UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSRS
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-21506
Name of Fund: Capital and Income Strategies Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief Executive
Officer, Capital and Income Strategies Fund, Inc., 800 Scudders Mill
Road, Plainsboro, NJ, 08536. Mailing address: P.O. Box 9011,
Princeton, NJ, 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 12/31/06
Date of reporting period: 01/01/06 - 06/30/06
Item 1 - Report to Stockholders
Semi-Annual Report
June 30, 2006
Capital and Income
Strategies Fund, Inc.
(BULL LOGO) Merrill Lynch Investment Managers
www.mlim.ml.com
Mercury Advisors
A Division of Merrill Lynch Investment Managers
www.mercury.ml.com
Capital and Income Strategies Fund, Inc. seeks to provide shareholders
with current income and capital appreciation. The Fund seeks to achieve
its investment objectives by investing in a portfolio of equity and debt
securities of U.S. and foreign issuers.
This report, including the financial information herein, is transmitted
to shareholders of Capital and Income Strategies Fund, Inc. for their
information. It is not a prospectus. The Fund leverages its Common Stock to
provide Common Stock shareholders with a potentially higher rate of return.
Leverage creates risk for Common Stock shareholders, including the likelihood
of greater volatility of net asset value and market price of Common Stock
shares, and the risk that fluctuations in short-term interest rates may reduce
the Common Stock's yield. Past performance results shown in this report should
not be considered a representation of future performance. Statements and other
information herein are as dated and are subject to change.
A description of the policies and procedures that the Fund uses to determine
how to vote proxies relating to portfolio securities is available (1)
without charge, upon request, by calling toll-free 1-800-637-3863; (2) at
www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
Web site at http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio during the most recent
12-month period ended June 30 is available (1) at www.mutualfunds.ml.com and
(2) on the Securities and Exchange Commission's Web site at http://www.sec.gov.
Capital and Income Strategies Fund, Inc.
Box 9011
Princeton, NJ 08543-9011
(GO PAPERLESS LOGO)
It's Fast, Convenient, & Timely!
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Capital and Income Strategies Fund, Inc.
Announcement to Shareholders
On February 15, 2006, BlackRock, Inc. ("BlackRock") and Merrill Lynch & Co.,
Inc. ("Merrill Lynch") entered into an agreement to contribute Merrill Lynch's
investment management business, Merrill Lynch Investment Managers, L.P. and
certain affiliates (including Fund Asset Management, L.P. and Merrill Lynch
Investment Managers International Limited), to BlackRock to create a new
independent company ("New BlackRock") that will be one of the world's largest
asset management firms with over $1 trillion in assets under management (based
on combined assets under management as of June 30, 2006) (the "Transaction").
The Transaction is expected to close at the end of the third quarter of 2006,
at which time the new company will operate under the BlackRock name. The
Fund's Board of Directors has approved a new investment advisory agreement
with BlackRock Advisors, Inc. or its successor on substantially the same terms
and for the same advisory fee as the current investment advisory agreement
with the Investment Adviser. If the new agreement is approved by the Fund's
shareholders, BlackRock Advisors, Inc. or its successor is expected to become
the investment adviser of the Fund upon the closing of the Transaction.
The Benefits and Risks of Leveraging
Capital and Income Strategies Fund, Inc. utilizes leverage through borrowings
or issuance of short-term debt securities or shares of Preferred Stock. The
concept of leveraging is based on the premise that the cost of assets to be
obtained from leverage will be based on short-term interest or dividend rates,
which normally will be lower than the income earned by the Fund on its longer-
term portfolio investments. To the extent that the total assets of the Fund
(including the assets obtained from leverage) are invested in higher-yielding
portfolio investments, the Fund's Common Stock shareholders are the
beneficiaries of the incremental yield.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend
rates on any Preferred Stock, if the Fund were to issue the Preferred Stock)
may reduce the Common Stock's yield and negatively impact its net asset value
and market price. If the income derived from securities purchased with assets
received from leverage exceeds the cost of leverage, the Fund's net income
will be greater than if leverage had not been used. Conversely, if the income
from the securities purchased is not sufficient to cover the cost of leverage,
the Fund's net income will be less than if leverage had not been used, and
therefore the amount available for distribution to Common Stock shareholders
will be reduced.
Portfolio Information as of June 30, 2006
Percent of
Total
Asset Mix Investments
Common Stocks 57.2%
Preferred Stocks 17.7
Foreign Government Obligations 11.9
Corporate Bonds 6.3
Capital Trusts 2.5
Trust Preferred 0.8
Real Estate Investments Trusts 0.4
Other* 3.2
* Includes portfolio holdings in options and short-term investments.
Repurchase Offer
On February 17, 2006, the Board of Directors of Capital and Income Strategies
Fund, Inc. (CII - the "Fund") authorized the Fund, at the discretion of the
Fund officers, to engage in periodic open market repurchases of up to 5% of
the Fund's outstanding Common Stock. As of June 30, 2006, the Fund had
repurchased a total of 131,300 shares, representing 1.0% of the outstanding
shares as of December 31, 2005. The shares were repurchased at a weighted
average price of $17.698, which was 13.4% below the average daily net asset
value of $20.43 for the period during the repurchase.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
A Letter From the President
Dear Shareholder
By now, you have probably heard of the important changes unfolding at
Merrill Lynch Investment Managers ("MLIM"). We have been communicating
with shareholders, via letters like this and in a detailed proxy mailing,
about MLIM's impending union with another highly regarded investment
manager - BlackRock, Inc. ("BlackRock"). This transaction marks the next
chapter in MLIM's growth story and, we believe, will be a benefit to our
investors.
MLIM, a division of Merrill Lynch with over $583 billion in assets under
management, is a leading investment manager offering more than 100 investment
strategies in vehicles ranging from mutual funds to institutional portfolios.
BlackRock, with $464.1 billion in assets under management, is one of the
largest publicly traded investment management firms in the United States
managing assets on behalf of institutional and individual investors worldwide
through a variety of equity, fixed income, liquidity and alternative
investment products. At the completion of the transaction, which is expected
by the end of third quarter 2006, the resultant firm will be a top-10
investment manager worldwide with over $1 trillion in assets under management.*
The combined company, to be known as BlackRock, will provide a wide selection
of high-quality investment solutions across a range of asset classes and
investment styles. The organization will have over 4,500 employees in 18
countries and a major presence in key markets worldwide. MLIM and BlackRock
possess complementary capabilities that together create a well-rounded
organization uniting some of the finest money managers in the industry. The
firms share similar values and beliefs - each strives for excellence in all
areas, and both make investment performance their single most important
mission. As such, our combination only reinforces our commitment to
shareholders.
Most of MLIM's investment products - including mutual funds, separately
managed accounts, annuities and variable insurance funds - eventually will
carry the "BlackRock" name. This will be reflected in newspaper and online
information sources beginning in October. Your account statements will reflect
the BlackRock name beginning with the October month-end reporting period.
Unless otherwise communicated via a proxy statement, your funds will maintain
the same investment objectives that they do today. Importantly, the MLIM/
BlackRock union will not affect your brokerage account or your relationship
with your financial advisor. If you are a client of Merrill Lynch, you will
remain a client of Merrill Lynch.
As always, we thank you for entrusting us with your investment assets. We look
forward to continuing to serve your investment needs with even greater
strength and scale as the new BlackRock.
Sincerely,
(Robert C. Doll, Jr.)
Robert C. Doll, Jr.
President and Chief Investment Officer
Merrill Lynch Investment Managers
* $1.047 trillion in assets under management as of June 30, 2006.
Data, including assets under management, are as of June 30, 2006.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
A Discussion With Your Fund's Portfolio Managers
The Fund provided shareholders with an attractive level of income during the
period while continuing to protect investor principal.
How did the Fund perform during the period in light of the existing market and
economic conditions?
For the six-month period ended June 30, 2006, the Common Stock of Capital and
Income Strategies Fund, Inc. had net annualized yields of 5.92% and 6.95%,
based on a period-end per share net asset value of $20.43 and a per share
market price of $17.40, respectively, and $.60 per share income dividends.
Over the same period, the total investment return on the Fund's Common Stock
was +4.01%, based on a change in per share net asset value from $20.31 to
$20.43, and assuming reinvestment of all distributions.
For the same six-month period, the Fund's composite benchmark returned
+3.14%,* while its comparable Lipper category of Income and Preferred Stock
Funds had an average return of +2.18%. (Funds in this Lipper category normally
seek a high level of current income through investment in income-producing
stocks, bonds and money market instruments, or funds in the category may
invest primarily in preferred securities, often considering tax-code
implications.) The Fund's preferred component outperformed its benchmark for
the period, although the common stock and emerging markets components lagged
their respective benchmarks.
Consistent with its stated investment objective, the Fund was able to provide
investors with current income while also seeking capital appreciation. The
Fund's shareholders realized a predictable level of cash flow during the
period, which was paid as $.30 per share, per quarter. Accordingly, over the
past six months, the Fund distributed $.60 per share income dividends.
Over the past six months, the U.S. financial markets sold off sharply amid
fears that the Federal Reserve Board (the Fed) would continue to raise
interest rates in its quest to ward off inflation. The Fed increased the
target federal funds rate in 2006 from 4.25% to 5.25% in an ongoing effort to
maintain a healthy pace of economic activity while also controlling
inflationary pressures. To date, we believe the Fed's tightening cycle has
struck the proper balance of fending off inflation while supporting economic
growth.
* The Fund's composite benchmark is a blend of the Merrill Lynch Preferred
Stock DRD-Eligible Index; the JPMorgan Emerging Markets Bond Global Index;
three-month LIBOR; and the S&P 500 Citigroup Value Index.
For a description of the Fund's total investment return based on a change in
the per share market value of the Fund's Common Stock (as measured by the
trading price of the Fund's shares on the New York Stock Exchange), and
assuming reinvestment of dividends, please refer to the Financial Highlights
section of this report. As a closed-end fund, the Fund's shares may trade in
the secondary market at a premium or discount to the Fund's net asset value.
As a result, total investment returns based on changes in the market value of
the Fund's Common Stock can vary significantly from total investment returns
based on changes in the Fund's net asset value.
What changes were made to the portfolio during the period?
The Fund's allocation at the end of the year comprised 58% U.S. large cap
value stocks, 22% preferred stocks, 14% short-term emerging markets debt and
6% intermediate-/long-term emerging markets bonds. The Fund's allocations were
little changed during the six-month period.
Within the equity portion of the portfolio, the Fund was overweight relative
to its benchmark in the consumer staples, information technology, health care
and consumer discretionary sectors, and underweight in financials, industrials
and telecommunications. After many of our energy holdings had reached our
price targets, we made the decision to begin trimming our overweight in energy
and redistributing those assets among other sectors, including health care,
consumer discretionary, industrials and financials. As the economic cycle
advances and earnings growth slows, we believe conditions favor the large,
multinational companies that can grow earnings in a relatively consistent
8% - 10% range. We added these types of investments to the equity portion of
the portfolio.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Within the preferred portion of the portfolio, we increased our weightings in
the banking and consumer product sectors for valuation and diversification
purposes. The preferred portfolio remained underweight in the agency and
brokerage sectors and overweight in energy and industrials. Preferred
securities underperformed corporate bonds in the first half of 2006 due to the
dramatic increase in interest rates, which negatively impacted the asset
class. Notably, the preferred index is 2.5 years longer from a duration
perspective than the Merrill Lynch Corporate Bond Index. The longer duration
means it is slightly more sensitive to changes in interest rates. On a
relative basis, DRD (dividends received deduction) preferred securities
outperformed non-tax-advantaged preferreds as investors continued to find
value in tax-advantaged paper.
Throughout the period, we expected Treasury yields to rise. As a result, we
kept the duration in the preferred portion of the portfolio short relative to
its benchmark. We believe the relatively short duration will help to limit the
portfolio's volatility and protect its net asset value from the negative price
impact associated with higher interest rates. At period-end, the effective
duration of the preferred portfolio was 5.2 years with an average credit
quality of Baa1.
Within the intermediate emerging markets segment of the portfolio, we
increased exposure to Argentina from underweight to overweight relative to our
benchmark, and also added to the Philippines and Turkish overweights in the
second quarter. We reduced our overweight position in Russia and moved Mexico
from a market weight to an underweight, as we expect spread compression to be
slower for these two countries. In the short-term emerging markets segment, we
reduced positions in Mexican and Philippines credits and added exposure to
Russia, where we continue to see value in short-term corporate names.
Of final note, the Fund was approximately 30% leveraged at June 30, 2006. For
a complete discussion of the benefits and risks of leveraging, see page 2 of
this report to shareholders.
How would you characterize the Fund's position at the close of the period?
We are encouraged by the strong economy, which has led to healthy corporate
profits, strong corporate balance sheets and robust merger-and-acquisition
activity. This backdrop has translated into healthy equity markets. While we
believe these factors should remain in place, we also are mindful that high
oil prices and recent weakness in the housing market, combined with continued
Fed vigilance in fighting inflation, could lead to a slower rate of economic
growth in the future. Given this outlook, we have migrated the equity portion
of the portfolio toward the larger end of our market-capitalization spectrum.
We believe large-capitalization companies offer a more compelling value
proposition as we enter a potentially slower phase of the economic recovery.
At period-end, the Fund had a 59% allocation to common stocks, with a bias
toward dividend-paying stocks.
Within the preferred portfolio, we intend to maintain a short duration
relative to the Merrill Lynch Preferred Stock DRD-Eligible Index. This is
based on our belief that the Fed is likely to raise the federal funds rate
another 25 basis points this year, resulting in a target short-term interest
rate of 5.50%. At period-end, the Fund maintained a 22% allocation to
preferred securities. The preferred allocation is more diversified in sectors
relative to its benchmark.
In emerging market bonds, benchmark spreads over U.S. Treasury issues widened
in the second quarter in tandem with a global episode of risk aversion that
resulted in far-reaching market corrections in May. However, fundamentals
remain strong across the emerging markets asset class, and policymakers have
responded to market volatility by increasing interest rates and reaffirming
their macroeconomic policies. Thus, we expect credit ratings to continue to
trend upward, although we believe spread tightening will become more
selective, benefiting higher-yielding credits.
We will continue to monitor market and economic conditions in an effort to
make the most effective use of its strategic allocations.
Brian Fullerton
Vice President and Co-Portfolio Manager
Kevin Rendino
Vice President and Co-Portfolio Manager, Equity Investments
Robert J. Martorelli
Vice President and Co-Portfolio Manager, Equity Investments
John Burger
Vice President and Co-Portfolio Manager, Fixed Income Investments
Aldo Roldan
Vice President and Co-Portfolio Manager, Fixed Income Investments
Patrick Maldari
Vice President and Co-Portfolio Manager, Fixed Income Investments
July 27, 2006
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Schedule of Investments (in U.S. dollars)
Preferred Securities
Face
Industry Capital Trusts Amount Value
Commercial Banks--3.6%
Dresdner Funding Trust I, 8.151%
due 6/30/2031 (j) $ 1,000,000 $ 1,114,678
Lloyds TSB Bank Plc, 6.90% (i) 2,000,000 1,955,000
Mizuho JGB Investment LLC,
9.87% (b)(i)(j) 2,000,000 2,141,480
SB Treasury Co. LLC, 9.40% (b)(i)(j) 2,000,000 2,124,462
Westpac Capital Trust III,
5.819% (b)(j) 2,000,000 1,951,360
Total Capital Trusts
(Cost--$9,726,134)--3.6% 9,286,980
Shares
Preferred Stocks Held
Capital Markets--2.4%
Goldman Sachs Group, Inc.
Series A, 3.91% 80,000 2,064,000
Lehman Brothers Holdings, Inc.
Series G, 3% 40,000 1,011,252
Lehman Brothers Holdings, Inc.
Series G, 6.50% 40,000 1,003,600
Morgan Stanley Group, Inc.
Series A, 6.186% 80,000 2,014,400
-------------
6,093,252
Commercial Banks--4.6%
Banco Santander Central
Hispano SA, 6.41% 60,000 1,440,000
First Republic Bank, 6.25% 27,734 656,949
First Tennessee Bank NA, 3.90% (b)(j) 1,674 1,691,263
HSBC USA, Inc., 3.50% 80,000 2,047,504
Royal Bank of Scotland Group Plc
Series L, 5.75% 20,000 430,400
Royal Bank of Scotland Group Plc
Series N, 6.35% 60,000 1,419,000
SG Preferred Capital II, 6.302% 2,000 2,073,125
Sovereign Bancorp, Inc.
Series C, 7.30% 40,000 1,044,000
US Bancorp Series B, 5.56% 40,000 1,000,000
-------------
11,802,241
Diversified Financial Services--0.5%
CIT Group, Inc. Series A, 6.35% 50,000 1,225,500
Electric Utilities--4.3%
Connecticut Light & Power, 5.28% 11,109 463,106
Delmarva Power & Light, 4.20% 11,394 871,641
Delmarva Power & Light, 4.28% 11,250 861,328
Duquesne Light Co., 6.50% 40,000 2,004,000
Entergy Arkansas, Inc., 6.45% 6,800 168,725
Entergy Louisiana LLC, 6.95% (j) 22,000 2,244,000
Interstate Power & Light Co.
Series B, 8.375% 40,000 1,220,000
PPL Electric Utilities Corp., 6.25% 20,000 481,250
Peco Energy Co. Series D, 4.68% 10,000 819,100
Southern California Edison Co., 5.349% 20,000 1,978,126
-------------
11,111,276
Food Products--1.5%
General Mills, Inc., 4.50% 2,000 1,956,000
HJ Heinz Finance Co., 6.226% (j) 20 2,028,125
-------------
3,984,125
Preferred Securities
Shares
Industry Preferred Stocks Held Value
Gas Utilities--0.3%
Southern Union Co., 7.55% 35,000 $ 892,150
Insurance--5.6%
ACE Ltd. Series C, 7.80% 80,000 2,068,000
Aegon NV, 6.375% 80,000 1,857,504
Arch Capital Group Ltd., 8% 40,000 996,252
Axis Capital Holdings Ltd.
Series A, 7.25% 8,000 196,800
Endurance Specialty
Holdings Ltd., 7.75% 48,000 1,157,280
Genworth Financial, Inc.
Series A, 5.25% 30,000 1,469,064
MetLife, Inc. Series B, 6.50% 72,000 1,773,360
Principal Financial Group
Series B, 6.518% 32,000 851,200
Prudential Plc, 6.75% 80,000 1,957,600
Zurich RegCaPS Funding
Trust, 6.58% (j) 2,200 2,216,500
-------------
14,543,560
Multi-Utilities--0.8%
Pacific Gas & Electric Co.
Series A, 6% 80,000 1,976,000
Oil, Gas & Consumable Fuels--0.7%
Apache Corp. Series B, 5.68% 19,500 1,907,954
Thrifts & Mortgage Finance--4.7%
Fannie Mae, 7% 45,000 2,415,938
Fanie Mae Series I, 5.375% 25,000 1,056,250
Fanie Mae Series L, 5.125% 59,350 2,474,895
Freddie Mac, 3.93% 150,000 6,354,000
-------------
12,301,083
Total Preferred Stocks
(Cost--$66,467,884)--25.4% 65,837,141
Real Estate Investment Trusts
Real Estate Investment Trusts (REITs)--0.5%
Alexandria Real Estate Equities, Inc.
Series C, 8.375% 52,000 1,360,320
Total Real Estate Investment Trusts
(Cost--$1,300,000)--0.5% 1,360,320
Trust Preferreds
Commercial Banks--0.8%
ABN AMRO North America Capital
Funding Trust I, 6.968%
due 9/15/2010 (b) 2,000,000 2,056,933
Gas Utilities--0.4%
Southwest Gas Capital II, 7.70%
due 9/15/2043 1,000,000 1,009,372
Total Trust Preferreds
(Cost--$3,121,538)--1.2% 3,066,305
Total Preferred Securities
(Cost--$80,615,556)--30.7% 79,550,746
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry Corporate Bonds Amount Value
Automobiles--0.4%
Hyundai Motor Manufacturing
Alabama LLC, 5.30%
due 12/19/2008 $1,200,000 $ 1,175,040
Beverages--0.1%
Coca-Cola Femsa SA de CV, 8.95%
due 11/01/2006 250,000 251,250
Commercial Banks--2.8%
Alfa MTN Issuance Ltd., 7.75%
due 2/09/2007 500,000 501,500
Banco Nacional de Desenvolvimento
Economico e Social, 5.873%
due 6/16/2008 (b) 750,000 736,125
Bangkok Bank Public Co. Ltd.
(Hong Kong), 8.75%
due 3/15/2007 1,350,000 1,371,411
Bayerische Hypo-und Vereinsbank
AG for MDM Bank OAO, 9.375%
due 9/23/2006 500,000 501,950
The Export-Import Bank of Korea,
4.25% due 11/27/2007 700,000 684,821
ICICI Bank Ltd., 4.75%
due 10/22/2008 750,000 727,285
Korea Development Bank,
5.25% due 11/16/2006 575,000 573,619
Sberbank, 6.858% due 10/24/2006 2,070,000 2,076,831
-------------
7,173,542
Diversified Financial Services--1.1%
AC International Finance Ltd.,
8.125% due 2/21/2008 900,000 903,470
Salomon Brothers AG for OAO
Gazprom, 9.125% due 4/25/2007 1,920,000 1,958,016
-------------
2,861,486
Diversified Telecommunication Services--0.9%
Empresa Brasileira de Telecom SA
Series B,11% due 12/15/2008 750,000 817,500
Excelcomindo Finance Company BV,
8% due 1/27/2009 675,000 676,688
Philipine Long Distance Telephone Co.,
7.85% due 3/06/2007 300,000 301,125
Telefonica de Argentina SA, 9.875%
due 7/01/2006 500,000 500,000
-------------
2,295,313
Independent Power Producers
& Energy Traders--0.1%
Aes Dominicana Energia Finance SA,
11% due 12/13/2015 (j) 150,000 147,750
Metals & Mining--0.6%
Companhia Siderurgica Pa, 7.25%
due 11/07/2006 320,000 321,600
Freeport-McMoRan Copper & Gold,
Inc., 7.50% due 11/15/2006 1,350,000 1,351,350
-------------
1,672,950
Multiline Retail--0.1%
SM Investments Corp., 8%
due 10/16/2007 250,000 254,406
Face
Industry Corporate Bonds Amount Value
Oil, Gas & Consumable Fuels--2.0%
Gazprom International SA, 7.201%
due 2/01/2020 $ 630,000 $ 638,127
MEI Euro Finance Ltd., 10%
due 3/19/2007 750,000 761,250
Pemex Project Funding Master Trust:
8.85% due 9/15/2007 900,000 928,350
6.125% due 8/15/2008 300,000 299,400
Petrobras Energia SA, 9%
due 1/30/2007 610,000 615,338
Petroliam Nasional Berhad,
7.75% due 8/15/2015 175,000 195,565
YPF SA Series A, 7.75%
due 8/27/2007 1,750,000 1,771,875
-------------
5,209,905
Paper & Forest Products--0.1%
SINO-FOREST Corp., 9.125%
due 8/17/2011 (j) 250,000 257,500
Wireless Telecommunication Services--0.8%
Mobile Telesystems Finance SA,
9.75% due 1/30/2008 625,000 641,375
Total Access Communication Public
Co. Ltd., 8.375% due 11/04/2006 1,425,000 1,426,981
-------------
2,068,356
Total Corporate Bonds
(Cost--$24,271,180)--9.0% 23,367,498
Foreign Government Obligations
Foreign Government Obligations--16.4%
Argentina Government International
Bond:
4.889% due 8/03/2012 179,375 165,950
1.33% due 12/31/2038 1,376,500 498,981
Brazilian Government International
Bond:
10% due 1/16/2007 1,670,000 1,703,400
11.50% due 3/12/2008 2,290,000 2,484,650
10% due 8/07/2011 1,540,000 1,757,140
10.50% due 7/14/2014 800,000 963,200
8% due 1/15/2018 450,000 474,750
10.125% due 5/15/2027 815,000 1,012,638
8.25% due 1/20/2034 200,000 210,000
7.125% due 1/20/2037 115,000 108,963
Bulgaria Government International
Bond, 8.25% due 1/15/2015 30,000 33,942
Chile Government International Bond:
5.625% due 7/23/2007 1,000,000 999,000
5.50% due 1/15/2013 110,000 107,525
Colombia Government International
Bond:
8.625% due 4/01/2008 1,420,000 1,476,800
10% due 1/23/2012 340,000 384,200
11.75% due 2/25/2020 300,000 394,500
Dominican Republic International
Bond, 9.04% due 1/23/2018 138,947 145,199
Indonesia Government International
Bond:
7.75% due 8/01/2006 965,000 969,825
7.50% due 1/15/2016 (j) 325,000 330,688
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Schedule of Investments (continued) (in U.S. dollars)
Foreign Government Face
Obligations Amount Value
Foreign Government Obligations (concluded)
Mexico Government International Bond:
9.875% due 1/15/2007 $ 1,170,000 $ 1,195,155
8.375% due 1/14/2011 950,000 1,035,500
Series A, 6.625% due 3/03/2015 850,000 860,625
Series A, 6.75% due 9/27/2034 1,150,000 1,118,375
Panama Government International Bond:
8.25% due 4/22/2008 1,425,000 1,471,313
7.25% due 3/15/2015 150,000 151,500
8.875% due 9/30/2027 435,000 492,638
Peru Government International Bond:
9.125% due 1/15/2008 1,090,000 1,133,600
5% due 3/07/2017 135,800 129,349
8.75% due 11/21/2033 240,000 267,000
Philippine Government International
Bond:
5.625% due 11/19/2006 250,000 249,532
7.50% due 9/11/2007 1,700,000 1,722,845
6.188% due 6/01/2008 611,102 601,965
8.375% due 2/15/2011 460,000 477,250
8.875% due 3/17/2015 180,000 194,850
10.625% due 3/16/2025 65,000 80,275
9.50% due 2/02/2030 750,000 858,750
7.75% due 1/14/2031 230,000 227,700
Russia Government International Bond:
10% due 6/26/2007 2,595,000 2,691,015
5% due 3/31/2030 155,000 164,966
11% due 7/24/2018 975,000 1,344,037
(Regulation S)
12.75% due 6/24/2028
(Regulation S) 100,000 168,870
Turkey Government International Bond:
11.375% due 11/27/2006 650,000 661,375
10% due 9/19/2007 2,080,000 2,158,208
11.50% due 1/23/2012 715,000 816,887
7.375% due 2/05/2025 500,000 450,000
11.875% due 1/15/2030 225,000 307,406
6.875% due 3/17/2036 930,000 771,900
Ukraine Government International Bond:
11% due 3/15/2007 690,753 703,532
7.65% due 6/11/2013 (j) 50,000 50,250
United Mexican States, 8.125%
due 12/30/2019 (e) 375,000 423,750
Uruguay Government International Bond:
9.25% due 5/17/2017 200,000 215,000
7.875% due 1/15/2033 (g) 270,639 246,281
Venezuela Government International
Bond:
9.125% due 6/18/2007 1,710,000 1,744,200
6.438% due 12/18/2007 285,682 285,682
5.375% due 8/07/2010 360,000 340,200
10.75% due 9/19/2013 725,000 864,925
9.375% due 1/13/2034 495,000 580,388
South Africa Government International
Bond, 8.375% due 10/17/2006 1,000,000 1,006,250
Total Foreign Government Obligations
(Cost--$42,244,305)--16.4% 42,484,695
Face
Industry Municipal Bonds Amount Value
Municipal Bonds--0.7%
Dresdner Bank AG for City of Kiev,
8.75% due 8/08/2008 $ 500,000 $ 510,550
Dresdner Bank AG for Kyivstar GSM:
10.375% due 8/17/2009 450,000 475,110
7.75% due 4/27/2012 100,000 97,000
Santa Fe de Bogota DC, 9.50%
due 12/12/2006 793,000 793,000
Total Municipal Bonds
(Cost--$1,929,119)--0.7% 1,875,660
Shares
Common Stocks Held
Aerospace & Defense--5.7%
Honeywell International, Inc. 82,600 3,328,780
Lockheed Martin Corp. 32,500 2,331,550
Northrop Grumman Corp. 66,000 4,227,960
Raytheon Co. 109,800 4,893,786
-------------
14,782,076
Beverages--1.3%
Coca-Cola Enterprises, Inc. 163,200 3,324,384
Capital Markets--4.1%
The Bank of New York Co., Inc. 110,800 3,567,760
Morgan Stanley 113,400 7,168,014
-------------
10,735,774
Chemicals--1.4%
E.I. du Pont de Nemours & Co. 89,800 3,735,680
Commercial Banks--2.5%
Wells Fargo & Co. 95,000 6,372,600
Communications Equipment--0.5%
Nokia Oyj (a) 44,700 905,622
Motorola, Inc. 21,200 427,180
-------------
1,332,802
Computers & Peripherals--4.2%
Hewlett-Packard Co. 96,200 3,047,616
International Business Machines Corp. 76,600 5,884,412
Sun Microsystems, Inc. (d) 488,300 2,026,445
-------------
10,958,473
Diversified Financial Services--6.9%
Bank of America Corp. 119,327 5,739,629
Citigroup, Inc. 100,790 4,862,110
JPMorgan Chase & Co. 172,272 7,235,424
-------------
17,837,163
Diversified Telecommunication
Services--3.8%
AT&T, Inc. 168,900 4,710,621
BellSouth Corp. 77,600 2,809,120
Verizon Communications, Inc. 68,200 2,284,018
-------------
9,803,759
Electric Utilities--2.4%
FPL Group, Inc. 66,000 2,731,080
The Southern Co. 109,500 3,509,475
-------------
6,240,555
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Schedule of Investments (continued) (in U.S. dollars)
Shares
Industry Common Stocks Held Value
Energy Equipment & Services--2.9%
BJ Services Co. 40,800 $ 1,520,208
GlobalSantaFe Corp. 66,200 3,823,050
Halliburton Co. 28,400 2,107,564
-------------
7,450,822
Food & Staples Retailing--0.3%
The Kroger Co. 29,900 653,614
Food Products--3.8%
General Mills, Inc. 85,100 4,396,266
Kraft Foods, Inc. 48,100 1,486,290
Unilever NV (a) 158,500 3,574,175
Cadbury Schweppes Plc 11,400 442,548
-------------
9,899,279
Health Care Equipment & Supplies--1.2%
Baxter International, Inc. 86,200 3,168,712
Hotels, Restaurants & Leisure--1.1%
McDonald's Corp. 85,000 2,856,000
Household Durables--0.9%
Koninklijke Philips Electronics NV 74,300 2,313,702
Household Products--1.7%
Kimberly-Clark Corp. 73,300 4,522,610
IT Services--1.0%
Unisys Corp. (d) 421,300 2,645,764
Industrial Conglomerates--3.2%
General Electric Co. 114,400 3,770,624
Tyco International Ltd. 164,700 4,529,250
-------------
8,299,874
Insurance--7.6%
The Allstate Corp. 38,700 2,118,051
American International Group, Inc. 67,200 3,968,160
Genworth Financial, Inc. Class A 83,700 2,916,108
Hartford Financial Services Group, Inc. 31,700 2,681,820
Marsh & McLennan Cos., Inc. 50,900 1,368,701
The St. Paul Travelers Cos., Inc. 101,600 4,529,328
XL Capital Ltd. Class A 33,100 2,029,030
-------------
19,611,198
Machinery--0.7%
Deere & Co. 22,600 1,886,874
Media--6.0%
Comcast Corp. Special Class A (d) 107,700 3,530,406
Gannett Co., Inc. 23,100 1,291,983
Interpublic Group of Cos., Inc. (d) 308,500 2,575,975
Time Warner, Inc. 290,400 5,023,920
Walt Disney Co. 100,900 3,027,000
-------------
15,449,284
Metals & Mining--1.8%
Alcoa, Inc. 144,600 4,679,256
Multi-Utilities--1.6%
Consolidated Edison, Inc. 51,100 2,270,884
Dominion Resources, Inc. 23,800 1,780,002
-------------
4,050,886
Shares
Industry Common Stocks Held Value
Office Electronics--1.0%
Xerox Corp. (d) 183,400 $ 2,551,094
Oil, Gas & Consumable
Fuels--4.4%
Anadarko Petroleum Corp. 27,200 1,297,168
Chevron Corp. 34,700 2,153,482
Exxon Mobil Corp. 130,500 8,006,175
-------------
11,456,825
Paper & Forest Products--0.7%
International Paper Co. 58,200 1,879,860
Pharmaceuticals--5.8%
Eli Lilly & Co. 50,900 2,813,243
GlaxoSmithKline Plc (a) 59,400 3,314,520
Johnson & Johnson 41,200 2,468,704
Pfizer, Inc. 164,900 3,870,203
Schering-Plough Corp. 141,000 2,683,230
-------------
15,149,900
Semiconductors & Semiconductor
Equipment--2.3%
Fairchild Semiconductor
International, Inc. (d) 146,700 2,665,539
LSI Logic Corp. (d) 337,100 3,017,045
Intel Corp. 11,800 223,610
-------------
5,906,194
Specialty Retail--0.9%
The Gap, Inc. 136,500 2,375,100
Tobacco--0.1%
Altria Group, Inc. 3,000 220,290
Total Common Stocks
(Cost--$199,132,050)--81.8% 212,150,404
Beneficial
Other Interests (f) Interest
Foreign Government Obligations--0.0%
Argentina Government International
Bond $ 300,000 25,950
Total Other Interests
(Cost--$13,883)--0.0% 25,950
Short-Term Securities
Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I, 4.78% (c)(h) 11,759,704 11,759,704
Face
Amount
Time Deposits
Brown Brothers Harriman & Co.,
4.43% due 7/03/2006 $ 2,090 2,090
Total Short-Term Securities
(Cost--$11,761,794)--4.5% 11,761,794
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Schedule of Investments (concluded) (in U.S. dollars)
Number of
Options Purchased Contracts Value
Put Options Purchased
Wells Fargo & Co., expiring July 2006
at USD 67, Broker Morgan Stanley
Capital Services, Inc. 1,000 $ 94,600
Total Options Purchased
(Premiums Paid--$210,870)--0.0% 94,600
Total Investments
(Cost--$360,178,757)--143.1% 371,311,347
Number of
Options Written Contracts Value
Call Options Written
Wells Fargo & Co., expiring October 2006
at USD 70, Broker Morgan Stanley
Capital Services, Inc. 1,000 $ (134,400)
Total Options Written
(Premiums Received--$122,008)--(0.0%) (134,400)
Total Investments, Net of Options Written
(Cost--$360,056,749*)--143.1% 371,176,947
Liabilities in Excess of Other Assets--(43.1%) (111,716,251)
-------------
Net Assets--100.0% $ 259,460,696
=============
* The cost and unrealized appreciation (depreciation) of investments,
including options, as of June 30, 2006, as computed for federal income
tax purposes, were as follows:
Aggregate cost $ 360,250,859
================
Gross unrealized appreciation $ 21,188,733
Gross unrealized depreciation (10,262,645)
----------------
Net unrealized appreciation $ 10,926,088
================
(a) Depositary receipts.
(b) Floating rate note.
(c) Investments in companies considered to be an affiliate of the Fund,
for purposes of Section 2(a)(3) of the Investment Company Act of 1940,
were as follows:
Net Interest
Affiliate Activity Income
Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I $(389,501) $106,202
(d) Non-income producing security.
(e) Brady Bonds are securities which have been issued to refinance
commercial bank loans and other debt. The risk associated with these
instruments is the amount of any uncollateralized principal or interest
payments since there is a high default rate of commercial bank loans by
countries issuing these securities.
(f) Other interests represent beneficial interest in liquidation trusts
and other reorganization entities and are non-income producing.
(g) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(h) Represents the current yield as of 6/30/2006.
(i) The security is a perpetual bond and has no definite maturity date.
(j) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
o For Fund compliance purposes, the Fund's industry classifications refer
to any one or more of the industry sub-classifications used by one or
more widely recognized market indexes or ratings group indexes, and/or
as defined by Fund management. This definition may not apply for purposes
of this report, which may combine industry sub-classifications for
reporting ease. Industries are shown as a percent of net assets.
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Statement of Assets, Liabilities and Capital
As of June 30, 2006
Assets
Investments in unaffiliated securities, at value (identified cost--$348,208,183) $ 359,457,043
Investments in affiliated securities, at value (identified cost--$11,759,704) 11,759,704
Options purchased, at value (premiums paid--$210,870) 94,600
Receivables:
Securities sold $ 6,728,616
Interest 1,653,518
Dividends 412,623 8,794,757
---------------
Prepaid expenses and other assets 44,468
---------------
Total assets 380,150,572
---------------
Liabilities
Loans 109,000,000
Options written, at value (premiums received--$122,008) 134,400
Bank overdraft 3,604,842
Payables:
Securities purchased 6,495,813
Dividends to shareholders 806,257
Investment adviser 240,718
Capital shares redeemed 207,445
Interest on loans 130,870
Other affiliates 1,335 7,882,438
---------------
Accrued expenses 68,196
---------------
Total liabilities 120,689,876
---------------
Net Assets
Net assets $ 259,460,696
===============
Capital
Common Stock, $.10 par value; 200,000,000 shares authorized $ 1,269,894
Paid-in capital in excess of par 240,794,951
Accumulated distributions in excess of investment income--net $ (5,266,193)
Undistributed realized capital gains--net 11,541,846
Unrealized appreciation--net 11,120,198
---------------
Total accumulated earnings--net 17,395,851
---------------
Total capital--Equivalent to $20.43 per share based on 12,698,936 shares of
capital stock outstanding (market price--$17.40) $ 259,460,696
===============
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Statement of Operations
For the Six Months Ended June 30, 2006
Investment Income
Dividends (net of $31,062 foreign withholding tax) $ 4,425,320
Interest (including $106,202 from affiliates) 2,650,610
---------------
Total income 7,075,930
---------------
Expenses
Loan interest expense $ 2,719,119
Investment advisory fees 1,587,034
Asset securitization fees 83,648
Accounting services 64,134
Custodian fees 39,782
Professional fees 33,432
Printing and shareholder reports 25,943
Transfer agent fees 19,763
Directors' fees and expenses 13,736
Listing fees 6,887
Pricing services 4,638
Other 12,589
---------------
Total expenses 4,610,705
---------------
Investment income--net 2,465,225
---------------
Realized & Unrealized Gain (Loss)--Net
Realized gain (loss) on:
Investments--net 10,661,606
Options written--net (1,736,619) 8,924,987
---------------
Change in unrealized appreciation/depreciation on:
Investments--net (3,474,955)
Options written--net 904,569 (2,570,386)
--------------- ---------------
Total realized and unrealized gain--net 6,354,601
---------------
Net Increase in Net Assets Resulting from Operations $ 8,819,826
===============
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Statements of Changes in Net Assets
For the Six For the
Months Ended Year Ended
June 30, December 31,
Increase (Decrease) in Net Assets: 2006 2005
Operations
Investment income--net $ 2,465,225 $ 5,949,548
Realized gain--net 8,924,987 13,884,930
Change in unrealized appreciation/depreciation--net (2,570,386) (10,144,730)
--------------- ---------------
Net increase in net assets resulting from operations 8,819,826 9,689,748
--------------- ---------------
Dividends & Distributions to Shareholders
Investment income--net (7,673,848) (5,977,423)
Realized gain--net -- (9,418,861)
--------------- ---------------
Net decrease in net assets resulting from dividends and distributions to shareholders (7,673,848) (15,396,284)
--------------- ---------------
Capital Stock Transactions
Shares redeemed in repurchase offer (2,323,711) --
--------------- ---------------
Net decrease in net assets resulting from capital stock transactions (2,323,711) --
--------------- ---------------
Net Assets
Total decrease in net assets (1,177,733) (5,706,536)
Beginning of period 260,638,429 266,344,965
--------------- ---------------
End of period* $ 259,460,696 $ 260,638,429
=============== ===============
* Accumulated distributions in excess of investment income--net $ (5,266,193) $ (57,570)
=============== ===============
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Statement of Cash Flows
For the Six Months Ended June 30, 2006
Cash Provided by Operating Activities
Net increase in net assets resulting from operations $ 8,819,826
Adjustments to reconcile net increase in net assets resulting from operations to
net cash provided by operating activities:
Decrease in receivables 225,549
Increase in prepaid expenses (39,826)
Decrease in other liabilities (25,117)
Realized and unrealized gain--net (6,354,601)
Realized loss on options--net (1,820,250)
Amortization of premium 833,739
Proceeds from sales and paydowns of long-term investments 79,920,124
Proceeds on other investment related transactions 149,142
Purchases of long-term investments (73,387,004)
Proceeds from short-term investments--net 245,167
Premiums received from options written 122,008
Premiums paid on closing options written (2,000,152)
---------------
Net cash provided by operating activities 6,688,605
---------------
Cash Used for Financing Activities
Shares redeemed in repurchase offer (2,323,711)
Dividends paid to shareholders (7,854,181)
Increase in bank overdraft payable 3,489,287
---------------
Net cash used for financing activities (6,688,605)
---------------
Cash
Net increase in cash --
Cash at beginning of period --
---------------
Cash at end of period --
===============
Cash Flow Information
Cash paid for interest $ 2,711,576
===============
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Financial Highlights
For the Six For the For the Period
Months Ended Year Ended April 30, 2004++
The following per share data and ratios have been derived June 30, December 31, to December 31,
from information provided in the financial statements. 2006 2005 2004
Per Share Operating Performance
Net asset value, beginning of period $ 20.31 $ 20.76 $ 19.10
------------ ------------ ------------
Investment income--net .19*** .46*** .46
Realized and unrealized gain--net .53 .29 1.84
------------ ------------ ------------
Total from investment operations .72 .75 2.30
------------ ------------ ------------
Less dividends and distributions:
Investment income--net (.60) (.47) (.48)
Realized gain--net -- (.73) (.11)
Tax return of capital -- -- (.01)
------------ ------------ ------------
Total dividends and distributions (.60) (1.20) (.60)
------------ ------------ ------------
Offering costs resulting from the issuance of Common Stock -- -- (.04)
------------ ------------ ------------
Net asset value, end of period $ 20.43 $ 20.31 $ 20.76
============ ============ ============
Market price per share, end of period $ 17.40 $ 17.21 $ 18.32
============ ============ ============
Total Investment Return**
Based on net asset value per share 4.01%+++ 4.69% 12.30%+++
============ ============ ============
Based on market price per share 4.54%+++ .52% (5.36%)+++
============ ============ ============
Ratios to Average Net Assets
Expenses, net of waiver and excluding interest expense 1.43%* 1.47% 1.20%*
============ ============ ============
Expenses, net of waiver 3.49%* 2.96% 1.96%*
============ ============ ============
Expenses 3.49%* 2.96% 2.19%*
============ ============ ============
Investment income--net 1.87%* 2.28% 3.52%*
============ ============ ============
Leverage
Amount of borrowings outstanding (in thousands) $ 109,000 $ 109,000 $ 109,000
============ ============ ============
Average amount of borrowings outstanding during the period
(in thousands) $ 109,000 $ 109,000 $ 98,750
============ ============ ============
Average amount of borrowings outstanding per share during
the period*** $ 8.58 $ 8.50 $ 7.70
============ ============ ============
Supplemental Data
Net assets, end of period (in thousands) $ 259,461 $ 260,638 $ 266,345
============ ============ ============
Portfolio turnover 20.23% 61.07% 19.88%
============ ============ ============
* Annualized.
** Total investment returns based on market price, which can be significantly greater or lesser than
the net asset value, may result in substantially different returns. Total investment returns exclude
the effects of sales charges.
*** Based on average shares outstanding.
++ Commencement of operations.
+++ Aggregate total investment return.
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Notes to Financial Statements
1. Significant Accounting Policies:
Capital and Income Strategies Fund, Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a diversified, closed-end
management investment company. The Fund's financial statements are prepared
in conformity with U.S. generally accepted accounting principles, which may
require the use of management accruals and estimates. Actual results may
differ from these estimates. These unaudited financial statements reflect all
adjustments, which are, in the opinion of management, necessary to present a
fair statement of the results for the interim period. All such adjustments
are of a normal, recurring nature. The Fund determines and makes available
for publication the net asset value of its Common Stock on a daily basis. The
Fund's Common Stock shares are listed on the New York Stock Exchange ("NYSE")
under the symbol CII. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of investments--Debt securities are traded primarily in the over-
the-counter ("OTC") markets and are valued at the last available bid price in
the OTC markets or on the basis of values as obtained by a pricing service.
Pricing services use valuation matrixes that incorporate both dealer-supplied
valuations and valuation models. The procedures of the pricing service and
its valuations are reviewed by the officers of the Fund under the general
direction of the Board of Directors. Such valuations and procedures will be
reviewed periodically by the Board of Directors of the Fund. Financial futures
contracts and options thereon, which are traded on exchanges, are valued at
their closing prices as of the close of such exchanges. Options written or
purchased are valued at the last sale price in the case of exchange-traded
options. In the case of options traded in the OTC market, valuation is the
last asked price (options written) or the last bid price (options purchased).
Swap agreements are valued based upon quoted fair valuations received daily
by the Fund from a pricing service or counterparty. Short-term investments with
a remaining maturity of 60 days or less are valued at amortized cost, which
approximates market value, under which method the investment is valued at cost
and any premium or discount is amortized on a straight line basis to maturity.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Fund, including valuations furnished by the
pricing services retained by the Fund, which may utilize a matrix system for
valuations.
Equity securities that are held by the Fund, which are traded on stock
exchanges or the Nasdaq National Market, are valued at the last sale price or
official close price on the exchange, as of the close of business on the day
the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available asked price for short
positions. In cases where equity securities are traded on more than one
exchange, the securities are valued on the exchange designated as the primary
market by or under the authority of the Board of Directors of the Fund. Long
positions traded in the OTC market, Nasdaq Small Cap or Bulletin Board are
valued at the last available bid price or yield equivalent obtained from one
or more dealers or pricing services approved by the Board of Directors of the
Fund. Short positions traded in the OTC market are valued at the last
available asked price. Portfolio securities that are traded both in the OTC
market and on a stock exchange are valued according to the broadest and most
representative market.
Generally, trading in foreign securities, as well as U.S. government
securities, money market instruments and certain fixed income securities, is
substantially completed each day at various times prior to the close of
business on the NYSE. The values of such securities used in computing the net
asset value of the Fund's shares are determined as of such times. Foreign
currency exchange rates also are generally determined prior to the close of
business on the NYSE. Occasionally, events affecting the values of such
securities and such exchange rates may occur between the times at which they
are determined and the close of business on the NYSE that may not be
reflected in the computation of the Fund's net asset value. If events (for
example, a company announcement, market volatility or a natural disaster)
occur during such periods that are expected to materially affect the value of
such securities, those securities may be valued at their fair value as
determined in good faith by the Fund's Board of Directors or by the
Investment Adviser using a pricing service and/or procedures approved by the
Fund's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio investment strategies both to increase the return of the Fund and
to hedge, or protect its exposure to interest rate movements and movements in
the securities markets. Losses may arise due to changes in the value of the
contract or if the counterparty does not perform under the contract.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Notes to Financial Statements (continued)
* Options--The Fund may write and purchase call and put options. When the
Fund writes an option, an amount equal to the premium received by the Fund
is reflected as an asset and an equivalent liability. The amount of the
liability is subsequently marked-to-market to reflect the current market
value of the option written. When a security is purchased or sold through an
exercise of an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from (or added
to) the proceeds of the security sold. When an option expires (or the Fund
enters into a closing transaction), the Fund realizes a gain or loss on the
option to the extent of the premiums received or paid (or gain or loss to the
extent the cost of the closing transaction exceeds the premium paid or
received).
Written and purchased options are non-income producing investments.
* Financial futures contracts--The Fund may purchase or sell financial
futures contracts and options on such futures contracts. Futures contracts
are contracts for delayed delivery of securities at a specific future date
and at a specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to
the daily fluctuation in value of the contract. Such receipts or payments are
known as variation margin and are recorded by the Fund as unrealized gains or
losses. When the contract is closed, the Fund records a realized gain or loss
equal to the difference between the value of the contract at the time it was
opened and the value at the time it was closed.
* Swaps--The Fund may enter into swap agreements, which are OTC contracts in
which the Fund and a counterparty agree to make periodic net payments on a
specified notional amount. The net payments can be made for a set period of
time or may be triggered by a predetermined credit event. The net periodic
payments may be based on a fixed or variable interest rate; the change in
market value of a specified security, basket of securities, or index; or the
return generated by a security. These periodic payments received or made by
the Fund are recorded in the accompanying Statement of Operations as realized
gains or losses, respectively. Gains or losses are realized upon termination
of the swap agreements. Swaps are marked-to-market and changes in value are
recorded as unrealized appreciation (depreciation). Risks include changes in
the returns of the underlying instruments, failure of the counterparties to
perform under the contracts' terms and the possible lack of liquidity with
respect to the swap agreements.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(e) Dividends and distributions--Dividends are declared and paid quarterly.
(f) Securities lending--The Fund may lend securities to financial
institutions that provide cash or securities issued or guaranteed by the U.S.
government as collateral, which will be maintained at all times in an amount
equal to at least 100% of the current market value of the loaned securities.
The market value of the loaned securities is determined at the close of
business of the Fund and any additional required collateral is delivered to
the Fund on the next business day. Where the Fund receives securities as
collateral for the loaned securities, it collects a fee from the borrower.
The Fund typically receives the income on the loaned securities but does not
receive the income on the collateral. Where the Fund receives cash collateral
it may invest such collateral and retain the amount earned on such
investment, net of any amount rebated to the borrower. Loans of securities
are terminable at any time and the borrower, after notice, is required to
return the borrowed securities within five business days. The Fund may pay
reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any
other reason, the Fund could experience delays and costs in gaining access to
the collateral. The Fund also could suffer a loss where the value of the
collateral falls below the market value of the borrowed securities, in the
event of borrower default or in the event of losses on investments made with
cash collateral.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Notes to Financial Statements (continued)
(g) Bank overdraft--The Fund recorded a bank overdraft, which resulted from a
failed trade that settled the next day.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services,
Inc. ("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co.,
Inc. ("ML & Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides
the necessary personnel, facilities, equipment and certain other services
necessary to the operations of the Fund. For such services, the Fund pays a
monthly fee at an annual rate of .85% of the Fund's average daily net assets,
including the proceeds of any outstanding borrowings used for leverage.
The Fund has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("MLPF&S"), an affiliate of FAM, or its
affiliates. Pursuant to that order, the Fund also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of FAM, as the
securities lending agent for a fee based on a share of the returns on
investment of cash collateral. MLIM, LLC may, on behalf of the Fund, invest
cash collateral received by the Fund for such loans, among other things, in a
private investment company managed by MLIM, LLC or in registered money market
funds advised by Merrill Lynch Investment Managers, L.P. ("MLIM"), an
affiliate of FAM.
In addition, MLPF&S received $30,239 in commissions on the execution of
portfolio security transactions for the Fund for the six months ended June
30, 2006.
For the six months ended June 30, 2006, the Fund reimbursed FAM $2,731 for
certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors
of FAM, PSI, ML & Co., MLIM, and/or MLIM, LLC.
In February 2006, ML & Co. and BlackRock, Inc. entered into an agreement to
contribute ML & Co.'s investment management business, including FAM, to the
investment management business of BlackRock, Inc. The transaction is expected
to close at the end of the third quarter of 2006.
3. Investments:
Purchases (including payups) and sales (including paydowns) of investments,
excluding short-term securities, for the six months ended June 30, 2006 were
$74,787,525 and $85,885,925, respectively.
Transactions in options written for the six months ended June 30, 2006
were as follows:
Number of Premiums
Call Options Written Contracts Received
Outstanding call options written,
beginning of period 34,279 $ 2,000,152
Options written 1,000 122,008
Options closed (17,225) (1,149,638)
Options expired (17,054) (850,514)
------------- --------------
Outstanding call options written,
end of period 1,000 $ 122,008
============= ==============
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which were initially classified as Common Stock.
The Board of Directors is authorized, however, to reclassify any unissued
shares of stock without approval of holders of Common Stock.
Common Stock
Shares issued and outstanding during the six months ended June 30, 2006
decreased by 131,300 as a result of a repurchase offer. Shares issued and
outstanding during the year ended December 31, 2005 remained constant.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Notes to Financial Statements (concluded)
5. Short-Term Borrowings:
On May 22, 2006, the Fund renewed its revolving credit and security agreement
funded by a commercial paper asset securitization program with Citigroup
North America, Inc. ("Citigroup") as Agent, certain secondary backstop
lenders, and certain asset securitization conduits as lenders (the
"Lenders"). The agreement was renewed for one year and has a maximum limit of
$135,000,000. Under the Citigroup program, the conduits will fund advances to
the Fund through the issuance of highly rated commercial paper. As security
for its obligations to the Lenders under the revolving securitization
facility, the Fund has granted a security interest in substantially all of
its assets to and in favor of the Lenders. The interest rate on the Fund's
borrowings is based on the interest rate carried by the commercial paper plus
a program fee. The Fund pays additional borrowing costs including a backstop
commitment fee.
The weighted annual interest rate was 4.98% and the average borrowing was
$109,000,000 for the six months ended June 30, 2006.
Disclosure of Investment Advisory Agreement
Activities and Composition of the Board of Directors
All but one member of the Board of Directors of the Fund is an independent
director whose only affiliation with Fund Asset Management, L.P. (the
"Investment Adviser") or other Merrill Lynch affiliates is as a director of
the Fund and as a trustee or director of certain other funds advised by the
Investment Adviser or its affiliates. The Chair of the Board is an
independent director. New director nominees are chosen by a Nominating
Committee comprised entirely of independent directors. All independent
directors also are members of the Board's Audit Committee, and the
independent directors meet in executive session at each in-person Board
meeting. The Board and the Audit Committee meet in person for at least two
days each quarter and conduct other in-person and telephone meetings
throughout the year, some of which are formal Board meetings and some of
which are informational meetings. Independent counsel to the independent
directors attends all in-person Board and Audit Committee meetings and other
meetings at the independent directors' request.
Investment Advisory Agreements--Matters Considered by the Board
Every year, the Board considers approval of the Fund's investment advisory
agreement (the "Investment Advisory Agreement"). The Board assesses the
nature, scope and quality of the services provided to the Fund by the
personnel of the Investment Adviser and its affiliates, including
administrative services, shareholder services, oversight of fund accounting,
marketing services and assistance in meeting legal and regulatory
requirements. The Board also receives and assesses information regarding the
services provided to the Fund by certain unaffiliated service providers.
At various times throughout the year, the Board also considers a range of
information in connection with its oversight of the services provided by the
Investment Adviser and its affiliates. Among the matters considered are: (a)
fees (in addition to management fees) paid to the Investment Adviser and its
affiliates by the Fund; (b) Fund operating expenses paid to third parties;
(c) the resources devoted to and compliance reports relating to the Fund's
investment objective, policies and restrictions, and the Fund's compliance
with its Code of Ethics and the Investment Adviser's compliance policies and
procedures; and (d) the nature, cost and character of non-investment
management services provided by the Investment Adviser and its affiliates.
The Board believes that the Investment Adviser is one of the most experienced
global asset management firms and considers the overall services provided by
the Investment Adviser to be of high quality. The Board also believes that
the Investment Adviser is financially sound and well managed and notes that
the Investment Adviser is affiliated with one of America's largest financial
firms. The Board works closely with the Investment Adviser in overseeing the
Investment Adviser's efforts to achieve good performance. As part of this
effort, the Board discusses portfolio manager effectiveness and, when
performance is not satisfactory, discusses with the Investment Adviser taking
steps such as changing investment personnel.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Disclosure of Investment Advisory Agreement (continued)
Annual Consideration of Approval by the Board of Directors
In the period prior to the Board meeting to consider renewal of the
Investment Advisory Agreement, the Board requests and receives materials
specifically relating to the Investment Advisory Agreement. These materials
include (a) information compiled by Lipper Inc. ("Lipper") on the fees and
expenses and the investment performance of the Fund as compared to a
comparable group of funds as classified by Lipper; (b) a discussion by the
Fund's portfolio management team of investment strategies used by the Fund
during its most recent fiscal year; (c) information on the profitability to
the Investment Adviser and its affiliates of the Investment Advisory
Agreement and other relationships with the Fund; and (d) information provided
by the Investment Adviser concerning investment advisory fees charged to
other funds under a similar investment mandate. The Board also considers
other matters it deems important to the approval process, such as payments
made to the Investment Adviser or its affiliates in connection with services
related to the valuation and pricing of Fund portfolio holdings, the Fund's
portfolio turnover statistics, allocation of Fund brokerage fees (including
the related benefits to the Investment Adviser of "soft dollars") and direct
and indirect benefits to the Investment Adviser and its affiliates from their
relationship with the Fund. The Board did not identify any particular
information as controlling, and each member of the Board attributed different
weights to the various items considered.
Certain Specific Renewal Data
In connection with the most recent renewal of the Fund's Investment Advisory
Agreement in May 2006, the independent directors' and the Board's review
included the following:
Services Provided by the Investment Adviser--The Board reviewed the nature,
extent and quality of services provided by the Investment Adviser, including
the investment advisory services and the resulting performance of the Fund.
The Board focused primarily on the Investment Adviser's investment advisory
services and the Fund's investment performance. The Board compared Fund
performance - both including and excluding the effects of the Fund's fees and
expenses - to the performance of a comparable group of funds and the
performance of a relevant index or combination of indexes. While the Board
reviews performance data at least quarterly, consistent with the Investment
Adviser's investment goals, the Board attaches more importance to performance
over relatively long periods of time, typically three to five years, or a
shorter period in the case of a fund that has been in existence less than
five years. According to Lipper's ranking of all closed-end leveraged income
and preferred stock funds, for the period ended February 28, 2006, the Fund's
performance after fees and expenses ranked in the third quintile for each of
the one-year period and the period since inception on April 30, 2004. The
Board concluded that the nature and quality of the services supported the
continuation of the Investment Advisory Agreement.
The Investment Adviser's Personnel and Investment Process--The Board reviews
at least annually the Fund's investment objectives and strategies. The Board
discusses with senior management of the Investment Adviser responsible for
investment operations and the senior management of the Investment Adviser's
equity and fixed income investment teams the strategies being used to achieve
the stated objectives. Among other things, the Board considers the size,
education and experience of the Investment Adviser's investment staff, its use
of technology, and the Investment Adviser's approach to training and retaining
portfolio managers and other research, advisory and management personnel.
The Board also reviews the Investment Adviser's compensation policies and
practices with respect to the Fund's portfolio managers. The Board also
considered the experience of the Fund's portfolio managers and noted that
Brian Fullerton, who is responsible for the overall asset allocation of the
Fund's portfolio, has more than 21 years of investment management experience.
They noted that Kevin Rendino and Robert J. Martorelli are co-portfolio
managers responsible for the common stock portion of the Fund's portfolio.
Mr. Rendino has more than 16 years and Mr. Martorelli has more than 21 years
experience in portfolio management. They noted that the fixed income portion
of the Fund is managed by Patrick Maldari, assisted by James Pagano, John
Burger and Frank Viola. Mr. Maldari has more than 22 years experience in
portfolio management. Moreover, the Investment Adviser and its investment
staff have extensive experience in analyzing and managing the types of
investments used by the Fund. The Board concluded that the Fund benefits from
that expertise.
Management Fees and Other Expenses--The Board reviews the Fund's contractual
management fee rate and actual management fee rate as a percentage of total
assets at common asset levels - the actual rate includes advisory and
administrative service fees and the effects of any fee waivers - compared to
the other funds considered comparable by Lipper. It also compares the Fund's
total expenses to those of other comparable funds. The Board noted that the
Investment Adviser had advised the Board that it had no other comparable
accounts with similar investment mandates. The Board noted that the Fund's
contractual management fee rate and actual management fee rate including
leverage were equal to the median of contractual and actual management fees
charged by comparable funds, as determined by Lipper, while the Fund's total
expenses were higher than the median total expenses for such comparable
funds. The Board concluded that the Fund's management fee rate and overall
expense ratio are reasonable when compared to those of other comparable
funds.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Disclosure of Investment Advisory Agreement (concluded)
Profitability--The Board considers the cost of the services provided to
the Fund by the Investment Adviser and the Investment Adviser's and its
affiliates' profits relating to the management and distribution of the Fund
and the MLIM/FAM-advised funds. As part of its analysis, the Board reviewed
the Investment Adviser's methodology in allocating its costs to the management
of the Fund and concluded that there was a reasonable basis for the allocation.
The Board concluded that the profits of the Investment Adviser and its
affiliates are reasonable in relation to the nature and quality of services
provided and given the level of fees and expenses overall.
Economies of Scale--The Board considered the extent to which economies of
scale might be realized as the assets of the Fund increase and whether there
should be changes in the management fee rate or structure in order to enable
the Fund to participate in these economies of scale. Because the Fund is a
closed-end fund, the Board concluded that the assets of the Fund are unlikely
to increase significantly and that the current advisory fee appropriately
reflects any economies of scale. The Board determined that the management fee
structure was reasonable and that no changes were currently necessary.
Conclusion
After the independent directors deliberated in executive session, the entire
Board of the Fund, including all of the independent directors, approved the
renewal of the existing Investment Advisory Agreement, concluding that the
advisory fee was reasonable in relation to the services provided and that a
contract renewal was in the best interests of the shareholders.
Disclosure of New Investment Advisory Agreement
New BlackRock Investment Advisory Agreement--Matters Considered by the Board
In connection with the Transaction between Merrill Lynch and BlackRock, the
Fund's Board of Directors considered a new investment advisory agreement (the
"New Investment Advisory Agreement") between the Fund and BlackRock Advisors,
Inc. or its successor ("BlackRock Advisors"). If the New Investment Advisory
Agreement is approved by the Fund's shareholders, it will become effective
upon the expected closing of the Transaction, which is expected in the third
quarter of 2006.
The Board discussed the New Investment Advisory Agreement at telephonic and
in-person meetings held during April and May 2006. The Board, including the
independent directors, approved the New Investment Advisory Agreement at a
meeting held on May 10, 2006.
To assist the Board in its consideration of the New Investment Advisory
Agreement, BlackRock provided materials and information about BlackRock,
including its financial condition and asset management capabilities and
organization, and Merrill Lynch provided materials and information about the
Transaction. The independent directors, through their independent legal
counsel, also requested and received additional information from Merrill
Lynch and BlackRock in connection with their consideration of the New
Investment Advisory Agreement. The additional information was provided in
advance of the May 10, 2006 meeting. In addition, the independent directors
consulted with their counsel and Fund counsel on numerous occasions,
discussing, among other things, the legal standards and certain other
considerations relevant to the directors' deliberations.
At the Board meetings, the directors discussed with Merrill Lynch management
and certain BlackRock representatives the Transaction, its strategic
rationale and BlackRock's general plans and intentions regarding the Fund. At
these Board meetings, representatives of Merrill Lynch and BlackRock made
presentations to and responded to questions from the Board. The directors
also inquired about the plans for and anticipated roles and responsibilities
of certain employees and officers of the Investment Adviser and certain
affiliates being transferred to BlackRock in connection with the Transaction.
The independent directors also conferred separately and with their counsel
about the Transaction and other matters related to the Transaction on a
number of occasions, including in connection with the April and May 2006
meetings. After the presentations and after reviewing the written materials
provided, the independent directors met in executive sessions with their
counsel to consider the New Investment Advisory Agreement.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Disclosure of New Investment Advisory Agreement (continued)
In connection with the Board's review of the New Investment Advisory
Agreement, Merrill Lynch and/or BlackRock advised the directors about a
variety of matters. The advice included the following, among other matters:
* that there is not expected to be any diminution in the nature, quality
and extent of services provided to the Fund and its shareholders by
BlackRock Advisors, including compliance services;
* that operation of New BlackRock as an independent investment management
firm will enhance its ability to attract and retain talented
professionals;
* that the Fund should benefit from having access to BlackRock's state of
the art technology and risk management analytic tools, including
investment tools, provided under the BlackRock Solutions (R) brand name;
* that BlackRock has no present intention to alter any applicable expense
waivers or reimbursements currently in effect and, while it reserves the
right to do so in the future, it would seek the approval of the Board
before making any changes;
* that in connection with the Transaction, Merrill Lynch and BlackRock have
agreed to conduct, and use reasonable best efforts to cause their
respective affiliates to conduct, their respective businesses in
compliance with the conditions of Section 15(f) of the Investment Company
Act of 1940 (the "1940 Act") in relation to any public funds advised by
BlackRock or the Investment Adviser (or its affiliates), respectively;
and
* that Merrill Lynch and BlackRock would derive benefits from the
Transaction and that, as a result, they have a different financial
interest in the matters that were being considered than do Fund
shareholders.
The directors considered the information provided by Merrill Lynch and
BlackRock above, and, among other factors, the following:
* the potential benefits to Fund shareholders from being part of a combined
fund family with BlackRock-sponsored funds, including possible economies
of scale and access to investment opportunities;
* the reputation, financial strength and resources of BlackRock and its
investment advisory subsidiaries and the anticipated financial strength
and resources of New BlackRock;
* the compliance policies and procedures of BlackRock Advisors;
* the terms and conditions of the New Investment Advisory Agreement,
including the fact that the schedule of the Fund's total advisory fees
will not increase by virtue of the New Investment Advisory Agreement, but
will remain the same;
* that in May 2005, the Board had performed a full annual review of the
investment advisory agreement currently in effect for the Fund (the
"Current Investment Advisory Agreement") as required by the 1940 Act and
has determined that the Investment Adviser has the capabilities,
resources and personnel necessary to provide the advisory and
administrative services currently provided to the Fund; and that the
advisory and/or management fees paid by the Fund, taking into account any
applicable agreed-upon fee waivers and breakpoints, represent reasonable
compensation to the Investment Adviser in light of the services provided,
the costs to the Investment Adviser of providing those services,
economies of scale, the fees and other expenses paid by similar funds
(including information provided by Lipper Inc. ["Lipper"]), and such
other matters as the directors have considered relevant in the exercise
of their reasonable judgment; and
* that Merrill Lynch agreed to pay all expenses of the Fund in connection
with the Board's consideration of the New Investment Advisory Agreement
and related agreements and all costs of shareholder approval of the New
Investment Advisory Agreement and as a result the Fund would bear no
costs in obtaining shareholder approval of the New Investment Advisory
Agreement.
Certain of these considerations are discussed in more detail below.
In its review of the New Investment Advisory Agreement, the Board assessed
the nature, scope and quality of the services to be provided to the Fund
by the personnel of BlackRock Advisors and its affiliates, including
administrative services, shareholder services, oversight of fund accounting
and assistance in meeting legal and regulatory requirements. In its review of
the New Investment Advisory Agreement, the Board also considered a range of
information in connection with its oversight of the services to be provided
by BlackRock Advisors and its affiliates. Among the matters considered were:
(a) fees (in addition to management fees) to be paid to BlackRock Advisors
and its affiliates by the Fund; (b) Fund operating expenses paid to third
parties; (c) the resources devoted to and compliance reports relating to the
Fund's investment objective, policies and restrictions, and its compliance
with its Code of Ethics and BlackRock Advisors' compliance policies and
procedures; and (d) the nature, cost and character of non-investment management
services to be provided by BlackRock Advisors and its affiliates.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
In the period prior to the Board meeting to consider renewal of the Current
Investment Advisory Agreement, the Board had requested and received materials
specifically relating to the Current Investment Advisory Agreement. These
materials included (a) information compiled by Lipper on the fees and
expenses and the investment performance of the Fund as compared to a
comparable group of funds as classified by Lipper; (b) information comparing
the Fund's market price with its net asset value per share; (c) a discussion
by the Fund's portfolio management team on investment strategies used by the
Fund during its most recent fiscal year; (d) information on the profitability
to the Investment Adviser of the Current Investment Advisory Agreement and
other payments received by the Investment Adviser and its affiliates from the
Fund; and (e) information provided by the Investment Adviser concerning
services related to the valuation and pricing of Fund portfolio holdings,
allocation of Fund brokerage fees, the Fund's portfolio turnover statistics,
and direct and indirect benefits to the Investment Adviser and its affiliates
from their relationship with the Fund.
In their deliberations, the directors considered information received in
connection with the most recent continuation of the Current Investment
Advisory Agreement, in addition to information provided by BlackRock and
BlackRock Advisors in connection with their evaluation of the terms and
conditions of the New Investment Advisory Agreement. The directors did not
identify any particular information that was all-important or controlling,
and each director attributed different weights to the various factors. The
directors, including a majority of the independent directors, concluded that
the terms of the New Investment Advisory Agreement are appropriate, that the
fees to be paid are reasonable in light of the services to be provided to the
Fund, and that the New Investment Advisory Agreement should be approved and
recommended to Fund shareholders.
Nature, Quality and Extent of Services Provided--The Board reviewed the
nature, extent and quality of services provided by the Investment Adviser,
including the investment advisory services and the resulting performance of
the Fund, as well as the nature, quality and extent of services expected to
be provided by BlackRock Advisors. The Board focused primarily on the
Investment Adviser's advisory services and the Fund's investment performance,
but also considered certain areas in which both the Investment Adviser and
the Fund receive services as part of the Merrill Lynch complex. The Board
compared the Fund's performance - both including and excluding the effects of
the Fund's fees and expenses - to the performance of a comparable group of
funds, and the performance of a relevant index or combination of indexes.
While the Board reviews performance data at least quarterly, consistent with
the Investment Adviser's investment goals, the Board attaches more importance
to performance over relatively long periods of time, typically three to five
years.
In evaluating the nature, quality and extent of the services to be provided
by BlackRock Advisors under the New Investment Advisory Agreement, the
directors considered, among other things, the expected impact of the
Transaction on the operations, facilities, organization and personnel of
BlackRock Advisors and how it would affect the Fund; the ability of BlackRock
Advisors to perform its duties after the Transaction; and any anticipated
changes to the current investment and other practices of the Fund. The
directors considered BlackRock's advice as to proposed changes in portfolio
management personnel of the Fund after the closing of the Transaction.
The directors were given information with respect to the potential benefits
to the Fund and its shareholders from having access to BlackRock's state of
the art technology and risk management analytic tools, including the
investment tools provided under the BlackRock Solutions brand name.
The directors were advised that, as a result of Merrill Lynch's equity
interest in BlackRock after the Transaction, the Fund will continue to be
subject to restrictions concerning certain transactions involving Merrill
Lynch affiliates (for example, transactions with a Merrill Lynch broker-
dealer acting as principal) absent revised or new regulatory relief. The
directors were advised that a revision of existing regulatory relief with
respect to these restrictions was being sought from the Securities and
Exchange Commission and were advised of the possibility of receipt of such
revised regulatory relief. There can be no assurance that such relief will be
obtained.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Disclosure of New Investment Advisory Agreement (continued)
Based on their review of the materials provided and the assurances they had
received from the management of Merrill Lynch and of BlackRock, the directors
determined that the nature and quality of services to be provided to the Fund
under the New Investment Advisory Agreement were expected to be as good as or
better than that provided under the Current Investment Advisory Agreement. It
was noted, however, that it is expected that there will be changes in
personnel following the Transaction and the combination of the operations of
the Investment Adviser and its affiliates with those of BlackRock. The
directors noted that if current portfolio managers or other personnel cease
to be available, the Board would consider all available options, which could
include seeking the investment advisory or other services of BlackRock
affiliates. Accordingly, the directors concluded that, overall, they were
satisfied at the present time with assurances from BlackRock and BlackRock
Advisors as to the expected nature, extent and quality of the services to be
provided to the Fund under the New Investment Advisory Agreement.
Costs of Services Provided and Profitability--It was noted that, in
conjunction with the recent review of the Current Investment Advisory
Agreement, the directors had received, among other things, a report from
Lipper comparing the Fund's fees, expenses and performance to those of a peer
group selected by Lipper, and information as to the fees charged by the
Investment Adviser or its affiliates to other registered investment company
clients for investment management services. The Board reviewed the Fund's
contractual management fee rate and actual management fee rate as a
percentage of total assets at common asset levels - the actual rate includes
advisory fees and the effects of any fee waivers - compared to the other
funds in its Lipper category. They also compared the Fund's total expenses to
those of other comparable funds. The information showed that the Fund had
fees and expenses within the range of fees and expenses of comparable funds.
The Board considered the services to be provided by and the fees to be
charged by BlackRock Advisors to other funds with similar investment mandates
and noted that the fees charged by BlackRock Advisors in those cases,
including fee waivers and expense reimbursements, were generally comparable
to those being charged to the Fund. The Board also noted that, as a general
matter, according to the information provided by BlackRock, fees charged to
institutional clients were lower than the fees charged to the Fund, but
BlackRock Advisors provided less extensive services to such clients. The
Board concluded that the Fund's management fee and fee rate and overall
expense ratio are reasonable compared to those of other comparable funds.
In evaluating the costs of the services to be provided by BlackRock Advisors
under the New Investment Advisory Agreement, the directors considered, among
other things, whether advisory fees or other expenses would change as a
result of the Transaction. Based on their review of the materials provided
and the fact that the New Investment Advisory Agreement is substantially
similar to the Current Investment Advisory Agreement in all material
respects, including the rate of compensation, the directors determined that
the Transaction should not increase the total fees payable, including any fee
waivers and expense reimbursements, for advisory and administrative services.
The directors noted that it was not possible to predict with certainty New
BlackRock's future profitability from its relationship with the Fund.
The directors discussed with BlackRock Advisors its general methodology to be
used in determining New BlackRock's profitability with respect to its
relationship with the Fund. The directors noted that they expect to receive
profitability information from New BlackRock on at least an annual basis and
thus be in a position to evaluate whether any adjustments in Fund fees and/or
fee breakpoints would be appropriate.
Fees and Economies of Scale--The Board considered the extent to which
economies of scale might be realized as the assets of the Fund increase and
whether there should be changes in the management fee rate or structure in
order to enable the Fund to participate in these economies of scale. The
Board determined that changes were not currently necessary and that the Fund
appropriately participated in these economies of scale.
In reviewing the Transaction, the directors considered, among other things,
whether advisory fees or other expenses would change as a result of the
Transaction. Based on the fact that the New Investment Advisory Agreement is
substantially similar to the Current Investment Advisory Agreement in all
material respects, including the rate of compensation, the directors
determined that as a result of the Transaction, the Fund's total advisory
fees would be no higher than the fees under its Current Investment Advisory
Agreement. The directors noted that in conjunction with their most recent
deliberations concerning the Current Investment Advisory Agreement, they had
determined that the total fees for advisory and administrative services for
the Fund were reasonable in light of the services provided. It was noted that
in conjunction with the recent review of the Current Investment Advisory
Agreement, the directors had received, among other things, a report from
Lipper comparing the Fund's fees, expenses and performance to those of a peer
group selected by Lipper, and information as to the fees charged by the
Investment Adviser or its affiliates to other registered investment company
clients for investment management services. The directors concluded that,
because the rates for advisory fees for the Fund would be no higher than its
current fee rates, the proposed management fee structure, including any fee
waivers, was reasonable and that no additional changes were currently
necessary.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Fall-Out Benefits--In evaluating the fall-out benefits to be received by
BlackRock Advisors under the New Investment Advisory Agreement, the directors
considered whether the Transaction would have an impact on the fall-out
benefits received by the Investment Adviser by virtue of the Current
Investment Advisory Agreement. Based on their review of the materials
provided, including materials received in connection with their most recent
continuance of the Current Investment Advisory Agreement, and their
discussions with management of the Investment Adviser and BlackRock, the
directors determined that those benefits could include increased ability for
BlackRock to distribute shares of its funds and other investment products and
to obtain research services using the Fund's portfolio transaction brokerage
commissions. The directors noted that any fall-out benefits were difficult to
quantify with certainty at this time, and indicated that they would continue
to evaluate them going forward.
Investment Performance--The directors considered investment performance for
the Fund. The directors compared the Fund's performance - both including and
excluding the effects of the Fund's fees and expenses - to the performance of
a comparable group of funds, and the performance of a relevant index or
combination of indexes. The comparative information received from Lipper
showed Fund performance at various levels within the range of performance of
comparable funds over different time periods. While the Board reviews
performance data at least quarterly, consistent with the Investment Adviser's
investment goals, the Board attaches more importance over relatively long
periods of time, typically three to five years. The directors believed the
Fund's performance was satisfactory. Also, the directors took into account
the investment performance of funds currently advised by BlackRock Advisors.
The Board considered comparative information from Lipper which showed that
the performance of the funds advised by BlackRock Advisors was within the
range of performance of comparable funds over different time periods. The
Board noted BlackRock's considerable investment management experience and
capabilities, but was unable to predict what effect, if any, consummation of
the Transaction would have on the future performance of the Fund.
Conclusion--After the independent directors of the Fund deliberated in
executive session, the entire Board, including the independent directors,
approved the New Investment Advisory Agreement, concluding that the advisory
fee rate was reasonable in relation to the services provided and that
the New Investment Advisory Agreement was in the best interests of the
shareholders. In approving the New Investment Advisory Agreement, the Board
noted that it anticipated reviewing the continuance of the agreement in
advance of the expiration of the initial two-year period.
Contingent BlackRock Subadvisory Agreement--Matters Considered by the Board
At the telephonic and in-person meetings held during April and May 2006 at
which the Board of Directors discussed and approved the New Investment
Advisory Agreement, the Board, including the independent directors, also
considered and approved a contingent subadvisory agreement (the "Contingent
Subadvisory Agreement") between the Investment Adviser and BlackRock Advisors
(the "BlackRock Subadviser"). The Contingent Subadvisory Agreement is
intended to ensure that the Fund operate with efficient portfolio management
services until the closing of the Transaction, in the event that the Board
deems it necessary and in the best interests of the Fund and its shareholders
that the BlackRock Subadviser assist in managing the operations of the
Fund during the interim period until the closing of the Transaction. If
shareholders approve the Contingent Subadvisory Agreement, it will take
effect only upon recommendation from the Investment Adviser and upon
subsequent approval of the Board in the period up to the closing of the
Transaction. The effectiveness of the Contingent Subadvisory Agreement,
therefore, would be contingent on further Board approval after shareholders
approve it. Pursuant to the Contingent Subadvisory Agreement, the BlackRock
Subadviser would receive a monthly fee from the Investment Adviser equal to
50% of the advisory fee received by the Investment Adviser. The Investment
Adviser would pay the BlackRock Subadviser out of its own resources. There
would be no increase in Fund expenses as a result of the Contingent
Subadvisory Agreement.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Disclosure of New Investment Advisory Agreement (concluded)
In making its approval at the May in-person meeting, the Board considered the
Contingent Subadvisory Agreement in conjunction with the New Investment
Advisory Agreement and reviewed the same information and factors discussed
above. The Board also considered in conjunction with the Contingent
Subadvisory Agreement the necessity of ensuring that the Fund operates with
effective management services until the closing of the Transaction. In
reviewing the subadvisory fee rate provided in the Contingent Subadvisory
Agreement, the Board took note of the fact that both the Investment Adviser
and the BlackRock Subadviser would have significant responsibilities under
their respective advisory agreements. The Investment Adviser would remain
responsible for oversight of the Fund's operations and administration and the
BlackRock Subadviser would provide advisory services to the Fund under the
Contingent Subadvisory Agreement. The Board also took into account the
expected short duration of the term of any Contingent Subadvisory Agreement
and the fact that total advisory fees paid by the Fund would not increase
as a result of the Contingent Subadvisory Agreement. Under all of the
circumstances, the Board concluded that it was a reasonable allocation of fees
for the BlackRock Subadviser to receive 50% of the advisory fee paid by the
Fund to the Investment Adviser.
After the independent directors deliberated in executive session, the entire
Board, including the independent directors, approved the Contingent
Subadvisory Agreement, concluding that the advisory fee was reasonable in
relation to the services provided and that the Contingent Subadvisory
Agreement was in the best interests of shareholders.
Managed Distribution Policy
The Fund has adopted a policy of paying regular distributions on its Common
Stock (the "Managed Distribution Policy"). The Fund's Board of Directors has
initially determined to pay quarterly distributions at an annualized rate of
6% of the initial public offering price per share ($.30 per share, per
quarter). The Fund's Board of Directors has determined to pay additional
distributions on an annual basis equal to any income earned by the Fund in
excess of the quarterly distributions as may be necessary to distribute
substantially all of the Fund's net investment company taxable income for
that year.
The Fund generally is not permitted to distribute net realized long-term
capital gains more than once per year without exemptive relief from the
Securities and Exchange Commission. As a result, the Fund has applied for
an exemption that will permit the Fund to make periodic distributions of
realized long-term capital gains to its shareholders. Until such time,
if any, as the exemptive relief is granted, the Fund intends to make
distributions from its net investment income on a quarterly basis and from
its net realized long-term capital gains, if any, on an annual basis. If such
exemptive relief is granted, the Fund intends to make distributions from its
net investment income and its realized long-term capital gains, if any, on a
quarterly basis.
If the total distributions paid by the Fund to its shareholders for any
calendar year exceed the Fund's net investment company taxable income and net
realized capital gain for that year, the excess will generally be treated as
a tax-free return of capital up to the amount of a shareholder's tax basis in
his or her stock. Any distributions that constitute tax-free return of
capital will reduce a shareholder's tax basis in his or her stock. In effect,
a return of capital is the return of a shareholder's investment in the Fund
and will result in a corresponding decline in the Fund's net asset value.
Return of capital distributions also may have the effect of increasing the
Fund's operating expense ratio. Any amounts distributed to a shareholder in
excess of such shareholder's tax basis in his or her stock will generally be
taxable to the shareholder as capital gain.
The Fund currently expects that the amount of distributions made under the
Managed Distribution Policy generally will be independent of, and not
contingent upon, the Fund's performance in any of the first three quarters of
the Fund's fiscal year. Distribution rates under the Managed Distribution
Policy may be increased in the Fund's fourth fiscal quarter in light of the
Fund's performance for the fiscal year and to enable the Fund to comply with
the distribution requirements applicable to regulated investment companies.
It also is currently expected that the Fund's investment portfolio initially
will not produce sufficient dividend and interest income to fully fund
distributions under the Managed Distribution Policy. Consequently, if the
Fund does not realize sufficient short-term capital gains and long-term
capital gains to make up any shortfall, distributions to the Fund's Common
Stock shareholders will include returns of capital. Prior to receipt of the
above-referenced exemptive order, long-term capital gains will be available
to make up any shortfall in funding distributions only on an annual basis,
thereby increasing the likelihood that distributions will include returns of
capital to shareholders. The Fund is not required to maintain the Managed
Distribution Policy and such policy (including the amount of the quarterly
distribution) may be modified or terminated at any time without notice. Any
such modification or termination of the Managed Distribution Policy may have
an adverse effect on the market price of the Fund's Common Stock.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Officers and Directors
Robert C. Doll, Jr., President and Director
David O. Beim, Director
James T. Flynn, Director
W. Carl Kester, Director
Karen P. Robards, Director
Donald C. Burke, Vice President and Treasurer
John Burger, Vice President and Co-Portfolio Manager
Brian J. Fullerton, Vice President and Co-Portfolio Manager
Patrick Maldari, Vice President and Co-Portfolio Manager
Robert J. Martorelli, Vice President and Co-Portfolio
Manager
Kevin M. Rendino, Vice President and Co-Portfolio Manager
Romualdo Roldan, Vice President and Co-Portfolio Manager
Jeffrey Hiller, Chief Compliance Officer
Alice A. Pellegrino, Secretary
Custodian
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109
Transfer Agent
Common Stock:
The Bank of New York
100 Barclay Street - 11 East
New York, NY 10286
NYSE Symbol
CII
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
Electronic Delivery
The Fund offers electronic delivery of communications to its shareholders. In
order to receive this service, you must register your account and provide us
with e-mail information. To sign up for this service, simply access this Web
site at http://www.icsdelivery.com/live and follow the instructions. When you
visit this site, you will obtain a personal identification number (PIN). You
will need this PIN should you wish to update your e-mail address, choose to
discontinue this service and/or make any other changes to the service. This
service is not available for certain retirement accounts at this time.
CAPITAL AND INCOME STRATEGIES FUND, INC. JUNE 30, 2006
Item 2 - Code of Ethics - Not Applicable to this semi-annual report
Item 3 - Audit Committee Financial Expert - Not Applicable to this semi-
annual report
Item 4 - Principal Accountant Fees and Services - Not Applicable to this semi-
annual report
Item 5 - Audit Committee of Listed Registrants - Not Applicable to this semi-
annual report
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies - Not Applicable to this semi-annual
report
Item 8 - Portfolio Managers of Closed-End Management Investment Companies -
Not Applicable to this semi-annual report
Item 9 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers -
Period (a) Total Number of (b) Average Price (c) Total Number of (d) Maximum Number
Shares Purchased Paid per Share Shares Purchased as (or Approx. Dollar Value)
Part of Publicly of Shares that May Yet Be
Announced Plans or Purchased Under the Plans
Programs or Programs
January 1-31, 2006
February 1-28, 2006
March 1-31, 2006
April 1-30, 2006
May 1-31, 2006 5,600 $17.86 per Share 5,600 (1) 635,911
June 1-30, 2006 113,679 $17.72 per Share 119,279 (1) 522,232
Total: 119,279 $17.72 per Share 119,279 (1) 522,232
(1) On February 17, 2006, the Board of Directors authorized the officers of the
fund to repurchase in the open market up to 5% of outstanding shares. As of
that date, 641,511 shares were authorized for repurchase.
Item 10 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 11 - Controls and Procedures
11(a) - The registrant's certifying officers have reasonably designed such
disclosure controls and procedures to ensure material information
relating to the registrant is made known to us by others
particularly during the period in which this report is being
prepared. The registrant's certifying officers have determined that
the registrant's disclosure controls and procedures are effective
based on our evaluation of these controls and procedures as of a
date within 90 days prior to the filing date of this report.
11(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act
(17 CFR 270.30a-3(d)) that occurred during the last fiscal half-
year of the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
Item 12 - Exhibits attached hereto
12(a)(1) - Code of Ethics - Not Applicable to this semi-annual report
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(b) - Certifications - Attached hereto
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Capital and Income Strategies Fund, Inc.
By: /s/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Capital and Income Strategies Fund, Inc.
Date: August 23, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the dates indicated.
By: /s/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Capital and Income Strategies Fund, Inc.
Date: August 23, 2006
By: /s/ Donald C. Burke
---------------------------
Donald C. Burke,
Chief Financial Officer of
Capital and Income Strategies Fund, Inc.
Date: August 23, 2006