessary or desirable, cash
in lieu of fractional Acquiring Fund Shares) and its assumption of the
Liabilities, followed by Acquired Fund's distribution of such shares PRO
RATA to the Stockholders (and of any such cash to the Stockholders
entitled thereto) actually or constructively in exchange for their
Acquired Fund Common Stock, in complete liquidation of Acquired Fund,
will qualify as a "reorganization" (as defined in section 368(a)(1)(C)
of the Code), and each Fund will be "a party to a reorganization"
(within the meaning of section 368(b) of the Code);
6.4.2. Acquired Fund will recognize no gain or loss on the
transfer of the Assets to Acquiring Fund in exchange solely for
Acquiring Fund Shares (and, if applicable, cash) and Acquiring Fund's
A-16
assumption of the Liabilities or on the subsequent distribution of such
shares (and cash) to the Stockholders in exchange for their Acquired
Fund Common Stock;
6.4.3. Acquiring Fund will recognize no gain or loss on its
receipt of the Assets in exchange solely for Acquiring Fund Shares (and,
if applicable, cash) and its assumption of the Liabilities;
6.4.4. Acquiring Fund's basis in each Asset will be the same as
Acquired Fund's basis therein immediately before the Reorganization, and
Acquiring Fund's holding period for each Asset will include Acquired
Fund's holding period therefor (except where Acquiring Fund's investment
activities have the effect of reducing or eliminating an Asset's holding
period);
6.4.5. A Stockholder will recognize no gain or loss on the
exchange of all its Acquired Fund Common Stock solely for Acquiring Fund
Shares pursuant to the Reorganization, except to the extent the
Stockholder receives cash in lieu of a fractional Acquiring Fund Share
in the Reorganization; and
6.4.6. A Stockholder's aggregate basis in the Acquiring Fund
Shares it receives in the Reorganization will be the same as the
aggregate basis in its Acquired Fund Common Stock it actually or
constructively surrenders in exchange for such Acquiring Fund Shares
less the basis in any fractional share for which the Stockholder
receives cash in the Reorganization; and its holding period for such
Acquiring Fund Shares will include, in each instance, its holding period
for such Acquired Fund Common Stock, provided the Stockholder holds such
stock as a capital asset at the Effective Time.
Notwithstanding subparagraphs 6.4.2 and 6.4.4, the Tax Opinion may state that no
opinion is expressed as to the effect of the Reorganization on the Funds or any
Stockholder with respect to any Asset as to which any unrealized gain or loss is
required to be recognized for federal income tax purposes at the end of a
taxable year (or on the termination or transfer thereof) under a mark-to-market
system of accounting.
6.5. Before the Stockholders Meeting at which the final vote on this
Agreement is taken, Acquired Fund shall irrevocably commence the process for
redeeming the Acquired Fund Preferred Stock in accordance with its Articles
Supplementary on file with the Department.
6.6. At any time before the Closing, either Fund may waive any of the
foregoing conditions (except those set forth in paragraphs 6.1, 6.4, and 6.5)
if, in the judgment of its Board, such waiver will not have a material adverse
effect on its Fund's stockholders' interests.
7. BROKERS AND EXPENSES
--------------------
7.1. Each Fund represents and warrants to the other that there are no
brokers or finders entitled to receive any payments in connection with the
transactions provided for herein.
7.2. All Reorganization Expenses, including fees and expenses related to
printing, mailing, solicitation of proxies, and tabulation of votes, accounting,
legal, and custodial fees and expenses, and fees payable to governmental
A-17
authorities for the registration or qualification of the Acquiring Fund Shares
distributable hereunder and all transfer agency costs related thereto, shall be
borne by the Funds and the Other Acquired Fund in proportion to their respective
net assets determined at the Valuation Time, provided that if the Closings of
the Reorganization and the Other Reorganization occur at different times, that
determination will be made at the Valuation Time on the date of the first
Closing. Notwithstanding the foregoing, expenses shall be paid by the Fund
directly incurring them if and to the extent that the payment thereof by another
person would result in such Fund's disqualification as a RIC or would prevent
the Reorganization from qualifying as a tax-free reorganization.
8. ENTIRE AGREEMENT; SURVIVAL
--------------------------
Neither Fund has made any representation, warranty, or covenant not set
forth herein, and this Agreement constitutes the entire agreement between the
parties. The representations, warranties, and covenants contained herein or in
any document delivered pursuant hereto or in connection herewith (except the
covenant set forth in paragraph 5.9) shall not survive the Closing.
9. TERMINATION
-----------
This Agreement may be terminated at any time at or before the Effective
Time:
9.1. By either Fund (a) in the event of the other Fund's material breach
of any representation, warranty, or covenant contained herein to be performed at
or before the Effective Time, (b) if a condition to its obligations has not been
met and it reasonably appears that such condition will not or cannot be met, or
(c) if the Closing has not occurred on or before [_________ __], 2008, or such
other date as to which the Funds may agree; or
9.2. By the Funds' mutual agreement.
In the event of termination under paragraphs 9.1(c) or 9.2, neither Fund (nor
its directors/trustees, officers, or stockholders/shareholders) shall have any
liability to the other Fund.
10. AMENDMENT
---------
This Agreement may be amended, modified, or supplemented at any time in
any manner mutually agreed on in writing by the Funds, notwithstanding Acquired
Fund's stockholders' approval thereof; provided that, following such approval no
such amendment, modification, or supplement shall have a material adverse effect
on the Stockholders' interests.
11. MISCELLANEOUS
-------------
11.1. This Agreement shall be governed by and construed in accordance
with the internal laws of the State of Delaware, without giving effect to
principles of conflict of laws; provided that, in the case of any conflict
between such laws and the federal securities laws, the latter shall govern.
A-18
11.2. Nothing expressed or implied herein is intended or shall be
construed to confer on or give any person, firm, trust, or corporation other
than the parties and their respective successors and assigns any rights or
remedies under or by reason of this Agreement.
11.3 This Agreement may be executed in one or more counterparts, all of
which shall be considered one and the same agreement, and shall become effective
when one or more counterparts have been executed by each Fund and delivered to
the other Fund. The headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.
11.4. Any term or provision of this Agreement that is invalid or
unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective
to the extent of such invalidity or unenforceability without rendering invalid
or unenforceable the remaining terms and provisions hereof or affecting the
validity or enforceability of any of the terms and provisions hereof in any
other jurisdiction.
11.5 Notice is hereby given that this instrument is adopted on behalf of
Acquiring Fund's trustees solely in their capacities as trustees, and not
individually, and that Acquiring Fund's obligations under this instrument are
not binding on or enforceable against any of its trustees, officers, or
shareholders but are only binding on and enforceable against its property.
Acquired Fund, in asserting any rights or claims under this Agreement, shall
look only to Acquiring Fund's property in settlement of such rights or claims
and not to such trustees, officers, or shareholders.
IN WITNESS WHEREOF, each party has caused this Agreement to be executed
and delivered by its duly authorized officers as of the day and year first
written above.
[NAME OF ACQUIRED FUND]
By:
--------------------------------
Name:
------------------------------
Title:
-----------------------------
HIGHLAND CREDIT STRATEGIES FUND
By:
--------------------------------
Name:
------------------------------
Title:
-----------------------------
A-19
APPENDIX B
DESCRIPTION OF INVESTMENT TYPES
----------------------------------------------------------------------------------------------------------------------------
ILLIQUID SECURITIES Certain of a Fund'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.
----------------------------------------------------------------------------------------------------------------------------
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 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 a Fund, a
reduction in the value of the investment and a potential decrease in the NAV of a Fund. 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, a Fund
could experience delays or limitations with respect to its ability to realize the benefits of the
collateral securing a senior loan. To the extent that a senior loan is collateralized by stock in
the borrower or its subsidiaries, such stock may lose all or substantially all of its value in the
event of the bankruptcy of a borrower. Some senior loans are subject to the risk that a court,
pursuant to fraudulent conveyance or other similar laws, could subordinate senior loans to
presently existing or future indebtedness of the borrower or take other action detrimental to the
holders of senior loans including, in certain circumstances, invalidating such senior loans or
causing interest previously paid to be refunded to the borrower. If interest were required to be
refunded, it could negatively affect a Fund'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 Fund may invest, and the issuers of such loans, may not be rated by a
rating agency, will not be registered with the SEC or any state securities commission and will not
be listed on any national securities exchange. The amount of public information available with
respect to issuers of senior loans will generally be less extensive than that available for issuers
of registered or exchange listed securities. In evaluating the creditworthiness of borrowers, the
Adviser will consider, and may rely in part, on analyses performed by others. The 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 a
Fund 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
or BB and below by 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 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 a Fund's actual loss recovery experience will be consistent with the
----------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------------
Adviser's prior experience or that a Fund'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. 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 a Fund's NAV.
USE OF AGENTS. 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 a Fund 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 a Fund 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, a Fund would incur certain costs and delays in realizing payment or could suffer
a loss of principal or interest. In this event, a Fund could experience a decrease in NAV.
FORM OF INVESTMENT. A Fund'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 a
Fund is a member of the originating syndicate for a senior loan, it may share in a fee paid to the
syndicate. When a Fund 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. A Fund will act as lender, or purchase an assignment or participation, with respect to
a senior loan only if the agent is determined by the Adviser to be creditworthy.
ORIGINAL LENDER. When a Fund 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.
ASSIGNMENTS. When a Fund 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.
PARTICIPATIONS. A Fund may also invest in participations in senior loans. The rights of a Fund
when it acquires a participation are likely to be more limited than the rights of an original
----------------------------------------------------------------------------------------------------------------------------
B-2
----------------------------------------------------------------------------------------------------------------------------
lender or an investor who acquired an assignment. Participation by a Fund in a lender's portion of
a senior loan typically means that the Fund has only a contractual relationship with the lender,
not with the borrower. This means that the Fund 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, a Fund 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, a Fund 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 Fund may be subject to
delays, expenses and risks that are greater than those that exist when the Fund is the original
lender or holds an assignment. This means the Fund must assume the credit risk of both the borrower
and the lender selling the participation. A Fund will consider a purchase of participations only in
those situations where the 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 a
Fund 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. A Fund attempts to manage this credit risk through multiple different investments within
the portfolio and ongoing analysis and monitoring of borrowers. A Fund also is subject to market,
liquidity, interest rate and other risks.
----------------------------------------------------------------------------------------------------------------------------
SECOND LIEN Second lien loans are loans made by public and private corporations and other non-governmental
LOANS 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, a Fund 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 Secured loans other than senior loans and second lien loans are made by public and private
LOANS 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
----------------------------------------------------------------------------------------------------------------------------
B-3
----------------------------------------------------------------------------------------------------------------------------
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, a Fund 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 by public and private corporations and other non-governmental
entities and issuers for a variety of purposes. Unsecured loans generally have lower priority in
right of payment compared to holders of secured debt of the borrower. Unsecured loans are not
secured by a security interest or lien to or on specified collateral securing the 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, a Fund 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 A Fund may invest in a wide variety of bonds that are rated or determined by the Adviser to be of
SECURITIES 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
----------------------------------------------------------------------------------------------------------------------------
B-4
----------------------------------------------------------------------------------------------------------------------------
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.
----------------------------------------------------------------------------------------------------------------------------
NON-INVESTMENT GRADE A Fund may invest in securities rated below investment grade, such as those rated Ba or lower by
SECURITIES 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.
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 a Fund to sell certain securities or could result in lower prices than those used in
calculating the Fund's NAV.
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 a Fund'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 a Fund invests in lower grade securities that have not been rated by a rating agency,
the Fund's ability to achieve its investment objectives will be more dependent on Highland's credit
analysis than would be the case when the Fund invests in rated securities.
----------------------------------------------------------------------------------------------------------------------------
B-5
----------------------------------------------------------------------------------------------------------------------------
ASSET-BACKED Asset-backed securities are generally issued as pass-through certificates, which represent
SECURITIES 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 A Fund may invest in certain asset-backed securities that are securitizing certain financial assets
OBLIGATIONS AND BOND by issuing securities in the form of negotiable paper that are issued by a financing company
OBLIGATIONS (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.
A Fund 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.
----------------------------------------------------------------------------------------------------------------------------
DISTRESSED DEBT A Fund may 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. A Fund
may invest in securities of a company for purposes of gaining control.
----------------------------------------------------------------------------------------------------------------------------
STRESSED DEBT A Fund may 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
----------------------------------------------------------------------------------------------------------------------------
B-6
----------------------------------------------------------------------------------------------------------------------------
results in market pricing uncertainty.
----------------------------------------------------------------------------------------------------------------------------
COMMON STOCKS Common stocks are shares 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 stock 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, a Fund generally expects to focus
primarily on the security's dividend paying capacity rather than on its potential for capital
appreciation. A Fund 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.
A Fund may also acquire warrants or other rights to purchase a borrower's common stock in
connection with the making of a senior loan.
----------------------------------------------------------------------------------------------------------------------------
PREFERRED Preferred securities are equity securities, but they have many characteristics of fixed income
SECURITIES securities, such as a fixed dividend payment rate and/or a liquidity preference over the issuer's
common shares. However, because preferred securities are equity securities, they may be more
susceptible to risks traditionally associated with equity investments than a Fund'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
stock are convertible into other equity securities. Perpetual preferred stocks provide a fixed
dividend throughout the life of the issue, with no mandatory retirement provisions, but may be
callable. Sinking fund preferred stocks provide for the redemption of a portion of the issue on a
regularly scheduled basis with, in most cases, the entire issue being retired at a future date. The
value of fixed rate preferred stocks can be expected to vary inversely with interest rates.
Adjustable rate preferred stocks have a variable dividend rate which is determined periodically,
typically quarterly, according to a formula based on a specified premium or discount to the yield
on particular U.S. Treasury securities, typically the highest base-rate yield of one of three U.S.
Treasury securities: the 90-day Treasury bill; the 10-year Treasury note; and either the 20-year or
30-year Treasury bond or other index. The premium or discount to be added to or subtracted from
this base-rate yield is fixed at the time of issuance and cannot be changed without the approval of
the holders of the adjustable rate preferred stock. Some adjustable rate preferred stocks have a
maximum and a minimum rate and in some cases are convertible into common stock.
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 A convertible security is a bond, debenture, note, preferred stock or other security that may be
SECURITIES 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. 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.
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.
----------------------------------------------------------------------------------------------------------------------------
B-7
----------------------------------------------------------------------------------------------------------------------------
MONEY MARKET Money market instruments include short-term U.S. government securities, U.S. dollar-denominated,
INSTRUMENTS 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 U.S. government securities may include debt obligations of varying maturities issued by the U.S.
SECURITIES 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 A Fund may invest in the securities of other investment companies to the extent that such
COMPANIES investments are consistent with the Fund's investment objectives and principal investment
strategies and permissible under the 1940 Act. Under one provision of the 1940 Act, a Fund may not
acquire the securities of other investment companies if, as a result, (i) more than 10% of the
Fund'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 Fund or (iii) more than 5% of the Fund's total assets would be
invested in any one investment company. Other provisions of the 1940 Act are less restrictive
provided that a Fund 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.
A Fund, as a holder of the securities of other investment companies, will bear its pro rata portion
----------------------------------------------------------------------------------------------------------------------------
B-8
----------------------------------------------------------------------------------------------------------------------------
of the other investment companies' expenses, including advisory fees. These expenses will be in
addition to the direct expenses incurred by a Fund.
----------------------------------------------------------------------------------------------------------------------------
EXCHANGE TRADED FUNDS Subject to the limitations on investment in other investment companies, a Fund 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 or the
National Association of Securities Dealers' Automatic Quotation System (NASDAQ). ETFs may be based
on underlying equity or fixed income securities. SPDRs, for example, seek to provide investment
results that generally correspond to the performance of the component common stocks of the S&P 500.
ETFs do not sell individual shares directly to investors and only issue their shares in large
blocks known as "creation units." The investor purchasing a creation unit may sell the individual
shares on a secondary market. Therefore, the liquidity of ETFs depends on the adequacy of the
secondary market. 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. A Fund, 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 Fund's own operations.
----------------------------------------------------------------------------------------------------------------------------
ZERO COUPON SECURITIES Zero coupon securities 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. A Fund 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 Fund's distribution obligations, in which case the Fund will
forego the purchase of additional income producing assets with these funds.
----------------------------------------------------------------------------------------------------------------------------
DEFERRED PAYMENT Deferred payment securities are securities that remain zero coupon securities until a predetermined
OBLIGATIONS 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.
----------------------------------------------------------------------------------------------------------------------------
DERIVATIVE A Fund may purchase and sell derivative instruments such as exchange-listed and over-the-counter
TRANSACTIONS 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. A Fund also may purchase derivative instruments that combine features of
these instruments. A Fund may 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 Fund's portfolio, protect the value of the
Fund's portfolio, facilitate the sale of certain securities for investment purposes, manage the
effective interest rate exposure of the Fund, protect against changes in currency exchange rates,
manage the effective maturity or duration of the Fund'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 Adviser's ability to predict pertinent market movements,
which cannot be assured. Thus, the use of Derivative Transactions may result in losses greater than
----------------------------------------------------------------------------------------------------------------------------
B-9
----------------------------------------------------------------------------------------------------------------------------
if they had not been used, may require a Fund to sell or purchase portfolio securities at
inopportune times or for prices other than current market values, may limit the amount of
appreciation a Fund can realize on an investment, or may cause a Fund to hold a security that it
might otherwise sell. The use of currency transactions can result in a Fund incurring losses as a
result of the imposition of exchange controls, suspension of settlements or the inability of a Fund
to deliver or receive a specified currency. Additionally, amounts paid by a Fund as premiums and
cash or other assets held in margin accounts with respect to Derivative Transactions are not
otherwise available to the Fund for investment purposes.
----------------------------------------------------------------------------------------------------------------------------
SENIOR LOAN BASED A Fund may obtain exposure to senior loans and baskets of senior loans through the use of
DERIVATIVES derivative instruments. Such derivative instruments have recently become increasingly available.
The Adviser reserves the right to utilize these instruments and similar instruments that may be
available in the future. For example, a Fund 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 a Fund 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. A Fund 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 DEFAULT SWAPS To the extent consistent with Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"), a Fund 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. A Fund may be either the buyer
or seller in the transaction. If a Fund is a buyer and no event of default occurs, the Fund 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, a
Fund 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 a Fund 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. A Fund 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 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 a Fund acts as a seller of a credit default swap
agreement it is exposed to many of the same risks of leverage described under "Risk Factors And
Special Considerations-Leverage Risk" since if an event of default occurs the seller must pay the
buyer the full notional value of the reference obligation.
----------------------------------------------------------------------------------------------------------------------------
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,
----------------------------------------------------------------------------------------------------------------------------
B-10
----------------------------------------------------------------------------------------------------------------------------
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. A Fund intends to enter into swaps primarily on a net
basis, i.e., the two payment streams are netted out, with the Fund 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 Fund's risk of loss will consist of the net amount of payments that the Fund is contractually
entitled to receive. The net amount of the excess, if any, of the Fund's obligations over its
entitlements will be maintained in a segregated account by the Fund's custodian. A Fund 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 Adviser. If there is a default by the other party to such
a transaction, the Fund 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 a Fund with another party of their respective
commitments to pay or receive interest (e.g., an exchange of fixed rate payments for floating rate
payments).
----------------------------------------------------------------------------------------------------------------------------
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).
----------------------------------------------------------------------------------------------------------------------------
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).
----------------------------------------------------------------------------------------------------------------------------
CREDIT-LINKED NOTES A credit-linked notes ("CLNs") 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.
----------------------------------------------------------------------------------------------------------------------------
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 a Fund expires unexercised, the Fund realizes on the expiration date a
capital gain equal to the premium received by the Fund at the time the option was written. If an
option purchased by a Fund expires unexercised, the Fund 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 a Fund desires. A Fund 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. A Fund 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 Fund will realize a capital loss. If the premium
received from a closing sale transaction is more than the premium paid to purchase the option, a
Fund will realize a capital gain or, if it is less, the Fund will realize a capital loss.
----------------------------------------------------------------------------------------------------------------------------
FUTURES CONTRACTS The sale of a futures contract creates an obligation by a Fund, as seller, to deliver the specific
----------------------------------------------------------------------------------------------------------------------------
B-11
----------------------------------------------------------------------------------------------------------------------------
AND OPTIONS ON type of financial instrument called for in the contract at a specified future time for a specified
FUTURES CONTRACTS price. Options on futures contracts are similar to options on securities except that an option on a
futures contract gives the purchaser the right in return for the premium paid to assume a position
in a futures contract (a long position if the option is a call and a short position if the option
is a put).
At the time a futures contract is purchased or sold, a Fund must allocate cash or securities as a
deposit payment ("initial margin"). It is expected that the initial margin that a Fund 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, a
Fund 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.
A Fund'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.
----------------------------------------------------------------------------------------------------------------------------
FORWARD FOREIGN A Fund may enter into forward currency contracts to purchase or sell foreign currencies for a fixed
CURRENCY CONTRACTS amount of U.S. dollars or another foreign currency. A forward currency contract involves an
obligation to purchase or sell a specific currency at a future date, which may be any fixed number
of days from the date of the forward currency contract agreed upon by the parties, at a price set
at the time the forward currency contract is entered into. Forward currency contracts are traded
directly between currency traders (usually large commercial banks) and their customers.
----------------------------------------------------------------------------------------------------------------------------
SHORT SALES A short sale is a transaction in which a Fund sells a security it does not own in anticipation that
the market price of that security will decline. When a Fund 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. A
Fund may have to pay a fee to borrow particular securities and is often obligated to pay over any
payments received on such borrowed securities.
A Fund'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. A Fund 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 a Fund on such security, the Fund 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 a
Fund replaces the borrowed security, the Fund will incur a loss; conversely, if the price declines,
the Fund will realize a gain. Any gain will be decreased, and any loss increased, by the
transaction costs described above. Although a Fund's gain is limited to the price at which it sold
the security short, its potential loss is unlimited.
A Fund 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 stock 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.
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 a Fund to unlimited risk with
---------------------------------------------------------------------------------------------------------------------------
B-12
----------------------------------------------------------------------------------------------------------------------------
respect to that security due to the lack of an upper limit on the price to which an instrument can
rise.
----------------------------------------------------------------------------------------------------------------------------
CAPITAL STRUCTURE Capital structure arbitrage typically involves establishing long and short positions in securities
ARBITRAGE (or their derivatives) at different tiers within an issuer's capital structure in ratios designed
to maintain a generally neutral overall exposure to the issuer while exploiting a pricing
inefficiency. Some issuers may also have more than one class of shares or an equivalent vehicle
that trades in a different market (e.g., European equities and their American Depositary Receipt
counterparts). This strategy seeks to profit from the disparity in prices between the various
related securities in anticipation that over time all tiers and classes will become more
efficiently priced relative to one another.
----------------------------------------------------------------------------------------------------------------------------
PAIR TRADES Pair trades involve the establishment of a long position in one security and a short position in
another security at the same time. A pair trade attempts to minimize the effect of larger market
trends and emphasizes the performance of one security relative to another.
----------------------------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENTS Repurchase agreements are loans or arrangements under which a Fund 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 Fund's purchase price, with the difference being
income to the Fund. Under the direction of the Board, the Adviser reviews and monitors the
creditworthiness of any institution which enters into a repurchase agreement with a Fund. 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 a Fund's custodian in a segregated, safekeeping account for the
benefit of the Fund. Repurchase agreements afford a Fund 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, a Fund 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 a Fund has not perfected a security interest in
the security, the Fund 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, a Fund would be at risk of losing
some or all of the principal and interest involved in the transaction. A Fund may enter into
repurchase agreements with broker-dealers, member banks of the Federal Reserve System and other
financial institutions.
----------------------------------------------------------------------------------------------------------------------------
REVERSE REPURCHASE A reverse repurchase agreement is an instrument under which a Fund sells an underlying debt
AGREEMENTS security and simultaneously obtains the commitment of the purchaser (generally, a commercial bank
or a broker or dealer) to sell the security back to the Fund at an agreed upon price on an agreed
upon date. Reverse repurchase agreements could involve certain risks in the event of default or
insolvency of the other party, including possible delays or restrictions upon a Fund's ability to
dispose of the underlying securities. An additional risk is that the market value of securities
sold by a Fund under a reverse repurchase agreement could decline below the price at which the Fund
is obligated to repurchase them. Reverse repurchase agreements will be considered borrowings by a
Fund and as such would be subject to any restrictions on borrowing.
----------------------------------------------------------------------------------------------------------------------------
PAY-IN-KIND BONDS Pay-in-kind, or "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, a Fund 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, a Fund 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.
----------------------------------------------------------------------------------------------------------------------------
WHEN-ISSUED, A Fund may purchase securities on a "when-issued" basis and may purchase or sell securities on a
DELAYED-DELIVERY "forward commitment" basis in order to acquire the security or to offset against anticipated
AND FORWARD 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
----------------------------------------------------------------------------------------------------------------------------
B-13
----------------------------------------------------------------------------------------------------------------------------
COMMITMENT payment for the securities take place at a later date. When-issued securities and forward
PURCHASES commitments may be sold prior to the settlement date, but a Fund 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 a Fund 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 a Fund 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 a Fund. There is always a risk that the securities may
not be delivered and that a Fund may incur a loss. Settlements in the ordinary course, which may
take substantially more than five business days, are not treated by a Fund as when-issued or
forward commitment transactions and accordingly are not subject to the foregoing restrictions.
----------------------------------------------------------------------------------------------------------------------------
SECURITIES LOANS A Fund may lend assets to registered broker-dealers or other institutional investors deemed by the
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. A Fund 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. A Fund
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. A Fund will lend portfolio
securities only to firms that have been approved in advance by the Board, which will monitor the
creditworthiness of any such firms.
----------------------------------------------------------------------------------------------------------------------------
FOREIGN SECURITIES A Fund may invest in non-U.S. securities, which may include securities denominated in U.S. dollars
or in non-U.S. currencies or multinational currency units. A Fund may invest in non-U.S. securities
of so-called emerging market issuers. For purposes of Credit Strategies Fund, 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, A
Fund 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.
----------------------------------------------------------------------------------------------------------------------------
INVERSE FLOATERS A Fund may invest in leveraged inverse floating rate debt instruments ("Inverse Floaters"). The
----------------------------------------------------------------------------------------------------------------------------
B-14
----------------------------------------------------------------------------------------------------------------------------
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.
----------------------------------------------------------------------------------------------------------------------------
TEMPORARY DEFENSIVE During periods in which Highland determines that it is temporarily unable to follow a Fund's
POSITION 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 Fund 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 a Fund'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 Fund's investment
strategy is extremely limited or absent. In such a case, shares of a Fund may be adversely affected
and the Fund may not pursue or achieve its investment objectives.
----------------------------------------------------------------------------------------------------------------------------
B-15
STATEMENT OF ADDITIONAL INFORMATION
RELATING TO REORGANIZATION OF
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
AND
PROSPECT STREET INCOME SHARES INC.
(each an "Acquired Fund" and collectively the "Acquired Funds")
INTO
HIGHLAND CREDIT STRATEGIES FUND
(the "Acquiring Fund," and together with the Acquired Funds, the "Funds")
DATED [__________], 2008
This Statement of Additional Information ("SAI") is available to the
shareholders of Prospect Street High Income Portfolio Inc. ("High Income
Portfolio") and Prospect Street Income Shares Inc. ("Income Shares") in
connection with proposed reorganizations (each a "Reorganization" and
collectively the "Reorganizations") whereby each Acquired Fund will reorganize
into the Acquiring Fund and shareholders of each Acquired Fund will receive
common shares of the Acquiring Fund equal to the net asset value of their
holdings in that Acquired Fund. Each Acquired Fund will then (1) de-register
with the Securities and Exchange Commission (the "SEC"), (2) de-list from the
NYSE and (3) dissolve under Maryland corporate law. Unless otherwise defined
herein, capitalized terms have the meanings given to them in the Proxy Statement
and Prospectus dated [________], 2008, relating to the Reorganizations (the
"Proxy Statement/Prospectus").
THIS SAI IS NOT A PROSPECTUS AND SHOULD BE READ IN CONJUNCTION WITH THE PROXY
STATEMENT/PROSPECTUS. A copy of the Proxy Statement/Prospectus may be obtained,
without charge, by writing to Highland Funds, c/o PFPC Inc., P.O. Box 9840,
Providence, RI 02940. You may also obtain a copy of the Proxy
Statement/Prospectus on the SEC's web site at (http://www.sec.gov).
Credit Strategies Fund's annual report to shareholders dated December 31, 2007,
High Income Portfolio's annual report to shareholders dated October 31, 2007,
and Income Shares' annual report to shareholders dated December 31, 2007 are
incorporated by reference into (and therefore legally part of) this Statement of
Additional Information.
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Investment Restrictions..................................................
Additional Investment Information........................................
Management of the Funds..................................................
Portfolio Transactions and Brokerage.....................................
Tax Matters..............................................................
Additional Information...................................................
Pro Forma Financial Statements...........................................
Appendix A Ratings of Investments........................................ A-1
Appendix B Proxy Voting Procedures....................................... B-1
ii
INVESTMENT RESTRICTIONS
CREDIT STRATEGIES FUND
----------------------
Except as described below, the Acquiring Fund, as a fundamental policy, may
not, without the approval of the holders of a majority of the outstanding common
shares and preferred shares, if any, voting together as a single class, and of
the holders of a majority of the outstanding preferred shares, if any, voting as
a separate class:
(1) invest 25% or more of the value of its total assets in any single
industry or group of industries;
(2) issue senior securities or borrow money other than as permitted by the
Investment Company Act of 1940, as amended (the "1940 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 Acquiring Fund'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 Acquiring Fund'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 Acquiring Fund may be deemed to be an underwriter;
(5) purchase or sell real estate, except that the Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund'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 Acquiring
Fund becoming subject to registration with the Commodity Futures Trading
Commission (the "CFTC") as a commodity pool.
As currently relevant to the Acquiring Fund, the 1940 Act requires an asset
coverage of 200% for a closed-end fund issuing preferred stock and for
borrowings exceeding 5% of the Acquiring Fund's assets (excluding temporary
borrowings).
The Acquiring Fund will not engage in any activities described under
investment restriction number 2 pursuant to which the lenders would be able to
foreclose on more than 33 1/3% of the Acquiring Fund's total assets.
The Acquiring Fund is also subject to the following non-fundamental
restrictions and policies, which may be changed by the Acquiring Fund's Board of
Trustees ("Acquiring Fund Board") and without shareholder approval. The
Acquiring Fund 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 Acquiring Fund's total assets and the Acquiring Fund'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 Acquiring Fund 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 Acquiring Fund 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 1940 Act or any exemptive relief obtained
thereunder. Under the 1940 Act, the Acquiring Fund 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 shares of any one investment company, provided the
1
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 Acquiring Fund will bear its ratable share of that
investment company's expenses and will remain subject to payment of advisory
fees and other expenses with respect to assets invested therein. Holders of
common shares will therefore be subject to duplicative expenses to the extent
the Acquiring Fund 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 regulated investment company, the Acquiring Fund's investments must meet
certain diversification requirements. See "Tax Matters."
For purposes of this SAI, a "majority of the outstanding" shares means (a)
67% or more of a Fund's outstanding voting securities present at a meeting, if
the holders of more than 50% of its outstanding voting securities are present or
represented by proxy, or (b) more than 50% of its outstanding voting securities,
whichever is less (a "1940 Act Majority Vote").
The percentage limitations applicable to the Acquiring Fund's portfolio
described in the Proxy Statement/Prospectus and this SAI apply only at the time
of investment, except that the percentage limitation with respect to borrowing
applies at all times, and the Acquiring Fund will not be required to sell
securities due to subsequent changes in the value of securities it owns.
INCOME SHARES
-------------
Income Shares' investment objectives, its policy to invest at least 50% of
its total assets in debt securities rated in the four highest rating categories
assigned by nationally recognized rating agencies, or other securities such as
U.S. and Canadian government securities, obligations of or guaranteed by banks,
commercial paper and cash equivalents, or nonrated debt securities deemed by
Highland Capital Management, L.P. ("Highland" or "Adviser") to be of comparable
quality, and all of the investment restrictions listed below have been adopted
by Income Shares as fundamental policies. Fundamental policies of Income Shares
may not be changed without a 1940 Act Majority Vote of the shares of common
stock and preferred stock, voting as separate classes. All other investment
policies or practices are considered by Income Shares not to be fundamental and
accordingly may be changed by Income Shares' Board of Directors ("Income Shares
Board") without stockholder approval.
Income Shares will not:
1. Issue senior securities as defined in the 1940 Act, except in
connection with borrowing permitted in restriction 2 below, issuing a class or
classes of preferred stock to the extent permitted under the 1940 Act or to the
extent investments in interest rate futures contracts or fixed income options
permitted in restriction 19 below are considered to result in the issuance of
senior securities.
2. Borrow money, except for investment leverage.
3. Mortgage, pledge or hypothecate its assets, except in connection with
borrowing money as mentioned in restriction 2 above or the issuance of a class
or classes of preferred stock as described in restriction 1 above. This
provision shall not apply to deposits, or similar arrangements, made in
connection with the entering into or holding of interest rate futures contracts
or purchasing, selling, holding or writing fixed income options.
4. Act as underwriter, except to the extent that, in connection with the
disposition of restricted portfolio securities, Income Shares may be deemed to
be an underwriter under applicable laws.
5. Purchase or sell real estate or interests in real estate, except that
Income Shares may invest in securities secured by real estate or interests
therein or issued by companies, including real estate investment trusts, which
deal in real estate or interests therein.
2
6. Purchase or sell commodities or commodity contracts, except that
Income Shares may enter into interest rate futures contracts or fixed income
options and make deposits or have similar arrangements in connection therewith.
7. Invest more than 5% of the value of its total assets in the securities
of any one issuer (other than cash items and securities of the U.S. government
or its agencies or instrumentalities), or purchase more than 10% of any class of
the outstanding voting securities of any one issuer.
8. Invest more than 25% of the value of its total assets in
restricted securities, which are securities acquired in private placement
transactions.
9. Invest more than 25% of the value of its total assets in securities
of issuers in any one industry (gas, electric and telephone companies will be
considered to be in separate industries, as will banks, finance companies,
savings and loan associations, insurance companies and other credit
institutions) except that at times when a significant portion of the market for
corporate debt securities is composed of issues in the electric utility industry
or the telephone utility industry, as the case may be, Income Shares may invest
up to 35% of its assets in the issues of such industry if Income Shares has cash
for such investment and if, in the judgment of management, the return available
from such securities and the marketability, quality and availability thereof
justify such concentration in light of Income Shares' investment objectives. The
market for corporate debt securities will be considered to be composed of a
significant portion of debt securities of either, the electric utility industry
or the telephone utility industry, as the case may be, at any time that, to the
best of Income Shares' knowledge, 10% or more of the principal amounts of all
new issue offerings of corporate debt securities in principal amounts of
$25,000,000 or more and within the four highest grades assigned by Moody's
Investors Service, Inc. ("Moody's"), Standard & Poor's, a division of The
McGraw-Hill Companies, Inc. ("Standard & Poor's"), or Fitch, Inc., offered
within the prior 60-day period or scheduled to be offered during the subsequent
30-day period consists of such issues in such industry.
10. Purchase or retain the securities of any issuer, if, to Income Shares'
knowledge, those officers or directors of Income Shares or of the Adviser who
individually own beneficially more than 0.5% of the outstanding securities of
such issuer, together own beneficially more than 5% of such outstanding
securities.
11. Make loans to other persons, except for the purchase of debt
securities in private placement transactions or public offerings in accordance
with Income Shares' investment objectives and policies and for loans of
portfolio securities as described above.
12. Purchase securities on margin, except that Income Shares may obtain
such short-term credits as may be necessary for the clearance of purchases or
sales of securities, and except that Income Shares may enter into and hold
interest rate futures contracts and purchase, sell, hold or write fixed income
options and may make deposits or make similar arrangements in connection
therewith.
13. Participate on a joint or joint and several basis in any securities
trading account. The "bunching" of orders for the sale or purchase of marketable
portfolio securities and other accounts under the management of the Adviser or
affiliates to save commissions or to average prices among them is not deemed to
result in a securities trading account.
14. Purchase interests in oil, gas, or other mineral exploration programs;
however, this limitation will not prohibit the acquisition of securities of
companies engaged in the production of or transmission of oil, gas or other
materials.
15. Invest in puts, calls or combinations thereof except fixed income
options.
16. Make short sales, except sales "against the box."
17. Purchase the securities of other investment companies.
3
18. Invest for the purposes of exercising control or management.
19. Enter into any interest rate futures contract or write any fixed
income option if, immediately thereafter, the sum of (a) the then aggregate
futures and option market prices of financial instruments and fixed income
options required to be delivered under open futures contract sales of Income
Shares and open fixed income call options written by Income Shares and (b) the
aggregate purchase price under open futures contract purchases of Income Shares
and open fixed income put options written by Income Shares, would exceed, in the
aggregate, an amount equal to the lesser of (i) 5% of Income Shares' net asset
value or (ii) one-third of the total assets of Income Shares less all
liabilities not related to fixed income options written by Income Shares and
interest rate futures contracts.
Although the provisions of restriction 3 (with respect to futures
contracts), 6 and 12 permit Income Shares to certain practices to a limited
extent, Income Shares does not have any current intention of engaging in such
practices. Income Shares will not make any investment permitted by the
exceptions to Income Shares' investment restrictions if the investment would
adversely affect the ratings assigned by Moody's and/or Standard & Poor's to its
outstanding preferred stock.
Notwithstanding restriction 6, Income Shares is permitted to buy certain
debt securities, known as Principal Exchange Rate Linked Securities (PERLS), in
which the interest or principal component is determined by calculating with
reference to a formula based on one or more commodities, including currencies,
so long as the security does not constitute a commodity or commodity contract.
For example, Income Shares may buy certain debt securities issued by the Federal
National Mortgage Association ("FNMA"), a U.S. government agency, which carry an
additional risk not associated with other FNMA issues. They pay interest based
upon a specified interest rate and a principal amount denominated in U.S.
dollars. At maturity, the principal is paid in U.S. dollars, but the amount of
principal that will be paid is calculated according to a predetermined formula
involving the value of one or more foreign currencies on a particular date near
the maturity date (the "principal payment formula"). This kind of security is
subject to the risk that the currency that is part of the principal payment
formula may be valued at an amount which could cause the principal paid at
maturity to be greater or less than the amount of principal upon which the
interest rate is calculated.
By virtue of restriction 8, it would be possible for Income Shares to
invest up to 25% of its assets in restricted securities, which are securities
acquired in private placement transactions. Such securities generally may not be
resold without registration under the Securities Act of 1933, as amended (the
"Securities Act"), except in transactions exempt from the registration
requirements of the Securities Act. This limitation on resale can have an
adverse effect on the price obtainable for such securities. Also, if in order to
permit resale, the securities are registered under the Securities Act at Income
Shares' expense, Income Shares' expenses would be increased.
By virtue of restriction 9, it would be possible for Income Shares to
invest up to 70% of its assets in securities of the electric utility and
telephone utility industries (up to 35% in each of such industries) if Income
Shares had cash for such investment and if, in Income Shares' judgment, the
return available from such industry, and the marketability, quality and
availability of the debt securities of such industry, justified such
concentration in light of Income Shares' investment objectives. However, if
sufficient cash was not available or if the securities available did not meet
the above-mentioned tests of return, marketability, quality and availability,
such concentration would not occur. Also, Income Shares would not be required to
sell portfolio securities in order to make cash available for such
concentration, although Income Shares would not be prohibited from doing so.
Furthermore, Income Shares' ability to so concentrate its assets would always be
contingent upon compliance with other applicable investment restrictions.
Concentration of Income Shares' assets in either the electric utility or the
telephone utility industries could result in increased risks. Risks of
investments in either industry may arise from difficulties in obtaining an
adequate return on capital because of financing costs and construction programs
and the fact that regulatory authorities might not approve rate increases
sufficient to offset increases in operating expenses. In addition, risks of
investments in the electric utility industry may arise from environmental
conditions, fuel shortages and government-mandated energy conservation programs.
By virtue of restriction 19, Income Shares has a limited ability to enter
into interest rate futures contracts and to write fixed income options. Interest
rate futures contracts and fixed income options create an obligation by Income
Shares to purchase or to sell a specific financial instrument at a specified
future time at a specified price. The principal risk of interest rate futures
4
contracts and fixed income options is that unexpected changes in the general
level of interest rates could adversely affect the value of the investment.
Income Shares has not written fixed income options for several years and has
never entered into interest rate futures contracts.
If a percentage restriction is adhered to at the time of investment, a
later increase or decrease in percentage resulting from a change in value of
Income Shares' investments or amount of total assets will not be considered a
violation of any of the foregoing restrictions. With respect to restriction 2,
however, if borrowings exceed the amount permitted under the 1940 Act as a
result of a change in values or assets, Income Shares must take steps to reduce
such borrowings at least to the extent of such excess.
HIGH INCOME PORTFOLIO
---------------------
High Income Portfolio's investment objective, its policy to invest at least
65% of its total assets in high-yield securities rated in the lower categories
by recognized rating agencies or nonrated fixed-income securities deemed by the
Adviser to be of comparable quality and the following investment restrictions
have been adopted by High Income Portfolio as fundamental policies. Fundamental
policies of High Income Portfolio may not be changed without a 1940 Act Majority
Vote of the shares of common stock and preferred stock, voting as separate
classes. All other investment policies or practices are considered by High
Income Portfolio not to be fundamental and accordingly may be changed by High
Income Portfolio's Board of Directors ("High Income Board") (collectively, High
Income Board, Income Shares Board and Acquiring Fund Board, the "Boards")
without stockholder approval.
High Income Portfolio may not:
1. Borrow money (through reverse repurchase agreements or otherwise) or
issue any senior securities (as defined in the 1940 Act), except as permitted by
the 1940 Act.
2. Pledge, hypothecate, mortgage or otherwise encumber its assets,
except to secure borrowings permitted by restriction 1 above. Collateral
arrangements with respect to margin for futures contracts and options are not
deemed to be pledges or other encumbrances for purposes of this restriction.
3. Purchase securities on margin, except such short-term credits as may
be necessary for the clearance of purchases and sales of securities and except
that High Income Portfolio may make margin payments in connection with
transactions in futures contracts and options.
4. Make short sales of securities or maintain a short position for the
account of High Income Portfolio unless at all times when a short position is
open High Income Portfolio owns an equal amount of such securities or owns
securities which, without payment of any further consideration, are convertible
into or exchangeable for securities of the same issuer as, and in equal amount
to, the securities sold short.
5. Underwrite securities issued by other persons, except to the extent
that, in connection with the disposition of its portfolio investments, High
Income Portfolio may be deemed to be an underwriter under the federal securities
laws.
6. Purchase or sell real estate, although High Income Portfolio may
purchase securities of issuers that deal in real estate, securities that are
secured by interests in real estate and securities representing interests in
real estate.
7. Purchase or sell commodities or commodity contracts, except that High
Income Portfolio may purchase or sell financial futures contracts and related
options as provided in the Proxy Statement/Prospectus and this SAI.
8. Make loans, except by the acquisition of loan interests and other debt
obligations in which High Income Portfolio may invest consistent with its
investment policies, by entering into repurchase agreements with respect to not
more than 25% of the value of its total assets, or through the lending of its
portfolio securities with respect to not more than one-third of the value of its
total assets.
5
9. With respect to 75% of the value of High Income Portfolio's total
assets, invest in securities of any issuer if, immediately after such
investment, more than 5% of the value of High Income Portfolio's total assets
would be invested in the securities of such issuer, provided that this
limitation does not apply to obligations issued or guaranteed as to interest and
principal by the U.S. government or its agencies or instrumentalities.
10. With respect to 75% of the value of High Income Portfolio's total
assets, acquire more than 10% of the outstanding voting securities of any
issuer.
11. Invest 25% or more of the value of its total assets in any one
industry, provided that this limitation does not apply to obligations issued or
guaranteed as to interest and principal by the U.S. government or its agencies
or instrumentalities.
12. Invest in the securities of other registered investment companies,
except as they may be acquired as part of a merger or consolidation or
acquisition of assets or by purchases in the open market involving only
customary brokers' commissions.
13. Buy or sell oil, gas or other mineral leases, rights or royalty
contracts, although High Income Portfolio may purchase securities of issuers
which deal in, represent interests in or are secured by interests in such
leases, rights or contracts.
14. Make investments for the purpose of exercising control or management
over the issuer of any security.
15. Write, purchase or sell puts, calls or combinations thereof, or
purchase or sell futures contracts or related options, except that High Income
Portfolio may write call options and invest in futures contracts and related
options as provided in the Proxy Statement/Prospectus and this SAI.
With respect to restriction 1, the 1940 Act permits a closed-end investment
company, such as High Income Portfolio, to issue a note in consideration for any
privately arranged loan that is not intended to be publicly distributed, or a
note evidencing a temporary loan that does not exceed 5% of the company's total
assets at the time it is made. The 1940 Act also permits closed-end investment
companies to issue senior securities representing debt or preferred stock,
subject to certain conditions. With respect to restrictions 1 and 2, the 1940
Act permits a closed-end investment company to borrow (leverage) by issuing debt
in an amount up to 33 1/3% of its total assets and by issuing preferred stock in
an amount up to 50% of its total assets (as described in the Proxy
Statement/Prospectus, in the case of debt, the company must have asset coverage
of 300% immediately after such issuance, and, in the case of stock, 200%
coverage is required). As such, under restriction 2, High Income Portfolio may
pledge, hypothecate, mortgage or otherwise encumber its assets in connection
with such borrowings permitted under restriction 1 in amounts up to 33 1/3% of
its total assets. In addition to the prohibitions listed in restriction 6, High
Income Portfolio has no intention to purchase or sell real estate or invest in
real estate mortgages.
Although the provisions of certain restrictions permit High Income
Portfolio to engage in transactions in futures contracts to a limited extent,
High Income Portfolio does not have any current intention of engaging in such
transactions. High Income Portfolio will not make any investment permitted by
the exceptions to High Income Portfolio's investment restrictions if the
investment would adversely affect the ratings assigned by Standard & Poor's
and/or Moody's to its outstanding preferred stock.
If a percentage restriction is adhered to at the time of investment, a
later increase or decrease in percentage resulting from a change in value of
High Income Portfolio's investments or amount of total assets will not be
considered a violation of any of the foregoing restrictions. With respect to
restriction 1, however, if borrowings exceed the amount permitted under the 1940
Act as a result of a change in values or assets, High Income Portfolio must take
steps to reduce such borrowings at least to the extent of such excess.
6
ADDITIONAL INVESTMENT INFORMATION
CREDIT STRATEGIES FUND
----------------------
The following is a description of the various investments Acquiring Fund
may acquire, whether as a primary or secondary strategy. The information
supplements the discussion of the Acquiring Fund's investment objectives,
policies and techniques that are described in the Proxy Statement/Prospectus.
SHORT-TERM DEBT SECURITIES
For temporary defensive purposes or to keep cash on hand, the Acquiring
Fund 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:
(1) U.S. government securities, including bills, notes and bonds differing
as to maturity and rates of interest that are either issued or guaranteed
by the U.S. Treasury or by U.S. government agencies or instrumentalities.
U.S. government securities include securities issued by (a) the Federal
Housing Administration, Farmers Home Administration, Export-Import Bank of
the United States, Small Business Administration, and Government National
Mortgage Association, whose securities are supported by the full faith and
credit of the United States; (b) the Federal Home Loan Banks, Federal
Intermediate Credit Banks, and Tennessee Valley Authority, whose securities
are supported by the right of the agency to borrow from the U.S. Treasury;
(c) the Federal National Mortgage Association, 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 Acquiring Fund may not be fully
insured by the Federal Deposit Insurance Corporation.
(3) Repurchase agreements, which involve purchases of debt securities. At
the time the Acquiring Fund 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
Acquiring Fund 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 Acquiring Fund to invest
temporarily available cash. The Acquiring Fund 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 Acquiring Fund may invest. Repurchase agreements
may be considered loans to the seller, collateralized by the underlying
securities. The risk to the Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund. If the seller were to be
subject to a federal bankruptcy proceeding, the ability of the Acquiring
Fund to liquidate the collateral could be delayed or impaired because of
certain provisions of the bankruptcy laws.
7
(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 Acquiring Fund and a
corporation. There is no secondary market for such notes. However, they
are redeemable by the Acquiring Fund 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 Acquiring Fund'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 Acquiring Fund may invest in equity securities including preferred
stock, 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.
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 Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund 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
8
variable and floating rate instruments must satisfy the same criteria as set
forth above for the Acquiring Fund. The absence of an active secondary market
with respect to particular variable and floating rate instruments, however,
could make it difficult for the Acquiring Fund to dispose of a variable or
floating rate instrument if the issuer defaulted on its payment obligation or
during periods when the Acquiring Fund 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 Acquiring Fund to dispose of a variable or floating rate note
if the issuer defaulted on its payment obligation or during periods that the
Acquiring Fund is not entitled to exercise its demand rights, and the Acquiring
Fund 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 Acquiring Fund 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
Proxy Statement/Prospectus and in addition to its option strategy, the Acquiring
Fund may also enter into certain risk management transactions. In particular,
the Acquiring Fund 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 Acquiring
Fund's portfolio resulting from fluctuations in the securities markets and
changes in interest rates, to protect the Acquiring Fund'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 Acquiring
Fund 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
Acquiring Fund may use are described below. Although the Acquiring Fund
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 Acquiring Fund 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 Acquiring Fund
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 Acquiring Fund will engage in such transactions only
for bona fide risk management and other portfolio management purposes.
FORWARD FOREIGN CURRENCY CONTRACTS. The Acquiring Fund 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 Acquiring Fund may engage in various forward currency contract
strategies:
o The Acquiring Fund may purchase a forward currency contract to lock in
the U.S. dollar price of a security denominated in a foreign currency
that the Acquiring Fund intends to acquire. The Acquiring Fund may
9
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.
o The Acquiring Fund may also use forward currency contracts to shift
the Acquiring Fund's exposure to foreign currency exchange rate
changes from one currency to another. For example, if the Acquiring
Fund owns securities denominated in a foreign currency and Highland
believes that currency will decline relative to another currency, the
Acquiring Fund 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.
o The Acquiring Fund 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.
o The Acquiring Fund 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.
o The Acquiring Fund could also enter into a forward currency contract
to sell another currency expected to perform similarly to the currency
in which the Acquiring Fund'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 Acquiring
Fund's existing investments are denominated.
o The Acquiring Fund 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.
o The cost to the Acquiring Fund of engaging in forward currency
contracts varies with factors such as the currency involved, the
length of the contract period and the market conditions then
prevailing. Because forward currency contracts are usually entered
into on a principal basis, no fees or commissions are involved.
o When the Acquiring Fund 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 Acquiring Fund 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
Acquiring Fund might be unable to close out a forward currency
contract. In either event, the Acquiring Fund 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 Acquiring Fund might
need to purchase or sell foreign currencies in the spot (cash) market
to the extent such foreign currencies are not covered by forward
currency contracts. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a
short-term strategy is highly uncertain.
CALLS ON SECURITIES, INDICES AND FUTURES CONTRACTS. In addition to its
option strategy, in order to enhance income or reduce fluctuations on net asset
value, the Acquiring Fund 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
10
time during the option period. All such calls sold by the Acquiring Fund must be
"covered" as long as the call is outstanding (I.E., the Acquiring Fund 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 Acquiring
Fund exposes the Acquiring Fund 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 Acquiring Fund to hold
an instrument which it might otherwise have sold. The purchase of a call gives
the Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund may also
sell puts on securities, indices or futures contracts on such securities if the
Acquiring Fund'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 Acquiring Fund 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
Acquiring Fund may enter into are interest rate swaps and the purchase or sale
of interest rate caps and floors. The Acquiring Fund 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 Acquiring Fund anticipates
purchasing at a later date. The Acquiring Fund intends to use these transactions
for risk management purposes and not as a speculative investment. The Acquiring
Fund will not sell interest rate caps or floors that it does not own. Interest
rate swaps involve the exchange by the Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund believe such obligations do
not constitute senior securities, and, accordingly will not treat them as being
subject to its borrowing restrictions. The Acquiring Fund will accrue the net
amount of the excess, if any, of the Acquiring Fund'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 Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund 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.
11
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 Acquiring Fund 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 Acquiring Fund. The
Acquiring Fund's risk of loss in a credit derivative transaction varies with the
form of the transaction. For example, if the Acquiring Fund purchases a default
option on a security, and if no default occurs with respect to the security, the
Acquiring Fund'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
Acquiring Fund'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 Acquiring Fund'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 Acquiring
Fund'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 Acquiring Fund being in a worse position than if such
techniques had not been used.
Certain provisions of the Internal Revenue Code of 1986, as amended
("Code"), may affect the Acquiring Fund's ability 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 Proxy Statement/Prospectus, the Acquiring
Fund will engage in Derivative Transactions. The Acquiring Fund will engage in
such activities in the 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 Acquiring Fund occur. The Acquiring Fund'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 Acquiring Fund 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 Acquiring Fund 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
Acquiring Fund'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 Acquiring Fund 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 Acquiring Fund will experience a loss in the amount of the
option premium plus any related commissions. When the Acquiring Fund sells put
and call options, it receives a premium as the seller of the option. The premium
that the Acquiring Fund 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
12
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 Acquiring Fund 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 Acquiring Fund'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 Acquiring
Fund. With OTC Options, such variables as expiration date, exercise price and
premium will be agreed upon between the Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund 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
Acquiring Fund, 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 Acquiring Fund must allocate cash or securities as a deposit payment
("initial margin"). It is expected that the initial margin that the Acquiring
Fund 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 Acquiring Fund
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 Acquiring Fund'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 Acquiring Fund currently may enter into such transactions
without limit for bona fide strategic purposes, including risk management and
duration management and other portfolio strategies. The Acquiring Fund may also
engage in transactions in futures contracts or related options for non-strategic
purposes to enhance income or gain provided that the Acquiring Fund 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
13
the amount of its initial deposits and premiums on open contracts and options
would exceed 5% of the Acquiring Fund'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 Acquiring Fund's Board at any time.
Also, when required, an account of cash equivalents designated on the books and
records will be maintained and marked to market on a daily basis in an amount
equal to the market value of the contract.
SEGREGATION AND COVER REQUIREMENTS. Futures contracts, interest rate swaps,
caps, floors and collars, short sales, reverse repurchase agreements and dollar
rolls, and listed or OTC options on securities, indices and futures contracts
sold by the Acquiring Fund are generally subject to earmarking and coverage
requirements of either the CFTC or the SEC, with the result that, if the
Acquiring Fund does not hold the security or futures contract underlying the
instrument, the Acquiring Fund 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 Acquiring Fund's
obligations with respect to such instruments.
SUCH AMOUNTS FLUCTUATE AS THE OBLIGATIONS INCREASE OR DECREASE. The
earmarking requirement can result in the Acquiring Fund 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 Acquiring Fund'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 Acquiring Fund 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 Acquiring Fund to successfully utilize Derivative Transactions will
depend on the 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 Acquiring Fund 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 Acquiring Fund 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
BRADY BONDS
The Acquiring Fund'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 Acquiring Fund may purchase have no or limited
collateralization, and the Acquiring Fund 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
Acquiring Fund may invest are likely to be acquired at a discount.
14
MEZZANINE INVESTMENTS
The Acquiring Fund 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 Acquiring Fund 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 Acquiring
Fund'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 Acquiring Fund having a contractual relationship only with the
Lender not the borrower. The Acquiring Fund 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 Acquiring Fund and only upon
receipt by the Lender of the payments by the borrower. In connection with
purchasing Participations, the Acquiring Fund 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 Acquiring
Fund may not directly benefit from any collateral supporting the Loan in which
is has purchased the Participation. As a result the Acquiring Fund 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 Acquiring Fund 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 Acquiring Fund will acquire Participations only if the Lender
interpositioned between the Acquiring Fund and the borrower is determined by
Highland to be creditworthy. When the Acquiring Fund purchases Assignments from
Lenders, the Acquiring Fund 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 Acquiring Fund as the purchaser of an Assignment may differ from, and be
more limited than, those held by the assigning Lender.
The Acquiring Fund may have difficulty disposing of Assignments and
Participations. Because there is no liquid market for such securities, the
Acquiring Fund 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 Acquiring
Fund's ability to dispose of particular Assignments or Participations when
necessary to meet the Acquiring Fund'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 Acquiring Fund to assign
a value to those securities for purposes of valuing the Acquiring Fund's
portfolio and calculating its net asset value.
STRUCTURED INVESTMENTS
The Acquiring Fund 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 Acquiring Fund anticipates it will invest typically involve no
credit enhancement, their credit risk generally will be equivalent to that of
the underlying instruments.
15
The Acquiring Fund 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 1940 Act. As a result, the Acquiring Fund's
investment in these Structured Investments may be limited by the restrictions
contained in the 1940 Act. Structured Investments are typically sold in private
placement transaction, and there currently is no active trading market for
Structured Investments.
PROJECT LOANS
The Acquiring Fund 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.
HIGH INCOME PORTFOLIO
---------------------
The following is a description of the investments of High Income Portfolio
may acquire, whether as a primary or secondary strategy. The following
information supplements the discussion of the High Income Portfolio's investment
objectives, policies and techniques that are described in the Proxy
Statement/Prospectus.
FOREIGN INVESTMENTS
High Income Portfolio may invest up to 10% of the value of its total assets
in securities principally traded in foreign markets and Eurodollar certificates
of deposit issued by branches of U.S. and foreign banks. Foreign investments may
involve risks not present to the same degree in domestic investments, such as
future political and economic developments, the imposition of withholding taxes
on interest income, seizure or nationalization of foreign deposits, the
establishment of exchange controls or the adoption of other foreign governmental
restrictions which might adversely affect the payment of principal and interest
on such obligations. Foreign securities may be less liquid and more volatile
than U.S. securities, and foreign accounting and disclosure standards may differ
from U.S. standards. In addition, settlement of transactions in foreign
securities may be subject to delays, which could result in adverse consequences
to High Income Portfolio including restrictions on the subsequent resale of such
securities. The value of foreign investments may rise or fall because of changes
in currency exchange rates. In addition, the costs of exchanging foreign
currencies for payments in U.S. dollars and nonnegotiated brokerage commissions
in foreign countries may reduce the yield on foreign securities. In the event of
a default in payment on foreign securities, High Income Portfolio may incur
increased costs to obtain a judgment against the foreign issuer in the United
States or abroad.
High Income Portfolio may buy or sell foreign currencies or deal in forward
foreign currency contracts to hedge against possible fluctuations in exchange
rates that may affect the yield of High Income Portfolio when the foreign
currencies are converted in payment in U.S. dollars. High Income Portfolio will
use currency transactions only for hedging and not speculative purposes. High
Income Portfolio may engage in currency exchange transactions to protect against
uncertainty in the level of future exchange rates. 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 contract agreed upon
by the parties, at a price set at the time of the contract. High Income
Portfolio's dealings in forward currency exchange will be limited to hedging
involving either specific transactions or portfolio positions. Transaction
hedging is the purchase or sale of forward currency with respect to specific
receivables or payables of High Income Portfolio generally arising in connection
with the purchase or sale of its portfolio securities. Position hedging is the
sale of forward currency with respect to portfolio security positions
denominated or quoted in the currency. High Income Portfolio may not use
position hedging with respect to a particular currency to an extent greater than
the aggregate market value (at the time of entering into the position hedge) of
the securities held in its portfolio denominated or quoted in or currently
convertible into that particular currency. If High Income Portfolio enters into
a position hedging transaction, High Income Portfolio will set aside cash or
permissible liquid securities in an amount equal to the value of High Income
Portfolio's total assets committed to the consummation of the forward contract.
If the value of the securities set aside declines, High Income Portfolio will
set aside additional cash or permissible liquid securities to equal the amount
16
of High Income Portfolio's commitment with respect to the forward contract.
OPTIONS
High Income Portfolio may write (sell) call options which are traded on
national securities exchanges with respect to securities in its portfolio. High
Income Portfolio may only write "covered" call options, that is, options on
securities it holds in its portfolio or has an immediate right to acquire
through conversion or exchange of securities held in its portfolio. High Income
Portfolio may write call options on its portfolio securities in an attempt to
realize a greater current return than would be realized on the securities alone.
High Income Portfolio also may write call options as a partial hedge against a
possible market decline. In view of its investment objective, High Income
Portfolio generally would write call options only in circumstances in which the
Adviser does not anticipate significant appreciation of the underlying security
in the near future or has otherwise determined to dispose of the security. As
the writer of a call option, High Income Portfolio receives a premium for
undertaking the obligation to sell the underlying security at a fixed price
during the option period if the option is exercised. So long as High Income
Portfolio remains obligated as a writer of a call option, it forgoes the
opportunity to profit from increases in the market price of the underlying
security above the exercise price of the option, except insofar as the premium
represents such a profit (and retains the risk of loss should the value of the
underlying security decline). High Income Portfolio also may enter into "closing
purchase transactions" to terminate its obligation as a writer of a call option
prior to the expiration of the option. Although the writing of call options only
on national securities exchanges increases the likelihood that High Income
Portfolio will be able to make closing purchase transactions, there is no
assurance that High Income Portfolio will be able to effect such transactions at
any particular time or at any acceptable price. The writing of call options
could result in increases in High Income Portfolio's portfolio turnover rate,
especially during periods when market prices of the underlying securities
appreciate. The extent to which High Income Portfolio may enter into
transactions involving call options also may be limited by the requirements of
the Code for qualification as a regulated investment company.
FINANCIAL FUTURES CONTRACTS AND RELATED OPTIONS
Currently, High Income Portfolio has no intention to trade in financial
futures contracts or options on financial futures contracts. However, High
Income Portfolio has reserved the right, subject to the approval of the High
Income Board, to purchase and sell financial futures contracts and options on
such futures contracts for the purpose of hedging its portfolio securities (or
portfolio securities which it expects to acquire) against anticipated changes in
prevailing interest rates. This technique could be employed if the Adviser
anticipates that interest rates may rise, in which event High Income Portfolio
could sell a futures contract to protect against the potential decline in the
value of its portfolio securities. Conversely, if declining interest rates were
anticipated, High Income Portfolio could purchase a futures contract to protect
against a potential increase in the price of securities High Income Portfolio
intends to purchase.
High Income Portfolio will not be a commodity pool. In addition, High
Income Portfolio has claimed an exclusion from the definition of commodity pool
operator and, therefore, is not subject to registration or regulation as a pool
operator under the Commodity Exchange Act.
RISKS OF HEDGING TRANSACTIONS
The use of options, financial futures and options on financial futures may
involve risks not associated with other types of investments which High Income
Portfolio intends to purchase and it is possible that a portfolio that utilizes
hedging strategies may not perform as well as a portfolio that does not make use
of such strategies. In particular, High Income Portfolio's positions in options
and financial futures may be entered and closed out only on a federally licensed
exchange which provides a market therefor, and there can be no assurance that a
liquid market will exist for any particular option or futures contract. Because
financial futures and related options markets generally impose limits on daily
price movement, it is possible that the Adviser will not be able to close out
hedge positions promptly. The inability to close out options and futures
positions could have an adverse impact on High Income Portfolio's ability to
hedge its securities effectively and might, in some cases, require High Income
Portfolio to deposit substantial amounts of additional cash to meet applicable
margin requirements. High Income Portfolio's ability to hedge effectively
through transactions in financial futures or options depends on the degree to
which price movements, which include, in part, changes in interest rates, in
17
High Income Portfolio's holdings correlate with price movements of the hedging
instruments. Inasmuch as High Income Portfolio's options and futures will not
duplicate such underlying securities, the correlation probably will not be
perfect. Consequently, the prices, which include, in part, changes in interest
rates, of the securities being hedged may not move in the same amount as the
hedging instrument. It is possible that there may be a negative correlation
between the hedging instrument and the hedged securities, which would prevent
High Income Portfolio from achieving the anticipated benefits of hedging
transactions or may cause High Income Portfolio to realize losses and thus be in
a worse position than if such strategies had not been used.
ADDITIONAL LEVERAGE
Although it has no current intention of doing so, High Income Portfolio may
borrow to the extent then permitted by the 1940 Act through the public or
private issuance of debt securities and/or from lenders of all types, such as
banks, savings and loan associations, insurance companies and similar financial
institutions. In addition, High Income Portfolio may borrow up to 5% of its
total assets for temporary purposes.
MANAGEMENT OF THE FUNDS
DIRECTORS/TRUSTEES
The Boards provide broad oversight over the operations and affairs of the
Funds and they protect the interests of shareholders. The Boards have overall
responsibility to manage and control the business affairs of the Funds,
including the complete and exclusive authority to establish policies regarding
the management, conduct and operation of the Funds' business. The names and ages
of the Directors/Trustees and officers of the Funds, 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 director/trustee and other
directorships or trusteeships they hold are shown below.
NUMBER OF
---------
PORTFOLIOS IN
-------------
POSITION TERM OF OFFICE HIGHLAND FUND
-------- -------------- -------------
NAME, ADDRESS(1) WITH EACH AND LENGTH OF PRINCIPAL OCCUPATION(S) COMPLEX OTHER DIRECTORSHIPS/
---------------- --------- ------------- ----------------------- ------- --------------------
AND AGE FUND TIME SERVED(2) DURING PAST FIVE YEARS OVERSEEN(3) TRUSTEESHIPS HELD
------- ---- -------------- ---------------------- ----------- -----------------
INDEPENDENT DIRECTORS/TRUSTEES(4)
---------------------------------
Timothy Hui
(Age 59) Director Director of High Dean of Educational 12 None
of Income Income Portfolio Resources since July
Shares since January 2000 2006; Assistant Provost
and High (with a term for Graduate Education
Income expiring at the from July 2004 to June
Portfolio; 2008 annual 2006, and Assistant
Trustee meeting) and Provost for Educational
of Credit Income Shares Resources from July 2001
Strategies since July 2001 to June 2004, Philadelphia
Fund (with a term Biblical University.
expiring at the
2009 annual
meeting).
Trustee
of Credit
Strategies Fund
2006 (with a
term expiring at
the 2008 annual
meeting).
18
Scott
Kavanaugh Director Director of Private Investor 12 None
(Age 47) of Income High Income since February
Shares Portfolio since 2004. Sales
and High January 2000 Representative at
Income (with a term Round Hill
Portfolio; expiring at the Securities from
Trustee 2008 annual March 2003 to
of Credit meeting) and January 2004;
Strategies Income Shares Executive at
Fund since July 2001 Provident Funding
(with a term Mortgage
expiring at the Corporation,
2009 annual February 2003 to
meeting); July 2003;
Trustee of Executive Vice
Credit President. Director
Strategies Fund and CAO, Commercial
since 2006 Capital Bank,
(with a term January 2000 to
expiring at the February 2003;
2008 annual Managing Principal
meeting). 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.
James F. Leary
(Age 78) Director Director of Managing Director, 12 Board Member
of High Income Benefit Capital of Capstone
Income Portfolio since Southwest, Inc. (a Group of Funds
Shares January 2000 financial (7 portfolios).
and (with a term consulting firm)
High expiring at the since January 1999.
Income 2009 annual
Portfolio; meeting) and
Trustee Income Shares
of since July 2001
Credit (with a term
Strategies expiring at the
Fund 2010 annual
meeting); Trustee
of Credit Strategies
Fund since 2006
(with a term
expiring at the 2010
annual meeting).
Bryan A. Ward
(Age 52) Director Director of Senior Manager 12 None
of High Income since January 2002
Income Portfolio since and Special
Shares November 2001 Projects Advisor,
and (with a term Accenture, LLP
High expiring at the (consulting firm)
Income 2009 annual with focus on the
Portfolio; meeting) and oil and gas
Trustee Income Shares industry, from
of since July 2001 September 1998 to
Credit (with a term December 2001.
19
Strategies expiring at the
Fund 2010 annual
meeting); Trustee
of Credit Strategies
Fund since 2006
(with a term expiring
at the 2010 annual
meeting).
INTERESTED DIRECTOR/TRUSTEE
---------------------------
R. Joseph Senior Director of High Senior Portfolio None
Dougherty(5) Vice Income Shares since Manager of the Adviser 12
(Age 37) President 2004 (with a term since 2000. Director and
of the expiring at the 2010 Senior Vice President of
Funds; annual meeting) the funds in the Highland
Director of and Income Shares Fund Complex.
Income since 2004 (with a
Shares term expiring at the
and 2008 annual meeting);
High Trustee of Credit
Income Strategies Fund
Portfolio; since 2006 (with a
Trustee term expiring at
of the 2008 annual
Credit meeting). Senior
Strategies Vice President of
Fund High Income Shares
since January 2000,
Income Shares since
July 2001, and
Credit Strategies
Fund since 2006.
(1) The address of each Director/Trustee 13455 Noel Road, Suite 800, Dallas, Texas 75240.
(2) Each Fund's Board is divided into three classes with the term of office of one class expiring each year.
(3) The Highland Fund Complex consists of all of the registered investment companies advised by the
Adviser as of the date of this SAI. In addition, each of the Directors/Trustees oversees Highland Distressed
Opportunities Fund, Inc., a closed-end company that has filed an election to be regulated as a business
development company under the 1940 Act.
(4) Independent Directors/Trustees are those who are not "interested persons" as that term is defined under
section 2(a)(19) of the 1940 Act.
(5) Mr. Dougherty is deemed to be an "interested person" of each Fund under the 1940 Act because of his
position with the Adviser.
In addition to Mr. Dougherty, each Fund's other executive officers are
James D. Dondero, Mark K. Okada, M. Jason Blackburn and Michael Colvin. Set
forth below are the names and certain biographical and other information for
Messrs. Dondero, Okada, Blackburn and Colvin as reported by them to each Fund.
20
OFFICERS(1)
-----------
POSITION WITH EACH FUND, TERM
-----------------------------
OF OFFICE(3) AND LENGTH OF PRINCIPAL OCCUPATION(S)
-------------------------- -----------------------
NAME AND AGE AND ADDRESS(2) TIME SERVED DURING PAST FIVE YEARS
--------------------------- ----------- ----------------------
James D. Dondero Chief Executive Officer and President and Director of
(Age 45) President of Credit Strand Advisors, Inc.
Strategies Fund since May ("Strand"), the General
2006, High Income Portfolio Partner of the Adviser;
since January 2000 and Income Chairman of the Board of
Shares since July 2001. Directors of Highland
Financial Partners and
President of the funds
in the Highland Fund
Complex.
Mark Okada Executive Vice President of Executive Vice President of
(Age 45) Credit Strategies Fund since Strand; Chief Investment
May 2006, High Income Officer of the Adviser and
Portfolio since January 2000 Executive Vice President of
and Income Shares since July the funds in the Highland
2001. Fund Complex.
M. Jason Blackburn Secretary and Treasurer of Assistant Controller of the
(Age 31) Credit Strategies Fund since Adviser since November 2001
May 2006, High Income and Treasurer and Secretary
Portfolio and Income Shares of the funds in the Highland
since March 2003. Fund Complex; Accountant,
KPMG LLP, September 1999
to October 2001.
Michael Colvin Chief Compliance Officer of General Counsel and Chief
(Age 38) the Funds since July 2007. Compliance Officer of the
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, 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) Each officer serves in the same capacity for each of the Highland Funds.
(2) The address of each officer is 13455 Noel Road, Suite 800, Dallas, Texas 75240.
(3) Each officer serves for an indefinite term.
BENEFICIAL OWNERSHIP OF EQUITY SECURITIES OF FUNDS
DOLLAR RANGE AGGREGATE DOLLAR RANGE
DOLLAR RANGE DOLLAR RANGE OF EQUITY OF EQUITY SECURITIES
OF EQUITY OF EQUITY SECURITIES OVERSEEN BY TRUSTEES IN
SECURITIES SECURITIES IN IN CREDIT THE FAMILY OF
IN HIGH INCOME INCOME STRATEGIES REGISTERED INVESTMENT
NAME OF DIRECTOR/TRUSTEE PORTFOLIO SHARES FUND COMPANIES
------------------------------- ----------------- ----------------- ------------------- -------------------------
INTERESTED DIRECTOR/TRUSTEE
R. Joseph Dougherty $50,001 - $100,000 $50,001 - $100,000 $1 - $10,000 over $100,000
INDEPENDENT DIRECTORS/TRUSTEES
Bryan A. Ward $1 - $10,000 $1 - $10,000 $0 $1 - $10,000
21
Scott F. Kavanaugh $50,001 - $100,000 $0 $0 $50,001 - $100,000
James F. Leary $10,001 - $50,000 $0 $0 $10,001 - $50,000
Timothy K. Hui $1 - $10,000 $1 - $10,000 $0 $1 - $10,000
COMPENSATION OF DIRECTORS/TRUSTEES
The executive officers of the Funds and the Directors/Trustees who are
"interested persons" (as defined in the 1940 Act) receive no direct remuneration
from the Funds. Effective January 1, 2008, each Independent Director/Trustee
receives an annual retainer of $150,000 payable in quarterly installments and
allocated among each portfolio in the Highland Funds Complex based upon relative
net assets. Prior to January 1, 2008, the Independent Directors/Trustees of High
Income Portfolio, Income Shares and Credit Strategies Fund were compensated at a
rate of $15,000, $5,000 and $7,500 annually. Independent Directors/Trustees are
reimbursed for actual out-of-pocket expenses relating to attendance at meetings.
The following table summarizes the compensation paid by each Fund to the
Directors/Trustees and the aggregate compensation paid by the Highland Fund
Complex to the Directors/Trustees.
AGGREGATE AGGREGATE AGGREGATE AGGREGATE
COMPENSATION COMPENSATION COMPENSATION COMPENSATION
FROM HIGH FROM INCOME FROM CREDIT FROM HIGHLAND
INCOME PORTFOLIO SHARES FOR THE STRATEGIES FUND FUND COMPLEX
FOR THE FISCAL FISCAL YEAR ENDED FOR THE FISCAL FOR THE CALENDAR
YEAR ENDED DECEMBER 31, YEAR ENDED YEAR ENDED
NAME OF TRUSTEE OCTOBER 31, 2007 2007 DECEMBER 31, 2007 DECEMBER 31, 2007
----------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
R. Joseph Dougherty $0 $0 $0 $0
INDEPENDENT TRUSTEES
Bryan A. Ward $15,000 $5,000 $7,500 $122,722
Scott F. Kavanaugh $15,000 $5,000 $7,500 $122,722
James F. Leary $15,000 $5,000 $7,500 $122,722
Timothy K. Hui $15,000 $5,000 $7,500 $122,722
BOARD COMMITTEES
In connection with the Boards' responsibility for the overall management
and supervision of the Funds' affairs, the Directors/Trustees meet periodically
throughout the year to oversee the Funds' activities, review contractual
arrangements with service providers for the Funds and review the Funds'
performance. To fulfill these duties, each Fund has an Audit Committee, a
Nominating Committee, a Litigation Committee and a Qualified Legal Compliance
Committee.
The Audit Committee consists of Bryan Ward, Scott Kavanaugh, James Leary
and Timothy Hui. 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 each Fund's accounting
and financial reporting processes and the audits of each Fund's financial
statements and (ii) providing assistance to the board of directors/trustees of
each Fund in connection with its oversight of the integrity of each Fund's
financial statements, each Fund's compliance with legal and regulatory
requirements and the independent registered public accounting firm's
qualifications, independence and performance. The Boards have determined that
each Fund 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 each Fund. The Audit Committee
for High Income Portfolio met three times in the fiscal year ended October 31,
22
2007. The Audit Committee for Income Shares met three times in the fiscal year
ended December 31, 2007. The Audit Committee for Credit Strategies Fund met
three times in the fiscal year ended December 31, 2007.
The Nominating Committee's function is to canvass, solicit, recruit,
interview and nominate directors/trustees. The Nominating Committee will
consider recommendations for nominees from shareholders sent to the Secretary of
each Fund, 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 directors/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 a
Board 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. Ward, Kavanaugh, Leary and Hui. The Nominating Committee for High Income
Portfolio met one time in the fiscal year ended October 31, 2007. The Nominating
Committee for Income Shares met one time in the fiscal year ended December 31,
2007. The Nominating Committee for Credit Strategies Fund met one time in the
fiscal year ended December 31, 2007.
The Litigation Committee's function is to seek to address any potential
conflicts of interest between or among each Fund and the Adviser in connection
with any potential or existing litigation or other legal proceeding relating to
securities held by each Fund and the Adviser or another client of the Adviser.
The Litigation Committee is comprised of Messrs. Ward, Kavanaugh, Leary and Hui.
The Litigation Committee for High Income Portfolio met 4 times in the fiscal
year ended October 31, 2007. The Litigation Committee for Income Shares did not
meet in the fiscal year ended December 31, 2007. The Litigation Committee for
Credit Strategies Fund also did not meet in the fiscal year ended December 31,
2007.
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 each
Fund who appear and practice before the SEC on behalf of that Fund. The QLCC is
comprised of Messrs. Ward, Kavanaugh, Leary and Hui. There were no QLCC meetings
during the fiscal years ended October 31, 2007 or December 31, 2007.
PROXY VOTING POLICIES AND PROCEDURES
The Boards of the Funds have delegated the voting of proxies for each
Fund's securities to Highland pursuant to Highland's proxy voting policies and
procedures. Under these policies and procedures, Highland will vote proxies
related to each Fund's securities in the best interests of each Fund and its
shareholders. A copy of Highland's proxy voting policies and procedures is
attached as Appendix B to this SAI. Each Fund's proxy voting record for the most
recent 12-month period ending December 31 will be available (i) without charge,
upon request, by calling 1-877-665-1287 and (ii) on the SEC's web site
(http://www.sec.gov).
CODES OF ETHICS
Each Fund and the Adviser have adopted codes of ethics under Rule 17j-1 of
the 1940 Act. These codes permit personnel subject to the codes to invest in
securities, including securities that may be purchased or held by each Fund.
These codes can be reviewed and copied at the SEC's Public Reference Room in
Washington, D.C. Information on the operation of the Public Reference Room may
be obtained by calling the SEC at 1-202-551-8090. The codes of ethics are
available on the EDGAR Database on the SEC'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 SEC's Public Reference Section, Washington, D.C. 20549-0102.
ADMINISTRATION SERVICES
Pursuant to the Acquiring Fund's administration services agreement,
Highland performs the following services: (i) prepare monthly security
transaction listings; (ii) supply various normal and customary statistical data
as requested on an ongoing basis; (iii) prepare for execution and file the
Acquiring Fund'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 Form 1099 calculations; (iv) coordinate contractual
23
relationships and communications between the Acquiring Fund and its contractual
service providers; (v) coordinate printing of the Acquiring Fund'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 Acquiring Fund's compliance with Code, SEC and prospectus
requirements; (ix) prepare, coordinate with the Acquiring Fund's counsel and
coordinate the filing with the SEC: semi-annual reports on Form N-SAR and Form
N-CSR; Form N-Q; and Form N-PX based upon information provided by the Acquiring
Fund, 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 1940
Act for the officers and trustees of the Acquiring Fund, 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
Acquiring Fund in accordance with the requirements of Rule 17g-1 and 17d-1(d)(7)
under the 1940 Act as such bond and policies are approved by the Acquiring
Fund's board of trustees; (xii) monitor the Acquiring Fund'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 Acquiring Fund's calendar
to assure compliance with various filing and board approval deadlines; (xvii)
furnish the Acquiring Fund 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 Acquiring Fund; (xviii)
assist the Acquiring Fund in the handling of SEC examinations and responses
thereto; (xix) perform clerical, bookkeeping and all other administrative
services not provided by the Acquiring Fund's other service providers; (xx)
determine or oversee the determination and publication of the Acquiring Fund's
net asset value in accordance with the Acquiring Fund's policy as adopted from
time to time by the Board of Trustees; (xxi) oversee the maintenance by the
Acquiring Fund's custodian and transfer agent and dividend disbursing agent of
certain books and records of the Acquiring Fund as required under Rule
31a-1(b)(2)(iv) of the 1940 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 Acquiring Fund; (xxii)
prepare such information and reports as may be required by any stock exchange or
exchanges on which the Acquiring Fund's shares are listed; (xxiii) determine the
amounts available for distribution as dividends and distributions to be paid by
the Acquiring Fund to its shareholders; prepare and arrange for the printing of
dividend notices to shareholders; and provide the Acquiring Fund'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 Acquiring Fund's dividend reinvestment plan; (xxiv) serve as liaison between
the Acquiring Fund and each of its service providers; and (xxv) perform such
additional administrative duties relating to the administration of the Acquiring
Fund as may subsequently be agreed upon in writing between the Acquiring Fund
and Highland. Highland shall have the authority to engage a sub-administrator in
connection with the administrative services of the Acquiring Fund, which
sub-administrator may be an affiliate of Highland; provided, however, that
Highland shall remain responsible to the Acquiring Fund with respect to its
duties and obligations set forth in the administration services agreement.
ADMINISTRATION AND ACCOUNTING SERVICES
Each Acquired Fund is a party to an administration and accounting services
agreement with PFPC Inc. dated April 10, 2006 pursuant to which PFPC Inc.
provides administrative and accounting services to each Acquired Fund. PFPC Inc.
will receive an annual fee, payable monthly, in an amount equal to 0.026%,
subject to a minimum fee, of the average weekly value of each Acquired Fund's
Managed Assets plus certain other fees.
PORTFOLIO MANAGERS
James Dondero and Mark Okada are portfolio managers for each Fund. In
addition, Kurtis Plumer is a portfolio manager of Credit Strategies Fund.
As of December 31, 2007, Kurtis Plumer managed the following client
accounts:
NUMBER OF ASSETS
--------- ------
ACCOUNTS SUBJECT TO A
-------- ------------
ASSETS OF SUBJECT TO A PERFORMANCE
--------- ------------ -----------
NUMBER OF ACCOUNTS PERFORMANCE FEE
--------- -------- ----------- ---
TYPE OF ACCOUNT ACCOUNTS ($ MILLIONS) FEE ($ MILLIONS)
--------------- -------- ------------ --- ------------
Registered Investment Companies........... 2 933 1 85
Other Pooled Investment Vehicles.......... 6 3,189 4 2,610
Other Accounts............................ 0 0 0 0
24
As of December 31, 2007, James Dondero managed the following client
accounts:
NUMBER OF ASSETS
--------- ------
ACCOUNTS SUBJECT TO A
-------- ------------
ASSETS OF SUBJECT TO A PERFORMANCE
--------- ------------ -----------
NUMBER OF ACCOUNTS PERFORMANCE FEE
--------- -------- ----------- ---
TYPE OF ACCOUNT ACCOUNTS ($ MILLIONS) FEE ($ MILLIONS)
--------------- -------- ------------ --- ------------
Registered Investment Companies............ 4 1,297 2 413
Other Pooled Investment Vehicles........... 11 6,569 10 6,564
Other Accounts............................. 0 0 0 0
As of December 31, 2007, Mark Okada managed the following client accounts:
NUMBER OF ASSETS
--------- ------
ACCOUNTS SUBJECT TO A
-------- ------------
ASSETS OF SUBJECT TO A PERFORMANCE
--------- ------------ -----------
NUMBER OF ACCOUNTS PERFORMANCE FEE
--------- -------- ----------- ---
TYPE OF ACCOUNT ACCOUNTS ($ MILLIONS) FEE ($ MILLIONS)
--------------- -------- ------------ --- ------------
Registered Investment Companies............ 14 8,088 0 0
Other Pooled Investment Vehicles........... 28 19,248 24 17,841
Other Accounts............................. 0 0 0 0
The 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
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 Adviser furnishes advisory services to numerous clients in addition to each
Fund, and the 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 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 each Fund. In addition, the
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
Adviser recommends to each Fund. Actions with respect to securities of the same
kind may be the same as or different from the action which the 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
Adviser may refrain from rendering any advice or services concerning securities
of companies of which any of the Adviser's (or its affiliates') officers,
directors or employees are directors or officers, or companies as to which the
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 Adviser includes disclosure regarding these matters to
its clients in both its Form ADV and investment advisory agreements.
The 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
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 each Fund. As a result, the Adviser will face
conflicts in the allocation of investment opportunities to each Fund 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 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 each Fund and such other clients or may involve a rotation of
opportunities among each Fund and such other clients.
While the Adviser does not believe there will be frequent conflicts of
interest, if any, the Adviser and its affiliates have both subjective and
objective procedures and policies in place designed to manage the potential
conflicts of interest between the Adviser's fiduciary obligations to each Fund
and their similar fiduciary obligations to other clients so that, for example,
investment opportunities are allocated in a fair and equitable manner among each
25
Fund and such other clients. An investment opportunity that is suitable for
multiple clients of the 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
1940 Act. There can be no assurance that the 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 each Fund. Not all conflicts of interest can
be expected to be resolved in favor of each Fund.
COMPENSATION
The 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 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 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
The following table sets forth the dollar range of equity securities of
each Fund beneficially owned by each portfolio manager as of the end of each
Fund's most recently completed fiscal year.
---------------------------------------------------------------------------------------------------
NAME OF PORTFOLIO DOLLAR RANGE OF DOLLAR RANGE OF DOLLAR RANGE OF
MANAGER EQUITY SECURITIES EQUITY SECURITIES EQUITY SECURITIES
BENEFICIALLY OWNED BY BENEFICIALLY OWNED BY BENEFICIALLY OWNED BY
PORTFOLIO MANAGER IN PORTFOLIO MANAGER IN PORTFOLIO MANAGER IN
HIGH INCOME PORTFOLIO INCOME SHARES FOR THE CREDIT STRATEGIES FOR
FOR THE FISCAL YEAR FISCAL YEAR ENDED FUND THE FISCAL YEAR ENDED
ENDED OCTOBER 31, 2007 DECEMBER 31, 2007 DECEMBER 31, 2007
---------------------------------------------------------------------------------------------------
James Dondero [$____ - $____] [$____ - $____] [$____ - $____]
---------------------------------------------------------------------------------------------------
Mark Okada [$____ - $____] [$____ - $____] [$____ - $____]
---------------------------------------------------------------------------------------------------
Kurtis Plumer Not applicable Not applicable [$____ - $____]
---------------------------------------------------------------------------------------------------
26
PORTFOLIO TRANSACTIONS AND BROKERAGE
In placing portfolio transactions for each Fund, the Adviser will give
primary consideration to securing the most favorable price and efficient
execution. Consistent with this policy, the 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 Adviser may be a party. Neither
the Funds nor the Adviser has adopted a formula for allocation of the Funds'
investment transaction business. The 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 each Fund
than would otherwise result when allocating brokerage transactions to other
brokers on the basis of seeking the most favorable price and efficient
execution. The Adviser, therefore, is authorized to place orders for the
purchase and sale of securities for each Fund with such brokers, subject to
review by each Fund's Board 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 Adviser in connection with its services to other
clients.
On occasions when the Adviser deems the purchase or sale of a security to
be in the best interest of each Fund as well as other clients, the 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 Adviser in
the manner it considers to be the most equitable and consistent with its
fiduciary obligations to each Fund and to such other clients.
During the fiscal year ended October 31, 2006, High Income Portfolio paid
brokerage commissions of $[ ], of which $[ ] was paid to NexBank Securities,
Inc. NexBank Securities, Inc. ("NexBank"), an affiliate of Highland.
During the fiscal year ended October 31, 2007, High Income Portfolio paid
brokerage commissions of $[ ], of which $[ ] was paid to NexBank. During the
fiscal year ended October 31, 2007, transactions in which High Income Portfolio
used NexBank as broker comprised [ ]% of the aggregate dollar amount of
transactions involving the payment of commissions, and [ ]% of the aggregate
brokerage commissions paid by High Income Portfolio. [ ]% of the $[ ] paid to
other brokers by High Income Portfolio during the fiscal year ended October 31,
2007 (representing commissions on transactions involving approximately $[ ]) was
directed to those brokers at least partially on the basis of research services
they provided. During the fiscal year ended October 31, 2007, High Income
Portfolio acquired securities of the following of its regular brokers or
dealers: [ ] at that date, High Income Portfolio held the securities of its
regular brokers or dealers with an aggregate value as follows: [ ].
During the fiscal year ended December 31, 2006, Income Shares paid
brokerage commissions of $[ ], of which $[ ] was paid to NexBank.
During the fiscal year ended December 31, 2007, Income Shares paid
brokerage commissions of $[ ], of which $[ ] was paid to NexBank. During the
fiscal year ended December 31, 2007, transactions in which Income Shares used
NexBank as broker comprised [ ]% of the aggregate dollar amount of transactions
involving the payment of commissions, and [ ]% of the aggregate brokerage
commissions paid by Income Shares. [ ]% of the $[ ] paid to other brokers by
Income Shares during the fiscal year ended December 31, 2007 (representing
commissions on transactions involving approximately $[ ]) was directed to those
brokers at least partially on the basis of research services they provided.
During the fiscal year ended December 31, 2007, Income Shares acquired
securities of the following of its regular brokers or dealers: [ ] at that date,
27
Income Shares held the securities of its regular brokers or dealers with an
aggregate value as follows: [ ].
During the fiscal period ended December 31, 2006, Credit Strategies Fund
paid brokerage commissions of $[ ], of which $[ ] was paid to NexBank.
During the fiscal year ended December 31, 2007, Credit Strategies Fund paid
brokerage commissions of $[ ], of which $[ ] was paid to NexBank. During the
fiscal year ended December 31, 2007, transactions in which Credit Strategies
Fund used NexBank as broker comprised [ ]% of the aggregate dollar amount of
transactions involving the payment of commissions, and [ ]% of the aggregate
brokerage commissions paid by Credit Strategies Fund. [ ]% of the $[ ] paid to
other brokers by Credit Strategies Fund during the fiscal year ended December
31, 2007 (representing commissions on transactions involving approximately $[ ])
was directed to those brokers at least partially on the basis of research
services they provided. During the fiscal year ended December 31, 2007, Credit
Strategies Fund acquired securities of the following of its regular brokers or
dealers: [ ] at that date, Credit Strategies Fund held the securities of its
regular brokers or dealers with an aggregate value as follows: [ ].
TAX MATTERS
The following discussion summarizes certain material federal income and
excise tax considerations affecting each Fund and the purchase, ownership and
disposition of each Fund's common shares by shareholders that are "United States
persons" (as defined for federal tax purposes) and hold those shares as capital
assets. This discussion is based on current provisions of the Code and the
regulations promulgated thereunder and existing judicial decisions and
administrative pronouncements, all of which are subject to change or differing
interpretations by the courts or the Internal Revenue Service ("IRS"), possibly
with retroactive effect. No attempt is made to present a detailed and complete
explanation of all federal tax concerns affecting the Funds and their
shareholders (including shareholders owning large positions in a Fund) in light
of their particular circumstances. Prospective investors should consult their
own tax advisers with regard to the federal tax consequences of the purchase,
ownership or disposition of common shares, as well as the tax consequences
arising under the laws of any state, locality, foreign country or other taxing
jurisdiction.
THE DISCUSSIONS SET FORTH HEREIN AND IN THE PROXY STATEMENT/PROSPECTUS DO
NOT CONSTITUTE TAX ADVICE, AND YOU ARE URGED TO CONSULT YOUR OWN TAX ADVISOR TO
DETERMINE THE SPECIFIC FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO YOU
OF INVESTING IN A FUND AND OWNING OR DISPOSING OF COMMON SHARES THEREOF.
TAXATION OF EACH FUND
Each Fund has elected to be, and has qualified annually to be treated as, a
regulated investment company under Part I of Subchapter M of Chapter 1 of the
Code ("RIC"). To continue to qualify as a RIC, each Fund must, among other
things, annually meet the following requirements regarding the source of its
income and the diversification of its assets:
(i) Each Fund 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,
and gains from the sale or other disposition of stock, securities or
foreign currencies, or other income (including gain from options, futures
and forward contracts) derived with respect to its business of investing in
such stock, securities or foreign currencies; and (b) net income from an
interest in a "qualified publicly traded partnership" (as defined below)
("QPTP") ("Income Requirement"); and
(ii) Each Fund must diversify its holdings so that, at the end of each
quarter of each taxable year, (a) at least 50% of the value of its total
assets is represented by cash and cash items, U.S. government securities,
the securities of other RICs and other securities limited, in respect of
any one issuer, to a value not greater than 5% of the value of the Fund's
total assets and to not more than 10% of the issuer's outstanding voting
securities (equity securities of QPTPs being considered voting securities
for these purposes) and (b) not more than 25% of the value of its total
assets is invested in (1) the securities (other than U.S. government
securities and the securities of other RICs) of any one issuer, (2) the
securities (other than the securities of other RICs) of two or more issuers
28
that the Fund controls and are engaged in the same, similar or related
trades or businesses or (3) the securities of one or more QPTPs.
A QPTP is defined as a publicly traded partnership (generally, a partnership the
interests in which are "traded on an established securities market" or are
"readily tradable on a secondary market (or the substantial equivalent
thereof)") other than a partnership at least 90% of the gross income of which
consists of income that satisfies the Income Requirement.
If a Fund qualifies as a RIC, it generally will not be subject to federal
income tax on net income and gains that it distributes to its shareholders,
provided that it distributes each taxable year at least the sum of (i) 90% of
its investment company taxable income (generally consisting of net investment
income, the excess of net short-term capital gain over net long-term capital
loss ("short-term capital gain") and net gains and losses from certain foreign
currency transactions, if any, reduced by deductible expenses), determined
without regard to the deduction for dividends paid, plus (ii) 90% of its net
tax-exempt interest (the excess of its gross tax-exempt interest over certain
disallowed deductions) ("Distribution Requirement"). Each Fund intends to
continue to distribute substantially all of such income and its net capital gain
(I.E., the excess of net long-term capital gain over net short-term capital
loss) each taxable year.
If for any taxable year a Fund does not qualify for treatment as a RIC, all
of its taxable income (including its net capital gain) would be subject to tax
at regular corporate rates without any deduction for distributions to its
shareholders and the shareholders would treat all those distributions, including
distributions of net capital gain, as dividends to the extent of the Fund's
earnings and profits, taxable as ordinary income (except that, for individual
shareholders, the part thereof that is "qualified dividend income" would be
subject to federal income tax at the rate for net capital gain -- a maximum of
15%), and those dividends would be eligible for the dividends-received deduction
available to corporations under certain circumstances. In addition, such a Fund
could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying for treatment as
a RIC.
Each Fund will be subject to a nondeductible 4% federal excise tax ("Excise
Tax") to the extent it fails to distribute by the end of any calendar year at
least the sum of (i) 98% of its ordinary income for the calendar year, (ii) 98%
of its capital gain net income (I.E., 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
Fund's fiscal year) plus (iii) 100% of any retained amount of either from the
prior year. While each Fund intends to distribute its income and capital gain in
the manner necessary to minimize imposition of the Excise Tax, there can be no
assurance that each Fund will be able to do so. In that event, a Fund will be
liable for the Excise Tax only on the amount by which it does not meet the
foregoing distribution requirement.
The use of hedging strategies, such as writing (selling) and purchasing
options and futures contracts and entering into forward contracts, involves
complex rules that will determine for income tax purposes the amount, character
and timing of recognition of the gains and losses a Fund realizes in connection
therewith. Gains from the disposition of foreign currencies (except certain
gains that may be excluded by future regulations), and gains from options,
futures and forward contracts a Fund derives with respect to its business of
investing in securities or foreign currencies, will be treated as qualifying
income under the Income Requirement.
Certain of a Fund's investment practices are subject to special and complex
federal income tax rules that may, among other things, (i) disallow, suspend or
otherwise limit the allowance of certain losses or deductions, (ii) convert
lower-taxed long-term capital gain to higher-taxed short-term capital gain or
ordinary income, (iii) convert an ordinary loss or a deduction to a capital loss
(the deductibility of which is more limited), (iv) cause the Fund to recognize
income or gain without a corresponding receipt of cash, (v) adversely affect the
time when a purchase or sale of securities is deemed to occur and (vi) adversely
alter the characterization of certain complex financial transactions. Each Fund
will monitor its transactions and may make certain tax elections to mitigate the
effect of these rules and prevent its disqualification as a RIC.
A Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is any foreign corporation (with certain exceptions) that, in
general, meets either of the following tests: (i) at least 75% of its gross
income for the taxable year is passive or (ii) an average of at least 50% of its
assets produce, or are held for the production of, passive income. Under certain
29
circumstances, if a Fund holds stock of a PFIC, it will be subject to federal
income tax on a portion of any "excess distribution" the Fund receives on the
stock or of any gain on its disposition of the stock (collectively, "PFIC
income"), plus interest thereon, even if the Fund distributes the PFIC income as
a taxable dividend to its shareholders. (Certain elections may be available to a
Fund to avoid such treatment.) The balance of a Fund's PFIC income will be
included in the Fund's investment company taxable income and, accordingly, will
not be taxable to it to the extent it distributes that income to its
shareholders. Fund distributions attributable to PFIC income will not be
eligible for the 15% maximum federal income tax rate on qualified dividend
income mentioned above.
Interest, dividends and other income a Fund receives, and gains it
realizes, on investments outside the United States may be subject to income,
withholding and other taxes imposed by foreign countries and U.S. possessions
that would reduce the total return on its securities. Tax treaties between the
United States and certain other countries may reduce or eliminate such taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors. The Funds do not expect that any of
them 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 or deductions for
such taxes on their own tax returns.
A Fund may acquire zero coupon or other securities that are issued with
original issue discount ("OID"). As a holder of those securities, a Fund must
include in its gross income the OID that accrues on them during the taxable
year, even if it receives no corresponding payment on them during the year.
Similarly, a Fund must include in its gross income securities it receives as
"interest" on payment-in-kind securities. Because each Fund annually must
distribute substantially all of its investment company taxable income, including
any accrued OID and other non-cash income, to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax, it may be required in a
particular year to distribute as a dividend an amount that is greater than the
total amount of cash it actually receives. Those distributions will be made from
a Fund's cash assets, from borrowings, or from the proceeds of sales of its
portfolio securities, if necessary. A Fund may realize capital gains or losses
from those sales, which would increase or decrease its investment company
taxable income and/or net capital gain.
TAXATION OF SHAREHOLDERS
As long as a Fund qualifies for treatment as a RIC, distributions it makes
to you from its investment company taxable income will be taxable to you as
ordinary income to the extent of its earnings and profits. Each Fund currently
expects that most of the dividends it pays will not be eligible for the
dividends-received deduction available to corporations or the 15% maximum
federal income tax rate on "qualified dividend income" received by individuals.
A Fund's distributions to you of net capital gain that it properly designates as
such ("capital gain dividends") will be taxable to you as long-term capital
gain, regardless of how long you have held the Fund's shares. Capital gain
dividends a Fund pays to individuals with respect to net capital gain it
recognizes on sales or exchanges of capital assets through October 31, 2011,
will be subject to a maximum federal income tax rate of 15%.
A Fund may determine to retain for reinvestment all or part of its net
capital gain. If a Fund does so, it may designate all or part of the retained
amount as undistributed capital gains in a notice to its shareholders. If a Fund
makes such a designation, it would be required to pay federal income tax at the
rate of 35% on the undistributed gain ("Fund tax") and each shareholder subject
to federal income tax (i) would be required to include in income, as long-term
capital gain, his or her proportionate share of the designated gain (which would
be taxed at the 15% rate mentioned above to the extent the Fund recognizes the
designated gain on sales or exchanges of capital assets through December 31,
2010), (ii) would be entitled to credit his or her proportionate share of the
Fund tax against his or her federal income tax liability, if any, and to claim a
refund to the extent the credit exceeds that liability and (iii) would increase
the basis in his or her Fund shares by the difference between the included
income and such share of the Fund tax.
Distributions to you on a Fund's common shares are generally subject to
federal income tax as described above, even though those distributions may
economically represent a return of your investment. Those distributions are
likely to occur on a Fund's common shares purchased when their net asset value
includes gains that are either unrealized or realized but not distributed or
income that is not distributed. Those realized gains may be required to be
distributed even when the common shares' net asset value reflects unrealized
losses. A Fund's distributions are taxable to you even if they are paid from
income or gains the Fund earned before you invested in its shares (and thus were
reflected in the price you paid).
If a Fund makes a distribution to you in excess of its current and
accumulated earnings and profits, the excess distribution will be treated as a
"return of capital" to the extent of your basis in your Fund shares and
30
thereafter as capital gain. A return of capital is not taxable, but it reduces
your basis in your shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by you of the shares. Current earnings and
profits will be, and accumulated earnings and profits may be, treated as first
being used to pay distributions on an Acquired Fund's preferred stock, and only
the remaining earnings and profits will be treated as being used to pay
distributions on its common stock.
Dividends and other taxable distributions on a Fund's common shares are
taxable to you even if they are reinvested in additional common shares of the
Fund. Dividends and other distributions paid by a Fund are generally treated as
received by you at the time the distribution is made. However, a distribution a
Fund declares in the last quarter of any calendar year that is payable to
shareholders of record on a date in that quarter will be deemed to have been
paid by the Fund and received by those shareholders on December 31 of that year
if the Fund pays the distribution during the following January. Accordingly,
that distribution will be taxed to those shareholders for the taxable year in
which that December 31 falls.
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.
Each Fund will send you information after the end of each year setting
forth the amount and tax status of any distributions it paid to you. Dividends
may also be subject to state and local income taxes.
Each Fund generally is required to withhold and remit to the U.S. Treasury
28% (except as noted below) of all distributions (including capital gain
dividends) and redemption proceeds, if any, otherwise payable to you (if you are
an individual or certain other non-corporate shareholder) if you fail to
properly furnish the Fund with a correct taxpayer identification number.
Withholding at that rate also is required from all distributions by a Fund
otherwise payable to such a shareholder who has under-reported dividend or
interest income or who fails to certify to the Fund that he or she is not
otherwise subject to that withholding (together with the withholding described
in the preceding sentence, "backup withholding"). The backup withholding rate
will increase to 31% for amounts paid after December 31, 2010, unless Congress
enacts legislation providing otherwise. Backup withholding is not an additional
tax, and any amounts withheld with respect to you may be credited against your
federal income tax liability.
If you sell or otherwise dispose of common shares of a Fund, you will
generally recognize a gain or loss in an amount equal to the difference between
your basis in those shares and the amount you receive on the disposition. Any
such gain or loss on common shares held as capital assets will be long-term
capital gain or loss (and thus eligible, in the case of individuals, for the 15%
maximum federal income tax rate on net capital gain described above) if you held
those shares for more than one year; otherwise, any such gain or loss will be
treated as short-term capital gain or loss. Any loss on 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 you received (and amounts
credited to you as undistributed capital gain) with respect to those shares. Any
loss you realize on a disposition of common shares will be disallowed if you
acquire other common shares within a 61-day period beginning 30 days before and
ending 30 days after the disposition. In that case, your basis in the newly
acquired shares will be adjusted to reflect the disallowed loss.
Dividends a Fund pays to a foreign shareholder, other than (i) dividends
paid to a foreign shareholder whose ownership of shares is effectively connected
with a U.S. trade or business the shareholder carries on and (ii) capital gain
dividends paid to a nonresident alien individual who is physically present in
the United States for no more than 182 days during the taxable year, generally
will be subject to a federal withholding tax of 30% (or lower treaty rate).
However, two categories of dividends, "interest-related dividends" and
"short-term capital gain dividends," if properly designated by a Fund, will be
exempt from that tax. "Interest-related dividends" are dividends that are
attributable to "qualified net interest income" ("qualified interest income,"
which generally consists of certain original issue discount, interest on
obligations "in registered form" and interest on deposits, less allocable
deductions). "Short-term capital gain dividends" are dividends that are
attributable to short-term capital gain, computed with certain adjustments. The
exemption from withholding tax will apply to interest-related dividends and
short-term capital gain dividends a Fund pays to foreign investors, with certain
exceptions, only with respect to its current taxable year (ending October 31,
31
2008), unless Congress enacts legislation extending its applicability.
ADDITIONAL INFORMATION
A registration statement on Form N-14, relating to the shares offered by
the Prospectus/Proxy Statement (the "Registration Statement"), has been filed by
the Acquiring Fund with the SEC. The Proxy Statement/Prospectus and this SAI 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 Acquiring Fund and the such shares, reference is made to the
Registration Statement. Statements contained in the Proxy Statement/Prospectus
and this SAI 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 SEC's principal office in Washington, D.C., and copies of all or any part
thereof may be obtained from the SEC upon the payment of certain fees prescribed
by the SEC.
PRO FORMA FINANCIAL STATEMENTS
Shown below are the financial statements for Highland Credit Strategies
Fund and Prospect Street High Income Portfolio, PRO FORMA Highland Credit
Strategies Fund financial statements including the proceeds of its rights
offering and PRO FORMA financial statements for the combined Fund. The PRO FORMA
Combined Schedule of Investments and the PRO FORMA Combined Statement of Assets
and Liabilities have been prepared as though the reorganization had been
effective on December 31, 2007. The PRO FORMA Combined Statement of Operations
reflects the results of Highland Credit Strategies Fund and Prospect Street High
Income Portfolio for the twelve months ended December 31, 2007 as if the
reorganization occurred on January 1, 2007.
The first table presents the Schedule of Investments for Highland Credit
Strategies Fund and Prospect Street High Income Portfolio and PRO FORMA figures
for the combined Fund. The second table presents the Statements of Assets and
Liabilities for Highland Credit Strategies Fund and Prospect Street High Income
Portfolio, PRO FORMA figures for Highland Credit Strategies Fund including the
proceeds of its rights offering, and estimated PRO FORMA figures for the
combined Fund. The third table presents the Statements of Operations for
Highland Credit Strategies Fund and Prospect Street High Income Portfolio, PRO
FORMA figures for Highland Credit Strategies Fund including the proceeds of its
rights offering, and estimated PRO FORMA figures for the combined Fund. These
tables are followed by the Notes to the PRO FORMA Financial Statements.
PROSPECT PRO FORMA
STREET COMBINED PRO FORMA
HIGHLAND HIGH HIGHLAND PROSPECT COMBINED
CREDIT INCOME CREDIT HIGHLAND STREET HIGH HIGHLAND
STRATEGIES PORTFOLIO STRATEGIES CREDIT INCOME CREDIT
FUND (HCF) (PHY) FUND (HCF) STRATEGIES PORTFOLIO STRATEGIES
PRINCIPAL PRINCIPAL PRINCIPAL FUND (HCF) (PHY) FUND (HCF)
AMOUNT ($) AMOUNT ($) AMOUNT ($) SECURITY VALUE ($) VALUE ($) VALUE ($)
---------------------- ---------- ---------- ------------------------------------------------ ------------ ------------ -----------
SENIOR LOANS (a)- 55.5%
AEROSPACE - AEROSPACE/DEFENSE -
0.9%
AWAS Capital, Inc.
2,022,750 - 2,022,750 Second Priority Term Loan, 11.25%, 03/15/13 1,951,953 - 1,951,953
IAP Worldwide Services, Inc.
2,969,697 - 2,969,697 First Lien Term Loan, 11.50%, 12/30/12 2,663,462 - 2,663,462
2,000,000 - 2,000,000 Second Lien Term Loan, 17.00%, 06/30/13 1,600,000 - 1,600,000
Travelport LLC
356,888 - 356,888 Synthetic Letter of Credit, 7.45%, 08/23/13 339,640 - 339,640
1,778,654 - 1,778,654 Tranche B Dollar Term Loan, 7.08%, 08/23/13 1,690,041 - 1,690,041
-------------------------------------
8,245,096 - 8,245,096
-------------------------------------
AEROSPACE - AIRLINES
- 1.5%
Delta Airlines, Inc.
8,281,894 - 8,281,894 Term Loan Equipment Notes, 8.63%, 09/29/12 7,992,028 - 7,992,028
Northwest Airlines, Inc.
6,930,000 - 6,930,000 Term Loan, 6.97%, 08/21/13 6,545,939 - 6,545,939
US Airways Group, Inc.
- 500,000 500,000 Term Loan, 7.28%, 03/23/14 - 463,330 463,330
-------------------------------------
14,537,967 463,330 15,001,297
-------------------------------------
AUTOMOBILE - 1.4%
Ford Motor Co.
14,850,000 - 14,850,000 Term Loan, 8.70%, 12/15/13 13,773,375 - 13,773,375
-------------------------------------
BROADCASTING - 2.4%
Bresnan Communications, LLC
- 1,000,000 1,000,000 Additional Term Loan B, 06/30/13 (e) - 958,120 958,120
ComCorp Broadcasting, Inc.
622,034 - 622,034 Revolving Loan, 10.84%, 10/02/12 (b) (c) 622,034 - 622,034
11,309,712 - 11,309,712 Term Loan, 10.44%, 04/02/13 (b) 11,309,712 - 11,309,712
Millennium Digital Media Systems, LLC
9,060,582 - 9,060,582 First Lien Term Loan, 8.98%, 06/30/11 8,935,999 - 8,935,999
1,238,322 - 1,238,322 Revolver, 8.43%, 06/30/11 (c) 1,217,357 - 1,217,357
-------------------------------------
22,085,102 958,120 23,043,222
-------------------------------------
CABLE - US CABLE -
0.2%
Charter Communications Operating, LLC
2,000,000 - 2,000,000 New Term Loan, 6.99%, 03/06/14 1,872,200 - 1,872,200
-------------------------------------
CHEMICALS - COMMODITY & FERTILIZER - 0.2%
Ferro Corp.
1,677,500 - 1,677,500 Term Loan, 7.06%, 06/06/12 1,639,756 - 1,639,756
-------------------------------------
CONSUMER DURABLES - 0.3%
Rexair LLC
2,559,468 - 2,559,468 First Lien Term Loan, 9.45%, 06/30/10 2,514,677 - 2,514,677
-------------------------------------
CONSUMER NON-DURABLES - 0.9%
Camelbak Products LLC
1,391,780 - 1,391,780 First Lien Term Loan, 9.18%, 08/04/11 1,303,624 - 1,303,624
DS Waters of America, Inc.
1,980,000 - 1,980,000 Term Loan, 7.10%, 10/27/12 1,910,700 - 1,910,700
Spectrum Brands, Inc.
4,008,292 - 4,008,292 Dollar Term B Loan, 9.31%, 03/30/13 3,898,064 - 3,898,064
201,369 - 201,369 Synthetic Letter of Credit, 4.57%, 03/30/13 195,832 - 195,832
VNU Inc./Nielsen Finance LLC
1,970,056 - 1,970,056 Dollar Term Loan, 7.18%, 08/09/13 1,880,182 - 1,880,182
-------------------------------------
9,188,402 - 9,188,402
-------------------------------------
DIVERSIFIED MEDIA -
4.8%
Clarke American Corp.
1,990,000 - 1,990,000 Tranche B Term Loan, 7.70%, 06/30/14 1,795,975 - 1,795,975
Endurance Business Media, Inc.
3,000,000 - 3,000,000 Second Lien Term Loan, 12.10%, 01/26/14 2,970,000 - 2,970,000
Metro-Goldwyn-Mayer Holdings II, Inc.
10,333,487 - 10,333,487 Tranche B Term Loan, 8.61%, 04/08/12 9,594,642 - 9,594,642
2,977,500 - 2,977,500 Tranche B-1 Term Loan, 8.45%, 04/08/12 2,766,842 - 2,766,842
Penton Media, Inc.
5,000,000 - 5,000,000 Second Lien Term Loan, 9.98%, 02/01/14 4,225,000 - 4,225,000
Tribune Co.
11,940,000 - 11,940,000 Initial Tranche B Advance, 7.91%, 05/19/14 10,286,191 - 10,286,191
7,466,667 - 7,466,667 Tranche X Advance, 7.74%, 05/18/09 7,226,091 - 7,226,091
Univision Communications, Inc.
- 110,738 110,738 Delayed Draw Term Loan, 09/29/14 (c) (e) - 101,148 101,148
- 2,389,262 2,389,262 Initial Term Loan, 09/29/14 (e) - 2,182,356 2,182,356
6,000,000 - 6,000,000 Initial Term Loan, 09/29/14 (e) 5,880,000 - 5,880,000
-------------------------------------
44,744,741 2,283,505 47,028,246
-------------------------------------
ENERGY - EXPLORATION & PRODUCTION - 1.1%
ATP Oil & Gas Corp.
11,262,205 - 11,262,205 First Lien Term Loan, 8.48%, 04/14/10 11,132,014 - 11,132,014
-------------------------------------
ENERGY - OTHER ENERGY - 0.5%
Alon USA Energy, Inc.
218,889 - 218,889 Edington Facility, 7.10%, 06/22/13 211,228 - 211,228
1,751,111 - 1,751,111 Paramount Facility , 7.10%, 06/22/13 1,689,822 - 1,689,822
Endeavour International Holding B.V.
3,000,000 - 3,000,000 Second Lien Term Loan, 11.91%, 11/01/11 3,045,000 - 3,045,000
-------------------------------------
4,946,050 - 4,946,050
-------------------------------------
FINANCIAL - 0.5%
Concord Re Ltd.
5,000,000 - 5,000,000 Term Loan, 9.61%, 02/29/12 4,975,000 - 4,975,000
-------------------------------------
FOOD/TOBACCO - BEVERAGES & BOTTLING - 0.2%
PBM Holdings, Inc.
1,888,356 - 1,888,356 Term Loan, 7.35%, 09/28/12 1,850,589 - 1,850,589
-------------------------------------
FOOD/TOBACCO - RESTAURANTS - 0.2%
Restaurant Co., The
1,970,000 - 1,970,000 Term Loan, 7.62%, 05/09/13 1,861,650 - 1,861,650
-------------------------------------
FOREST PRODUCTS - PAPER - 1.1%
Verso Paper Financial Holding LLC
11,000,000 - 11,000,000 Unsecured Loan, 11.16%, 02/01/13 10,395,000 - 10,395,000
-------------------------------------
GAMING/LEISURE - GAMING - 1.6%
Drake Hotel Acquisition
6,041,285 - 6,041,285 B Note 1, 12.90%, 04/01/08 6,041,285 - 6,041,285
Fontainebleu Florida Hotel LLC
10,000,000 - 10,000,000 Tranche C Term Loan, 11.11%, 06/06/12 9,375,000 - 9,375,000
-------------------------------------
15,416,285 - 15,416,285
-------------------------------------
GAMING/LEISURE - OTHER LEISURE - 3.1%
Cedar Fair L.P.
3,940,000 - 3,940,000 US Term Loan, 6.82%, 08/30/12 3,737,484 - 3,737,484
Kuilima Resort Co.
5,954,660 - 5,954,660 First Lien Term Loan, 11.50%, 09/30/10 5,666,871 - 5,666,871
Lake at Las Vegas Joint Venture
9,000,000 - 9,000,000 Additional Term Loan, 12.50%, 01/24/08 9,000,000 - 9,000,000
2,407,407 - 2,407,407 Synthetic Revolver, 11.96%, 06/20/12 (d) 1,119,444 - 1,119,444
18,193,575 - 18,193,575 Term Loan, 16.35%, 06/20/12 (d) 8,460,013 - 8,460,013
Orbitz Worldwide, Inc.
1,995,000 - 1,995,000 Term Loan, 7.84%, 07/25/14 1,890,263 - 1,890,263
-------------------------------------
29,874,075 - 29,874,075
-------------------------------------
HEALTHCARE - ACUTE CARE - 3%
Alliance Imaging, Inc.
8,795,180 - 8,795,180 Tranche C Term Loan, 7.52%, 12/29/11 8,663,252 - 8,663,252
HCA, Inc.
12,870,000 - 12,870,000 Tranche B Term Loan, 7.45%, 11/17/13 12,403,462 - 12,403,462
National Mentor Holdings, Inc.
230,000 - 230,000 Institutional Line of Credit Facility, 5.32%, 225,400 - 225,400
06/29/13
3,713,450 - 3,713,450 Tranche B Term Loan, 7.20%, 06/29/13 3,639,181 - 3,639,181
Triumph Healthcare Second Holdings LLC
4,500,000 - 4,500,000 Second Lien Term Loan, 12.90%, 07/28/14 4,387,500 - 4,387,500
-------------------------------------
29,318,795 - 29,318,795
-------------------------------------
HEALTHCARE - ALTERNATE SITE SERVICES - 0.3%
LifeCare Holdings
2,984,733 - 2,984,733 Term Loan, 8.20%, 08/11/12 2,643,339 - 2,643,339
-------------------------------------
HEALTHCARE - MEDICAL PRODUCTS - 3%
CCS Medical, Inc.
9,851,731 1,977,349 11,829,080 First Lien Term Loan, 8.10%, 09/30/12 9,527,412 1,912,255 11,439,667
Danish Holdco A/S
3,077,311 - 3,077,311 Mezzanine Facility, 12.73%, 05/01/17 PIK 2,984,991 - 2,984,991
2,500,000 - 2,500,000 Second Lien Term Facility D, 8.98%, 11/01/16 2,300,000 - 2,300,000
Golden Gate National Senior Care LLC
4,000,000 - 4,000,000 Second Lien Term Loan, 12.56%, 09/14/11 3,960,000 - 3,960,000
HealthSouth Corp.
2,946,052 - 2,946,052 Term Loan B, 7.75%, 03/11/13 2,819,608 - 2,819,608
Nyco Holdings 3 ApS
3,500,000 - 3,500,000 Facility A, 12/29/13 (e) 3,130,330 - 3,130,330
Warner Chilcott Co., Inc.
1,682,626 - 1,682,626 Tranche B Acquisition Date Term Loan, 7.36%, 1,634,267 - 1,634,267
01/18/12
Warner Chilcott Corp.
578,754 - 578,754 Tranche C Acquisition Date Term Loan, 7.36%, 562,121 - 562,121
01/18/12
-------------------------------------
26,918,729 1,912,255 28,830,984
-------------------------------------
HOUSING - BUILDING MATERIALS - 2.8%
Custom Building Products, Inc.
5,175,258 - 5,175,258 First Lien Term Loan, 6.98%, 10/20/11 4,890,619 - 4,890,619
1,625,000 - 1,625,000 Second Lien Term Loan, 10.20%, 04/20/12 1,543,750 - 1,543,750
Realogy Corp.
- 1,574,920 1,574,920 Initial Term B Loan, 10/10/13 (e) - 1,384,827 1,384,827
- 425,080 425,080 Synthetic Letter of Credit, 10/10/13 (e) - 373,968 373,968
Roofing Supply Group LLC
3,960,000 - 3,960,000 First Lien Term Loan, 9.20%, 08/31/13 3,564,000 - 3,564,000
Spirit Finance Corp.
3,000,000 - 3,000,000 Term Loan, 7.91%, 08/01/13 2,622,480 - 2,622,480
WAICCS Las Vegas 3 LLC
6,000,000 - 6,000,000 First Lien Term Loan, 8.19%, 07/30/08 5,820,000 - 5,820,000
7,000,000 - 7,000,000 Second Lien Term Loan, 14.25%, 07/30/08 6,790,000 - 6,790,000
-------------------------------------
25,230,849 1,758,796 26,989,645
-------------------------------------
HOUSING - REAL ESTATE DEVELOPMENT - 4%
DESA LLC
418,880 - 418,880 Term Loan, 14.25%, 11/26/11 376,297 - 376,297
Ginn LA Conduit Lender, Inc.
2,358,201 - 2,358,201 First Lien Tranche A Credit-Linked Deposit, 1,924,882 - 1,924,882
5.10%, 06/08/11
5,067,988 - 5,067,988 First Lien Tranche B Term Loan, 8.70%, 4,136,745 - 4,136,745
06/08/11
LNR Property Corp.
10,000,000 - 10,000,000 Initial Tranche B Term Loan, 7.63%, 07/12/11 9,541,700 - 9,541,700
MPH Mezzanine II, LLC
6,000,000 - 6,000,000 Mezzanine 2B, 8.27%, 02/09/08 (b) 5,992,680 - 5,992,680
MPH Mezzanine III, LLC
4,000,000 - 4,000,000 Mezzanine 3, 9.27%, 02/09/08 3,990,000 - 3,990,000
November 2005 Land Investors, LLC
2,500,000 - 2,500,000 Second Lien Term Loan, 11.81%, 05/09/12 1,250,000 - 1,250,000
Westgate Investments LLC
7,757,893 - 7,757,893 Senior Secured Loan, 13.00%, 09/25/10 (f) 8,068,209 - 8,068,209
1,740,500 - 1,740,500 Senior Unsecured Loan, 18.00%, 09/25/12 1,792,715 - 1,792,715
Weststate Land Partners LLC
- 2,000,000 2,000,000 Second Lien Term Loan, 13.22%, 05/01/08 - 1,970,000 1,970,000
-------------------------------------
37,073,228 1,970,000 39,043,228
-------------------------------------
INFORMATION TECHNOLOGY - 2.8%
DTN, Inc.
1,990,000 - 1,990,000 First Lien Tranche C Term Loan, 8.18%, 1,960,150 - 1,960,150
03/10/13
Freescale Semiconductor, Inc.
- 3,840,302 3,840,302 Term Loan, 7.33%, 11/29/13 - 3,564,453 3,564,453
Infor Enterprise Solutions Holdings, Inc.
2,708,571 - 2,708,571 Delayed Draw Term Loan, 8.95%, 07/28/12 2,548,874 - 2,548,874
3,000,000 - 3,000,000 Dollar Tranche B-1, Second Lien Term Loan, 2,700,000 - 2,700,000
10.81%, 03/02/14
5,191,429 - 5,191,429 Initial US Term Facility, 9.11%, 07/28/12 4,942,655 - 4,942,655
2,566,667 - 2,566,667 Second Lien Delayed Draw Term Loan, 11.45%, 2,319,625 - 2,319,625
03/02/14
4,433,333 - 4,433,333 Second Lien Term Loan, 11.45%, 03/02/14 4,006,625 - 4,006,625
Metrologic Instruments, Inc.
2,000,000 - 2,000,000 Second Lien Term Loan, 11.08%, 12/21/13 1,927,500 - 1,927,500
Secure Computing Corp.
1,222,222 - 1,222,222 Term Loan, 8.45%, 08/31/13 1,210,000 - 1,210,000
Serena Software, Inc.
1,840,000 - 1,840,000 Term Loan, 7.18%, 03/11/13 1,787,119 - 1,787,119
-------------------------------------
23,402,548 3,564,453 26,967,001
-------------------------------------
MANUFACTURING - 2.4%
Acument Global Technologies, Inc.
7,902,475 - 7,902,475 Term Loan, 8.33%, 08/11/13 7,744,425 - 7,744,425
CST Industries, Inc.
2,962,500 - 2,962,500 Term Loan, 7.90%, 08/09/13 2,795,800 - 2,795,800
Generac Acquisition Corp.
1,666,667 - 1,666,667 Second Lien Term Loan, 11.23%, 05/10/14 1,367,717 - 1,367,717
Global Petroleum Inc.
5,900,101 - 5,900,101 Term Loan, 9.49%, 09/18/13 5,723,098 - 5,723,098
Hunter Defense Technologies, Inc.
1,000,000 - 1,000,000 First Lien Term B Loan, 8.08%, 08/13/14 955,000 - 955,000
Matinvest 2 SAS / Butterfly Wendal US, Inc.
2,250,000 - 2,250,000 B-2 Facility, 7.40%, 06/22/14 2,098,125 - 2,098,125
2,250,000 - 2,250,000 C-2 Facility, 7.65%, 06/22/15 2,109,375 - 2,109,375
Matinvest 2 SAS / Deutsche Connector
1,011,458 - 1,011,458 Mezz A USD Facility, 9.33%, 06/22/16 940,656 - 940,656
-------------------------------------
23,734,196 - 23,734,196
-------------------------------------
METALS/MINERALS - OTHER METALS/MINERALS - 1.1%
Euramax International Holdings B.V.
1,326,316 - 1,326,316 Second Lien European Loan, 13.36%, 06/29/13 1,027,895 - 1,027,895
Euramax International, Inc.
2,753,611 - 2,753,611 First Lien Domestic Term Loan, 8.24%, 06/29/12 2,450,713 - 2,450,713
3,673,684 - 3,673,684 Second Lien Domestic Term Loan, 13.24%, 3,039,974 - 3,039,974
06/29/13
Oglebay Norton Co.
1,518,943 - 1,518,943 Tranche B Term Loan, 7.50%, 07/31/12 1,496,159 - 1,496,159
United Central Industrial Supply Co., L.L.C.
1,615,602 - 1,615,602 Term Loan, 7.91%, 03/31/12 1,575,211 - 1,575,211
Universal Buildings Products, Inc.
1,455,231 - 1,455,231 Term Loan, 8.24%, 04/28/12 1,338,813 - 1,338,813
-------------------------------------
10,928,765 - 10,928,765
-------------------------------------
RETAIL - 2.8%
Blockbuster, Inc.
2,352,062 - 2,352,062 Tranche B Term Loan, 9.43%, 08/20/11 2,266,400 - 2,266,400
Burlington Coat Factory Warehouse Corp.
11,680,028 493,530 12,173,558 Term Loan, 7.32%, 05/28/13 10,447,084 441,433 10,888,517
CSK Auto, Inc.
2,962,687 - 2,962,687 Term Loan, 8.25%, 06/30/12 2,755,299 - 2,755,299
Home Interiors & Gifts, Inc.
7,223,706 - 7,223,706 Initial Term Loan, 10.36%, 03/31/11 3,918,861 - 3,918,861
Sports Authority, Inc., The
1,970,000 - 1,970,000 Term Loan B, 7.08%, 05/03/13 1,827,175 - 1,827,175
Toys "R" Us
5,970,149 - 5,970,149 Tranche B Term Loan, 9.16%, 07/19/12 5,876,895 - 5,876,895
-------------------------------------
27,091,714 441,433 27,533,147
-------------------------------------
SERVICE - ENVIRONMENTAL SERVICES - 0.8%
Safety-Kleen Systems, Inc.
1,627,119 - 1,627,119 Synthetic Letter of Credit, 4.75%, 08/02/13 1,562,034 - 1,562,034
6,174,915 - 6,174,915 Term Loan B, 7.75%, 08/02/13 6,051,417 - 6,051,417
-------------------------------------
7,613,451 - 7,613,451
-------------------------------------
SERVICE - OTHER SERVICES - 2.1%
Cydcor, Inc.
3,000,000 - 3,000,000 Second Lien Term Loan, 11.30%, 01/30/14 2,985,000 - 2,985,000
Education Management LLC
2,912,289 - 2,912,289 Tranche C Term Loan, 6.63%, 06/01/13 2,780,333 - 2,780,333
NES Rentals Holdings, Inc.
7,765,705 - 7,765,705 Second Lien Permanent Term Loan, 12.13%, 7,299,762 - 7,299,762
07/20/13
Sabre, Inc.
4,859,038 - 4,859,038 Initial Term Loan, 6.96%, 09/30/14 4,428,236 - 4,428,236
Survey Sampling International LLC
1,315,028 - 1,315,028 Term Loan, 7.33%, 05/06/11 1,262,427 - 1,262,427
United Rentals, Inc.
1,633,916 - 1,633,916 Initial Term Loan, 7.11%, 02/14/11 1,597,969 - 1,597,969
309,692 - 309,692 Tranche B Credit-Linked Deposit, 5.43%, 302,984 - 302,984
02/14/11
-------------------------------------
20,656,711 - 20,656,711
-------------------------------------
TELECOMMUNICATIONS - 1.1%
American Messaging Services, Inc.
2,300,901 - 2,300,901 Senior Secured Note, 11.38%, 09/03/08 2,312,406 - 2,312,406
PaeTec Communications, Inc.
4,177,367 - 4,177,367 Initial Term Loan, 7.35%, 02/05/13 4,136,262 - 4,136,262
Sorenson Communications, Inc.
1,824,792 - 1,824,792 Tranche C Term Loan, 8.00%, 02/28/13 1,778,607 - 1,778,607
Stratos Global Corp./Stratos Funding LP
1,225,000 - 1,225,000 Term B Facility, 7.59%, 02/13/12 1,192,084 - 1,192,084
Time Warner Telecom Holdings Inc.
990,000 - 990,000 Term Loan B, 6.85%, 01/07/13 957,825 - 957,825
-------------------------------------
10,377,184 - 10,377,184
-------------------------------------
TRANSPORTATION - AUTO - 2.1%
BST Safety Textiles Acquisition GMBH
2,662,000 - 2,662,000 Second Lien Facility, 12.49%, 06/30/09 2,395,800 - 2,395,800
Dana Corp.
3,000,000 - 3,000,000 DIP Term Loan, 7.36%, 04/13/08 2,994,750 - 2,994,750
Delphi Corp.
5,000,000 - 5,000,000 Tranche C Term Loan, 8.94%, 12/31/08 4,988,100 - 4,988,100
Lear Corp.
4,940,090 - 4,940,090 First Lien Term Loan B, 7.79%, 04/25/12 4,804,238 - 4,804,238
Motor Coach Industries International, Inc.
5,752,270 - 5,752,270 Second Lien Term Loan, 13.64%, 12/01/08 5,579,702 - 5,579,702
-------------------------------------
20,762,590 - 20,762,590
-------------------------------------
TRANSPORTATION - LAND - 0.6%
New Century Transportation, Inc.
1,973,842 - 1,973,842 Term Loan B, 8.08%, 08/14/12 1,677,765 - 1,677,765
SIRVA Worldwide, Inc.
831,429 - 831,429 Revolver, 12.43%, 12/01/08 (c) 552,900 - 552,900
17,143 - 17,143 Revolver, 12.38%, 12/01/08 (c) 11,400 - 11,400
6,008,774 - 6,008,774 Tranche B Term Loan, 12.50%, 12/01/10 3,909,489 - 3,909,489
-------------------------------------
6,151,554 - 6,151,554
-------------------------------------
UTILITIES - 3.3%
ANP Funding I, LLC
4,888,889 - 4,888,889 Tranche A Term Loan, 8.73%, 07/29/10 4,856,280 - 4,856,280
Calpine Construction Finance Company, L.P.
- 5,508 5,508 First Lien Term Loan, 11.34%, 08/26/09 - 5,663 5,663
Coleto Creek Power, LP
5,465,915 - 5,465,915 First Lien Term Loan, 7.95%, 06/28/13 5,274,607 - 5,274,607
4,925,000 - 4,925,000 Second Lien Term Loan, 8.83%, 06/28/13 4,752,625 - 4,752,625
382,166 - 382,166 Synthetic Facility, 5.10%, 06/28/13 368,790 - 368,790
Entegra TC LLC
6,198,643 - 6,198,643 Third Lien Term Loan, 11.20%, 04/19/14 5,815,133 - 5,815,133
GBGH LLC (U S Energy)
5,128,912 - 5,128,912 First Lien Term Loan, 14.25%, 08/07/13 5,141,734 - 5,141,734
5,478,811 - 5,478,811 Second Lien Term Loan, 7.89%, 08/07/14 5,492,508 - 5,492,508
-------------------------------------
31,701,677 5,663 31,707,340
-------------------------------------
WIRELESS - CELLULAR/PCS - 1.3%
Cricket Communications, Inc.
1,970,000 - 1,970,000 Term Loan B, 7.83%, 06/16/13 1,946,596 - 1,946,596
Insight Midwest Holdings, LLC
8,000,000 - 8,000,000 Term Loan B, 7.00%, 04/07/14 7,708,880 - 7,708,880
Level 3 Financing, Inc.
3,000,000 - 3,000,000 New Term Loan, 7.49%, 03/13/14 2,896,500 - 2,896,500
-------------------------------------
12,551,976 - 12,551,976
-------------------------------------
WIRELESS COMMUNICATIONS - 1%
Clearwire Corp.
9,975,000 - 9,975,000 Term Loan, 11.15%, 07/03/12 9,625,875 - 9,625,875
-------------------------------------
TOTAL SENIOR LOANS 524,835,160 13,357,554 538,192,714
-------------------------------------
FOREIGN DENOMINATED SENIOR LOANS
(a) - 10.3%
AUSTRALIA - 2%
AUD
Seven Media Group
22,940,476 - 22,940,476 Facility A Term Loan, 12/22/13 19,463,019 - 19,463,019
-------------------------------------
FRANCE - 2.1%
EUR
Ypso Holding SA
2,012,048 - 2,012,048 Eur B Acq 1 Facility, 7.43%, 06/15/14 2,818,373 - 2,818,373
3,282,814 - 3,282,814 Eur B Acq 2 Facility, 7.43%, 06/15/14 4,598,397 - 4,598,397
5,213,674 - 5,213,674 Eur B Recap 1 Facility, 7.43%, 06/15/14 7,277,282 - 7,277,282
1,389,750 - 1,389,750 Eur C Acq Facility, 7.68%, 12/31/15 1,953,538 - 1,953,538
2,610,250 - 2,610,250 Eur C Recap Facility, 7.68%, 12/31/15 3,669,165 - 3,669,165
-------------------------------------
20,316,755 - 20,316,755
-------------------------------------
NETHERLANDS - 1%
EUR
Amsterdamse Beheer- En Consultingmaatschappij B.V.
Casema
2,500,000 - 2,500,000 Kabelcom B Term Loan, 6.67%, 09/12/14 3,595,735 - 3,595,735
2,500,000 - 2,500,000 Kabelcom C Term Loan, 7.17%, 09/12/15 3,636,855 - 3,636,855
1,500,000 - 1,500,000 Kabelcom D Term Loan Second Lien, 8.41%, 2,170,227 - 2,170,227
03/12/16
-------------------------------------
9,402,817 - 9,402,817
-------------------------------------
SWEDEN - 0.5%
SEK
Nordic Cable Acquisition Co., Sub-Holding AB
15,333,333 - 15,333,333 Facility B2, 6.67%, 01/31/14 2,289,372 - 2,289,372
14,666,667 - 14,666,667 Facility C2, 6.79%, 01/31/15 2,201,180 - 2,201,180
-------------------------------------
4,490,552 - 4,490,552
-------------------------------------
UNITED KINGDOM - 1.1%
GBP
Mobileserv Ltd.
2,764,925 - 2,764,925 Facility B , 8.82%, 09/22/14 4,855,901 - 4,855,901
3,250,000 - 3,250,000 Facility C, 9.32%, 09/22/15 5,733,561 - 5,733,561
-------------------------------------
10,589,462 - 10,589,462
-------------------------------------
TOTAL FOREIGN DENOMINATED SENIOR LOANS 64,262,605 - 64,262,605
-------------------------------------
ASSET-BACKED SECURITIES (g) - 0.5%
Commercial Industrial Finance Corp.
1,000,000 - 1,000,000 Series 2006-1BA, Class B2L, 8.88%, 12/22/20 728,906 - 728,906
Marquette US/European CLO, PLC
1,000,000 - 1,000,000 Series 2006-1A, Class D1, 6.99%, 07/15/20 (h) 822,969 - 822,969
Ocean Trails CLO
1,000,000 - 1,000,000 Series 2006-1A, Class D, 9.00%, 10/12/20 (h) 757,969 - 757,969
Venture CDO, Ltd.
2,000,000 - 2,000,000 Series 2007-9A, Class D, 9.27%, 10/12/21 (h) 1,884,062 - 1,884,062
Westbrook CLO, Ltd.
1,000,000 - 1,000,000 Series 2006-1A, Class D, 6.63%, 12/20/20 (h) 788,750 - 788,750
-------------------------------------
TOTAL ASSET-BACKED SECURITIES 4,982,656 - 4,982,656
-------------------------------------
FOREIGN ASSET-BACKED SECURITIES (g) - 0.6%
IRELAND - 0.6%
EUR
Static Loan Funding
2,000,000 - 2,000,000 Series 2007-1X, Class D, 07/31/17 2,793,982 - 2,793,982
2,000,000 - 2,000,000 Series 2007-1X, Class E, 07/31/17 2,815,913 - 2,815,913
-------------------------------------
TOTAL FOREIGN ASSET-BACKED SECURITIES 5,609,895 - 5,609,895
-------------------------------------
CORPORATE NOTES AND BONDS - 29.8%
AEROSPACE - AIRLINES - 0.2%
Delta Airlines, Inc.
5,000,000 - 5,000,000 8.00%, 06/30/23 (d) 244,000 - 244,000
- 4,000,000 4,000,000 8.30%, 08/11/20 (d) (l) - 200,000 200,000
Northwest Airlines, Inc.
- 1,899,659 1,899,659 Series 2002-1, Class C2, 9.06%, 05/20/12 - 1,914,322 1,914,322
- 1,500,000 1,500,000 8.88%, 12/30/27 (d) (l) - 56,250 56,250
-------------------------------------
244,000 2,170,572 2,414,572
-------------------------------------
BROADCASTING - 1%
Univision Communications, Inc.
6,000,000 2,960,000 8,960,000 9.75%, 03/15/15 PIK (h) 5,497,500 2,712,100 8,209,600
Young Broadcasting, Inc.
- 2,000,000 2,000,000 10.00%, 03/01/11 - 1,572,500 1,572,500
-------------------------------------
5,497,500 4,284,600 9,782,100
-------------------------------------
CABLE - US CABLE - 1.7%
CCH I Holdings LLC
1,250,000 - 1,250,000 9.92%, 04/01/14 739,062 - 739,062
3,375,000 - 3,375,000 10.00%, 05/15/14 2,012,344 - 2,012,344
2,500,000 - 2,500,000 11.75%, 05/15/14 1,593,750 - 1,593,750
CCH I LLC
8,358,000 4,861,000 13,219,000 11.00%, 10/01/15 6,853,560 3,986,020 10,839,580
Charter Communications, Inc., Convertible
2,634,000 - 2,634,000 6.50%, 10/01/27 1,600,155 - 1,600,155
-------------------------------------
12,798,871 3,986,020 16,784,891
-------------------------------------
CONSUMER NON-DURABLES - 2.8%
Ames True Temper, Inc.
3,000,000 2,000,000 5,000,000 9.24%, 01/15/12 (g) 2,565,000 1,710,000 4,275,000
1,500,000 1,375,000 2,875,000 10.00%, 07/15/12 (l) 832,500 763,125 1,595,625
Outsourcing Services Group, Inc.
- 801,760 801,760 9.00%, 03/01/09 PIK (b) - - -
Spectrum Brands, Inc.
- 2,000,000 2,000,000 11.50%, 10/02/13 PIK (g) (l) - 1,810,000 1,810,000
- 2,450,000 2,450,000 7.38%, 02/01/15 (l) - 1,825,250 1,825,250
Solo Cup Co.
11,875,000 8,300,000 20,175,000 8.50%, 02/15/14 (l) 10,271,875 7,179,500 17,451,375
-------------------------------------
13,669,375 13,287,875 26,957,250
-------------------------------------
DIVERSIFIED MEDIA - 0.6%
Network Communications, Inc.
4,500,000 1,500,000 6,000,000 10.75%, 12/01/13 4,432,500 1,477,500 5,910,000
-------------------------------------
ELECTRONICS - 0.1%
WII Components, Inc.
- 1,000,000 1,000,000 10.00%, 02/15/12 - 1,007,500 1,007,500
-------------------------------------
ENERGY - EXPLORATION & PRODUCTION - 0.2%
McMoran Exploration Co.
- 1,800,000 1,800,000 11.88%, 11/15/14 - 1,815,750 1,815,750
Opti Canada, Inc.
375,000 - 375,000 8.25%, 12/15/14 (h) 373,125 - 373,125
-------------------------------------
373,125 1,815,750 2,188,875
-------------------------------------
ENERGY - OTHER ENERGY - 1.1%
Energy XXI Gulf Coast, Inc.
6,000,000 1,750,000 7,750,000 10.00%, 06/15/13 5,535,000 1,614,375 7,149,375
Helix Energy Solutions
2,000,000 1,100,000 3,100,000 9.50%, 01/15/16 (h) 2,045,000 1,124,750 3,169,750
-------------------------------------
7,580,000 2,739,125 10,319,125
-------------------------------------
FINANCIAL - 2.1%
HUB International Holdings, Inc.
14,200,000 7,000,000 21,200,000 10.25%, 06/15/15 (h) 12,141,000 5,985,000 18,126,000
Penhall International, Corp.
2,000,000 - 2,000,000 12.00%, 08/01/14 (h) 1,870,000 - 1,870,000
-------------------------------------
14,011,000 5,985,000 19,996,000
-------------------------------------
FOOD AND DRUG - 0.1%
Cinacalcet Royalty Sub LLC
441,291 - 441,291 8.00%, 03/30/17 516,311 - 516,311
-------------------------------------
FOOD/TOBACCO - 1.7%
Chiquita Brands International, Inc.
3,000,000 5,300,000 8,300,000 7.50%, 11/01/14 2,647,500 4,677,250 7,324,750
5,000,000 - 5,000,000 8.88%, 12/01/15 4,550,000 - 4,550,000
Land O' Lakes Capital Trust I
- 500,000 500,000 7.45%, 03/15/28 (h) - 440,000 440,000
Pinnacle Foods Group Inc.
- 500,000 500,000 9.25%, 04/01/15 (h) - 458,750 458,750
- 2,000,000 2,000,000 10.63%, 04/01/17 (h) (l) - 1,730,000 1,730,000
Select Medical Corporation
- 975,000 975,000 7.63%, 02/01/15 - 838,500 838,500
- 1,162,000 1,162,000 11.26%, 09/15/15 (g) (l) - 1,016,750 1,016,750
-------------------------------------
7,197,500 9,161,250 16,358,750
-------------------------------------
FOREST PRODUCTS - CONTAINERS - 0%
NewPage Corporation
- 279,321 279,321 11.82%, 11/01/13 PIK (g) - 269,545 269,545
-------------------------------------
GAMING/LEISURE - OTHER LEISURE - 2%
Six Flags, Inc.
4,081,000 2,267,000 6,348,000 4.50%, 05/15/15 2,963,826 1,646,409 4,610,235
4,500,000 2,000,000 6,500,000 8.88%, 02/01/10 (l) 3,712,500 1,650,000 5,362,500
Tropicana Entertainment LLC
6,525,000 8,000,000 14,525,000 9.63%, 12/15/14 (h) (l) 4,176,000 5,120,000 9,296,000
-------------------------------------
10,852,326 8,416,409 19,268,735
-------------------------------------
HEALTHCARE - ACUTE CARE - 3.1%
Argatroban Royalty Sub LLC
9,803,340 3,640,494 13,443,834 18.50%, 09/21/14 9,852,357 3,658,696 13,511,053
Eszopiclone Royalty Sub LLC
- 1,794,000 1,794,000 12.00%, 06/30/14 - 1,865,760 1,865,760
HCA, Inc.
10,000,000 - 10,000,000 6.30%, 10/01/12 8,950,000 8,950,000
- 500,000 500,000 7.50%, 11/15/49 - 384,623 384,623
- 500,000 500,000 7.69%, 06/15/25 - 416,451 416,451
3,000,000 - 3,000,000 8.36%, 04/15/24 2,652,669 - 2,652,669
Risperidone Royalty Sub LLC
- 2,000,000 2,000,000 7.00%, 01/01/18 - 1,830,000 1,830,000
-------------------------------------
21,455,026 8,155,529 29,610,555
-------------------------------------
HEALTHCARE - ALTERNATE SITE SERVICES - 0.3%
LifeCare Holdings
5,000,000 - 5,000,000 9.25%, 08/15/13 3,325,000 - 3,325,000
-------------------------------------
HOUSING - BUILDING MATERIALS - 2.2%
Associated Materials, Inc.
- 1,767,000 1,767,000 0.00%, 03/01/14 (l) (m) - 1,139,715 1,139,715
Masonite Corp.
4,000,000 250,000 4,250,000 11.00%, 04/06/15 (l) 3,140,000 196,250 3,336,250
Realogy Corp.
8,000,000 5,000,000 13,000,000 10.50%, 04/15/14 (h) (l) 6,000,000 3,750,000 9,750,000
5,500,000 - 5,500,000 11.00%, 04/15/14 PIK (h) 3,836,250 - 3,836,250
4,000,000 570,000 4,570,000 12.38%, 04/15/15 (h) (l) 2,530,000 360,525 2,890,525
-------------------------------------
15,506,250 5,446,490 20,952,740
-------------------------------------
INFORMATION TECHNOLOGY - 2.7%
Charys Holding Co., Inc.
- 2,500,000 2,500,000 8.75%, 02/16/12 (h) - 1,762,500 1,762,500
Freescale Semiconductor, Inc.
3,800,000 - 3,800,000 10.13%, 12/15/16 3,154,000 - 3,154,000
- 2,000,000 2,000,000 8.87%, 12/15/14 (g) - 1,710,000 1,710,000
MagnaChip Semiconductor
8,000,000 6,500,000 14,500,000 8.24%, 12/15/11 (g) 7,160,000 5,817,500 12,977,500
NXP BV/NXP Funding LLC
2,000,000 - 2,000,000 7.99%, 10/15/13 (g) 1,847,500 - 1,847,500
Spansion LLC
5,000,000 - 5,000,000 11.25%, 01/15/16 (h) 4,275,000 - 4,275,000
-------------------------------------
16,436,500 9,290,000 25,726,500
-------------------------------------
RETAIL - 2.6%
Blockbuster, Inc.
11,500,000 8,000,000 19,500,000 9.00%, 09/01/12 (l) 9,890,000 6,880,000 16,770,000
Dollar General Corp.
5,500,000 3,250,000 8,750,000 10.63%, 07/15/15 (h) (l) 5,073,750 2,998,125 8,071,875
-------------------------------------
14,963,750 9,878,125 24,841,875
-------------------------------------
TELECOMMUNICATIONS - 2.5%
Digicel Group, Ltd.
12,454,260 6,537,854 18,992,114 9.13%, 01/15/15 PIK (h) (l) 11,395,648 5,982,136 17,377,784
Grande Communications Holdings, Inc.
- 2,000,000 2,000,000 14.00%, 04/01/11 - 2,065,000 2,065,000
Intelsat Bermuda, Ltd.
- 4,500,000 4,500,000 11.25%, 06/15/16 (h) - 4,657,500 4,657,500
-------------------------------------
11,395,648 12,704,636 24,100,284
-------------------------------------
TRANSPORTATION - 1.8%
American Tire Distributors Holdings, Inc.
5,000,000 3,500,000 8,500,000 11.48%, 04/01/12 (g) 4,875,000 3,412,500 8,287,500
Delphi Corp.
2,933,000 - 2,933,000 6.55%, 06/15/06 (d) 1,759,800 - 1,759,800
7,834,000 - 7,834,000 7.13%, 05/01/29 (d) 4,817,910 - 4,817,910
1,200,000 417,000 1,617,000 6.50%, 05/01/09 (d) (l) 726,000 252,285 978,285
200,000 - 200,000 6.50%, 08/15/13 (d) 117,000 - 117,000
Federal-Mogul Corp.
1,579,000 - 1,579,000 7.50%, 01/15/09 (d) - - -
1,000,000 - 1,000,000 7.75%, 07/01/06 (d) - - -
Motor Coach Industries International, Inc.
- 1,000,000 1,000,000 11.25%, 05/01/09 - 852,500 -
Nordic Telephone Company Holdings
- 500,000 500,000 8.88%, 05/01/16 (h) - 515,000 -
-------------------------------------
12,295,710 5,032,285 17,327,995
-------------------------------------
UTILITIES - 0%
Enron Corp.
1,000,000 - 1,000,000 6.63%, 11/15/05 (d) (i) 182,500 - 182,500
USGen New England, Inc.
- 56,303 56,303 01/02/15 (d) (h) - - -
-------------------------------------
182,500 - 182,500
-------------------------------------
WIRELESS COMMUNICATIONS - 1.2%
SunCom Wireless Holdings, Inc.
5,000,000 6,000,000 11,000,000 8.50%, 06/01/13 5,200,000 6,240,000 11,440,000
-------------------------------------
TOTAL CORPORATE NOTES AND BONDS 177,932,892 111,348,211 289,281,103
-------------------------------------
CLAIMS - 0.1%
AEROSPACE - AIRLINES - 0.1%
Delta Airlines, Inc.
581,794 - 581,794 Delta ALPA Claim, 12/31/10 (d) 29,334 - 29,334
Northwest Airlines, Inc.
2,000,000 600,000 2,600,000 ALPA Trade Claim, 08/21/13 (d) 72,500 21,750 94,250
3,551,000 1,065,300 4,616,300 Flight Attendant Claim, 08/21/13 (d) 128,724 38,617 167,341
2,107,500 632,250 2,739,750 IAM Trade Claim, 08/21/13 (d) 76,397 22,919 99,316
2,341,500 702,450 3,043,950 Retiree Claim, 08/21/13 (d) 84,879 25,464 110,343
-------------------------------------
TOTAL CLAIMS 391,834 108,750 500,584
-------------------------------------
COMMON STOCKS - 6.9%
AEROSPACE - AIRLINES - 1%
199,342 91,819 291,161 Delta Air Lines, Inc. (j) 2,968,198 1,367,183 4,335,381
253,611 113,554 367,165 Northwest Airlines Corp. (j) 3,679,896 1,647,676 5,327,572
-------------------------------------
6,648,094 3,014,858 9,662,952
-------------------------------------
BROADCASTING - 0.4%
357,343 - 357,343 Gray Television, Inc. 2,865,891 - 2,865,891
121,072 - 121,072 Gray Television, Inc., Class A 1,029,112 - 1,029,112
- 1,184 1,184 Time Warner Cable, Inc. (j) - 32,678 32,678
-------------------------------------
3,895,003 32,678 3,927,681
-------------------------------------
CONSUMER NON-DURABLES - 0%
- 24,015 24,015 Outsourcing Services Group, Inc. (b) (j) - - -
-------------------------------------
DIVERSIFIED MEDIA - 0.1%
- 46,601 46,601 American Banknote Corp. (j) - 1,095,124 1,095,124
-------------------------------------
FINANCIAL - 0%
- 555,258 555,258 Altiva Financial Corp. (j) - 5,553 5,553
-------------------------------------
FOREST PRODUCTS - CONTAINERS - 0.4%
563,258 - 563,258 Graphic Packaging Corp. (j) 2,078,422 - 2,078,422
100,067 - 100,067 Louisiana-Pacific Corp. 1,368,917 - 1,368,917
-------------------------------------
3,447,339 - 3,447,339
-------------------------------------
HOUSING - BUILDING MATERIALS - 0.3%
150,285 - 150,285 Owens Corning, Inc. (j) 3,038,755 - 3,038,755
-------------------------------------
HOUSING - REAL ESTATE DEVELOPMENT - 0%
8 - 8 Westgate Investments LLC (b) - - -
-------------------------------------
INFORMATION TECHNOLOGY - 0%
- 303 303 Viatel Holding Bermuda, Ltd. (j) - 7 7
-------------------------------------
SERVICE - ENVIRONMENTAL SERVICES - 0.3%
136,990 - 136,990 Safety-Kleen Systems, Inc. (j) 2,876,790 - 2,876,790
-------------------------------------
TELECOMMUNICATIONS - 0.5%
753,981 - 753,981 Communications Corp. of America (b) (j) 5,004,775 - 5,004,775
- 232 232 Knology, Inc. (j) - 2,965 2,965
-------------------------------------
5,004,775 2,965 5,007,740
-------------------------------------
TRANSPORTATION - 0.2%
1,544,148 - 1,544,148 Delphi Corp. (j) 223,901 - 223,901
58,949 - 58,949 Federal-Mogul Corp., Class A (j) 1,473,725 - 1,473,725
-------------------------------------
1,697,626 - 1,697,626
-------------------------------------
UTILITIES - 0.5%
81,194 - 81,194 Entegra TC LLC 2,715,939 - 2,715,939
59,600 - 59,600 NRG Energy, Inc. (j) 2,583,064 - 2,583,064
-------------------------------------
5,299,003 - 5,299,003
-------------------------------------
WIRELESS COMMUNICATIONS - 3.2%
225,000 853,905 1,078,905 ICO Global Communications Holding Ltd. (j) (l) 715,500 2,715,418 3,430,918
1,037,196 - 1,037,196 SunCom Wireless Holdings, Inc., Class A (j) 27,547,926 - 27,547,926
-------------------------------------
28,263,426 2,715,418 30,978,844
-------------------------------------
TOTAL COMMON STOCKS 60,170,811 6,866,602 67,037,413
-------------------------------------
WARRANTS - 0.0%
20,000 - 20,000 Clearwire Corp., expires 08/15/10 (j) 3,688 - 3,688
- 5,000 5,000 XM Satellite Radio, Inc., expires 03/05/10 (j) - - -
-------------------------------------
TOTAL WARRANTS 3,688 - 3,688
-------------------------------------
TOTAL INVESTMENTS - 135.0% 838,189,541 131,681,117 969,870,658
-------------------------------------
Investments sold short
outstanding as of December 31,
2007:
PRO FORMA
PRO FORMA COMBINED
HIGHLAND COMBINED HIGHLAND HIGHLAND
CREDIT PROSPECT STREET HIGHLAND CREDIT PROSPECT STREET CREDIT
STRATEGIES HIGH INCOME CREDIT STRATEGIES STRATEGIES HIGH INCOME STRATEGIES
FUND (HCF) PORTFOLIO (PHY) FUND (HCF) FUND (HCF) PORTFOLIO (PHY) FUND (HCF)
----------- ---------------- ----------------- ------------------------------ ---------- --------------- ------------
# OF SHARES # OF SHARES # OF SHARES SECURITY VALUE ($) VALUE ($) VALUE ($)
----------- ---------------- ----------------- ------------------------------ ---------- --------------- ------------
19,593 - 19,593 Superior Industries 116,578 - 116,578
International, Inc.
51,587 - 51,587 IndyMac Bancorp, Inc. 937,336 - 937,336
------------
1,053,914
Forward foreign currency contracts outstanding as of December 31, 2007 were as follows:
PRO FORMA COMBINED
HIGHLAND CREDIT PROSPECT STREET HIGH HIGHLAND CREDIT
STRATEGIES FUND (HCF) INCOME PORTFOLIO (PHY) STRATEGIES FUND (HCF)
-----------------------------------------------------------------------
CONTRACTS PRINCIPAL AMOUNT PRINCIPAL AMOUNT PRINCIPAL AMOUNT
TO BUY OR COVERED COVERED COVERED
TO SELL CURRENCY BY CONTRACTS BY CONTRACTS BY CONTRACTS
---------------------------------------------------------------------------------------------------
Sell AUD 4,000,000 0 4,000,000
Sell AUD 5,400,000 0 5,400,000
Sell AUD 2,700,000 0 2,700,000
Sell EUR 11,000,000 0 11,000,000
Sell EUR 4,900,000 0 4,900,000
Sell EUR 5,100,000 0 5,100,000
Sell GBP 4,000,000 0 4,000,000
Sell GBP 500,000 0 500,000
Sell GBP 500,000 0 500,000
PRO FORMA COMBINED
HIGHLAND CREDIT PROSPECT STREET HIGH HIGHLAND CREDIT
STRATEGIES FUND (HCF) INCOME PORTFOLIO (PHY) STRATEGIES FUND (HCF)
-----------------------------------------------------------------------
NET UNREALIZED NET UNREALIZED NET UNREALIZED
APPRECIATION/ APPRECIATION/ APPRECIATION/
EXPIRATION (DEPRECIATION) (DEPRECIATION) (DEPRECIATION)
------------------------------------------------------------------------------------
02/28/2008 ($236,992) 0 ($236,992)
02/29/2008 -353,149 0 ($353,149)
03/11/2008 -147,955 0 ($147,955)
02/04/2008 -940,067 0 ($940,067)
05/29/2008 108,967 0 $108,967
05/30/2008 54,955 0 $54,955
02/07/2008 169,210 0 $169,210
05/29/2008 36,435 0 $36,435
05/30/2008 33,338 0 $33,338
(a) Senior loans in which the Fund invests generally pay interest at rates which are periodically predetermined
by reference to a base lending rate plus a premium. (Unless otherwise identified by Note (f), all senior
loans carry a variable rate interest.) These base lending rates are generally (i) the Prime Rate offered by
one or more major United States banks, (ii) the lending rate offered by one or more European banks such as
the London Inter-Bank Offered Rate ("LIBOR") or (iii) the Certificate of Deposit rate. Rate shown
represents the weighted average rate at December 31, 2007. Senior loans, while exempt from registration
under the Security Act of 1933, as amended (the "1933 Act"), contain certain restrictions on resale and
cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow
or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a
contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual
remaining maturity may be substantially less than the stated maturities shown.
(b) Represents fair value as determined in good faith under the direction of the Board.
(c) Senior Loan Notes have additional unfunded loan commitments.
(d) The issuer is in default of certain debt covenants. Income is not being accrued.
(e) All or a portion of this position has not settled. Contract rates do not take effect until settlement date.
(f) Fixed Rate Senior Loan.
(g) Floating rate security. The interest rate shown reflects the rate in effect at December 31, 2007.
(h) Securities exempt from registration pursuant to Rule 144A under the 1933 Act. These securities may only be
resold, in transactions exempt from registration, to qualified institutional buyers. These securities have
been determined by the Adviser to be liquid securities.
(i) This issuer is under the protection of the U.S. federal bankruptcy court.
(j) Non-income producing security.
(l) Securities (or a portion of securities) on loan as of December 31, 2007.
(m) Step Coupon. A bond that pays an initial coupon rate for the first period and then a higher coupon rate for
the following periods until maturity.
AUD Australia Dollar
DIP Debtor in Possession
EUR Euro Currency
GBP Great Britian Pound
PIK Payment in Kind
SEK Swedish Krona
STATEMENT OF ASSETS AND LIABILITIES
PRO FORMA COMBINED STATEMENT OF ASSETS AND LIABILITIES FOR HIGHLAND CREDIT
STRATEGIES FUND AND PROSPECT STREET HIGH INCOME PORTFOLIO INC. AS OF
DECEMBER 31, 2007 (UNAUDITED)
PRO FORMA
INCLUDING RIGHTS PRO FORMA
HIGHLAND OFFERING COMBINED
CREDIT RIGHTS OFFERING HIGHLAND CREDIT PROSPECT STREET HIGHLAND CREDIT
STRATEGIES PRO FORMA STRATEGIES HIGH INCOME PRO FORMA STRATEGIES
FUND (HCF) ADJUSTMENTS FUND (HCF) PORTFOLIO (PHY) ADJUSTMENTS FUND (HCF)
---------- --------------- ---------------- --------------- ------------ ---------------
Assets:
Investments, at value 838,189,541 838,189,541 131,681,117 969,870,658
Cash 2,837,166 143,563,458[3] 146,400,624 3,954,306 150,354,930
Restricted Cash 39,261,591 39,261,591 - 39,261,591
Net unrealized appreciation
on forward currency
contracts 402,905 402,905 - 402,905
Receivable for: -
Investments Sold 22,028,985 22,028,985 2,180,241 24,209,226
Swap agreements 1,054,833 1,054,833 - 1,054,833
Dividends and interest
receivables 13,150,972 13,150,972 2,526,024 15,676,996
Other assets 41,483 41,483 80,287 121,770
------------- -------------- --------------- ------------- ----------- --------------
Total assets 916,967,476 143,563,458 1,060,530,934 140,421,974 - 1,200,952,908
------------- -------------- --------------- ------------- ----------- --------------
LIABILITIES:
Note payable 248,000,000 248,000,000 - 40,000,000 288,000,000
Securities sold short, at
value 1,053,914 1,053,914 - 1,053,914
Net discount and unrealized
depreciation on unfunded
transactions 1,556,736 1,556,736 - 1,556,736
Net unrealized depreciation
on forward currency
contracts 1,678,163 1,678,163 - 1,678,163
Net unrealized depreciation
on credit default swaps 29,158 29,158 - 29,158
Net unrealized depreciation
on total return swaps 6,341,169 6,341,169 - 6,341,169
Payables for: -
Distributions 5,178,082 5,178,082 - 5,178,082
Investments purchased 29,734,707 29,734,707 3,841,806 33,576,513
Investment advisory fee
payable 748,663 748,663 76,695 825,358
Preferred dividend
payable - - 34,262 34,262
Administration fee 149,733 149,733 6,482 156,215
Interest Expense 1,278,012 1,278,012 - 1,278,012
Accrued expenses and
other liabilities 140,978 140,978 105,414 561,950[1] 808,342
------------- ------------- --------------- -------------- ----------- --------------
Total liabilities 295,889,315 - 295,889,315 4,064,658 40,561,950 340,515,923
============= ============= =============== ============== =========== ==============
AUCTION RATE PREFERRED STOCK - - - 40,000,000[4] (40,000,000) -
NET ASSETS APPLICABLE TO
COMMON SHARES: 621,078,161 764,641,619 96,357,317 (561,950) 860,436,986
COMPOSITION OF NET ASSETS:
Par value of common shares 34,521 11,536[3] 46,057 926,241 (920,438) 51,860
Paid-in capital in excess
of par value of common
shares 657,755,847 143,551,922[3] 801,307,769 116,809,414 920,438 919,037,621
Undistributed net
investment income 7,645,585 7,645,585 1,935,367 (561,950)[1] 9,019,002
Accumulated net realized
gain/(loss) from
investments, swaps and
foreign currency
transactions 10,712,407 10,712,407 16,912 10,729,319
Net unrealized
appreciation/
(depreciation) on
investments, unfunded
transactions, short
positions, -
forward currency
contracts, swaps and
translation of assets
and liabilities
denominated -
in foreign currency (55,070,199) (55,070,199) (23,330,617) (78,400,816)
------------- ------------- --------------- ----------- ----------- -------------
NET ASSETS APPLICABLE TO
COMMON SHARES 621,078,161 143,563,458 764,641,619 96,357,317 (561,950)[1] 860,436,986
============= ============= =============== =========== =========== =============
COMMON SHARES
Net Assets 621,078,161 764,641,619 96,357,317 860,436,986
Shares outstanding
(unlimited
authorization) 34,520,550 46,056,165 30,874,699 (25,070,395)[2] 51,860,469
Net asset value per
share (net assets/
shares outstanding) 17.99 16.60 3.12 16.59
[1] Reflects adjustments for estimated reorganization expenses of $561,950.
[2] Reflects adjustments to the number of shares outstanding due to the reorganization
[3] Reflects the proceeds received from the rights offering that closed on January 28, 2008
[4] Auction Rate Preferred Stock (1,000,000 shares authorized, and 1,600 shares issued at $25,000 per share)
See Notes to Pro Forma Combined Financial Statements
STATEMENT OF OPERATIONS
PRO FORMA COMBINED STATEMENT OF OPERATIONS FOR HIGHLAND CREDIT
STRATEGIES FUND AND PROSPECT STREET HIGH INCOME PORTFOLIO INC.
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2007 (UNAUDITED)
PRO FORMA
INCLUDING RIGHTS PRO FORMA
HIGHLAND OFFERING COMBINED
CREDIT RIGHTS OFFERING HIGHLAND CREDIT PROSPECT STREET HIGHLAND CREDIT
STRATEGIES PRO FORMA STRATEGIES HIGH INCOME PRO FORMA STRATEGIES
FUND (HCF) ADJUSTMENTS(b) FUND (HCF) PORTFOLIO (PHY) ADJUSTMENTS FUND (HCF)
---------- --------------- ---------------- --------------- ------------ ---------------
INVESTMENT INCOME:
Interest 85,031,062 85,031,062 12,132,742 - 97,163,804
Accretion of bond discount - - 678,083 678,083
Dividends 1,826,564 1,826,564 - - 1,826,564
Securities lending income 7,479 7,479 163,872 - 171,351
---------- -------------- ---------------- --------------- ------------ ---------------
Total investment income 86,865,105 - 86,865,105 12,974,697 - 99,839,802
---------- -------------- ---------------- --------------- ------------ ---------------
EXPENSES:
Investment advisory fees 9,368,976 1,967,689 11,336,665 947,447 501,770 12,785,882
Administration fees 1,873,796 393,538 2,267,334 33,406(a) 289,884 2,509,624
Accounting service fees 449,908 38,470 488,378 33,406(a) (6,846) 514,938
Transfer agent fees 34,147 - 34,147 29,371 (29,371) 34,147
Professional fees 332,701 - 332,701 64,245 (64,245) 332,701
Trustees' fees 32,295 - 32,295 46,036 (46,036) 32,295
Custodian fees 118,582 24,905 143,487 13,640 - 157,127
Registration fees 37,005 - 37,005 29,746 (29,746) 37,005
Preferred shares broker
expense - - - 102,437 (102,437) -
Reports to shareholders 113,710 23,882 137,592 40,216 (22,627) 155,181
Other Expenses 413,714 19,696 433,410 82,223 (72,909) 442,724
----------- -------------- ---------------- --------------- ------------ --------------
NET OPERATING EXPENSES 12,774,834 2,468,180 15,243,014 1,422,173 417,437 17,082,624
----------- -------------- ---------------- --------------- ------------ --------------
Interest Expense 14,759,102 14,759,102 14,204 2,331,990 17,105,297
Dividends on securities
sold short 226,480 226,480 - - 226,480
----------- -------------- ---------------- --------------- ------------ --------------
TOTAL EXPENSES 27,760,416 2,468,180 30,228,596 1,436,377 2,749,427 34,414,401
----------- -------------- ---------------- --------------- ------------ --------------
Less: Fee waiver - - - - (791,654) (791,654)
----------- -------------- ---------------- --------------- ------------ --------------
NET EXPENSE 27,760,416 2,468,180 30,228,596 1,436,377 1,957,773 33,622,747
----------- -------------- ---------------- --------------- ------------ --------------
NET INVESTMENT INCOME 59,104,689 (2,468,180) 56,636,509 11,538,320 (1,957,773) 66,217,055
----------- -------------- ---------------- --------------- ------------ --------------
NET REALIZED AND UNREALIZED
GAIN/(LOSS) ON INVESTMENTS:
Net realized gain/(loss)
on investments 17,716,313 17,716,313 3,680,385 21,396,698
Net realized gain/(loss)
on swaps 877,812 877,812 - 877,812
Net realized gain/(loss)
on foreign currency
transactions (988,007) (988,007) 76,789 (911,218)
Net change in unrealized
appreciation/
(depreciation) on
investments (72,891,311) (72,891,311) (14,923,803) (87,815,114)
Net change in unrealized
appreciation/
(depreciation) on
unfunded transactions (1,205,082) (1,205,082) - (1,205,082)
Net change in unrealized
appreciation/
(depreciation) on short
positions 324,633 324,633 - 324,633
Net change in unrealized
appreciation/
(depreciation) on
forward currency
contracts (1,275,258) (1,275,258) - (1,275,258)
Net change in unrealized
appreciation/
(depreciation) on swaps (6,370,327) (6,370,327) - (6,370,327)
Net change in unrealized
appreciation/
(depreciation) on
translation of assets
and -
liabilities denominated
in foreign currency (55,214) (55,214) 73,767 18,553
----------- -------------- ---------------- --------------- ------------ --------------
NET REALIZED AND
UNREALIZED GAIN/(LOSS)
ON INVESTMENTS (63,866,441) - (63,866,441) (11,092,863) - (74,959,304)
Distributions to Preferred
Shareholders - - - (2,149,833) 2,149,833 -
NET (DECREASE)/INCREASE
IN NET ASSETS, APPLICABLE
TO COMMON SHAREHOLDERS,
FROM OPERATIONS (4,761,752) (2,468,180) (7,229,932) (1,704,376) 192,060 (8,742,248)
See Notes to Pro Forma Combined Financial Statements
(a) On historical financial statements the administration fee has included both
accounting and administrative services payable to third party service
providers.
(b) Reflects adjustments due to proceeds received from the rights offering that
closed on January 28, 2008.
PROSPECT STREET HIGH INCOME PORTFOLIO INC. MERGER WITH
AND INTO HIGHLAND CREDIT STRATEGIES FUND
NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF COMBINATION:
The accompanying unaudited Pro Forma Combined Statement of Assets and
Liabilities, the Pro Forma Combined Schedule of Investments at December 31, 2007
and the related Pro Forma Combined Statement of Operations ("Pro Forma
Statements") for the twelve months ended December 31, 2007, reflect the accounts
of Prospect Street High Income Portfolio Inc. ("Acquired Fund") and Highland
Credit Strategies Fund ("Acquiring Fund"), each a "Fund." Following the
reorganization, Highland Credit Strategies Fund will be the accounting survivor.
The Pro Forma Statements assume the preferred shares of the Acquired Fund were
redeemed prior the reorganization and a corresponding amount was borrowed under
the credit facility of the Acquiring Fund. For the Acquiring Fund an adjustment
has been made to the Pro Forma Statements to reflect the proceeds received from
the rights offering that closed on January 28, 2008.
Under the terms of the Agreement and Plan of Reorganization, the
Reorganization is intended to qualify as a "reorganization" within the meaning
of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended. If the
Reorganization so qualifies, in general, stockholders of the Acquired Fund will
recognize no gain or loss upon the receipt solely of shares of the Acquiring
Fund in connection with the Reorganization. Additionally, the Acquired Fund will
recognize no gain or loss as a result of the Reorganization. Neither the
Acquiring Fund nor its shareholders will recognize any gain or loss in
connection with the Reorganization. However, stockholders of the Acquired Fund
may recognize gain or loss with respect to cash such holders receive pursuant to
the Agreement and Plan of Reorganization in lieu of fractional shares. The
reorganization would be accomplished by an acquisition of the net assets of the
Acquired Fund in exchange for shares of the Acquiring Fund at net asset value.
The unaudited Pro Forma Combined Schedule of Investments and the unaudited Pro
Forma Combined Statement of Assets and Liabilities have been prepared as though
the combination had been effective on December 31, 2007. The unaudited Pro Forma
Combined Statement of Operations reflects the results of the Funds for the
twelve months ended December 31, 2007 as if the merger occurred on January 1,
2007. These pro forma statements have been derived from the books and records of
the Funds utilized in calculating daily net asset values at the dates indicated
above in conformity with U.S. generally accepted accounting principles. The
historical cost of investment securities will be carried forward to the
surviving entity. The fiscal year ends are October 31 for the Prospect Street
High Income Portfolio Inc. and December 31 for the Highland Credit Strategies
Fund. The Pro Forma Combined Financial Statements should be read in conjunction
with the historical financial statements of each Fund, which are incorporated by
reference in the Statement of Additional Information.
2. USE OF ESTIMATES:
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles ("GAAP") requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
3. INVESTMENT VALUATION:
In computing the Fund's net assets attributable to Common Shares,
securities with readily available market quotations use those quotations for
valuation. When portfolio securities are traded on the relevant day of
valuation, the valuation will be the last reported sale price on that day. If
there are no such sales on that day, the security will be valued at the mean
between the most recently quoted bid and asked prices provided by the principal
market makers. If there is more than one such principal market maker, the value
shall be the average of such means. Securities without a sale price or
quotations from principal market makers on the valuation day will be valued by
an independent pricing service. If securities do not have readily available
market quotations or pricing service prices, including circumstances under which
such are determined not to be accurate or current (including when events
materially affect the value of securities occurring between the time when market
price is determined and calculation of the Fund's net asset value), such
securities are valued at their fair value, as determined by Highland Capital
Management, L.P. in good faith in accordance with procedures approved by the
Fund's Board of Trustees. In these cases, the Fund's net asset value will
reflect the affected portfolio securities' value as determined in the judgment
of the Board of Trustees or its designee instead of being determined by the
market. Using a fair value pricing methodology to value securities may result in
a value that is different from a security's most recent sale price and from the
prices used by other investment companies to calculate their net asset values.
There can be no assurance that the Fund's valuation of a security will not
differ from the amount that it realizes upon the sale of such security.
Short-term investments, that is, those with a remaining maturity of 60 days or
less, are valued at amortized cost. Repurchase agreements are valued at cost
plus accrued interest. Foreign price quotations are converted to U.S. dollar
equivalents using the 4 PM London Time Spot Rate.
4. CAPITAL SHARES:
The unaudited pro forma net asset values per share assumes additional
shares of capital stock of the Acquiring Fund were issued in connection with the
proposed acquisition of the Acquired Fund as of December 31, 2007. The number of
additional shares issued was calculated by dividing the net asset value of each
class of the Acquired Fund by the respective class net asset value per share of
the Acquiring Fund.
5. PRO FORMA OPERATIONS:
In the Pro Forma Combined Statement of Operations certain expenses have
been adjusted to reflect the expected expenses of the combined entity. The pro
forma investment management fees of the combined entity are based on the fee
schedules in effect for the Acquiring Fund's combined level of average net
assets for the twelve months ended December 31, 2007.
6. FEDERAL INCOME TAXES:
It is the policy of the Funds to comply with the federal income and
excise tax requirements of the Internal Revenue Code of 1986, as amended,
applicable to regulated investment companies. Accordingly, the Funds intend to
distribute substantially all of their net investment income and net realized
gains on investments, if any, to their shareholders. Therefore, no federal
income tax provision is required.
APPENDIX A
RATINGS OF INVESTMENTS
STANDARD & POOR'S--A brief description of the applicable rating symbols of
Standard & Poor's and their meanings (as published by Standard & Poor's)
follows:
ISSUE CREDIT RATING DEFINITIONS
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:
o 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;
o Nature of and provisions of the obligation; and
o Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization, or other arrangement under
the laws of bankruptcy and other laws affecting creditors' rights.
The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.
AAA
An obligation rated "AAA" has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA
A-1
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
A-2
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-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
A-4
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.
o 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.
o Preliminary ratings are assigned to Rule 415 Shelf Registrations. As
specific issues, with defined terms, are offered from the master
registration, a final rating may be assigned to them in accordance
with Standard & Poor's policies. The final rating may differ from the
preliminary rating.
t
This symbol indicates termination structures that are designed to honor
their contracts to full maturity or, should certain events occur, to terminate
and cash settle all their contracts before their final maturity date.
INACTIVE QUALIFIERS (NO LONGER APPLIED OR OUTSTANDING)
*
This symbol indicated continuance of the ratings is contingent upon
Standard & Poor `s receipt of an executed copy of the escrow agreement or
closing documentation confirming investments and cash flows. Discontinued use in
August 1998.
c
This qualifier was used to provide additional information to investors that
the bank may terminate its obligation to purchase tendered bonds if the
long-term credit rating of the issuer is below an investment-grade level and/or
the issuer's bonds are deemed taxable. Discontinued use in January 2001.
q
A "q" subscript indicates that the rating is based solely on quantitative
analysis of publicly available information. Discontinued use in April 2001.
r
The "r" modifier was assigned to securities containing extraordinary risks,
particularly market risks, that are not covered in the credit rating. The
absence of an "r" modifier should not be taken as an indication that an
obligation will not exhibit extraordinary non-credit related risks. Standard &
Poor's discontinued the use of the "r" modifier for most obligations in June
2000 and for the balance of obligations (mainly structured finance transactions)
in November 2002.
A-5
MOODY'S INVESTORS SERVICE, INC.--A brief description of the applicable
Moody's rating symbols and their meanings (as published by Moody's) follows:
LONG-TERM OBLIGATION RATINGS
Moody's long-term obligation ratings are opinions of the relative credit
risk of a fixed income obligations with an original maturity of one year or
more. They address the possibility that a financial obligation will not be
honored as promised. Such ratings reflect both the likelihood of default and any
financial loss suffered in the event of default.
MOODY'S LONG-TERM RATING DEFINITIONS:
Aaa
Obligations rated Aaa are judged to be of the highest quality, with minimal
credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to
very low credit risk.
A
Obligations rated A are considered upper medium-grade and are subject to
low credit risk.
Baa
Obligations rated Baa are subject to moderate credit risk. They are
considered medium-grade and as such may possess certain speculative
characteristics.
Ba
Obligations rated Ba are judged to have speculative elements and are
subject to substantial credit risk.
B
Obligations rated B are considered speculative and are subject to high
credit risk.
Caa
Obligations rated Caa are judged to be of poor standing and are subject to
very high credit risk.
Ca
Obligations rated Ca are highly speculative and are likely in, or very
near, default, with some prospect of recovery of principal and interest.
C
Obligations rated C are the lowest rated class of bonds and are typically
in default, with little prospect for recovery of principal or interest.
NOTE: Moody's appends numerical modifiers 1, 2, and 3 to each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
A-6
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 pari 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:
o Notes containing features that link interest or principal to the
credit performance of any third party or parties (I.E., credit-linked
notes);
o Notes allowing for negative coupons, or negative principal
o Notes containing any provision that could obligate the investor to
make any additional payments
o Notes containing provisions that subordinate the claim.
For notes with any of these characteristics, the rating of the individual
note may differ from the indicated rating of the program.
For credit-linked securities, Moody's policy is to "look through" to the
credit risk of the underlying obligor. Moody's policy with respect to non-credit
linked obligations is to rate the issuer's ability to meet the contract as
stated, regardless of potential losses to investors as a result of non-credit
developments. In other words, as long as the obligation has debt standing in the
event of bankruptcy, we will assign the appropriate debt class level rating to
the instrument.
Market participants must determine whether any particular note is rated,
and if so, at what rating level. Moody's encourages market participants to
contact Moody's Ratings Desks or visit www.moodys.com directly if they have
questions regarding ratings for specific notes issued under a medium-term note
program. Unrated notes issued under an MTN program may be assigned an NR (not
rated) symbol.
SHORT-TERM RATINGS:
Moody's short-term ratings are opinions of the ability of issuers to honor
short-term financial obligations. Ratings may be assigned to issuers, short-term
programs or to individual short-term debt instruments. Such obligations
generally have an original maturity not exceeding thirteen months, unless
explicitly noted.
Moody's employs the following designations to indicate the relative
repayment ability of rated issuers:
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior ability
to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability to
repay short-term debt obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP
Issuers (or supporting institutions) rated Not Prime do not fall within any
of the Prime rating categories.
A-7
NOTE: Canadian issuers rated P-1 or P-2 have their short-term ratings
enhanced by the senior most long-term rating of the issuer, its guarantor or
support provider.
A-8
APPENDIX B
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.
B-1
2.4 NON-VOTES. The Company may determine not to vote proxies in respect
of securities of any issuer if it determines it would be in its Client's overall
best interests not to vote. Such determination may apply in respect of all
Client holdings of the securities or only certain specified Clients, as the
Company deems appropriate under the circumstances. As examples, the portfolio
manager(s) may determine: (a) not to recall securities on loan if, in its
judgment, the negative consequences to Clients of disrupting the securities
lending program would outweigh the benefits of voting in the particular instance
or (b) not to vote certain foreign securities positions if, in its judgment, the
expense and administrative inconvenience outweighs the benefits to Clients of
voting the securities.
2.5 RECORDKEEPING. Following the submission of a proxy vote, the
applicable portfolio manager(s) shall submit a report of the vote to a
settlement designee of the Company. Records of proxy votes by the Company shall
be maintained in accordance with Section 4 of this Policy.
2.6 CERTIFICATION. On a quarterly basis, each portfolio manager shall
certify to the Compliance Department that they have complied with this Policy in
connection with proxy votes during the period.
3. Conflicts of Interest
3.1 Voting the securities of an issuer where the following relationships
or circumstances exist are deemed to give rise to a material conflict of
interest for purposes of this Policy:
3.1.1 The issuer is a Client of the Company accounting for more
than 5% of the Company's annual revenues.
3.1.2 The issuer is an entity that reasonably could be expected to
pay the Company more than $1 million through the end of the Company's next
two full fiscal years.
3.1.3 The issuer is an entity in which a "Covered Person" (as
defined in the Retail Funds' and the Company's Policies and Procedures
Designed to Detect and Prevent Insider Trading and to Comply with Rule
17j-1 of the Investment Company Act of 1940, as amended (each, a "Code of
Ethics")) has a beneficial interest contrary to the position held by the
Company on behalf of Clients.
3.1.4 The issuer is an entity in which an officer or partner of
the Company or a relative(1) of any such person is or was an officer,
director or employee, or such person or relative otherwise has received
more than $150,000 in fees, compensation and other payment from the issuer
during the 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.
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.
-------------------------------
(1) For the purposes of this Policy, "relative" includes the following family
members: spouse, minor children or stepchildren or children or stepchildren
sharing the person's home.
B-2
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/Trustees/Managers and, with respect to Retail Funds other than
business development companies, to the SEC on an annual basis pursuant to Form
N-PX.
Revised: February 22, 2007
B-3
PROSPECT STREET(R) HIGH INCOME PORTFOLIO INC.
COMMON STOCK
Using a BLACK INK pen, mark your votes with an X as shown in this example. /X/
Please do not write outside the designated areas.
A. TO APPROVE AN AGREEMENT AND PLAN OF REORGANIZATION BETWEEN PROSPECT STREET
HIGH INCOME PORTFOLIO INC. ("HIGH INCOME PORTFOLIO") AND HIGHLAND CREDIT
STRATEGIES FUND (THE "ACQUIRING FUND") PURSUANT TO WHICH HIGH INCOME
PORTFOLIO WILL TRANSFER ITS ASSETS TO ACQUIRING FUND IN EXCHANGE FOR
ACQUIRING FUND SHARES (AND CASH IN LIEU OF CERTAIN FRACTIONAL SHARES) AND
THE ACQUIRING FUND'S ASSUMPTION OF HIGH INCOME PORTFOLIO'S LIABILITIES AND
HIGH INCOME PORTFOLIO WILL DISSOLVE UNDER APPLICABLE STATE LAW -- THE
BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE AGREEMENT AND PLAN OF
REORGANIZATION.
For Against Abstain
/ / / / / /
B. NON-VOTING ITEMS
CHANGE OF ADDRESS -- COMMENTS -- Please print your comments
Please print new address below. below.
------------------------------------- ----------------------------------------
------------------------------------- ----------------------------------------
C. AUTHORIZED SIGNATURES -- THIS SECTION MUST BE COMPLETED FOR YOUR VOTE TO
BE COUNTED. -- DATE AND SIGN BELOW
Please sign exactly as names appear on this proxy. If shares are held jointly,
each holder should sign. If signing as an attorney, trustee, executor,
administrator, custodian, guardian or corporate officer, please give full title.
Date (mm/dd/yyyy) -- Signature 1 -- Please Signature 2 -- Please
Please print date below. keep signature within keep signature within
the box. the box.
------------------------- ------------------------ ----------------------
/ /
------------------------- ------------------------ ----------------------
PROXY -- PROSPECT STREET(R) HIGH INCOME PORTFOLIO INC.
SPECIAL MEETING OF STOCKHOLDERS -- ________, 2008
COMMON STOCK PROXY SOLICITED ON BEHALF OF BOARD OF DIRECTORS
The undersigned holder of shares of Common Stock of Prospect Street(R) High
Income Portfolio Inc., a Maryland corporation ("High Income Portfolio"), hereby
appoints R. Joseph Dougherty and M. Jason Blackburn, and each of them, with full
power of substitution and revocation, as proxies to represent the undersigned at
the Special Meeting of Stockholders of High Income Portfolio to be held at 13455
Noel Road, Suite 800, Dallas, Texas 75240, on _______, 2008, at 10:00 a.m.
Central Time, and at any and all adjournments thereof (the "Meeting"), and
thereat to vote all Common Stock of High Income Portfolio which the undersigned
would be entitled to vote, with all powers the undersigned would possess if
personally present, in accordance with the instructions on this proxy.
THIS PROXY IS SOLICITED BY HIGH INCOME PORTFOLIO'S BOARD OF
DIRECTORS AND WILL BE VOTED FOR THE PROPOSALS UNLESS OTHERWISE
INDICATED. BY SIGNING THIS PROXY CARD, RECEIPT OF THE
ACCOMPANYING NOTICE OF SPECIAL MEETING AND COMBINED PROXY
STATEMENT AND PROSPECTUS IS ACKNOWLEDGED.
PLEASE VOTE, DATE AND SIGN ON REVERSE AND RETURN PROMPTLY IN THE
ENCLOSED ENVELOPE.
---------------------------------------------------------
PROSPECT STREET(R) HIGH INCOME PORTFOLIO INC.
PREFERRED STOCK
Using a BLACK INK pen, mark your votes with an X as shown in this example. /X/
Please do not write outside the designated areas.
A. TO APPROVE AN AGREEMENT AND PLAN OF REORGANIZATION BETWEEN PROSPECT STREET
HIGH INCOME PORTFOLIO INC. ("HIGH INCOME PORTFOLIO") AND HIGHLAND CREDIT
STRATEGIES FUND (THE "ACQUIRING FUND") PURSUANT TO WHICH HIGH INCOME
PORTFOLIO WILL TRANSFER ITS ASSETS TO ACQUIRING FUND IN EXCHANGE FOR
ACQUIRING FUND SHARES (AND CASH IN LIEU OF CERTAIN FRACTIONAL SHARES) AND
THE ACQUIRING FUND'S ASSUMPTION OF HIGH INCOME PORTFOLIO'S LIABILITIES AND
HIGH INCOME PORTFOLIO WILL DISSOLVE UNDER APPLICABLE STATE LAW -- THE
BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE AGREEMENT AND PLAN OF
REORGANIZATION.
For Against Abstain
/ / / / / /
B. NON-VOTING ITEMS
CHANGE OF ADDRESS -- COMMENTS -- Please print your comments
Please print new address below. below.
------------------------------------- ----------------------------------------
------------------------------------- ----------------------------------------
C. AUTHORIZED SIGNATURES -- THIS SECTION MUST BE COMPLETED FOR YOUR VOTE TO
BE COUNTED. -- DATE AND SIGN BELOW
Please sign exactly as names appear on this proxy. If shares are held jointly,
each holder should sign. If signing as an attorney, trustee, executor,
administrator, custodian, guardian or corporate officer, please give full title.
Date (mm/dd/yyyy) -- Signature 1 -- Please Signature 2 -- Please
Please print date below. keep signature within keep signature within
the box. the box.
------------------------- ------------------------ ----------------------
/ /
------------------------- ------------------------ ----------------------
PROXY -- PROSPECT STREET(R) HIGH INCOME PORTFOLIO INC.
SPECIAL MEETING OF STOCKHOLDERS -- ________, 2008
PREFERRED STOCK PROXY SOLICITED ON BEHALF OF BOARD OF DIRECTORS
The undersigned holder of shares of Preferred Stock of Prospect Street(R) High
Income Portfolio Inc., a Maryland corporation ("High Income Portfolio"), hereby
appoints R. Joseph Dougherty and M. Jason Blackburn, and each of them, with full
power of substitution and revocation, as proxies to represent the undersigned at
the Special Meeting of Stockholders of High Income Portfolio to be held at 13455
Noel Road, Suite 800, Dallas, Texas 75240, on _______, 2008, at 10:00 a.m.
Central Time, and at any and all adjournments thereof (the "Meeting"), and
thereat to vote all Preferred Stock of High Income Portfolio which the
undersigned would be entitled to vote, with all powers the undersigned would
possess if personally present, in accordance with the instructions on this
proxy.
THIS PROXY IS SOLICITED BY HIGH INCOME PORTFOLIO'S BOARD OF
DIRECTORS AND WILL BE VOTED FOR THE PROPOSALS UNLESS OTHERWISE
INDICATED. BY SIGNING THIS PROXY CARD, RECEIPT OF THE
ACCOMPANYING NOTICE OF SPECIAL MEETING AND COMBINED PROXY
STATEMENT AND PROSPECTUS IS ACKNOWLEDGED.
PLEASE VOTE, DATE AND SIGN ON REVERSE AND RETURN PROMPTLY IN THE
ENCLOSED ENVELOPE.
---------------------------------------------------------
PROSPECT STREET(R) INCOME SHARES INC.
COMMON STOCK
Using a BLACK INK pen, mark your votes with an X as shown in this example. /X/
Please do not write outside the designated areas.
A. TO APPROVE AN AGREEMENT AND PLAN OF REORGANIZATION BETWEEN PROSPECT STREET
INCOME SHARES INC. ("INCOME SHARES") AND HIGHLAND CREDIT STRATEGIES FUND
(THE "ACQUIRING FUND") PURSUANT TO WHICH INCOME SHARES WILL TRANSFER ITS
ASSETS TO ACQUIRING FUND IN EXCHANGE FOR ACQUIRING FUND SHARES (AND CASH
IN LIEU OF CERTAIN FRACTIONAL SHARES) AND THE ACQUIRING FUND'S ASSUMPTION
OF INCOME SHARES' LIABILITIES AND INCOME SHARES WILL DISSOLVE UNDER
APPLICABLE STATE LAW -- THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE
AGREEMENT AND PLAN OF REORGANIZATION.
For Against Abstain
/ / / / / /
B. NON-VOTING ITEMS
CHANGE OF ADDRESS -- COMMENTS -- Please print your comments
Please print new address below. below.
------------------------------------- ----------------------------------------
------------------------------------- ----------------------------------------
C. AUTHORIZED SIGNATURES -- THIS SECTION MUST BE COMPLETED FOR YOUR VOTE TO
BE COUNTED. -- DATE AND SIGN BELOW
Please sign exactly as names appear on this proxy. If shares are held jointly,
each holder should sign. If signing as an attorney, trustee, executor,
administrator, custodian, guardian or corporate officer, please give full title.
Date (mm/dd/yyyy) -- Signature 1 -- Please Signature 2 -- Please
Please print date below. keep signature within keep signature within
the box. the box.
------------------------- ------------------------ ----------------------
/ /
------------------------- ------------------------ ----------------------
PROXY -- PROSPECT STREET(R) INCOME SHARES INC.
SPECIAL MEETING OF STOCKHOLDERS -- ________, 2008
COMMON STOCK PROXY SOLICITED ON BEHALF OF BOARD OF DIRECTORS
The undersigned holder of shares of Common Stock of Prospect Street(R) Income
Shares Inc., a Maryland corporation ("Income Shares"), hereby appoints R. Joseph
Dougherty and M. Jason Blackburn, and each of them, with full power of
substitution and revocation, as proxies to represent the undersigned at the
Special Meeting of Stockholders of Income Shares to be held at 13455 Noel Road,
Suite 800, Dallas, Texas 75240, on _______, 2008, at 10:00 a.m. Central Time,
and at any and all adjournments thereof (the "Meeting"), and thereat to vote all
Common Stock of Income Shares which the undersigned would be entitled to vote,
with all powers the undersigned would possess if personally present, in
accordance with the instructions on this proxy.
THIS PROXY IS SOLICITED BY INCOME SHARES' BOARD OF DIRECTORS AND
WILL BE VOTED FOR THE PROPOSALS UNLESS OTHERWISE INDICATED. BY
SIGNING THIS PROXY CARD, RECEIPT OF THE ACCOMPANYING NOTICE OF
SPECIAL MEETING AND COMBINED PROXY STATEMENT AND PROSPECTUS IS ACKNOWLEDGED.
PLEASE VOTE, DATE AND SIGN ON REVERSE AND RETURN PROMPTLY IN THE
ENCLOSED ENVELOPE.
--------------------------------------------------------
PROSPECT STREET(R) INCOME SHARES INC.
PREFERRED STOCK
Using a BLACK INK pen, mark your votes with an X as shown in this example. /X/
Please do not write outside the designated areas.
A. TO APPROVE AN AGREEMENT AND PLAN OF REORGANIZATION BETWEEN PROSPECT STREET
INCOME SHARES INC. ("INCOME SHARES") AND HIGHLAND CREDIT STRATEGIES FUND
(THE "ACQUIRING FUND") PURSUANT TO WHICH INCOME SHARES WILL TRANSFER ITS
ASSETS TO ACQUIRING FUND IN EXCHANGE FOR ACQUIRING FUND SHARES (AND CASH
IN LIEU OF CERTAIN FRACTIONAL SHARES) AND THE ACQUIRING FUND'S ASSUMPTION
OF INCOME SHARES' LIABILITIES AND INCOME SHARES WILL DISSOLVE UNDER
APPLICABLE STATE LAW -- THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE
AGREEMENT AND PLAN OF REORGANIZATION.
For Against Abstain
/ / / / / /
B. NON-VOTING ITEMS
CHANGE OF ADDRESS -- COMMENTS -- Please print your comments
Please print new address below. below.
------------------------------------- ----------------------------------------
------------------------------------- ----------------------------------------
C. AUTHORIZED SIGNATURES -- THIS SECTION MUST BE COMPLETED FOR YOUR VOTE TO
BE COUNTED. -- DATE AND SIGN BELOW
Please sign exactly as names appear on this proxy. If shares are held jointly,
each holder should sign. If signing as an attorney, trustee, executor,
administrator, custodian, guardian or corporate officer, please give full title.
Date (mm/dd/yyyy) -- Signature 1 -- Please Signature 2 -- Please
Please print date below. keep signature within keep signature within
the box. the box.
------------------------- ------------------------ ----------------------
/ /
------------------------- ------------------------ ----------------------
PROXY -- PROSPECT STREET(R) INCOME SHARES INC.
SPECIAL MEETING OF STOCKHOLDERS -- ________, 2008
PREFERRED STOCK PROXY SOLICITED ON BEHALF OF BOARD OF DIRECTORS
The undersigned holder of shares of Preferred Stock of Prospect Street(R) Income
Shares Inc., a Maryland corporation ("Income Shares"), hereby appoints R. Joseph
Dougherty and M. Jason Blackburn, and each of them, with full power of
substitution and revocation, as proxies to represent the undersigned at the
Special Meeting of Stockholders of Income Shares to be held at 13455 Noel Road,
Suite 800, Dallas, Texas 75240, on _______, 2008, at 10:00 a.m. Central Time,
and at any and all adjournments thereof (the "Meeting"), and thereat to vote all
Preferred Stock of Income Shares which the undersigned would be entitled to
vote, with all powers the undersigned would possess if personally present, in
accordance with the instructions on this proxy.
THIS PROXY IS SOLICITED BY INCOME SHARES' BOARD OF DIRECTORS AND
WILL BE VOTED FOR THE PROPOSALS UNLESS OTHERWISE INDICATED. BY
SIGNING THIS PROXY CARD, RECEIPT OF THE ACCOMPANYING NOTICE OF
SPECIAL MEETING AND COMBINED PROXY STATEMENT AND PROSPECTUS IS
ACKNOWLEDGED.
PLEASE VOTE, DATE AND SIGN ON REVERSE AND RETURN PROMPTLY IN THE
ENCLOSED ENVELOPE.
----------------------------------------------------------
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION
Article V of the Registrant's Agreement and Declaration of Trust provides as
follows:
5.1 No Personal Liability of Shareholders, Trustees, etc. No Shareholder of the
Trust shall be subject in such capacity to any personal liability whatsoever to
any Person in connection with Trust Property or the acts, obligations or affairs
of the Trust. Shareholders shall have the same limitation of personal liability
as is extended to stockholders of a private corporation for profit incorporated
under the Delaware General Corporation Law. No trustee or officer of the Trust
shall be subject in such capacity to any personal liability whatsoever to any
Person, save only liability to the Trust or its Shareholders arising from bad
faith, willful misfeasance, gross negligence or reckless disregard for his duty
to such Person; and, subject to the foregoing exception, all such Persons shall
look solely to the Trust Property for satisfaction of claims of any nature
arising in connection with the affairs of the Trust. If any Shareholder, trustee
or officer, as such, of the Trust, is made a party to any suit or proceeding to
enforce any such liability, subject to the foregoing exception, he shall not, on
account thereof, be held to any personal liability. Any repeal or modification
of this Section 5.1 shall not adversely affect any right or protection of a
trustee or officer of the Trust existing at the time of such repeal or
modification with respect to acts or omissions occurring prior to such repeal or
modification.
5.2 Mandatory Indemnification. (a) The Trust hereby agrees to indemnify each
person who at any time serves as a trustee or officer of the Trust (each such
person being an "indemnitee") against any liabilities and expenses, including
amounts paid in satisfaction of judgments, in compromise or as fines and
penalties, and reasonable counsel fees reasonably incurred by such indemnitee in
connection with the defense or disposition of any action, suit or other
proceeding, whether civil or criminal, before any court or administrative or
investigative body in which he may be or may have been involved as a party or
otherwise or with which he may be or may have been threatened, while acting in
any capacity set forth in this Article V by reason of his having acted in any
such capacity, except with respect to any matter as to which he shall not have
acted in good faith in the reasonable belief that his action was in the best
interest of the Trust or, in the case of any criminal proceeding, as to which he
shall have had reasonable cause to believe that the conduct was unlawful,
provided, however, that no indemnitee shall be indemnified hereunder against any
liability to any person or any expense of such indemnitee arising by reason of
(i) willful misfeasance, (ii) bad faith, (iii) gross negligence, or (iv)
reckless disregard of the duties involved in the conduct of his position (the
conduct referred to in such clauses (i) through (iv) being sometimes referred to
herein as "disabling conduct"). Notwithstanding the foregoing, with respect to
any action, suit or other proceeding voluntarily prosecuted by any indemnitee as
plaintiff, indemnification shall be mandatory only if the prosecution of such
action, suit or other proceeding by such indemnitee (1) was authorized by a
majority of the trustees or (2) was instituted by the indemnitee to enforce his
or her rights to indemnification hereunder in a case in which the indemnitee is
found to be entitled to such indemnification. The rights to indemnification set
forth in this Declaration shall continue as to a person who has ceased to be a
trustee or officer of the Trust and shall inure to the benefit of his or her
heirs, executors and personal and legal representatives. No amendment or
restatement of this Declaration or repeal of any of its provisions shall limit
or eliminate any of the benefits provided to any person who at any time is or
was a trustee or officer of the Trust or otherwise entitled to indemnification
hereunder in respect of any act or omission that occurred prior to such
amendment, restatement or repeal.
(b) Notwithstanding the foregoing, no indemnification shall be made hereunder
unless there has been a determination (i) by a final decision on the merits by a
court or other body of competent jurisdiction before whom the issue of
entitlement to indemnification hereunder was brought that such indemnitee is
entitled to indemnification hereunder or, (ii) in the absence of such a
decision, by (1) a majority vote of a quorum of those trustees who are neither
"interested persons" of the Trust (as defined in Section 2(a)(19) of the
Investment Company Act) nor parties to the proceeding ("Disinterested Non-Party
Trustees"), that the indemnitee is entitled to indemnification hereunder, or (2)
if such quorum is not obtainable or even if obtainable, if such majority so
directs, independent legal counsel in a written opinion concludes that the
indemnitee should be entitled to indemnification hereunder. All determinations
to make advance payments in connection with the expense of defending any
proceeding shall be authorized and made in accordance with the immediately
succeeding paragraph (c) below.
(c) The Trust shall make advance payments in connection with the expenses of
defending any action with respect to which indemnification might be sought
hereunder if the Trust receives a written affirmation by the indemnitee of the
indemnitee's good faith belief that the standards of conduct necessary for
indemnification have been met and a written undertaking to reimburse the Trust
unless it is subsequently determined that the indemnitee is entitled to such
indemnification and if a majority of the trustees determine that the applicable
standards of conduct necessary for indemnification appear to have been met. In
addition, at least one of the following conditions must be met: (i) the
indemnitee shall provide adequate security for his undertaking, (ii) the Trust
shall be insured against losses arising by reason of any lawful advances, or
(iii) a majority of a quorum of the Disinterested Non-Party Trustees, or if a
majority vote of such quorum so direct, independent legal counsel in a written
opinion, shall conclude, based on a review of readily available facts (as
opposed to a full trial-type inquiry), that there is substantial reason to
believe that the indemnitee ultimately will be found entitled to
indemnification.
(d) The rights accruing to any indemnitee under these provisions shall not
exclude any other right which any person may have or hereafter acquire under
this Declaration, the By-Laws of the Trust, any statute, agreement, vote of
stockholders or trustees who are "disinterested persons" (as defined in Section
2(a)(19) the Investment Company Act) or any other right to which he or she may
be lawfully entitled.
(e) Subject to any limitations provided by the Investment Company Act and this
Declaration, the Trust shall have the power and authority to indemnify and
provide for the advance payment of expenses to employees, agents and other
Persons providing services to the Trust or serving in any capacity at the
request of the Trust to the full extent corporations organized under the
Delaware General Corporation Law may indemnify or provide for the advance
payment of expenses for such Persons, provided that such indemnification has
been approved by a majority of the trustees.
5.3 No Bond Required of Trustees. No trustee shall, as such, be obligated to
give any bond or other security for the performance of any of his duties
hereunder.
5.4 No Duty of Investigation; Notice in Trust Instruments, etc. No purchaser,
lender, transfer agent or other person dealing with the trustees or with any
officer, employee or agent of the Trust shall be bound to make any inquiry
concerning the validity of any transaction purporting to be made by the trustees
or by said officer, employee or agent or be liable for the application of money
or property paid, loaned, or delivered to or on the order of the trustees or of
said officer, employee or agent. Every obligation, contract, undertaking,
instrument, certificate, Share, other security of the Trust, and every other act
or thing whatsoever executed in connection with the Trust shall be conclusively
taken to have been executed or done by the executors thereof only in their
capacity as trustees under this Declaration or in their capacity as officers,
employees or agents of the Trust. The trustees may maintain insurance for the
protection of the Trust Property, its Shareholders, trustees, officers,
employees and agents in such amount as the trustees shall deem adequate to cover
possible tort liability, and such other insurance as the trustees in their sole
judgment shall deem advisable or is required by the Investment Company Act.
5.5 Reliance on Experts, etc. Each trustee and officer or employee of the Trust
shall, in the performance of its duties, be fully and completely justified and
protected with regard to any act or any failure to act resulting from reliance
in good faith upon the books of account or other records of the Trust, upon an
opinion of counsel, or upon reports made to the Trust by any of the Trust's
officers or employees or by any advisor, administrator, manager, distributor,
selected dealer, accountant, appraiser or other expert or consultant selected
with reasonable care by the trustees, officers or employees of the Trust,
regardless of whether such counsel or expert may also be a trustee.
Insofar as indemnification for liabilities arising under the Securities Act of
1933, may be permitted to trustees, officers and controlling persons of the
Trust, pursuant to the foregoing provisions or otherwise, the Trust has been
advised that in the opinion of the Commission such indemnification is against
public policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Trust of expenses incurred or paid by
a trustee, officer or controlling person of the Trust in the successful defense
of any action, suit or proceeding) is asserted by such trustee, officer or
controlling person in connection with the securities being registered, the Trust
will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue. Reference is made to Section 8 of the underwriting
agreement attached as Exhibit (h), which is incorporated herein by reference and
discusses the rights, responsibilities and limitations with respect to indemnity
and contribution.
ITEM 16. EXHIBITS
(1) Agreement and Declaration of Trust (Incorporated by reference to
Pre-Effective Amendment No. 4 to the Registrant's Registration Statement,
File Nos. 333-132436 and 811-21869, filed on June 9, 2006)
(2) By-laws (Incorporated by reference to Pre-Effective Amendment No. 4 to the
Registrant's Registration Statement, File Nos. 333-132436 and 811-21869,
filed on June 9, 2006)
(3) Voting Trust Agreement. (Not Applicable)
(4) Form of Agreement and Plan of Reorganization. (Filed herewith as Appendix A
to the Proxy Statement/Prospectus)
(5) Provisions of instruments defining the rights of holders of securities are
contained in the Registrant's Agreement and Declaration of Trust and
By-laws.
(6) Investment Advisory Agreement. (Incorporated by reference to Pre-Effective
Amendment No. 5 to the Registrant's Registration Statement, File Nos.
333-132436 and 811-21869, filed on June 21, 2006)
(7) (a) Underwriting Agreement. (Incorporated by reference to Pre-Effective
Amendment No. 5 to the Registrant's Registration Statement, File Nos.
333-132436 and 811-21869, filed on June 21, 2006)
(b) Dealer Manager Agreement with respect to rights offering.
(Incorporated by reference to Pre-Effective Amendment No. 2 to the
Registrant's Registration Statement, File Nos. 333-147121 and
811-21421, filed on December 14, 2007)
(8) Bonus, profit sharing or pension contracts. (Not applicable)
(9) Custodian Services Agreement. (Incorporated by reference to Pre-Effective
Amendment No. 4 to the Registrant's Registration Statement, File Nos.
333-132436 and 811-21869, filed on June 9, 2006)
(10) 12b-1 of 18f-3 Plans. (Not applicable)
(11) Opinion and Consent of Counsel as to the legality of shares being
registered. (Filed herewith)
(12) Opinion and Consent of Counsel regarding certain tax matters and
consequences to shareholders discussed in the Proxy Statement/Prospectus.
(To be filed by amendment)
(13) (a) Administration Services Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 5 to the Registrant's Registration
Statement, File Nos. 333-132436 and 811-21869, filed on June 21, 2006)
(b) Sub-administration Services Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 4 to the Registrant's Registration
Statement, File Nos. 333-132436 and 811-21869, filed on June 9, 2006)
(c) Transfer Agency Services Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 4 to the Registrant's Registration
Statement, File Nos. 333-132436 and 811-21869, filed on June 9, 2006)
(d) Accounting Services Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 4 to the Registrant's Registration
Statement, File Nos. 333-132436 and 811-21869, filed on June 9, 2006)
(e) Marketing and Structuring Fee Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 5 to the Registrant's Registration
Statement, File Nos. 333-132436 and 811-21869, filed on June 21, 2006)
(14) (a) Consent of Independent Registered Public Accounting Firm. (Filed
herewith)
(b) Consent of Independent Registered Public Accounting Firm. (Filed
herewith)
(15) Omitted Financial Statements. (Not applicable)
(16) Powers of Attorney. (Filed herewith)
ITEM 17. UNDERTAKINGS
(1) The undersigned registrant agrees that prior to any public
reoffering of the securities registered through the use of a
prospectus which is a part of this registration statement by any
person or party who is deemed to be an underwriter within the
meaning of Rule 145(c) of the Securities Act of 1933 ("1933 Act"),
the reoffering prospectus will contain the information called for by
the applicable registration form for the reofferings by persons who
may be deemed underwriters, in addition to the information called
for by the other items of the applicable form.
(2) The undersigned registrant agrees that every prospectus that is
filed under paragraph (1) above will be filed as a part of an
amendment to the registration statement and will not be used until
the amendment is effective, and that, in determining any liability
under the 1933 Act, each post-effective amendment shall be deemed a
new registration statement for the securities offered therein, and
the offering of the securities at that time shall be deemed the
initial bona fide offering of them.
SIGNATURES
As required by the Securities Act of 1933, as amended (the "1933 Act"), the
Registrant has duly caused this registration statement on Form N-14 to be signed
on its behalf by the undersigned, thereunto duly authorized in the City of
Dallas and State of Texas, on the 27th day of February, 2008.
/s/ James D. Dondero
--------------------
James D. Dondero*
Chief Executive Officer and President
Pursuant to the requirements of the 1933 Act, this Registration Statement has
been signed below by the following persons in the capacities and on the dates
indicated.
NAME TITLE
---- -----
/s/ R. Joseph Dougherty Trustee
----------------------------
R. Joseph Dougherty*
/s/ Timothy Hui Trustee
----------------------------
Timothy Hui*
/s/ Scott Kavanaugh Trustee
----------------------------
Scott Kavanaugh*
/s/ James Leary Trustee
----------------------------
James Leary*
/s/ Bryan Ward Trustee
----------------------------
Bryan Ward*
/s/ James D. Dondero Chief Executive Officer and President
----------------------------
James D. Dondero*
/s/ M. Jason Blackburn Chief Financial Officer (Principal
---------------------------- Accounting Officer), Treasurer
M. Jason Blackburn and Secretary
*By: /s/ M. Jason Blackburn
----------------------
M. Jason Blackburn
Attorney-in-Fact
February 27, 2008